Compagnie Générale des Établissements Michelin Société en commandite par actions (ML) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Michelin Conference Call. I'll now hand over to Mr. Yves Chapot, General Manager and Group CFO. Gentleman, please go ahead.

Thank you, Sabrina. Good evening, everyone. Thank you for being available this evening for our Q3 Revenue Disclosure. I will first comment on the presentation that we have disseminated 45 minutes ago, along with our press release and then answer to your questions. First, I want to [indiscernible] this on the fact that despite a very volatile environment, the group has delivered a 20.5% growth in revenue, 14% at constant exchange rate. We confirm our full year guidance on the segment operating income, and we lower our guidance on free cash flow, primarily to take in account the effect of inflation and the exchange rate on our working capital. Markets have been globally oriented according to our midyear forecast, taking in account a very weak comparison basis as 2021 Q3 markets were probably the worst in terms of ship supply shortage for carmakers and overall supply chain disruption. 3 market has been positive for both SR1 and SR2 with a global 4% growth with huge disparities according to the segment. Original equipment grew sharply in SR1, while replacement was slightly down and of course, disparities between regions. Regarding SR3, mining is posting a steady double-digit growth during Q3. On the other hand, we are seeing a sharp decrease in agriculture and construction markets. In this context, our sales at the end of September are up by 20.5%, including 6.5% of ForEx effect. This performance is pulled by an overall good performance in Q3, plus 23.8%, including 8.9% ForEx effect. This performance has been achieved despite lower volumes, 2.6% on the quarter. During the third quarter, our volume losses is fully attributed to the Eastern European region. We posted strong price mix effect, 14.3% year-to-date and 14.9% for the sole third quarter. Our non-tire businesses, although they represent today 5% of our overall group sales, have been growing by 22%, contributing by 1.1 point to the group's sales growth which is a clear demonstration of the validity of our strategy on testing and growing around and beyond tires. We have, of course, reassessed market trends for the last quarter of 2022 and the evolution of external factors such inflation. We maintained our guidance on segment operating income, aiming to exceed EUR 3.2 billion at ISO ForEx, and we adjust our structural free cash flow guidance to EUR 700 million. The EUR 500 million discrepancy versus our previous estimation is primarily linked to the other inflators and raw materials in the working capital. This is a one-off effect. Altogether, we estimate that between raw materials that are included in the adjustment for structural free cash flow and other inflators, and on top of that, some ForEx effect, the impact of inflation of our working capital will be probably reaching around EUR 1 billion for the full year of 2022. Starting now on Page 3 on the market. First, you can see that during the third quarter, market has evolved according to the forecast ranges we communicated at the end of July, both for SR1 and SR2. The selling market has been artificially boosted by inflows of Asian tires in Europe and North America due mainly to the recovery of maritime supply chain. SR3 market have been more contrasted with the steady growth of mining tire demand on one hand and the deterioration of Agricultural and Construction tire segment. Looking now at the bridge of our sales for the first 9 months. So you will see that at the end of the first 9 months, we recorded a 20.5% growth in revenue, including 6.5% related to the ForEx, largely due to the USD euro conversion rate. The USD represents around EUR 875 million among the EUR 1.1 billion of currency effect, which is 78% of our total currency exchange rate effect on sales, of course. The scope effect is due to the integration of Allopneus since January 1. Volumes are down by 2.4%, largely due to the stock of our business in Russia and the outbreak of COVID in China, which has triggered lockdown in different provinces and cities, particularly during Q2 and Q3. Price effect represents 13.4% due mostly to 3 causes: First, the full effect of the price increase implemented during the first half of the year; second, the effect of the raw material clause in our index business; and third, in this index business, the work done by our team to include other factors such in this [indiscernible], such energy and transportation inflation -- inflators. The mix effect is at 0.9% for the first year-to-date. I remind you that this effect was at 1.1% at the end of June. The decrease of this effect during the third quarter is due to a strong market mix effect in the first segment. OE market has been up by 23% during Q3 for SR1 when replacement market were slightly decreasing by 1.5%. Moving to the breakdown of our sales by business segment. I just would like to highlight beyond the comments written on this slide that SR1 is a segment, which is the most exposed to Russia in China and has been the most affected by external factors. On contrary, on SR2, we have beneficiated both from the strong resilience of transportation activities, particularly in North America, the rebound of original equipment outside China, which grew by 11.5% during the Q3 and the growth of our entire businesses, mostly fleet management and telematics. SR3 sales have been boosted by a recovery in our mining tire sales according to our expectations, thanks to the improvement in maritime expedition particularly from our North American operations and a steady mining extraction activities. This segment is impacted by a slowdown in our beyond road business line due to a decrease in construction and agricultural markets. But is also benefiting from our beyond tire segment growth, which is a material contributor to the group's growth. Before moving to the guidance, I would like to come back on 2 elements, which are explaining the strength of our business model and the resilience of our performance, despite the accumulation of crisis and disruptions we are facing for the past 2.5 years. So we have built over time a balanced portfolio of activities between -- on one hand, low or very low cyclical activities, such automotive replacement or 2-wheel tires and our non-tire businesses. And on the other hand, businesses that are more cyclical, such automotive original equipment and specialty businesses. This balance of portfolio of activity is comforted by a balanced geographical footprint, as you can see on the bottom right of this slide. The other element -- the second element I wanted to share with you and to remind you, is the improvement achieved in the sharing of our operation over time, despite closing 15% -- 14% of volume in 2020 and not fully recovering 2019 volume, we have achieved a better segment operating income at constant exchange rate in 2021 than in 2019. A strong reduction of our CapEx at a lower level of inventory have contributed to a EUR 3.8 billion of free cash flow generation in the past 2 years. If you compare the second with the year of 2008 to 2010, you can see that we have improved our ability to absorb shocks and monitor our businesses. Moving to the full year guidance. I will first come back on the market scenario and external factors before explaining why we maintained our segment operating income guidance, while adjusting our free cash flow guidance. You have seen that during the third quarter, you have observed that both automotive and transportation market has been exceeding 2021 Q3 markets. Keep always in mind that 2021 second half -- second -- Q3 markets has been very sluggish due to carmaker chip shortage, labor force shortage in some regions and maritime shipping disruptions. And this market has partially rebound during the fourth quarter of 2021. Therefore, we anticipate that Q4 2022 markets will probably be weaker than in 2021, except for original equipment in SR1. We are, at the same time, observing a timid start of the winter season in Europe and still some disruption in China with diverse cities being locked down during -- due to COVID-19 outbreaks. On the specialty side, we confirm that Agricultural and Construction tire market will remain very soft when we still expect to benefit from steady mining activities. In this context, due to the consequence of our Russian operation stops and of some COVID-19 upgrades in China and comforted by the confirmation by Chinese authorities of their Zero Covid policy. And on the other hand, the priority given to high-value segment and the projection of our unit margin, we expect our volume to land slightly below the market trend. We also expect all inflators, so raw material prices, transportation, energy and other inflators included in the cost of goods sales to reach between EUR 2.5 billion to EUR 2.6 billion. Since our half year publication, it represents an additional increase between EUR 100 million to EUR 200 million, that is fully due to the rise of energy prices, particularly in Europe during this summer and this fall. With the price increase implemented during the first half of the year and the application of quarterly adjustments on our index business, we should be able to generate a slightly positive price and mix effect over all these inflators. So in this very challenging context, we are maintaining our segment operating guidance aiming to generate more than EUR 3.2 billion for the full year of 2022 at constant exchange rate. And we have decided to lower our structural free cash flow guidance to EUR 700 million instead of EUR 1.2 billion, mostly because of a one-off impact of inflation and in some extent of ForEx in our working capital. Beyond the effect of raw material prices, which is already captured in the structural free cash flow and that we estimate around EUR 450 million. We are also facing the impact of other inflators, such as energy, labor costs and other manufacturing supplies in our inventories. We estimate all these elements, along with the ForEx effect in the working capital and other inventory increase such our company-owned distribution inventory at around EUR 400 million. The remaining gap between the EUR 500 million and EUR 400 million is explained by lower sales volume during -- particularly during Q3 and Q4. We have decided on the other hand, not to cut our capital expenditure at this inflationary effect in the working capital is due to be -- is not current. And that after having cut EUR 600 million in CapEx in 2020, we do not want to jeopardize the group's future growth and our future improvements in efficiency, safety and productivity. I just want to remind again that we have generated EUR 3.8 billion structural free cash flow in 2020 and 2021, which was EUR 800 million above our initial expectations. Part of this 2020 and 2021 performance was due to CapEx reductions and lower inventories versus our normative level and we have been recovering this normative level in 2020. Last, before moving to the Q&A session, I would like to remind you our upcoming meetings on February 13, 2023, we will disclose our 2022 full year results and our 2023 guidance. Considering the current financial market context, we have decided to postpone our intermediary Capital Market Day to update you on our Machine in Motion strategy after our full year 2022 release and our 2023 guidance assuming that if we organize this meeting end of November, we'll have a lot of questions about 2023, and we prefer to wait February to share our '23 guidance. So this CMD -- intermediary CMD will be scheduled in March-April 2023 and early January, you will receive a save-the-date message. I'm now at the end of my presentation and I'm welcoming your questions. Thank you very much for your attention.

[Operator Instructions] The first question is from Tom Narayan of RBC.

Yes, Tom Narayan, RBC. The first one is how did Michelin's Q3 SR1 replacement volume performance in Europe and North America compare to the overall market? I'm just curious what drove this? I've been hearing from some peers about, I guess, Asian tire inflows, particularly coming into Europe. Just curious if that's having an impact and obviously, a large peer talked about softening replacement market in H2. And then the second question on the reduced specialty market outlook. Just wondering if you could comment a little more on the state of the Ag and Construction markets that you called out. Just curious what is driving that softness and perhaps how long that may persist?

Okay. Thank you, Tom. So as far as SR1 is concerned, it's right, and I mentioned it, there was during the summer -- end of the summer and during the summer -- sorry, end of H1 and during the summer an inflow of Asian tires that we attribute mostly to the fact that maritime shipping line has been heavily disrupted. We are seeing that on our side because we export from some of this region, by the way. And there was a sudden inflow that have probably in some way overwhelmed the inventory capacity of some dealers. So it's probably one of the reason that we have seen this situation. There is some trade down effect in some regions in Europe and to some extent in China. We did not observe a similar or same effect in North America or at least with the same magnitude. And for the time being, we are rather observing that this trade down is more between Tier 2 and Tier 3. And that the Tier 1 segment of the market is remaining overall globally resilient. In Europe, of course, we have been impacted by Russia. Russia represent -- the Eastern European region represent -- used to represent to 2.1% of our sales in 2021. So of course, it weighs more on our overall European performance. And in North America, in replacement, we have a pretty steady performance during the Q3. As far as specialty outlook is concerned, it's really related to the situation of agriculture and in construction businesses, both at OE, but also at replacement. And we observed, let's say, a drop in these markets during Q3. That's why we are relatively prudent regarding the prospect of this market for the last quarter. On the other hand, as you know, specialty is a mix of very different activities. On the other hand, we still expect to post a growth on the mining business during the fourth quarter.

Okay. And just a quick follow-up. So on the specialty outlook, I mean, is there any kind of light at the end of the tunnel for construction and Ag or is this just kind of a structural thing we can expect to continue for some time?

I think it's far too early to say. Agriculture, for example, has been traditionally a cyclical business. But on one hand, we are seeing a rise of agriculture commodity goods in term of price, which gives some purchasing power to farmers. But on the other hand, it's trigger inflation and some challenge also from the input they have to purchase. So for me, it's far too early to see if it's -- if we are in a normal cycle or if it's, let's say, on a little bit abnormal situation. Maybe as far as construction is concerned, there is a lot of project, maybe private project might slow down a bit. But on the other hand, we are seeing a lot of initiatives from public authorities to reinforce infrastructure project. So here also we are seeing some mixed message from the end markets.

Next question is from Thomas Besson of Kepler Cheuvreux.

A few questions as well. Maybe could you first come back to your definition of structural free cash flow? I mean I thought it was incorporating more of the changes in working capital, but visibly not anything linked with energy, wages or logistics. So just for clarity and the explanation of why this is a one-off? The second question would be on the ForEx effect we should expect for the full year. On your adjusted EBIT, it was a bit lower than expected in H1. Could you give us a direction for the full year? And lastly, SR3 was the only positive segment in terms of volumes sequentially in the absolute terms in Q3. Could you confirm despite the drop -- the cuts you've made for the outlook for SR3, how much visibility you have in the coming quarters for the overall volumes of SR3? So is it a given that Q4 is a positive, H1 is a positive or what kind of visibility do you have for this overall segment?

Okay. Thank you, Thomas. So maybe regarding the structural free cash flow, it is a definition that we -- that has been elaborated in 2011, if I remember well, or 2010. At that time, the group was mostly sensitive to, let's say, in its working capital to the fluctuation of raw materials. And that's all we have lived with this concept for the past 11 years. So in fact, it's in the definition of structural free cash flow, we took the net free cash flow. And we were integrating the free cash flow, the impact of raw material inflation in the working capital. The news that we have to deal with now is that if I look 2022, we'll have among the EUR 2.6 billion of inflators that we have in the cost during the year, we'll have probably, let's say, 45% coming from raw material and 55% coming from other inflators, mostly from energy, transportation and in some aspect, labor cost and other manufacturing supplies. And of course, these costs are incorporated in the valorization of our inventory and our cost of goods sold. So they are waiting -- they will probably wait at the end of this year as much as the raw material effect, which is incorporated in the structural free cash flow. So that's why we have made this precision and modify our guidance. Looking at the ForEx, so most of the ForEx is due to the U.S. dollar. If I remember well, the average USD euro conversion rate for 2021 was at 1.13%. At the end of September, the average conversion rate for the first 9 months was at 1.06% or 1.07%. So you have basically between 5 to 7 points of, let's say, USD positive effect. If you take -- so for full year, we estimate that USD 0.01 of USD improvement versus euro is EUR 330 million in segment operating income. So I'll let you do the math, if this 0.6 -- let's say, USD 0.7 improvement of USD versus euro is confirmed, we are going to land somewhere around EUR 200 million, EUR 220 million in ForEx effect on our EBIT. Regarding the SR3 volume. So I will probably rebound on the answer I did to Tom previously. You have to keep in mind that we are evolving in an environment with a very low visibility that has been exacerbated, of course, by the different crisis and events that we have to deal with in the past 2.5 year. We are -- let's say, confident about the -- our mining customer activity and we believe that, of course, we have seen a sharper growth during the second half of this year because in 2021, we underperformed versus the market because of operational challenges. 2023 for mining, which will come back at, let's say, a growth which is more correlated to the overall growth of the mining business. So in the past, it has been, let's say, a single-digit rate around 3% to 5%, depending on the year. For the other segments, the beyond tire businesses, such about belting, coated fabrics, activities, sealings are more resilient. And if there is a slowdown, they will probably experiment or see the consequence of the slowdown later in the cycle. And of course, we are -- we have the beyond road activity, which is mostly due to agriculture, construction and material handling, so logistics operations, which are partially correlated to some commodities, such as price of agriculture goods but also to public spending decisions and, let's say, overall international trade volumes. For the time being, we don't have enough visibility -- I don't have enough visibility to comment on what is going to be this market in 2023.

The next question is from Philipp Konig of Goldman Sachs.

I just want to come back on the volumes. You obviously mentioned that you saw some influx of Asian imports coming into the market. Is that something that also affected your selling against your sell-outs? And is that potentially also affecting your finished good inventory as we think about the free cash flow? And my other question is just on the winter tire market. You made some quick remarks earlier, but I think October is always one of the key points of the selling season on the winter tire side. Maybe you can give some additional color how that has started so far? And then my last question is just on the pricing. I think you didn't do another round of increases in Q3. So I guess, most of the incremental price came from the indexation clauses. Do you expect further indexation clauses becoming active in the fourth quarter?

Okay. So maybe I will start with the last one, the last part of your question. Depends on the contract. We have some contracts with half year indexation adjustments. And we have some contracts with the quarterly adjustments. So there will be some adjustments on some index businesses on -- from 1 of October due to the application of the clause related to this contract with the quarterly adjustment. The volume balance between sell-in and sell-out in Europe and the impact of important first, we have to deal with this inflow of Asian tires, which occupy a lot of our customer shelf during the summer. And it will make the transition with the next question, but we're also seeing, particularly in Europe, I mean, pretty mild weather and a very slow start of the winter season. But to come back on the question on the free cash flow, the first question, we have decided to slow down some of our operations. in order to make sure that we'll end the year at our expected level of inventory, both for finished goods and for raw material and semifinished inventories. So we are taking the appropriate measures in order to update our inventory level according, of course, to the future activity, but also to our yearly targets. The winter season, as I said, that the weather -- I mean, we are in France, temperature over 25 degrees these days. It's end of October. And for sure, we are observing in all markets, but not only in France, that the case in Germany and in Northern Europe, a very softer start of the winter season. The winter season is pretty balanced between October and November. If it's snowing, in 2 weeks, we can have a stronger need for winter tires, but we are relatively prudent about the outcome of this winter season in Europe.

The next question is from Christoph Laskawi of Deutsche Bank.

Christoph Laskawi from Deutsche Bank. I would like to come back a bit on the imports as well. And you said those have taken space on the customers' shelf. Do you expect that to normalize in the coming 1 or 2 quarters? And with that same market share developments are more or less a small blip and come back to where they have been before. That will be the first one. And then the pricing effect of those inflows. Obviously, in Q3, price/mix was strong. You've kept your operating profit guidance unchanged despite cutting volumes so for '22, probably not the thing. But in case we see higher inflows for a bit longer, could you comment on the pricing effects of those inflows.

It's very difficult for me to comment on what is going to be the inflows in the coming quarters. As I said, these inflows were probably triggered by the fact that maritime shipping activities were normalized. We have seen also the cost of maritime transportation decreasing, although they are still way above 2019 level. And will they normalize or not? Honestly, I don't know, but what I can -- what I know for sure is that it will have no effect on our pricing. We have -- if we have to deal with further inflators and if we need to implement further price increase in order to protect our margin per unit, we will do it. And as I already mentioned, we have a policy which consists to look every quarter at our positioning versus future inflators. And of course, we look at our positioning versus our Tier 1 competitors. And we adjust our price if we consider that we need to adjust our price. So I mean the inflows of Asian tires will not have, let's say, an immediate effect on our pricing policy.

The next question is from Jose Asumendi of JPMorgan.

It's Jose from JPMorgan. Just a couple of questions, please. You have, I think, fantastic data points, I think very strong reach, and you understand very well the market. And you mentioned also that you are looking to keep inventories low, you're looking to maybe slow down a little bit the level of activity across the plant. So can you maybe just give us some color of what you're seeing in the European market in replacement and to your distributors as well? Are you seeing consumers in general getting hit by inflation? And are you seeing maybe lower miles driven across SR1, SR2, or is the momentum still strong? First question. Second, you've talked a little bit around your ability to generate efficiency gains to offset higher energy costs and additional costs in the second half. But maybe just kicking those efficiency gains that we talked about in the last meeting in London? And third one, can you please remind us where do we stand in terms of demand versus 2019 levels in replacement for SR1 and SR2? Have we hit again the 2019 levels or are we still below 2019 levels?

Okay. So regarding the European market, I already comment that we are seeing a very timid start of the winter season, particularly in winterized market. And as I mentioned earlier, we are also seeing some trade down, particularly between Tier 2 and Tier 3 brands. And that's -- we are clearly seeing that in the different markets, European market. Efficiency gain, so we continue to work on productivity, digitalizing our operations. We have been sharing last week with media, the way we transform our manufacturing operation with a testimony of our Cuneo factory in Italy. There was a lot of examples of digital manufacturing project. So for sure, we continue to work on this project and that's why we don't want to jeopardize this project by cutting our CapEx. On the other hand, in the past, we used to -- thanks to all these efforts, we used to hedge and sometimes to beat inflation. When inflation was in the range of 1.5%, 2%. When you are facing such a level of inflation, let's say, non-raw material tires inflation will exceed EUR 1 billion in 2022, you cannot match that by productivity improvement. But we continue to work on improving our productivity, improving our operations in order to make sure that when inflation will come back at, let's say, more normalized level, this progress will be here to be, let's say, visible in our operations. Regarding the demand of 2022 versus 2019. So if I start by SR1, first, I think in 2019, original equipment, the OE market was at 90 million vehicle. I remember well that the highest point of the regional equipment market was in 2017 at nearly EUR million or 95 million. So 90 million vehicles in 2019 and the estimation for 2022 is around 81 million. So we are far although in the second half, the OE market will grow. We are far away from 2019 level. On replacement, I believe, we are still below 2019. I don't have the exact figure, but we should land slightly below 2019 for SR1. For SR2, I believe that original equipment is probably back to 2019 level and replacement should be in 2022, nearly at 2019 level despite all the, let's say, the distribution, including what is happening in Eastern Europe. So that's roughly what I can share with you related to 2022 versus 2019. So overall, what we can say is if we consolidate the 2 segments, particularly because of SR1, we are probably in 2022, still below 2019 volumes.

The next question is from Martino De Ambroggi of Equita.

Just a couple of confirmation double checks. The first is on the price mix. You guided for EUR 2.5 billion, EUR 2.6 billion inflation, all inclusive. And you already achieved price mix positive by almost EUR 2.5 billion. And you are guiding for slightly positive balance between the 2 figures. So am I right in estimating that price mix in Q4 in the region of 6%, 7%, if not lower, just to double check this. And the second double check is on CapEx because you mentioned that you don't want to jeopardize the investments, but probably if I don't miss it, you didn't quantify the CapEx and it was EUR 1.9 billion, if I'm right? And third question, sorry to go back to SR3, specifically on construction equipment of agriculture, but could you elaborate the splitting original equipment a aftermarket for these 2 businesses, please?

Okay. I will start with this last question for construction and agriculture, you can roughly consider that OE and RT are evolving in a range of 40% to 50%. So sometimes OE is higher than RT it's 55% or RT's 45% and some time, it's still underway. But basically, it's in average on the long run 50-50.

Sorry I was referring to the trend -- the downward trend is mainly due to original equipment or aftermarket in these 2 businesses?

It's due to both as far as I'm -- I think it's due to both. Regarding price mix, so yes, we have already recorded in our sales, strong price mix. We believe that we should continue to have a positive price effect on the Q4, although it will gradually decrease on the replacement side because the last price increase we implement was at the end of the first semester. And last year, we increased price on replacement on 1 of October. And we should have also a mix effect. But if you look in the presentation in the appendix, you will see that the mix effect for Q3 was only 0.6 points versus 1 end of June, which traded 0.9 end of September. So overall, price mix should exceed the consolidation of all inflators. Keep in mind that when we present our segment operating bridge, we always compare price with the cost of goods sold, but we have also inflation in SG&A, and we want to hedge the effect of inflation in SG&A as well.