Pirelli & C. S.p.A. (PIRC) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Pirelli conference call in which Pirelli's top management will present the company's first half 2020 financial results. A live webcast of the event and the presentation slides are available in the Investor Relations section of the Pirelli webcast. I remind you that a Q&A session will follow the presentation. I would now like to introduce you to Mr. Marco Tronchetti Provera. Please go ahead, sir.

Good evening, ladies and gentlemen, and welcome to our conference call. This afternoon I shall address the outlook for the industry and the company for the second half of the year as well as the progress of our strategic evolution. Mr. Andrea Casaluci, our General Manager of Operations will elaborate on Pirelli's first half operating results; while Mrs. Valeria Leone, our Head of Strategic Planning and Controlling and Investor Relations, will discuss our financial results. Before getting to the core of our discussion, I wish to welcome Mr. Angelos Papadimitriou, General Manager, co-CEO, who has just joined our management team. You really know the hardships we are all going through. The second quarter of 2020 has put our business to the test more than ever. We took extraneous steps to cope with the general crisis triggered by COVID-19, never compromising on the health and safety of our people. We trusted our company through the high value segment which proved once again its resilience. We kept on working on our competitiveness and COVID action programs, which are well on track, and we are accelerating our Transformation Program towards a leaner, faster and more profitable company. In more volatile environment on ForEx and raw mat, let us review our guidance for the full year by confirming all the internal levels, namely volume, Price/Mix, efficiencies and cost reduction. A solid cash flow generation is still expected. Pirelli was the only one tire company to provide a full year outlook in the middle of the COVID-19 crisis. Despite the high volatility of the external scenario, we confirmed that we foresaw in earlier -- what we foresaw in earlier April. Car production to decrease by around 22% compared with last year. Premium prestige car manufacturers to overperform the Synergic segment by almost 10 percentage points. This, coupled with the 18 inches and above tire market now expected at minus 13% year-over-year, is proving again that high value and target is more resilient. Pirelli volume guidance is also confirmed, with around 52 million car tires, a reduction of minus 19% versus 2019 levels, which with 18 inches and above performance expected above market trend. Turning to the next slide. The high value resilience is expected to become even more established in the second half of the year, sustained by recovery in Europe and APAC and a rebound in U.S. In this context, we expect to outperform the market, benefiting from strengthened leadership in 18 inches and above in China, where we expect to grow double-digit and accelerate the new product pipeline to catch new consumer trends and SUVs growth. In Europe, targeting the growing all season segment, and the new high value push demand coming mostly from Synergic SUVs. In U.S., leveraging on our first-generation of high mileage products for SUVs, in China developing new dedicated lines for the highly growing e-commerce channel. We launched 6 new product lines in next 9 to 12 months, 3 for Europe, 2 for U.S., 1 for China. First half performance in high value discounted our policy to support its partners in keeping low stock levels and our exposure to areas most impacted by mobility restrictions, as Mr. Casaluci will better detail. Moving to our cost-reduction plan. Progress in line with our expectation, pursuing a flexible cost structure and limiting the effect of the production lockdown and fall in demand. The combined growth benefit for the competitiveness program and COVID actions for the full year are confirmed at about EUR 280 million, approximately 6% of 2019 cost base or EUR 140 million net of inflation and slowdown. In particular, as for many indications, the cost competitiveness plan will contribute for approximately EUR 160 million or EUR 110 million net of inflation while the COVID action plan is expected to generate approximately a further EUR 120 million, EUR 30 million net of production slowdown worth EUR 90 million. During the first half of 2020, consistent with our forecast, gross benefits from the 2 plants amounted to 45% of full year target. Net of inflation and slowdown, efficiencies were equal to around EUR 32 million since the slowdown was felt more in the second quarter. For the second half, we expect approximately EUR 150 million of gross efficiencies, the major contribution from SG&A, product range optimization and footprint rationalization. Net of inflation and slowdown benefits are expected to amount to EUR 110 million. Next slide, improving the 2020 cost competitiveness is obviously not our only objective. As I said in May, we are changing the way we work to achieve 3 major objectives: a leaner company, a faster company and economic benefits. We are also integrating digital technologies across the company for a more effective execution. More specifically, the design effort is led by multi-disciplinary teams, integrating business and staff, as well as people, management and technology. The 3 vital ingredients for a change of mindset, which are the 3 vital ingredients for a change of mindset. The target working model is much more horizontal, linking all actors of the value chain from consumers owning cars, fitting high value tires, right through all the suppliers. The operating model is built around 14 journeys, under which 80 processes are being redesigned. These processes and workflow around digitally on 4 integrated cloud-based platforms like sales force, artificial intelligence models are integrated in the workflows since they help improve the decision-making and act as early warning systems. The transformation program is broken down in waves. In the first wave, we are working on application to improve our relationship with consumers and customers and get us close to them as possible. Their needs will guide the performance of our value chain. Progress is underway. First key milestones have been achieved and with positive feedbacks from our organization, where a new digital way of working has been adopted with enthusiasm and effectiveness. To mention just a few example, in the pilot countries where we have released our new sales processes, Italy and Germany, we have already reached over 90% adoption rate from our workforce. More than 300 products have already been developed with the support of virtualization. Our transformation program is a major undertaking and will take around 2 years to reach a higher ground, from which further opportunity will be captured. To accelerate this undertaking, and in parallel, broaden the management team in consideration of my future succession, my proposal to the Board to nominate Angelos Papadimitriou as a new General Manager and co-CEO, has been accepted. Mr. Papadimitriou has had leadership positions in important multinational companies and has proved his skills in profitable growth, both organically and with M&A. He has formerly joined Pirelli 4 days ago on August 1. Our respective roles and key missions are summarized as follows: I will be responsible for our strategy setting, orchestrating the plan and controlling strategy implementation. I will also approve major corporate policies, initiatives and projects. Finally, together with Germany, will represent management and the Board to all our key stakeholders, the general public, institutions, shareholders and investors. The General Manager and co-CEO will start off by focusing on the acceleration of our wide-ranging transformation program and with the achievement of its targets. The General Manager operations focus is on day-to-day operations, integrating all new improvements in our line functions, R&D, manufacturing, supply chain, sales, marketing and so on in all regions. Let's now move to 2020 targets. With the first quarter release, we confirmed our April guidance, be more confident in its lower range, revenue approximately EUR 4.3 billion, adjusted EBIT margin approximately 14%, implying an absolute value of EUR 590 million, and net cash flow of about EUR 230 million. We confirm the impact of all internal levers, namely volumes, price/mix and actions on cost. However, we now face a more volatile external scenario on both ForEx and raw materials, as Mr. Casaluci will better detail. We now forecast revenues between minus 20% and minus 22% year-over-year. And adjusted EBIT margin between 12% and 13%, implying an absolute adjusted EBIT of EUR 530 million in the midpoint of the range, EUR 6 million less versus the previous indication due to the above-mentioned external headwinds and an increase on the other costs. This increase is related to noncash items. A net cash flow between EUR 190 million and EUR 220 million, leading to a net debt of about EUR 3.3 billion. Mrs. Leone will give you more color on second half trend. And now I leave the call to Mr. Casaluci, please.

Thank you, Mr. Tronchetti, and good evening, ladies and gentlemen. Let me start with the second quarter tough market dynamics and how Pirelli weathered the storm. COVID-19 outbreak heavily impacted car tire demand in second quarter with a 36% drop in volume, affecting both the regional equipment and replacement channels. In the original equipment, minus 47%, several production facilities around the world were kept locked, especially in April and May. Replacement demand, minus 32%, also suffered from mobility restrictions that kept consumers at home for several weeks. High value, minus 26% in replacement, showed again its better solidity versus the standard segment, minus 33%. Overall, Pirelli, 18 inches and above performance in second quarter was aligned with the market, minus 35%, with different trends among channels. Over performance in original equipment, minus 43% versus minus 47%, still benefiting from the customer base widening in North America and Asia Pacific, already underway since the second half of 2019. Slight underperformance in the Replacement channel, minus 29% versus minus 26%. To support our main distributors, we took destocking actions until April in Europe, and for the whole quarter in the U.S. In the U.S., we were more affected by lockdowns since stricter measures have been taken where the concentration of premium and prestige cars is high, example, California, Florida and the Upper East Coast, and some consumers trading down towards lower brands, given their economical hardship. In general, performance in Europe was solid, and very strong in Asia Pacific, where we gained market share. For the standard car, our drop was more pronounced at minus 50% for the second quarter compared to the market, minus 36% for the second quarter. Due to our high exposure to Latin America, where we keep reducing less profitable lower rim diameter products and we are gradually exiting from the less profitable mass market segments. Looking ahead, visibility is still very low. We can confirm our market view at around minus 19% year-over-year for the full year. This figure does not assume, so far, a severe second wave of COVID-19 with new mobility restrictions. In the second half of the year, the market trend is expected to be approximately minus 10%. All regions are still expected to record a double-digit drop apart from APAC. China is absolutely driving the market recovery, especially in high value. The 18 inches and above replacement market in the region is expected to be already growing in the third quarter. In Europe, the market is rebounding, but there are some concerns over the upcoming winter season because of reducing new car registrations, low consumption of winter tires during the lockdown, trade stocks likely to be realigned to the new demand scenario. In North America, there are good signs coming from the original equipment but it is still very difficult to assess the replacement trends due to very heterogeneous situations in stock levels and supply chains, coastal areas more damaged by lockdown restrictions, some consumers trading down towards lower brands due to the economic crisis, a still rather high number of coronavirus cases. In some regions, LatAm and Russia and Middle East and Africa, a gradual recovery is expected. Yet the presence of scattered COVID breaks, coupled with the difficulties of the real economy will extend the challenging market situation. As already said by Mr. Tronchetti, our efficiency efforts over the entire Pirelli value chain and across all regions are confirmed and in line with forecast. We are optimizing our cost baseline and facing the short-term impact of COVID-19 with an overall program of approximately EUR 280 million, out of which around 45% or EUR 126 million already saved in the first half. Let me give you an update on the major activities within each stream. On product cost, with a full year target of EUR 60 million and 50% of the target already achieved during the first half, we are on track with expectations. Continuing to streamline the entire product range toward a value-based portfolio, working on tire structure simplification, weight reduction and material portfolio de-complexity and exploiting virtual design process, reducing need for physical prototypes. After freezing about EUR 20 million worth of benefits last quarter, manufacturing initiatives are now in line with forecast, having reached about 50% of the EUR 60 million full year target. In this stream, we leverage on both structural and short-term actions, in particular. We continue to rationalize our footprint, especially in Latin America, and constantly exploit benefits from lowered waste, increase the flexibility and plant digitalization. We focus on quick efficiencies from factory flows optimization and strict control over fixed and invariable costs, mainly consumables, ancillaries, and direct materials and energy consumption. Regarding SG&A, in the first half, we recorded almost 40% of the full year target since we expect a major contribution from belt-tightening of G&A and marketing during the second part of the year. In particular, this stream, we continue applying a strict control over professional services and overheads, deeply reviewing marketing, communication and motorsport events supporting more digital activities, taking advantage of procurement renegotiations, optimizing distribution flows and exploiting warehousing efficiencies from stock reduction. Finally, we confirm our efforts toward a leaner organization that will bring us a full year cost saving of around EUR 50 million, out of which 50% already saved in the first half. In terms of activities, we are leveraging on: Footprint rationalization in Latin America; development of our existing shared service centers in Latin America and Europe; processor engineering, also thanks to digital transformation; and forthcoming introduction of structural remote working. Pirelli took a number of measures to address the harsh demand scenario which led to low utilization rates in second quarter. On the manufacturing side, the production slowdown has allowed the significant reduction in inventory levels in second quarter by over 2 million pieces in car, minus 15% compared to March 31, which partially anticipated the reduction expected for the third quarter. Added to this decrease was a reduction in inventories of finished motorcycle products, minus 7% compared to March. In parallel, we increased mix rotation to provide optimal customer service level. Complexity is coming down, thanks to the already mentioned improvements in the component design modularity and range optimization activities. On the commercial side, actions are balanced with the need of our partners to keep low stock levels so as to safeguard the financial health. Strong investments in the online business, in particular in China, this channel is growing fast, and we are consolidating there our leadership in 18 inches and above with ambitious growth targets. Trade innovation aimed to bring new traffic to the point of sales of our partners, where, together with them, we have successfully designed a contactless customer experience. Turning to innovation. COVID-19 crisis is not impacting the pace of our new product pipeline. Indeed, we are accelerating in the areas where we see opportunities, and we will launch 6 new lines in the next 9 to 12 months. Key boost a strong post COVID-19 recovery. The new product pipeline will catch new consumer trends and SUVs growth. We have just launched in the global market, the new CINTURATO P7 flagship product, designed for the premium segment with many innovative features. A distinctive design to optimize safety braking distance as proven by the Ecolabel A on wet braking across the entire present range. Flat profile, aimed for rolling resistance reduction and mileage to a low consistent CO2 savings, optimized footprint, structure and the aerodynamics set to limit noise, allowing to reach the perfect fit with electric cars as proven by Pirelli-owned Elect Marking. New level of performance reached in cooperation with OE partners such as BMW, Audi, Mercedes, Jaguar, Volvo, Alfa Romeo and many others that allowed us to be leaders in homologations already at product launch. Let's finally move to the operational drivers of our guidance. All internal levers are confirmed, with volume between minus 18% and minus 20%, of which high value at around minus 14% and standard around 26%. Price/mix is about plus 2%, driven by the improvement in both channel and regional mix as already shown in the second quarter. Net efficiencies, worth EUR 110 million and cost-cutting COVID worth EUR 30 million, net of slowdown. However, we now face a more volatile external scenario on both ForEx and raw materials. ForEx outlook worsened in second quarter and we now foresee that the volatility of emerging currencies, especially in LatAm, will continue for the rest of the year, coupled with a weaker U.S. dollar. We now expect ForEx to impact negatively the group revenues by 4%. The shift of raw materials from a EUR 15 million of tailwind to a minus EUR 10 million headwind is due to: Higher volatility of the oil, which is streaming down the overall commodities tailwind, from plus EUR 105 million to plus EUR 95 million; and the different exchange rates outlook. We remind you that 78% of our production is located in low-cost countries whose currencies are expected to devaluate against the U.S. dollar, making the raw material bill more expensive, fixed impact from minus EUR 90 million to minus EUR 105 million. For our assumptions of raw materials and ForEx, please refer to Slide #26 and 27. The EUR 70 million of other costs include: EUR 35 million EUR of noncash items; provisions on bad debt accrued in the second quarter; other provisions; and some costs related to the reduction of inventories; EUR 20 million related to transformation programs and EUR 15 million of lower earnings. The difference versus the May guidance is only related to the increase of nonmonetary cost, EUR 20 million more related to fixed from stock and bad debt and other provisions. As a reminder, we confirm the usual drop-through 42% on volumes, around 50% on price/mix and 15% on ForEx. As already pointed out by Mr. Tronchetti, we are putting all the efforts needed to protect our cash generation also from an operational point of view. I now leave the floor to Valeria for the review of the financial results.

Thank you, Andrea. Good evening, ladies and gentlemen. I'm glad to participate in our conference call in my capacity as Head of Strategic Planning and Control. On Slide 18, let's analyze the net sales bridge. In the first half, our performance showed that the impact of the actions taken against the COVID crisis. Price/mix rebounded in the second quarter, mainly supported by a strengthening of our positioning in China. Efficiencies and cost-cutting measures, we produced savings for EUR 126 million, more than offsetting inflation and the impact of the slowdown. Strong inventory reduction, allowing us to bring cash absorption almost 0 in the second quarter. Let's go through our financial results starting from our top line. We ended the first half of 2020 with net sales of about EUR 1.8 billion, minus 31.6% year-over-year. As Mr. Casaluci told you previously, the global demand slowdown affected our volume trend, minus 29.5%, especially in the standard segment, minus 35.4%, where we kept following the selective strategy. Our high value performance proved to be resilient, with the last [ 2 month ] decrease in line with the market, minus 23%. Price/mix was plus 1% in the first half and discounts a different trend between quarters, minus 1.3% in the first quarter with a negative channel mix, steeper decline for the Replacement sales, and a temporary drop in the regional mix. In the second quarter, we were back to a sound plus 3.3%, supported by the rebound of both the channel and regional mix recovery of sales in China, with the continuous contribution from product mix. This trend is expected to continue in the second part of the year. Finally, ForEx was negative by minus 3.1% in the first half, with a downward acceleration in the second quarter, minus 4.7% due to the increased volatility of emerging marketing currencies, the Brazilian real, the Argentinian peso, the Russian ruble, the Mexican peso. This trend is expected to continue in the second half with pressure also on the U.S. dollar. Moving to profitability on Slide 19, we used our internal levers to minimize the impact of the external scenario. The cost competitiveness program produced structural efficiencies worth 3.5% of our sales, covering inflation, minus EUR 23 million, ForEx minus EUR 17 million, a raw mat headwind minus EUR 15 million, the latter impacted by the depreciation of main currencies of minus EUR 37 million of countries where the group's production is located, for example, Latin America, Romania and Russia. COVID emergencies cost-cutting measures, EUR 62 million or 3.5% of sales, basically offset the impact of the slowdown, minus EUR 71 million. As mentioned in Slide 26, the slowdown was mainly felt in the second quarter reaching in the first half, about 80% of its expected annual impact that's worth EUR 90 million. Price/mix was positive EUR 7 million in the first half. Thanks to the solid performance in the second quarter, that is EUR 22 million. The decline of volumes was minus EUR 332 million, reflecting the usual EUR 42 million drop-through. Finally, G&A and other costs with the latter amounting to minus EUR 35 million and mainly related to noncash items, that's minus EUR 28 million, such as provision on credits approximately minus EUR 10 million due to a more conservative stance in the current scenario. Nonmonetary costs relating to the strong stock reduction in the second quarter, minus EUR 15 million, and other provisions worth EUR 3 million for LTI. The remaining EUR 7 million was the balance amount. Costs related to transformation programs, approximately EUR 10 million and lower earnings related to promotion royalties. And the positive impact of approximately EUR 13 million of loan costs included in the first quarter '20 due to postponement of some activities to the second half due the COVID, for example, F1 Motorsport racing, events and sponsorships. For the second half of the year, the impact of the other cost is expected to be more or less minus EUR 35 million, of which EUR 7 million noncash and EUR 70 million on full year. On Slide 20, about our cash flow and financial position, we closed the first 6 months with a net debt of about EUR 4.3 billion, almost flat versus the first quarter. Cash absorption in the second quarter was basically 0 or minus EUR 4 million, mainly supported by the sharp reduction in inventories, EUR 175 million or 2.1 million car tires and 200,000 motorbike pieces, with an increase of 285,000 car pieces and 230,000 motorbike pieces in the first quarter due to the lock down measures. In the first half of the year, inventories went down by a net 1.8 million pieces in the car and 400,000 pieces in the motorbike. At the end of June, inventories accounted for 21.4% sales, about 1 percentage point less than the last year and in the first quarter. Inventories are expected to be further reduced in the second half by around 200,000 car pieces reaching a 20% normalized sales. In the second half of the year, we expect to generate a net cash flow of close to the second half of last year, that is EUR 963 million versus EUR 985 million in the second half '19, thus reaching approximately EUR 190 million, EUR 220 million of full year target. For the second half of 2020, operating cash flow is expected to be almost in line with the second half 2019, that is EUR 1,160 million versus EUR 1,182 million in second half '19, supported by an EBITDA, basically at the second half of 2019 level EUR 658 million versus EUR 674 million in the second half '19, a contained CapEx of EUR 49 million versus EUR 223 million in the second half '19, a more contained positive net working capital, EUR 576 million versus EUR 765 million in the second half '19 consistent with the lower level of activities compared with 2019, with lower receivables and payables. Lower interest and lower taxes are almost offsetting the cash out for restructuring. Now finally, just a few words on the comparison between the new and the previous guidance. The midpoint of new guidance on adjusted EBITDA is equal to EUR 530 million, EUR 60 million less versus the EUR 590 million indicated as a floor in last May. The midpoint of the new target for cash flow is EUR 205 million, EUR 25 million less versus the floor of the previous guidance worth EUR 230 million. In terms of cash flow, the EUR 60 million reduction in EBITDA translates into just EUR 25 million cash absorption. Part of this is due to the additional noncash items versus the previous guidance, amounting to EUR 20 million, included in the other costs, in particular, higher provisions and stock accounting treatment linked to 300,000 pieces additional inventory reduction versus previous guidance. The rest comes from the higher target for year-end inventory reduction, which should bring an additional benefit of at least EUR 10 million. Finally, on Slide 21, our capital structure. As of June 2020, our gross debt stands at EUR 6.2 billion. When compared to the first quarter, this increase is due to the drawdown occurred on April 2 on our EUR 800 million, 5 years bank line subscribed on March 31. Net financial position and liquidity margin remained stable versus the end of March at EUR 4.3 billion and EUR 2.2 billion, respectively. Thanks to the action taken to preserve liquidity balance. As quick reminder, during the first half, we have managed to subscribe at a very favorable terms. The previously mentioned EUR 800 million loan, which made our debut in the sustainable finance space, extend the maturity over EUR 200 million by lateral financing original due in June 2020 and now postponed to September 2021. Exercised sole discretionary option we had on the tranche of our main bank line coming due in June 2020, that is EUR 253 million other for now postponed to June 2021. During our first quarter call, we anticipated we have proactively approached our lenders to gain flexibility on those financial covenants, which are the certain point in here, and with an extended slowdown could go under pressure. We can confirm that we have successfully addressed our need for the next 18 months and have received support by all lenders. Finally, during the first 6 months of 2020, our cost of debt went down to 2.22% from 2.83% in December 2019, mainly thanks to a lower exposure of high-yield currencies, generalized interest rate reduction and lower margin applied to our bank financial debt due to our financial performance. I thank you very much for your attention. Now I'll leave back the floor to Mr. Tronchetti.

Thank you. So this ends our presentation. We may now open a Q&A session.

[Operator Instructions] The first question is from Monica Bosio of Intesa Sanpaolo.

I have 3. The first one is on the inventories. I understood that the group reduced materially the inventories. And I just -- I'm just wondering if you can give us more color on the dealer inventories level. Do you see the dealers' inventories in a healthy position now to face the demand trend ahead? Or are there any areas where we can see some tensions in terms of dealers’ inventory? And the second question is on the expected slowdown of the replacement in the third quarter due to a likely winter season. I know it's -- maybe it's difficult, but could you please quantify what kind of slowdown do you expect in the replacement for the third quarter? And the very last is on the footprint rationalization in LatAm. Do you expect any assets write-down ahead, or can you quantify the restructuring costs for 2020?

Thank you. I answer to the last question, and then I give the floor to Mr. Casaluci. We already put in our account the effects of the restructuring in Brazil. So nothing is expected this year on this area. But in general, we don't see major restructuring of assets around the world. We have done much that have been done last year. Mr. Casaluci?

Thank you Mr. Tronchetti. As far as stock in the dealers is concerned, we see, let me say, mostly recovered picture in Europe on summer. So the level of stock we see in the trade in summer in Europe is in line with the needs of the market. While in winter is still too high comparing to the expected reduced demand in the last quarter of the year. China, we don't see major risk on the stock level. Overall, the situation is back to the normal environment. While in the U.S., there are different pictures compared to -- if we look at the, let me say, most affected areas of the United States, as I said in the presentation, California, Florida and the Upper East Coast, the supply chain overall is not yet stabilized, and there are still risk in the stock level of the dealers, while in the rest of the U.S. is more back to a normal environment. As far as the expectation of the winter season, as I said before, the prebooking started in line with our expectations. So we don't expect a negative surprise in the third quarter, while for the normal season, that normally start end of October. In Europe, there are some risks related to the lower car registration in the first half of the year and to the high stock level in the trade. So our estimation is one-digit negative demand on winter in the last quarter.

The next question is from Akshat Kacker of JPMorgan.

Akshat from JPMorgan. Three from my side. The first one on your full year EBIT guidance. When I look at the implication for the second half, a large part of it depends on the pickup in the cost savings, EUR 70 million from EUR 40 million in the first half. Could you just summarize what parts of those cost saving measures are really accelerating in the second half? And if there are any risks to achieving those cost savings? That's the first one. The second one is on your market underperformance in the high value replacement market. I can understand dealer restocking and clearly trying to maintain pricing power. Can you just give us a picture, if you have, of how market shares have to hold on a sell-out level in the first half for high value replacement, please? And the third one is on raw materials. I can see that your core underlying assumptions on raw materials are more bearish than peers, especially on synthetic rubber and Brent crude oil. Can you comment on that, please? And the second element of raw material effects. Has this FX impact factored in the sharp depreciation of the dollar? Because even against emerging market currencies, like the Turkish lira and the Chinese renminbi, the dollar has depreciated. So just trying to understand what drives that weaker FX impact on raw materials then.

Andrea will answer. On exchange rate, we consider the trend of devaluation in Turkey, Brazil to continue. There is a weakening also of the dollar that we don't see any major changes. And so our forecast for the full year includes this trend. We do not expect any change in the trend. I'll leave the floor to Mr. Casaluci to answer to the business questions. And for the cost, Mrs. Leone will give you the answers.

Thank you. As far as the expectation on the high value performance in the second half, considering that we have finalized our destocking process in Europe.

Sorry, I mean the sellout share in the first half on high value replacement.

Yes. In the second half of the year, we projected to gain market share and we project in the high value to overperform the market, all in all, at least 0.3 in terms of share, drivers, enlargement of the customer base, introduction of new products, mainly in U.S. and Europe and completed destocking phase in the trade.

So with regard to the profitability of the second half, I'll try to give you more color. Consider that in the second half, we will expect a stronger contribution from internal levers, first of all, lower volume decline. We should have more or less 9%, 10% minus versus 29.5% in the first half. The price/mix should be around 3% with a higher drop-through. So that means approximately 50% second half versus 26% in first half. And that's -- what's very important is the contribution that will come from efficiencies recorded net of inflation has slowed down, that should stand more or less more than EUR 100 million versus net effect and for sales of around EUR 32 million.

One point I just want to add. But we -- you have to take into account that first half in Europe of our results was affected also by the bankruptcy of Fintyre in Germany and also the negative effects in Italy. And so now we are recovering volumes lost because of it through our other clients. So I think that this is over. And so the second half should profit of it. Thank you.

The next question is from Kai Mueller of Bank of America.

The first one sort of follows up a little bit with regards to the market. Obviously, a lot of people are talking about somewhat more driving that's happening in the summer, back end of the year when people travel. Have you seen some more promising trends on your sellout from your customers that, that demand is coming through, that the sell-out is accelerating, but you obviously are still worried about the sell-in, given where the dealer should stand right now with the inventory level? The first one. And then what I found is quite interesting is your comments with regards to downtrading in the U.S. in terms of brands or price points. Does that mean customers are no longer purchasing, let's say, a Pirelli tire? Or do they go for a lower cost version?

First, I'll leave to Mr. Casaluci the other answers. For the downtrading, we have to consider this as something that is not affecting Pirelli in a consistent manner. It happened in the United States, only United States. And it's something we see we can cope with. Thanks to the new lines that we are launching in the United States that will be much more performing in terms of mileage, and that will satisfy the demand of people asking price per kilometer. That's the -- I think the answer we are giving to this downtrading that can be offset. Thanks to the brand-related also to a mileage effect. Casaluci?

Yes. I confirm there is a recovery in the demand. And if we look on the trend of April, May and June, during the second quarter, this is clearly visible in all the major high value markets. For example, the market in June in the 18 inches and above was basically flat in Europe and was a minus 14% in North America versus the minus 35% of May. And was flat in -- flattish, slightly positive in China already in the month of May.

The next question is from Gabriel Adler of Citi.

Gabriel from Citi. My first question is on price/mix. Your full year guidance adjusted price/mix will remain around 3% in the second half. Given the positive channel mix would have helped in Q2 and this channel mix is likely to slow in the second half if replacement and OE growth converge. What's going to offset this? That means that price/mix will stay at around 3% in the second half, similar to what was achieved in Q2. My second question is on the other costs that you're guiding to. Can you just give a little bit more detail, please, on what gives you confidence that this is going to be limited to EUR 35 million additional other costs in the second half? Could you talk through your assumptions on other costs and specifically around provisions, what you're expecting in the second half? And then my third and final question is on CapEx. Because you've reaffirmed your CapEx guidance for 2020. But could you give us a sense how much this relates to delays and how much will come back in 2021, given that we're clearly seeing overcapacity in the industry and high value. Is it fair to assume that CapEx will remain significantly below 2019 levels in the coming years?

I'll answer the last question, and then I'll leave the floor for the other answers. CapEx, obviously, there will be an increase compared to 2020. We don't see a reason to go back to the level of 2019 because we are introducing a number of changes that are increasing our productivity in the factory. So we believe that this time, these 3 months of lock down and smart working, helped us in finding ways to be more efficient. And so an increase compared to 2019 -- 2020, but not at the level of 2019. That is the trend we see today. Mr. Casaluci?

Yes. Price/mix expected to be plus 3% in the second half. This plus 3% is basically done by minus 1% on price that confirms the performance of the first half, mainly related to original equipment and a positive 4% on mix. The positive 4% on mix in the second half, expect it to be driven by a plus 1% on region mix, because of the overweight of China in the performance of the market and in our sales. And the 3%, which is the usual product mix performance, that is the combination of the growth, the high value and the decrease of the standard and the micro mix inside our product offer.

As per the additional other costs, as you asked before, we will raise up from EUR 35 million up to EUR 70 million. The additional EUR 35 million to first half related to EUR 7 million on noncash items related to additional reduction of finished product stock and EUR 30 million of cash then fall into transformation, now to which EUR 10 million more or less will be related to R&D, some activities to digital and to lower earnings from [ Prometeon ] that we'll be working in second half by around EUR 5 million. And motorsport sponsorships due to the concentration of Formula 1 and other sporting events in the second half. So the difference versus the May guidance is only related to the increase on nonmonetary costs, as we said during this pitch, and they will be equal to EUR 20 million related to fixed from stock, plus EUR 3 million, the debt, plus EUR 10 million, and other provision, plus EUR 7 million.

Okay. If I could just quickly follow-up on the price/mix. Is the 3% product mix you mentioned, an acceleration compared to first half? What was product mix contribution in the first half?

So the different speed compared to the first half and the second half is related to the bad performance of the first quarter that was affected negatively by the region mix and the channel mix. As you remember, the region mix in the first quarter was affected by the slowdown of China. And the slowdown of China is affecting negatively our performance because our average selling price in China is roughly 20% higher to the average of our replacement phase because of the mix, mainly. And so this is affecting -- was the main reason of the negative performance of the first quarter that was minus EUR 1.3 million. Now in the second quarter, we are back to a normal performance, with the positive impact of the region mix is a plus 3.3%. And as I mentioned before, we do expect a stable performance from now on, on a 3% on the entire half, second half.

The next question is from Henning Cosman of HSBC.

I understand the guidance cut as you moved through the external sector. So I just wanted to make sure on the internal sector that you're now giving yourself enough cushion for the second half, so that you don't have to cut again, and specifically, and maybe on the COVID actions, you're obviously looking to generate the same amount of growth savings, again, while the net impact is much higher because the slowdown is allegedly much lower. So if you could just remind us of the dynamic there. How do you sustain the gross savings while the negative offsetting element of slowdown comes down. And then the second question, also maybe to take the opportunity of the FX cut again to discuss this a little bit more. If I accumulate the FX components on either just within the raw material, I think over the last 4 years, it's accumulated number of something like EUR 330 million. And it appears that there's also a structural component to this. And maybe we could just talk again about if it's just the volatility that makes this structurally very difficult to contain? Or is it really just the continuous depreciation of the emerging market currencies? And I perfectly understand you have the 78% in low-cost countries. But it just seems there's no real offsetting element because you sell, of course, mostly into hard currency denominated countries.

First of all, we suffer on 40 -- Latin America devaluation was much, let's say, deeper than expected. And that affected, obviously, the impact on our exchange rate. And cost of raw material increase also was the second element that factoring -- is affecting our cost in future. In the second half, the effect will be lower in the original equipment because in original equipment, we had the cost metrics that was creating an advantage for our customers. And for us, was a minus. In the second half, this effect will be offset. So the big numbers will be more balanced in the second half. But I leave to Mrs. Leone the answer on details.

So with regards the ForEx, in order to recouple the number, on the full year, the ForEx will account, we expect to have EUR 200 million in terms of revenues. And will be driven by the weakness of LatAm currencies that were worth 82% of the total effect, plus 7% will come from Russia ruble. On EBIT adjustment, the impact of this ForEx is twofold for us. One, first, because we have the negative consolidation effects from the translation of the local statutory PBT in euro; and the second factor will emerge from raw mat purchase price in local currencies, more than offsetting the reduction of commodity prices in euro -- in dollar-euro. I remind you that the Pirelli production is located in low-cost countries for 78%, so it means in high volatile currencies, while 60% of Pirelli [indiscernible] are denominated in dollar and 35% in euro. Plus the fact in full year '20 is stronger than usual since the current COVID crisis as it severely impacted export volumes versus United States and Europe, thus reducing the natural currency hedge on our accounts from more competitive sourcing. So this is in order to recouple the ForEx effect. For what regards your previous demand on second half competitiveness and COVID details. For the second half of the year, we expect approximately EUR 150 million of gross efficiencies with a major contribution, as Mr. Casaluci said before, during a speech from SG&A, throughout the range of optimization and footprint rationalization. Net of inflation has slowdown benefit, we expect more or less EUR 110 million coming from the 4 main projects included in competitiveness.

The next question is from Martino De Ambroggi of Equita.

Two more questions on the full year guidance. If I take the midpoint of your adjusted EBIT guidance, it implies the second half is not far from last year, roughly minus 4%, high end would be even higher. So my question is, what's your level of confidence, low end and high end of this range, considering the remarks that you made at the beginning, saying that the visibility at market level remains low.

Yes. We base our expectation in the second half on a better performance on the 18 inches and above. We expect to have something close to 0.6% reduction compared to last year versus a minus 3% of the market. In the standard segment, we will continue the pruning of our portfolio. So the reason why we are confident on second half EBIT is based on this, on the mix that Mr. Casaluci elaborate before. So that's why we consider that the replacement market, as a whole, in our segment, will be close to what was last year, considering that we will have -- we expect to have between 10% and 15% reduction in winter due to the lower number of kilometers made by winter tires last year. And because in Europe, there was 38% less sales of new cars in the first half, which means that for Germany and Italy mainly the season -- the winter season for new cars, is really very poor.

Okay. The second question on the guidance related to the COVID costs, EUR 26 million, which are not in the guidance or below the guidance. What's the rough figure for this line for the full year?

They are below the guidance.

Yes. Below the guidance, EUR 26 million in the first half, and what should we expect for the full year?

For the full year, we expect more or less EUR 55 million.

Okay. Not a big change. The last question is still on CapEx. Because none of your competitors cut CapEx by 60% as you did immediately when the emergency started. Is there any risk of losing any opportunity in some markets or segments because of this? And I understand that your indication of higher CapEx for next year, if I assume something in the region of EUR 300 million, is a reasonable assumption?

Yes. Mr. Casaluci speaking. Yes, it's reasonable. It's too early to have a clear number and clear picture, but it's reasonable to go back to a more normal level of CapEx. And no, there are no risk because we have decreased everything which is related to capacity increase, and we are protecting all the necessary investment for the technology upgrade, and to assure the business continuity. So no risk so far.

The next question is from Thomas Besson of Kepler.

I have 2 very quick questions, please. The first is on the EUR 25 billion incremental raw materials you are reporting. I was wondering why you're not trying to pass part of that to end customers, as you seem to anticipate a better mix in H2 with replacements stronger than -- that's the first question. And the second, when I look at your Slide 11, and you outperformed a lot in OE, you underperformed a lot in replacement in H1. So 2 small questions. First, are we still in the pull-through phase? Or is it just the fact that some of the models you are exposed to are working well while the replacement market was tough? That's it.

First of all, the raw materials, you have to take into account that the view we have today being in August, goes up to November. So our figures, considering the input cost of the raw mat was quite certain. So there could be something happening, but it will affect only the very last part of the year. So we expect this number being consistent with what is going to happen. Mr. Casaluci?

Yes. We are overperforming the market in Latin America, in the 17 inches and above segment, that is what we define premium segment in South America, because the 17 inches itself is still a high value segment for these regions. And we are overperforming both in original equipment and in replacement in the first half, and we do project a growth in the market share also in the second half. And this is, as you mentioned, leveraging, mainly on the pull-through rate of the original equipment that are fitting Pirelli tires in the last 2 years.

Next question is from Gianluca Bertuzzo of Intermonte.

I have 3 questions. The first one is, how will you describe your first half and second quarter performance compared to your peers mainly in terms of profitability? Second one is on 2021. I know it may be too early to comment, but do you see any structural reason preventing you in 2021 to go back to the same level of profitability of 2019? I mean if we look at some of the drivers that have led you to revise downward this year guidance, such as ForEx in low-cost countries, it seems this kind of pressure might not easily go away. And last question, more housekeeping question is on the level of total restructuring we can assume for this year.

I'll start with a question you raised about 2021. It's very, very early to say. What we can see is that our replacement market, 18 inches and above. We don't see major risks not to recover in 2021. That is a general statement we can make unless there are other ways of COVID that until now are unexpected. But for the rest, I leave the floor to Mr. Casaluci.

Yes. I confirm what Mr. Tronchetti mentioned before. So the risk related to ForEx is not -- so it's not something we can completely offset. It's too early to say if we will be back to the profitability of 2019 in 2021. We have still a high level of uncertainty from now until the end of the year. So it's extremely difficult to forecast 2021. But our target segment, the high value in 2021 is expected to be back to the normal level of 2019. While the other segments of the market, most probably will require at least another couple of years. So we do expect to be back to the normal level of the market of 2019, not before second half of 2022, with the exception of high value. So we are confident with our business model to protect the profitability.

The next question is from José Asumendi of JPMorgan.

José Asumendi. I want to follow-up on that last question and maybe ask a little bit more sort of longer-term for the coming 2 years. And coming back to the discussion we had during the IPO, product mix has always been an important opportunity for Pirelli. How do you think about product mix improvement over the coming, not 6 months, but 1, 2-year, which could actually allow us to understand how markets can actually normalize on a 1- and 2-year view and see the value with the case.

What we are working on is to reduce the breakeven point. So what you see, the actions we have taken already in our 3 years plan and the additional actions taken for COVID-19 are having an impact on our cost basis that's quite consistent, 6% on the base load gross, is something that will change the profile of risks on cost side looking forward. On product mix and product, in general, the new ways of making the new sets of tires in a faster shape and with better performance is related to all what has been done in the last few years. So we have invested heavily in R&D. We have invested in technology and R&D. So simulation, mathematic model, standardization inside factories. All this will provide us a number of new lines that will reduce drastically the cost. And this is an additional value that we can exploit in '21, '22 and should support our business model that I can call a high value, low cost. In a sense that we are trying to be as effective as possible and COVID helps, in a way, to make additional action in place. That's why we feel comfortable that our performance is -- will be much more performing in the next couple of years that one can expect today.

The next question is from Andrea Balloni of Mediobanca.

My first one is about interest cost. You did a good a reduction in the first half. I would like to know what are you projecting over the second part of the year. Can you expect a similar trend also in the second half? My second question, I'm sorry, for it is about free cash flow. I lost your comment about the full year '20 guidance, if you can give us the main driver of reduction in guidance, I guess this is basically made about the lower profitability, but could be probably something which could be offset also by net working capital, if you can repeat it, please? And my very last question is again about COVID-19 cost. I lost your answer to my colleague about the full year '20 amount. Just to understand, it was EUR 26 million in the first half and I lost the amount for the full year.

Yes. No problem at all. So with regards to the cash flow guidance, what we told before that the midpoint of your target is equal to EUR 205 million. That means a EUR 25 million less versus the guidance we gave in last May that was equal to EUR 230 million. And what's the difference? In terms of cash flow, we have EUR 60 million reduction in EBIT that translates adjusting to EUR 25 million cash absorption. But this is due to the additional noncash items versus the previous guidance that's equal to EUR 20 million, including in the other cost, in particular, higher provisions and stock accounting treatment that are linked to 300,000 pieces, additional inventory reduction versus previous guidance. And the rest comes from the highest target for the year-end inventory reduction. We should bring an additional benefit of at least EUR 10 million. For what regards, the COVID costs, what we told before, that we recorded in the first half, EUR 26 million of direct COVID cost. And our estimate for the full year is equal to EUR 35 million, so only EUR 8 million, EUR 9 million plus in the second half.

Okay. And about interest cost in full year?

I give the floor to Francesco Tanzi for the analysis.

Thank you. Francesco Tanzi speaking. For what is concerning the interest charges, we see a stable trend. And assuming interest credit curves and spread does not change, we will probably keep our cost of funds in line with the first quarter, with the first half.

That was the last question. I'll turn the conference back over to management for any closing remarks.

So this concludes our today program. Thank you for the attendance, and have a good evening.

Ladies and gentlemen, thank you for joining. The conference is now over, and you may disconnect your telephones.