Volvo Cars sees stronger second half despite steep China decline, rising costs

By Marie Mannes

STOCKHOLM, July 17 (Reuters) - Volvo Cars on Friday forecast that profits would recover in the second half, even as the Swedish carmaker warned of rising key raw material costs and an unexpectedly steep slowdown in China which sent its shares down 8%.

The Swedish automaker had previously warned the second quarter would be weak, pressured by high raw material and freight prices and tough discounting.

But the downturn in China was worse than the carmaker, and the whole industry, had feared, CFO Fredrik Hansson told Reuters.

"Everyone, including us, was thinking (the first quarter) is going to be a bit rocky, but I think in Q2 it has taken the industry by surprise," Hansson said. 

Sales in the world's largest auto market slumped a sharper-than-expected 35%, dragging Volvo's operating margin down to 1.1% from 1.6%.

The prolonged slowdown in China has hit other European automakers too. BMW said last week its China sales had fallen 30% in the second quarter, and issued a profit warning in June, partly due to China.

"It's a very tough situation; volumes are down and (there is) severe price competition," CEO Hakan Samuelsson told Reuters. "So profitability is far from satisfactory in China."

Volvo shares were down 7.4% at 1020 GMT, on track for their worst day since February. 

WILL CHINA EVER RECOVER?

Citi analysts said in a note the EBIT margin had collapsed and the company was dealing with a negative free cash flow, but the biggest question was whether China would ever recover.

European automakers have struggled to crack its electric vehicle market, but have relied on their reputations for safety and quality to sustain combustion-engine car sales. But now that part of the market is collapsing, Hansson said.

"It's the total market, it's the premium market, and now very noticeably in ICE cars as well," he added, citing oil price concerns as a factor.

Volvo Cars' Chief Commercial Officer Erik Severinson said the company was protecting its pricing.

"We are not going into discount wars," he said, adding plug-in hybrids were a lone bright spot in China, driven by sales of its new XC70 crossover SUV.

SPIRALING RAW MATERIAL PRICES IN SECOND HALF

Samuelsson returned to the carmaker majority-owned by China's Geely Holding last year to revive Volvo's fortunes amid disruption from U.S. President Donald Trump's trade war.

Now he is also battling soaring oil and key input costs like lithium and aluminium after the U.S.-Israeli war on Iran, which has cut off the Strait of Hormuz, a critical conduit for the world's raw materials.

Those higher prices will start to hit in the second half, CFO Hansson said. The company is protected by hedging, but "to a large extent it is outside of our control", he said.

Volvo said it expects earnings margins to rise in the second half as output of the new flagship EX60 SUV fully ramps up, and sees 10% volume growth from the first half. 

The company also said much of its indirect savings under a cost-cutting plan had been delivered six months ahead of schedule. 

($1 = 9.6661 Swedish crowns)

(Reporting by Marie Mannes; Additional reporting by Tomasz Kanik in Gdansk; Editing by Terje Solsvik and Jan Harvey)