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

Ladies and gentlemen, thank you, and welcome to the Michelin conference call. I now hand over to Mr. Yves Chapot, General Manager and Group CFO. Gentleman, please go ahead.

Thank you very much. Good evening, ladies and gentlemen. I'm very happy to share with you our Group sales figure for the third quarter of 2023 and update you regarding our full year on guidance. So as you have probably seen in the presentation and in the press release, our sales are up 2% by EUR 21.2 billion, despite soft volumes and forex headwind, supported by our mix enhancement, our non-tire activities and our brand and technological leadership. The market for the first 9 months are shaped by inventory drawdowns, particularly in Europe and North America, for Passenger car and truck tires particularly, and also BeyondRoad tires. So, if we look overall, Passenger car and light truck tire markets are stable overall at the end of the 9 months, with a robust Original Equipment demand in most regions slightly offset by a negative Replacement demand dampened by destocking in Europe and Americas. The demand for [ 19-inch ] and larger tire is still expanding. And we consider that inventory levels are back to normal in most regions except for winter tires in Europe. Truck tires outside China dropped 5% due to the substantial dealer and B2B fleet inventory reduction. Both in Europe and North America, Original Equipment demand is still robust. And of course, the destocking is impacting the Replacement market and we estimate that the destocking should be over by the end of the year. Specialty tire markets are dynamic in Mining, Aircraft and in Original Equipment for Agricultural tires. They are softer in Construction, Replacement [ for ] Agricultural, and of course, 2-wheel tires. Non-tire markets are up in most segments, both in fleet services, mining, energy and stable in general industry applications. Our sales are up by 2% at the end of the 9 months. And if we look at the different effect, so first, Q3 sales are stable, excluding the currency effect. But if we look overall for the 9 months, the volumes are down by 3.6%, reflecting mostly the market destocking and our Group priority on value-accretive segments. The price effect stood at 6.2%, confirming the recognized value of our products and solutions, and the impact of price indexation clauses from 2022. The mix effect reached 1%, reflecting our position in the [ 19-inch ] and larger Passenger car tire segments and a favorable geo-mix, partially offset by an adverse Original Equipment/Replacement Market mix across businesses. Non-tire sales are up by 13% at constant exchange rates, fueling the Group growth, and we are seeing a negative currency effect of 2.6% year-to-date, 5.5% for this whole Q3. We continue to grow Around and Beyond tire, and the growth in polymer composite solutions will accelerate with the end of September closing of Flex Composite Group acquisition that will drive higher our Group sales from Q4 onwards. And to come back on the '23 guidance, we confirm our guidance regarding the segment operating income, and I will come back at that at the end of the presentation, and we revised upwards our guidance for free cash flow. When we look now at market -- the sell-in market, you will see that they were above our estimation for Passenger car and light truck, and below our estimation for truck tire during the third quarter. At the end, Passenger car and light truck tires market is slightly above 2023 and -- 2022, sorry. And the truck and bus tires are far below 2022, minus 5% in average, of course, excluding China. Looking now at the bridge of our sales from 2022 to 2023 year-to-date. So we had a slight Scope effect of EUR 79 million, a negative volume effect at minus 3.6%, which weighed EUR 750 million, a strong positive price-mix effect of EUR 1.5 billion. Altogether, it's 7.2%, 6.2% of which being price effect and 1% the mix. Non-tire businesses are contributing for 0.6 points, and the currency effect is negative at 2.6%. So we are landing at EUR 21.2 billion at the end of the third quarter. Looking now only at the third quarter sales, you will see that they are down 5% versus last year. Outside the currency effect, I mean, in a nutshell, volume is neutralized by price-mix. So the sales are stable at constant exchange rate. And of course, the quarter has been penalized by the currency. You have to keep in mind that in Q3 2022, for example, the U.S. dollar was at its peak versus the euro. And overall, if we look at practically all currency, except the Brazilian real, depreciated against the euro during the third quarter of 2022. When we look at our sales by segment, so you will observe that year-to-date SL1 sales are up 3.6%, of which the volume is minus 1% and the segment is, of course, impacted by a strong negative forex on the third quarter. But we have sales growth under this price effect and the product mix enrichment, which is more than offsetting the effect of the distribution destocking, and we are, of course, benefiting from market share growth in 18-inch and above tire, that are now accounting for 60% of the MICHELIN-brand tire sales for the first 9 months of the year, up 5 points versus the first 9 months of 2022. The truck tire sales, so SR2 sales are down by 4.3%. So the sales are obviously penalized by lower volume, mainly from Replacement markets, impacting by the destocking in distribution and an unfavorable Original Equipment/Replacement mix. We have positive embedded price effect and double-digit growth in service to fleet. The third segment is up year-to-date at -- by 4% -- 5.4%. The sales growth is driven by embedded price effect and dynamic aircraft and mining activities, but unfavorable comparison basis for mining in H2, which has recorded higher performance during the third quarter and the overall second half of 2022. Beyond Road activities are focusing on value-creative segments [ weighting ] on volume, but improving margin. And High-tech materials sales are up 13%. I want also to draw your attention that this segment is the most impacted by the currency effect as it's probably the business segment which is the most exposed to the USD. Before moving to the full year guidance, I would like to come back on some of our fundamental competitive advantage. The first one is our leadership -- technological and brand leadership in high value and increasingly demanding market segments across the different business segments. If you look in the first segment, Passenger car tires, we have -- actually, we are accelerating in 18-inch and above segment, fostered by electrification. We are recording a 12% growth year-on-year. And as I already said, 60% of our MICHELIN-brand sales, OE and RT, are now 18-inch and above tires, improving by 5 points versus 2022. But if you look at the progression in 2015, it has been impressive. Overall, this continuously contribute to a sustainable [ accretion ] in our mix impact that we can estimate at around EUR 1 million tire. On the specialties, we are winning where we are able to create value for our customers. In 2023, we have seen the launch of the first radial tire for the world's largest loader. We are growing sharply in Agriculture, both in trucks and in high-power tractors, which represents 50% of the Agriculture market tire in value. And looking at the Transportation segment, I will focus on our[indiscernible] play on the most demanding customers, both from a geographical, but also the business segment, which represents -- the 3 business segment is straight on that slide, which represents 50% of the market value will contribute to the recovery of the SR2 segment operating income in the quarters to come. This leadership is also recognized by the price and by the [ test ], looking at recent publication regarding all season and winter tires. Michelin offers both the CrossClimate2 and the CrossClimate 2 SUV, as well as Pilot Alpin 5 SUV has been recognized in most of the [ tests ] shown on that slide, as a leader in the category with sustainable performance and balance of performance between the [ unrivaled ] performance on snow and dry roads, along with a strong performance in terms of endurance and abrasion. Electrification is also a key opportunity for the group. We are a natural leader with our premium BEV, thanks to our technological edge that has been recognized in the ADAC study published in December 2021 and [ completed ] in April 2022. And all Michelin tires are already meeting the EV requirements. In 2023, in the first 9 months, we have seen the number of BEV model with Michelin fitment increased by 28%. Our market share in Original Equipment is 2x higher for BEV premium versus the Original Equipment total market share. And with -- Michelin is an attractive choice on the Replacement market, considering the strong [ loyalty ] rates on our brand and our specific value positioning. And we estimate that by 2026, this would translate in Replacement in probably more than 5 million tires to be sold and above 10 million tires by 2028 on the Replacement market worldwide. And last, I would like to come back on the Flex Composite Group acquisition. The closing has been done on the 27th of September, 2023. It's a strong step towards Michelin ambitions to become a key player in polymer composite solutions. And at -- during the first weeks of this integration, FCG has been combined with our existing assets in coated fabrics to create a composite fabric and films business lines. We have already realized EUR 2 million in synergies from refinancing FCG debt, and from January '24 onwards, we should see the first synergies both on the cost side, the insurance contract, for example, but as well on the first cross-selling synergies. In 2023, beside, of course, the acquisition cash out of EUR 700 million, FCG should contribute to the Group sales in the last quarter by EUR 50 million and to our EBIT by EUR 12 million. So moving now to the guidance. As we are entering the last month of 2023, we are generally narrowing our hypothesis, particularly on the market scenario. Overall, we are betting that 2023 will end with a slight market improvement in Passenger car and light truck tires, which is reflected in our range of plus 1%, minus 1% versus minus 3% to plus 0% in last July. And you see that we are expecting OE in H1 '23 growth to [ reverse ] in H2 on a higher basis comparison, mainly in China. On the other hand, Replacement market proved to be resilient than -- more resilient than expected in Q3, mainly in North America. On the truck market, we have seen that -- during Q3, we have overestimated the market evolution. And we consider that although Original Equipment should remain robust, despite a few supply disruptions, Replacement market demand will be soft during the -- remain soft during the Q4 with some additional destocking actions. So altogether, we believe that the market should land in the range of minus 4% to minus 6% by the end of the year. And regarding specialties, we are approximately in the same range that in our previous expectations. Strong demand in Mining, tires and Aircraft. 2-wheel is penalized by a high inventory level, mainly bicycle, and Beyond Road with their contracted evolution between Original Equipment and Replacement, both in Agriculture and Construction. So all these elements lead us to consider that we should end the year with the volume effect of roughly minus 4%. Cost inflation, that should be between EUR 0 and EUR 200 million, but a net price-mix versus cost inflation factor, which remains strongly positive and cash-out CapEx, which is unchanged at EUR 2.2 billion. So taking all that in consideration, we confirmed our segment operating income at constant exchange rate guidance, which would be above EUR 3.4 billion. And we have upgraded our free cash flow forecast, which was previously above EUR 2 billion, and that should be now above EUR 2.3 billion, mainly based on the fact that we have a lower volume than expected. So, that should improve the working capital construction and as well as lower cost units in our inventory [ evaluation ]. On top of that, you are aware that in 2023, there was some one-off in the -- in our free cash flow, such -- the cash back we received from our joint venture TBC following the disposal of its retail division. I would like also to take this opportunity to come back on our capital allocation policy. So you are probably aware that the group has initiated a consultation on October 19 in Germany with our labor unions concerning the 3 industrial sites. And we have received a question about the potential impact of the scenario envisaged on our net income. First, I would like to make it clear that the consultation between Michelin Germany and its associate partners are going on, and that no decision has been made at this time. At the same time, so it gives me the opportunity to come back to be more specific on our capital allocation policy. As you know, we have communicated with [ the part ] our policy on dividend in order with the objective to gradually achieve a payoff ratio of 50% of net profit. Year-on-year, the net profit is impacted by different kind of nonrecurring events that are impacting the net income up or down. For example, last year, we had the negative impact of Russian -- our exit and the closure of our Russian operations. We have also positive impact such -- the one I mentioned regarding the return of capital from our joint venture [ with ] TBC. But these nonrecurring events are not reflecting any material change in the intrinsic performance or value of the company, which is recognized through the segment operating income. So if these nonrecurring events were to have a significant impact on our net profit, outside, of course, of [ systemic ] crisis, of course, we will take steps to ensure that they do not cause the value of the dividend to fluctuate too much. So we stick to our policy of going toward 50% payout ratio, that will, along with our -- with the advice of our Supervisory Board, we will propose to the shareholder meeting and smooth evolution, which might be independent from the fluctuation of nonrecurring impact in our [ metrics ]. So having shared with you this guidance, we can now open the Q&A session.

[Operator Instructions] The first question is from Martino De Ambroggi with Equita.

My first question is on prices. Because, if I remember correctly, in your last call, Yves, you mentioned that prices were expected to be flat in the second half. So I was wondering if you could confirm it, considering Q3 they were up 2%? So that means they should start to become a negative in Q4? This is my first question. The second one is on the forex effect in the operating profit guidance. Because also for this, if I remember correctly, you mentioned the EUR 200 million negative impact in the second half of the year, following EUR 61 million in the first half. But this was based on the forex rates at that time that you disclose it. And the third question is on the Slide #7, because you are presenting a mix impact in excess of EUR 100 million at EBIT level. I suppose this is referred to the past few years. But my question is if this could be an impact also foreseeable for the next few years, if I understand correctly, this is -- comes from the 18-inches and above contribution?

Yes. So maybe I will start by your last question, Martino. We expect this EBIT effect to continue in the years to come. If you look in the past, we have an incremental improvement of 18-inch and above sales at the MICHELIN-brand of -- between 3 to 5 points per year, which translated [ this ] EUR 100 million. Of course, you cannot read it directly in our P&L or in our bridges because in the mix, don't forget that you have other effects which lead to -- for other business lines, OE/RT market mix and, of course, some geographical mix effect. But I can confirm you that we consider that it's -- let's say, mix improvement should continue in the years to come. We look year after year at the fitment that we are awarded in Original Equipment. And we can see that in the fitment, we are currently going awarded for vehicles that will start production in 2025 or 2026, it's still improving. Regarding the overall price effect, so you are right, on Q2 -- Q3, we have a overall positive price of around 2% -- 2.1% exactly, which is linked partially to the price increase we implement first of Jan, but also from some, let's say, indexation clauses. And we consider that in Q4, price effect will probably around -- will be probably flat versus last year. The full year forex effect, and we have already mentioned that it should be negative on the second half of the year. It has been -- I don't know what will be the dollar value in the last 2 months of the year, but we knew already that USD was at its peak in August and September 2022. So the Q3, I've seen probably the worst of this negative effect. And if the different currency were stable from where they are now, we can estimate that by the end of the year or early 2024, this forex effect will probably flatten.

If I may, if I remember correctly, you mentioned the EUR 200 million at EBIT level negative in the second half. This is what I was referring to.

Yes. That -- I can confirm this figure for -- I mean if we look at our -- the forecast we did in July regarding the forex, we are still in line with this forecast.

The next question is from Giulio Pescatore with BNP Paribas Exane.

The first one on the mix expansion. I was just curious to know, how much do you think of the mix expansion of last year was driven by the mix of the market improving and how much has been driven by you gaining market share? And as you look ahead, how much of the further expansion do you think will be driven by the share of 18-inches and 19-inches growing in the market? And how much do you expect to be gaining market share within that premium space? The second question on raw material costs. We have recently seen raw material prices once again moved upwards. Do you see scope for further price increases? And if this trend should continue? Maybe one last question on the guidance. I mean, given the assumptions you are making, it does appear that the EUR 3.4 billion is fairly conservative. Can you just maybe share what expectations do you have for volume drop through in the second half and maybe the same for mix, please?

So maybe -- for the mix expansion, we are -- I can confirm you that we are gaining market share in 18-inch and above since 2017, and we have constantly overall gained, but steadily gain market share. How much it represents in the overall mix impact on EBIT, honestly, we don't look at that. We don't segregate between the market on one side and market share gain in the EBIT improvement. Raw material costs, they are up and down. Butadiene is really down. The natural rubber was probably at one of its lowest, but a slight rebound. And, let's say, all related materials are fluctuating. For the time being, we have not seen any, let's say, reason for further price increase. But if at one stage we see that raw materials are further increasing, we will, of course, contemplate it. Regarding the SOI guidance, maybe you have not completely read what we wrote, but we don't say EUR 3.4 billion, we say above EUR 3.4 billion. So I don't think given the overall market context that it's a conservative guidance. We are pretty active with the consensus at this stage.

The next question is from Jose Asumendi from JPMorgan.

A couple of questions, please. I was wondering if you could go back a bit to the volume guidance within SR3 and explain a little bit more the trends that we saw in the third quarter, the full year guidance on volume in Specialty, what are you expecting for the fourth quarter? And then the second question, completely unrelated to calling cycles, et cetera, which I think is quite difficult to do. Can you maybe explain what are the biggest improvement actions -- or efficiency improvement actions you're taking across SR1 and SR2 to improve the profitability on a [ personal ] view?

So volume guidance. First, we have -- I have mentioned that when we look at -- when we compare year-on-year, we have to be careful because in -- the Mining business, for example, had its record sales during the Q3 of 2022. So although volumes were pretty high because -- don't forget that, yes, I should come back on that, on 2022 during Q3, it was the moment where there was the unlocking of the bottlenecks for example, in maritime shipping, which translates for us in significant exportations from our North American and European manufacturing business. So the comparison versus last year is on a favorable basis. We know that also, nevertheless, this market as well as original equipment for Agriculture, for example, and the Aircraft market growing positively. On the other hand, there is some markets that are depressed such Replacement for Agriculture and Construction, the Construction industry being heavily penalized by the rising interest rates. And if I look at the -- Europe, the slowdown in the number of opening of new construction sites and buildings and housing. Profitability improvement drivers in SR1 and SR2 is concentrating on value-accretive segments. So it's mix effect. And of course, working on the competitivity of our operations, both from a manufacturing standpoint, but also sales, general and administration costs, as we did in the past. And we are continuously working with our teams, leveraging also technology, such artificial intelligence and improving, let's say, our operations.

The next question is from Sanjay Bhagwani from Citi.

I have 2 questions. First one is a follow-up to Giulio's question. So if I understood it correctly, the guidance for greater than EUR 3.4 billion is conservative, and you are comfortable with the consensus -- current consensus level, which is somewhere around, I think, slightly over EUR 3.6 billion. And related to that, on the Others line item, in the EBIT bridge, how should we think about that given the upgrade in the free cash flow guidance? So that is my first question. And second one is on, if you could provide some early impressions on '24, like how should we think of some of the key items such as volumes, price-mix, raw material? Particularly for the volumes, given that SR1 seems to be inflecting now, so would you see that the destocking in SR2 is tenacious in quarter 4? So any such color on '24 will be very helpful.

So I will [ rewind ] on the answer on your first question -- on the answer I already give you -- to Giulio. We -- Our guidance is a guidance above threshold. This threshold for EBIT is at EUR 3.4 billion. And for the time being, we are comfortable with the consensus. Regarding the free cash flow, you understand that there is some one-off, or let's say, a little bit a reverse effect of what happened in 2022 in our free cash flow, particularly the impact of inflation on the working capital and particularly inventory. On top of that, we have been more agile in managing our inventory over the year. And we are confident in our ability to land where we were expecting to land in terms of inventory volume by the end of the year. I will not come back on the dividend policy. I mentioned we are committed to gradually increase our dividend up to 50% payout ratio. While looking at our net results by including one-off effect on nonrecurring [ FX ] in order to have a smooth evolution of the dividend instead of up and downs linked to the fluctuation of the net results, which is again influenced by some nonrecurring [ FX ]. Regarding 2024, it's a little bit early, and I would invite you to join us on the 12th of February next year. But we believe that inventory destocking in SR2 should be finished by the end of Q4. And we hope that in Europe, winter inventory will also be destocked by distributors. 2024 should probably be -- we probably see a better balance between Original Equipment and Replacement markets, in favor of the second, what I can share with you. And regarding inflation, it's maybe a little bit too early to say. We have not yet seen any surge in energy or raw material prices that is alarming us at this stage. But we are closely monitoring all the inflator factors in order to maintain and improve our margins.

The next question is from Michael Jacks with Bank of America.

I just have 2. Firstly, just going back on the guidance. You reduced your volume guide by around 2 percentage points versus the midpoint from 2% to negative 4% -- negative 2% to negative 4%, which I guess at a 45% drop through equates to around a EUR 250 million headwind to operating income. And at the same time, you cut your cost inflation guide to around EUR 100 million, or it's EUR 100 million better than expected. So on a net basis, I guess that would imply an EBIT deterioration of around EUR 150 million versus your expectation at the first half earnings. Is that a correct way to interpret this? Or is there another moving part here that I'm missing?

So I'm not sure I fully follow your calculation. We have also maybe a slightly less optimistic landing figures regarding the volume. Take also in account that if we look on the first 9 months, we have further reduced our production than our sales. So it weighed on our [indiscernible] construction. On the other hand, our price effect and the impact of raw material and inflator is improving, if I may say, versus our Q2 -- end of Q2 [ expectation ]. So all in all, we are -- these effects are compensating each other.

Second question, on the truck segment, you flagged on growing destocking through Q4. Volumes are down significantly versus 2022 levels, but it would still appear that Replacement's higher market levels are still trending quite well above pre-COVID levels. Do you have any view on whether or not this level is sustainable? Or could there potentially be a further normalization in this segment?

For the time being, we are not seeing -- looking at the sell-out -- let's say, dramatic evolution in sell-out. We are looking at [indiscernible] constructed or [ gas ] construction, depending on the market and the regions. So, although there was some slowdown in some areas, but overall, we don't see a drop in sell-out as the drop we have seen in sell-in for the first 9 months, particularly in the Replacement market in Europe and North America. So that's true that if we look at the truck and bus tire market outside China, it's still slightly above 2019. I think -- and it's mostly driven by Original Equipment, taking account that in the Original Equipment for truck, there is some effect due to a change in regulation, and particularly new norms that are going to be implemented starting from Jan 2024. That has an effect on the sales -- on the new vehicles in 2023. So that's why next year we rather expect a mix between OE and RT that will be in favor of Replacement.

And then one last question, if I may. Can you perhaps just be a little bit more explicit for the second half of this year on what the likely impact in the EBIT bridge is likely to be from the bonus -- performance bonus accrual, especially given that you've now raised the cash flow guidance? Does that now mean that the performance bonus element is going to be even higher than what was expected?