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

Ladies and gentlemen, welcome to the Pirelli's Conference Call in which Pirelli's top management will present the company's 9 months 2020 financial results. A live webcast of the event and the presentation slides are available in the Investor Relations section of the Pirelli's website. I remind you that a question-and-answer session will follow the presentation. I would now like to introduce Mr. Marco Tronchetti Provera. Please go ahead, sir.

Thank you. Good evening, ladies and gentlemen, and welcome to our conference call. In a very volatile environment in the third quarter, we were able to strengthen our position on the high-value, largely outperforming the global market by 3 percentage points in both original equipment and replacement. This was particularly true in China, where we record an outstanding performance, plus 33% year-on-year on car 18 inches and above versus plus 21% of the market. Protect profitability through mix improvement and net savings coming back in the third quarter to an almost 17% EBIT margin, reinforced our cash profile, further reducing inventories. Our cost reduction plan is progressing in line with expectations, pursuing a flexible cost structure and limiting the effect of the production slowdown and falling demand. Our commitment to cash generation is confirmed despite a challenging external scenario, uncertainties on demand following the introduction of new mobility restriction in Europe, ForEx devaluation, all these are creating a very volatile environment. As we are near to the end of 2020, I want to highlight how we were learning from this unprecedented period of extreme uncertainty, unprecedented for the severity of the health crisis, the magnitude of the economic downturn, the duration of the crisis, the rapid pace with which causes generate effects. Not only have we taken early and indeed successful countermeasures and in this month, we're ramping our all working model to a new era of uncertainty. In particular, by staying very close to our customers, we are monitoring early warning signals, which we review with our global management team every week and where we decide the countermeasures. Our medium and short-term planning is now integrated and supported by an enterprise-wide digital platform, where we can simulate actions and update our plans and targets, maintaining overall coherence. While generally, I'm very reassured by the fact that one of Mr. Papadimitriou's key mission as co-CEO is exactly to accelerate our pace capitalizing on Pirelli's main strengths with novel eyes, simplify and accelerate our processes so as to capture the many opportunities in the resilient high value market. This change of pace will be visible in our new plan. Mr. Papadimitriou will give some thoughts on the new businesses plan, while Mr. Casaluci will elaborate on Pirelli's 10 months results and market outlook. And Mrs. Leone will discuss our financial results. Cost reduction plan is progressing in line with our expectations. The combined gross benefits of the competitiveness program and COVID action for the full year, confirmed about EUR 280 million, approximately 6% of the 2019 cost base, or EUR 140 million net of inflation and slowdown. In the first 9 months of 2020, consistent with our forecast, gross benefit from the 2 plans amounted to 71% of full year target. Net of inflation has slowed down, efficiencies were equal to around EUR 84 million since slowdown was almost entirely recorded during first half. For the fourth quarter, we expect approximately EUR 80 million of gross efficiencies, a major contribution from SG&A range optimization, logistic efficiencies and footprint rationalization. Net of inflation and slowdown benefits are expected to amount to about EUR 60 million. Moving to 2020 targets. We have updated the outlook for the full year, taking into account the change of the external scenario. Mr. Casaluci will provide you more details on. To sum it up, on the one hand, we see demand improving, mainly driven by better original equipment in APAC and North America, while maintaining a cautious view for Europe in the recently introduced restricting measures to cope with the COVID-19 emergency. On the other hand, we are expecting a more volatile ForEx environment following the depreciation of the euro against all major currencies in the second half of 2020. We now forecast revenues around EUR 4.2 billion. And adjusted EBIT margin between approximately 11.5% and 12%, implying absolute adjusted EBIT close to EUR 500 million. The midpoint of the range about EUR 35 million less compared to the August targets. Current indication has taken into account more negative external headwinds, ForEx and its impact on raw materials and the increase of the other costs, partly noncash. The net cash flow confirmed at around EUR 190 million, in case EU fine will become due by December 2020, or around EUR 220 million should this payment be delayed. The change in the profitability guidance is not impacting the net cash flow targets, thanks to a better working capital management, benefiting from a larger reduction of stocks than originally expected. Net debt of about EUR 3.3 billion is also confirmed. And now I leave the floor to Mr. Papadimitriou. Mr. Papadimitriou, please.

[Audio Gap] and business administration. Over the past almost 30 years, I have split my professional efforts between the global pharmaceutical industry and the advanced industrial machinery and services business, living between the United States and various European countries. For the last 10 years, I served as the CEO of Coesia, a global leader in packaging machinery and industrial solutions, where I focused on the strategy of profitable growth, organic and through mergers and acquisitions. Key themes in that journey were innovation through engineering and digital capabilities, service excellence, a global industrial footprint and the resilient international organization. It was rewarding and enriching experience in which I had to compete within a rapidly changing industry. I will bring the best of that experience to Pirelli. Roughly 3 months into the job, I have already had the opportunity to appreciate the depth of Pirelli's management team, the clarity of its high-value strategy, and the progress made towards an integrated business model, designed to support Pirelli's continued success. Similarly, Pirelli's premium brand and technology leadership are constant sources of inspiration and assets we are going to build on for the future. For today, I would simply like to make 3 general observations from my first weeks of exposure to the business. Pirelli's unique high-value strategy presented during the February 2020 strategic plan builds on the company's strengths and is clearly the right way forward. There is room for refining and enriching it, progressively accelerating its impact on our business. And the way to implementation is clear. The market discontinuity caused by the COVID-19 epidemic, brought out a solid response by Pirelli's management. The results of which are already showing in the second half of 2020 and prove the resilience of the management team and the business. Beyond COVID-19, an even broader set of these continuities will offer new opportunities for us. Electric vehicles, connectivity, change in mobility preferences, sustainability, to mention only a few. Our plan going forward will take stock of these discontinuities and will be based on profitable and sustainable growth. We will have the chance to further discuss Pirelli's strategic outlook during the upcoming presentation of the 2021, '23, '25 Strategic Plan in March of 2021. The Pirelli management team and I will be spending significant effort in preparing this plan in the coming months under the guidance of our CEO, Mr. Tronchetti. Of course, we will remain vigilant and resilient to possible external volatility in the near future as we gradually come back to a more stable business outlook. And now I would like to turn over to Andrea Casaluci for the review of the market and of Pirelli's performance. Thank you.

Thank you, Mr. Papadimitriou, and good evening, ladies and gentlemen. Let me comment on the third quarter market dynamics and Pirelli performance. Third quarter tire demand still is negative territory at minus 6% overall, but significantly improved compared with previous quarter level, minus 35%. Original equipment, partial recovery with a minus 4% has been driven by an improved demand, particularly in the premium segment. Replacement demand, minus 7% was also recovering, but still negatively impacted by the slow economic recovery in standard regions. The high-value trend, car 18 inches and above showed, again, the segment resilience versus the standard, High Value growth plus 2%, while demand for standard products fell by 8%. In the car 18 inches and above, Pirelli outperformed the market in the third quarter, plus 5% versus a market plus 2% in both channels. In the regional equipment, our performance has been driven by Asia Pacific where the higher exposure to the premium segment in China pulled us ahead of the market. In North America, we are benefiting from the widening of the customer base from the second half 2019 with the supply of relevant projects for the market. In the replacement channel, plus 6% versus market plus 3%, we gained the share loss at the beginning of the year due to the destocking of our trade partners completed in Europe in April and in the third quarter in North America. In the third quarter, we outperformed the market in China through a higher presence in both the online channel and car dealers. In Europe, we announced that our performance, leveraging on the product portfolio extension in the summer and All Season fast growing segments. In South America, in the third quarter, we gained share in the replacement channel of the standard segment, taking advantage of lower imports in the area, while continuing to reduce the exposure to the less profitable products. On the back of the third quarter market trend, we have updated the scenario for the remaining part of the year taking into account a better trend in the regional equipment in Asia Pacific and North America, while keeping a conservative stance for Europe. We are now assuming a global car demand down 17% for the full year, 2 percentage points better than our previous expectations, and a minus 5% in the fourth quarter. High-value is confirming its resilience. In more detail, in Europe, where the main concerns are the effects of scattered mobility restrictions on tire demand, we are assuming a double-digit drop in both original equipment and replacement demand, almost 10%. Asia Pacific instead pushed by the positive momentum of China is expected to continue to outpace the global market. This is more evident in the High Value, where a positive trend is expected in both the replacement channel and in the regional equipment. In North America, we expect a positive original equipment, also thanks to the weak relative comparison with 2019 while replacement is expected to keep third quarter momentum even in a volatile market environment with very heterogenous situations in stock levels and supply chains and a still rather high number of coronavirus cases. In some of the regions, Latin America and Russia and Middle East and Africa, a gradual recovery is expected. Yet, this low real economy upturn will limit the tire market expansion, which is still expected to decline at double digit. Let me give you now an update on the efficiencies and cost-cutting programs. On product costs, where we achieved 75% of the full year target, we are streamlining the entire product range toward a value-based portfolio, working on tire structure simplification, weight reduction and material portfolio decomplexity and exploiting vehicle design process, reducing need for physical prototypes. On manufacturing, we reached about 80% of the EUR 60 million full year target. In this stream, we continue to rationalize our footprint, mainly in Latin America and exploit benefits from lowered waste, increased flexibility and planned digitalization. We focus on quick efficiencies from factory flows optimization and strict control over fixed and variable costs. On SG&A, in the 9 months, we registered almost 60% of the full year target since we expect a major contribution from belt-tightening of G&A and marketing and procurement renegotiations during the last quarter of the year. Finally, we confirm our efforts towards a leaner organization that will bring us a full year cost saving of around EUR 50 million, out of which 75% already saved in the first 9 months. 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; process reengineering, also thanks to digital transformation; and forthcoming introduction of structural remote working. We are fully on track in the deployment of our key projects. On the commercial side, the stock reduction also amid safeguarding our customers' financial position did not affect the service level that we kept as best-in-class in both Europe and North America. We increased our focus on the online business in China, also through partnerships, such as the new with the JD.com, and the already in place with Tuhu and Alibaba Group. Pirelli is now the top Tier 1 premium brand in 18 inches and above segment in the e-commerce channel, which represents roughly 20% of our Replacement sales. The launch of the new CRM tools completed in the pilot country, Italy, and is preparing to other European countries, where it will be enabled to increase in retail coverage and effectiveness in demand fulfillment rates. On technology-based innovation, leadership in electric vehicle tire technology led to the homologation of 1/3 of new original equipment projects to be fully devoted to electric vehicle platforms, thanks to both consolidated partnership with traditional Pirelli customers and electric vehicles only producers in North America and China. Widening North America presence as we started to supply new, for example, F-150 iconic model. Extension in winter and All Season portfolio leading to the widest coverage in the industry in the winter High Value segment. And enlarging our coverage in the fast-growing market of the All Season. Let's finally move to the operational drivers of our guidance. Based on the market scenario already described, we now forecast for the group a volume decline, car plus moto between a minus 17% and minus 18%. Minus 18 and minus 20 was the range of the previous indication with high-value volumes recording a minus 11% from the previous minus 14% and standardized at minus 25% from the previous minus 26%. Car new premium volumes, 18 inches and above, are expected to be down 10%, minus 13% the previous indication. Price/mix is now forecasted to be approximately plus 1.5%, approximately plus 2% the previous target, reflecting a more positive trend in the original equipment during the second semester, in line with car production recovery, and a more cautious view on Europe, especially in the replacement channel following the recent restrictive measures. A 5% decline on ForEx is expected, minus 4% previous target following the appreciation of the euro versus the major currencies in the second half of this year. As a consequence, revenues are now expected to be between EUR 4.18 billion and EUR 4.23 billion. Previous target between EUR 4.15 billion and EUR 4.25 billion. On profitability, we now expect to adjusted EBIT margin between approximately 11.5% and approximately 12%. Based on the different external scenario with a worsening of ForEx also impacting the cost of raw materials, currently expected to be minus EUR 15 million versus minus EUR 10 million. And the increase of other costs from minus EUR 70 million to minus EUR 90 million, partially of nonmonetary nature and connected to the significant finished product stock reduction in the third quarter to lower earnings from Prometeon and higher sponsorship expenses. As already pointed out by Mr. Tronchetti, our cash flow generation target is confirmed, thanks to a better working capital management. I now leave the floor to Ms. Leone for the review of the financial results.

Thank you, Mr. Casaluci, and good evening, ladies and gentlemen. Let's now review Pirelli 9 month's results in detail. Our top line performance was impacted by a tough external scenario with the global demand falling, minus 20.5% corporate market in the first 9 months and high ForEx volatility due to the emerging market currency stuff. The above headwinds were partially countered by price/mix improvement driven by our exposure to High Value segment. France improved in the third quarter with a small drop of sales of minus 1.5% year-over-year net of ForEx. A rebound was recorded in the High Value segment, volume plus 3.9%, more pronounced in the car 18 inches and above, plus 5.3% year-over-year where Pirelli largely outperformed the global market by 3 percentage points in both OEM replacement. This is particular true for China, where we enjoyed an outstanding growth and consolidating our position in the most prominent market for High Value. We continue to reduce our exposure to standards with volumes minus 12%, now accounting for about 45% of total car volume without neglecting the vast opportunities as we did in Latin America to achieve a higher plant operation and decrease of the stock level. Price/mix improved by plus 2.3%, a touch lower than in the second quarter, due to a more balanced trend between replacement and original equipment and that the channel mix was -- which was positive in the second quarter became neutral in the third. Product and regional mix were the major contributors. The price component was marginally down in line with previous quarter due to its large streaming in the large technology intensive segment and to remain the exclusive for OE. ForEx devaluation was more pronounced in the third quarter minus 6%, minus 4.7% in second quarter, one, in addition to emerging market currency volatility, the euro appreciated against all the other major currencies. In the third quarter, we posted a stronger profitability than in the first half with an adjusted EBIT margin close to 17%, again, among the best in the entire industry. This was a result of robust delivery of our net savings, competitiveness about this inflation and COVID actions impact of slowdown recording plus EUR 51 million or about 60% of the 9 months progression. This was also possible due to the limiting impact of slowdown, EUR 8 million in the third quarter versus EUR 70 million in the first half. And the positive price/mix equal to plus EUR 14 million. These internal levers limited the fact of the following headwinds. Volume drop equal to minus EUR 22 million. The volatility of ForEx minus EUR 18 million, also impacting minus EUR 5 million as the main currencies of countries where the group's production located, for instance, Latin America, Romania, Russia, depreciated against the euro and the increase of other costs minus EUR 43 million in the quarter, which were higher-than-expected due to noncash items equal to minus EUR 15 million, mainly related to the accounting impact of the strong reduction of finished product stocks for the period. Minus EUR 14 million with minus EUR 1.1 million car pieces and cash items related to additional costs, such as lower earnings from Prometeon equal to minus EUR 5 million transformation costs and sponsorships like soccer team and clubs. Moving to cash flow. At the end of September, our net debt stands at about EUR 4.3 billion, almost flat versus the end of June. The third quarter net cash flow was positive for EUR 12 million and in line with the same period of the previous year, thanks to -- in EBITDA, basically at the third quarter 2019 level, a lower CapEx versus previous year, however, aligned to the full year target, a cash out of net working capital, reflecting the decrease of inventories now go to a more normal level, 18.8% on sales in 9 months '20 from 21.1% in the first half of '20. The inventories reduction partially offset the increase of trade receivables 22% of sales in 9 month versus 14% in the first half due to the strong improvement of the business in the third quarter. In line with the usual seasonality of the working capital, further receivables are to be collected in the fourth quarter. Lower interest and taxes paid are basically offsetting [indiscernible] restructuring and the other expenses. We confirm our net cash flow target of approximately EUR 190 million, in case of payment of the European anti-fraud fine before the year end and EUR 220 million in case of payment is due in 2021. The adjustment of EUR 35 million of the full year guidance, profitability is not affecting the cash flow target since part of the additional cost of EUR 4 million, impacting the adjusted EBIT of nonmonetary and relating to the accounting of inventories reduction and credit impairment. The remaining EUR 31 million are covered by a better working capital management, mainly coming from inventories reduction in products, raw material, semi-finished products. Finally, the EUR 10 million of additional CapEx are not impacting since its cash out is due in the first quarter '21. Let me close my remarks with our current capital structure situation. As of September 2020, our gross debt stands at EUR 5.8 billion, a reduction during the quarter also thanks to the repayment of EUR 200 million of floating rate notes, which came due in September. Net financial position less than EUR 4.3 billion, while liquidity margin remains strong at EUR 1.85 billion, covering debt maturities through the first half of 2023 when full extension options on our main bank financing are considered. Last 12 months cost debt reduced by 0.84 percentage points to 1.99%, thanks to our deleverage, which positively impacted the margins of our committed bank lines, reduced exposure to high-yield currencies general fund of interest rates in countries where the group has its production facilities. Finally, let me remind you that during the first half of the year, we have managed our financial covenants and gained appropriate flexibility until year-end 2021. So that we can now face the outbreak of the second wave from the most comfortable position. Now I leave the floor back to Mr. Tronchetti, and thank you.

Thank you. So this ends our presentation. And now we may open the Q&A session.

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

The first one is on the price/mix. I know that maybe it's too early to talk about 2021. But I was wondering what is your feeling on the price/mix for the 2021. And if we can imagine price/mix more in line with your traditional level, let's say, 2.5% on the back of a better balancing between original equipment and aftermarket. And my second question is on the dealer stock inventories. How do you see the stock inventories so far also on the back of a likely weak winter tire season? And very last question is on the EV platforms. Could you please elaborate a little bit more on Pirelli's penetration on the electric vehicles both in original equipment and maybe if you can, on the aftermarket? And what would you expect going forward?

And so Mr. Casaluci will elaborate on the different question about price/mix and the trend for 2020 -- what we expect from 2021 and I just want to make a comment on electric vehicles. So we see it becoming an opportunity. This year 1/3 approximately of our new homologations are coming from electric vehicle. We expect in the coming years going up close to 50% of our new homologation. This year, we will have more than 300 homologation. So it means that 100 will come from electric, all 18 inches and above. And there are [indiscernible]. So this is the feeling of what is happening and where is the Pirelli positioned. Our position will be in line with the position we have today in prestige and in the high end of the premium. So we see this as a great opportunity. Please, Mr. Casaluci.

Thank you, Mr. Tronchetti. As you correctly said, it's too early to have a clear understanding of the price/mix for 2021. What we can say is that coming out from this volatile environment, that is something we cannot predict when will happen, but we do expect a more stabilized region and channel mix versus what happened in the last quarters. While we do expect to maintain our product mix performance, which is, as always, overperforming the industry. What is interesting to analyze for the time being, is the price environment. As we mentioned, there is price stability in the industry and there is a low level of inventory that is supporting some thoughts, positive thoughts concerning the price environment for the beginning of 2021 as well. So all in all, I don't expect the same performance as we saw in the last years where we reduced the standard much higher than what we did or we will do in the coming future, but we target to overperform the industry.

Okay. Just a follow-up before the dealer stock inventory question. I can imagine that the increase in penetration related to vehicles might further support the price/mix given that electric vehicles are mainly related so far to premium cars. Is it correct?

Yes, I kindly ask to repeat the first part of the question, please.

Yes. It's just -- it was just a follow-up on the price mix. On the back also of the penetration into electric vehicle platforms, electric vehicle platforms are usually so far for premium cars, and they should carry a higher mix. So I was wondering if this could be a driver also for '21 for the price/mix or maybe it's a more long-term driver.

This is more a long-term perspective. The electric vehicle market is still too small to affect the price/mix environment for 2021. But looking forward, you are right, electric vehicle needs -- requires a high level of technology. And as a consequence, we do expect to have a better price protection in this segment. If I can answer to the question related to the stock inventories in the trade. As I mentioned before, all in all, in all the regions, we record quite low level of inventories as far as summer and All Season pass is concerned, while for winter, it's too early to have a conclusion because the winter season in Europe is still affected by the warm temperature and above all by the restriction in mobility. So the stock is still high, and it's too early to have a clear picture on what will happen at the end of the season.

The next question is from Martino De Ambroggi of Equita.

The first is still on price/mix. Your comments were clear, but there is also the growing prices of raw mat that sooner or later will lead higher prices in a very disciplined market like the tire one. So when do you expect the first moves -- the first action in order to cover the rebound of raw mat?

If I may, there are already signs of, let's say, the industry that's not introduced a price discipline, but there are signs of price increase. So we expect in the coming weeks and months that something positive can happen in raw mat.

Okay. The second is just 2 quick questions. One, on cost savings. Could you remind us how much is temporary and how much is permanent of all your cost-saving actions?

Mr. Casaluci?

Yes. The picture that we have presented in our presentation is showing you on a full year basis, a saving of EUR 140 million net of inflation, which is absolutely confirmable for 2020. As mentioned by Mr. Tronchetti, Ms. Leone, we already delivered EUR 84 million out of EUR 140 million in the first 9 months, and we are confident to confirm the full target for 2020. Again, it's we are in the full phase of preparing our new industrial plan. And it's too early to tell you the amount of this cost that will be confirmed and as a structure for the next year. The environment changed a lot. There are a lot of discontinuities. And at the same time, a lot of opportunity and things we learned during this difficult 2020, and we will reflect all these activities and jobs in our new industrial plan.

Okay. And the last question was on the net debt. Just if you could elaborate a bit more on net working capital trend which is probably also the risk, which could be affected by the more prudent, more cautious view that you have on the aftermarket in Europe. And if you could remind us what is the underlying factor in assumption in your guidance?

Ms. Leone?

Martino, I can you give you a flavor of the working capital for the end of the year. We expect that the operating working capital will reach 4% of sales at the end of this year versus the 3% of the last year. We have 3 different components. If you want to have more color inventories at the end of 2020 is forecasted by around EUR 100 million less than the previous year. So we should reach more or less 21% of net sales. So the receivable are expected to reach 15% on sales by the end of the year, thanks to the cashing of the third quarter sales and the trade payables will follow the usual seasonality of the business. So it will increase in the last quarter of the year and should reach a weight on sales by around 32% by the year-end.

And could you [indiscernible] the payables, sorry?

With regard to the trade payables should reach 32% by the end of 2020 versus 30% last year as a consequence of the general business recovery and stock increase.

Okay. And factoring the underlying?

So with regards the factoring on trade receivables by the end of 9 months '20 to the standard level versus last year due to the business downturn. And by the end of 2020, we should be just a bit lower than previous year, mainly due to the business downturn.

Next question comes from Henning Cosman of HSBC.

The first one is on volume, please. I appreciate you've outperformed the market...

I'm sorry sir, could you please speak closer to the microphone? We can't hear you.

Is that better. Can you hear me now?