Continental (CTTAY) Q2 2014 Results - Earnings Call Transcript

Aug. 3.14 | About: Continental AG (CTTAY)

Continental AG (OTCPK:CTTAY) Q2 2014 Earnings Conference Call July 31, 2014 10:00 AM ET

Executives

Rolf Woller - Investor Relations

Wolfgang Schaefer - Chief Financial Officer

Analysts

Philip Watkins - Citi

Stephan Puetter - Goldman Sachs

Alexander Heisler - Credit Suisse

Henning Cosman - Berenberg

Marc Tonn - Warburg Research

Tim Rokossa - Deutsche Bank

Thomas Besson - Kepler Cheuvreux

Horst Schneider - HSBC

Christian Ludwig - Bankhaus Lampe

Frank Biller - LBBW

Philippe Barrier - Société Générale

Paul Hartley - Merrill Lynch

Kristina Church - Barclays

Rolf Woller

Thank you to all. A very warm welcome here to our Half Year Conference Call. We hope all of you have somewhat digested the massive news flow and information on the sector over the last couple of days. As always, before we start with the presentation, we have to mention that you should have received a mail linked to our half year financial report, the press release as well as to the half year presentation. If not, you can find them you would always find our publications, which is under www.continental-ir.com. I should also make you aware of Page 23 in the presentation, which is the disclaimer and that you can also follow this conference call via webcast.

We will start as we did start in the last 17 quarters with a presentation given by our CFO, Wolfgang Schaefer, who is sitting here in our room in Hanover together with my colleagues from the media relations team and the Treasury and Finance department. We will host a Q&A after the presentation. And after the call, you can and should reach out to us via our team to clarify any open questions you might have. My name is Rolf Woller and I hand over to Wolfgang that he can start with the interesting part of this call. Wolfgang, please go ahead.

Wolfgang Schaefer

Thank you, Rolf. Welcome to our H1 conference call. I will guide you now through the presentation concentrating on the corporation highlights, followed by more details on the Automotive and the Rubber Group, our indebtedness and cash flow, and finally our outlook for this year.

Starting on Page 3, the corporation highlights, sales were up in the first half of the year by 2% to €16.9 billion, which is an organic sales growth of 6% mainly adjusted for €600 million exchange rate headwind, which we have had. Adjusted EBIT was up by 10% to €1.96 billion, which leads to an adjusted EBIT margin at 11.6%, up 80 basis points compared to the previous year and the net income after tax was up by 14% to €1.3 billion. Thanks to lower P&L interest and to favorable tax effect.

The free cash flow amounted to €575 million mainly due to the higher EBIT and lower cash interest and a good working capital management and the net indebtedness as a consequence was down to €4.3 billion from €6 billion 12 months ago, gearing ratio now at 36% and at 42% down from 69%, equity ratio now at 36%. Trailing royalty was up by 220 basis points to 20.8%.

Now, three other topics to be mentioned. First one, the acquisition on the remaining shares in Emitec, which was just closed this morning, caused an impairment loss on the previous carrying amount of €35 million. Now, this means we had already 50% of Emitec, had equity in our books. Now, we acquired the leftover 50% for acquisition price, which was €35 million less than our book value. So, you might take the conclusion out of that that we managed to negotiate a good acquisition price. This €35 million loss is now reducing our reported EBIT in Powertrain in the second quarter, but it is not impacting our adjusted EBIT as our policy always includes impairment losses and gains in the items to be adjusted for. Second topic to mention, we had recognition of deferred tax assets on the interest carry-forward in Germany amounting to €98 million. And the third topic, I would like to mention we acquired (indiscernible) tire retailer, which improves our market coverage in France to more than 400 outlets and quite well spread over the France region.

Moving to Page 5, the Q2 reported sales were basically stable year-over-year with €8.5 billion, while the growth in all divisions was basically consumed by FX effect. The Q2 organic sales growth was 3.3%. So, this is now adjusted for FX. And there, please consider that we had the shift in working days between the first and second quarter. So, I think this year – the better comparison for growth is to take the H1 numbers. And if you take the first half year numbers and compare the sales growth with the previous year first half, we have a 6% organic growth. And this is by the way the same number we basically expect for the rest of the year to come. The Q2 margin was up to 11.8% adjusted margin, but again then fair enough to take the H1 number, which was 11.6% adjusted margin, up by 80 basis points.

And if you then want to calculate leverage on the H1 sales to EBIT growth, this is 53%. This is supported by raw material tailwind of €110 million. If you separate those numbers in the Automotive and in the Rubber Group as we do it on Page 6 of the presentation, you can separate an important reason for the lower growth, which is not related to the seasonality and the FX, which I mentioned before in the Rubber Group. The Rubber Group in the Q2 had an organic growth of 2% only and this is – and you will see this later in the presentation mainly due to ContiTech, where specifically the mining business is with the weaker development. The Auto Group showed 5% organic growth to €5.176 billion, with an 8.5% margin in the second quarter.

The following page gives more inside into the growth pattern of Continental versus the relevant market segments. And then obviously I just moved to the upper right chart, which is ContiTech sales and there you can see ContiTech sales organically growing in the first half of the year by only 2%. This is somewhat below the numbers we know from the past and this is actually due to quite a strong reduction in mining, business of ContiTech, which is conveyor belts and which is oil and marine hoses. This could not be completely compensated with strong growth in Benecke-Kaliko, which is supplying to the interior, to the leather seats of the car, which has a good performance and development.

Now, moving on to the upper left chart, Conti Automotive Group organic sales was 7% first half of 2014 while the worldwide passenger car and light truck production was growing by 3%. So, again, we manage to outgrow the markets by the 4%, which is our target Europe and after we are growing by 4%. Passenger and light truck tire volume growth was 6% basically in line with the replacement tire volume growth in Europe and in North America. And if I move to the lower right bars, the commercial vehicle tire volume growth at Continental was 8% and by that outgrowing Europe and basically in line with the growth, which we have seen in North America.

Page 8 is showing we are showing we are continuously creating value the return on capital employed was trailing at 20.8%. And as in the previous reportings, the improvement to the previous year was due to the improvement in the EBIT, but as well good working capital and overall operating assets management with, consequently, assets being stable on the actual level basically over the last eight quarters though the company in that time was significantly growing. Just to remind you, this still includes the €5.6 billion and will include the €5.6 billion in goodwill. There is no change in our maturities profile development.

Page 9 is showing this, thanks to a good free cash flow development in Q2 again. There were no amounts drawn under the revolver and the maturity timeline is very well adjusted with our cash flow potential. The total liquidity as you see in the upper left bar is at €5.8 billion similar to the level we have seen in the Q1 low we have paid €500 million dividend in Q2.

I move now to more details on the Automotive Group, I have commented already on Slide 10 and therefore move directly on to Slide 11, which is giving details on the organic sales growth and the adjusted EBIT margin by division. Starting with the sales growth, we have a Chassis & Safety growth rate of 6.4%, so faster growing than the market was growing in the first half of the year, that’s the advanced driver assistance system was giving a nice tailwind to this growth. Powertrain growing with 4.5%, at the lower end of the growth rate of our three automotive divisions, but as well – and outgrowing the market and interior was strong close to 9% growth driven by body controls by displays and by aftermarket growth led to overall €10.3 billion sales volume and the first organic sales in the first six months was 6.7% growth.

The adjusted EBIT at Chassis & Safety was at 9.2%, down from the 9.4%, which we have seen same period of previous year, so down 0.2%, but the numbers now include an R&D quota, which was up 0.7%. So, the basic business obviously managed to increase the margin by 0.5%, but this was eaten up by additional R&D spend of – R&D expenditures of 0.7%. Main reason and basically only reason for this is that we are now developing advanced driver assistance products for a sales volume of €1 billion, while at the moment, the actual sales is only around €500 million level. So, we are investing basically into the future growth of our company. And to remind you again, we are not capitalizing this R&D only a very few R&D of this is capitalized is if we were doing that, of course, the margin would be above previous year’s level.

Powertrain with 5.2% margin compared to the 4.9% increasing the margin to the expected level next year, which we are expecting not taking into account the HEV business. And interior with a margin of 10.3%, somewhat above the expectation and here I – well one reason of course the restructuring we have done last year in Australia and Brazil and Tunisia. Closing down the factories there helped to improve the profitability, but here as well, an additional comment, we are on the group level naturally hedged with currencies. This is obvious when you look at the development of our EBIT margin, but this is not true for all divisions individually.

Interior has some tailwind from the end, from the low end, where they are buying electronic products and displays, while they have few sales in the end area. This is just the other way around with Chassis & Safety. So, some headwind for Chassis & Safety, the highest sales of the Group in Japan, while at the same time they are basically not buying specific components from the end area. Overall, this lead to an automotive profitability in the first half of the year of 8.4% compared to the 7.8%, which we have seen as adjusted margin in the previous year.

The R&D expenses went up for the total Automotive Group from 8.4% to 8.9% driven by Chassis & Safety and as well by Powertrain CapEx with €389 million, 3.8% of sales was basically in line with the, to be expected CapEx number. Please always take into mind that we have some seasonality and that always the second half of the year sees stronger capital expenditures than the first half of the year.

Moving on to more details in the Rubber Group and again here I skip Page 12 and move directly to the divisional details. As we have seen it in Q1 and as I have already briefly commented on, we see different growth rates in ContiTech and in tires. ContiTech growing with 1.8% in the first half of the year, while – and I mentioned already the reasons for the lower growth rate than you might have expected, mining business is the reason, while tire was growing close to 5%, although also in the Rubber Group €6.6 billion in the first six months with a 4.3% growth rate.

If I split this growth in tires into its components, this reads as follows: volume was up plus 6%, price down minus 3% to minus 4%, mix was up plus 4% and FX was around 4% to 4.5% to leave us in the total with a 1.7% to 2%, which we see as reported sales change in the tire and rubber group, mainly tire group. Profitability 11.4% at ContiTech compares to the 12.4% in the previous year and the main reason here is that the profitable mining business was reduced as I said before. So, it’s a mixed effect and still well within the line of the 11% to 12% and sometimes a little bit more profitability we see at ContiTech. Tires with a 19.8% margin compared to the 17.4% in the previous year was supported by overall €110 million raw material tailwind in H1 Q2 at €60 million Q1 at €50 million, so overall the €110 million. Overall, margin in the Rubber Group, up to 17.5%. R&D was stable on 2.3% of sales, €152 million and CapEx with €404 million, 6.1% of sales now showing that no longer these big investments into the two tire plants, which we had previous year are to be final.

We saw earlier that the replacement tire markets in Europe and in the U.S. were growing with 5% to 6%. Page 14 is reconfirming that, you see on a monthly basis, the growth rates to the previous year on the left chart for Europe and on the right chart for North America and the breakdown of these growth rates in these monthly numbers confirms a lasting return to growth in Europe and in the U.S.

Raw material prices as shown on Page 15 are still low. We revised again our natural rubber price expectations for this year now to $2.10 per kilogram in 2014, before we were at $2.30. Synthetic rubber price butadiene feedstocks are forecasted now to average at $1.44 this year, which leads to the expectation of 160 million tailwind from natural and synthetic rubber cost for this year, so double what we had forecasted up to now as a tailwind for this year. We have unchanged the oil-based chemicals and textiles to increase year-over-year. We do expect rubber prices to increase in the course of 2014 as demand further stabilizes. And we do see that butadiene prices are already trading above the Q3 2013 level.

Some more information on the indebtedness and cash flow, Page 16 gives details on the net indebtedness components. If I start with the full year of 2013, net indebtedness was at €4.28 billion, gearing ratio of 46%. Now, we have paid our dividends of €500 million, we had CapEx of €827 million, and then we had a typical for the – Q2 typical increase even below the typical level increase of €785 million change in working capital. Depreciation and amortization reduced in net indebtedness by €796 million and then we had other cash flow basically the net income. So, overall, the net indebtedness stayed stable at €4.27 billion, 42% gearing ratio, but including dividend payments of €500 million.

And as a consequence, our net indebtedness if you look at the longer term picture continues further reduction specifically when you look at the 2013 numbers, Q1 to H1, Q1 to Q2 we had an increase in our net indebtedness due to the dividend payments, which we do not see this year stable development though this is reconfirming good, free cash flow development as well in the second quarter and the liquidity I mentioned is already, including the undrawn lines is at €5.8 billion. With this development now, we do expect that the gearing ratio will stay at below 50% even if we consolidate Veyance in the fourth quarter. We are still optimistic that this might work. We have now the clearance from some of the antitrust offices, though some big offices are still working on this case. And so it is not completely sure that this will happen in the fourth quarter. It might be shifted to the first quarter 2015, but at the moment, we are still confident that the consolidation in Q4 should be possible.

Page 18 is giving a cash flow overview comparing always the 2013 H1 numbers to the 2014 H1 numbers. The cash flow from operating activities improved by €800 million to €1.4 billion. And the reason is the improvement in EBIT, less taxes paid, less interest paid and the positive development of the working capital. So, all components were contributing to this improvement. The cash flow used for investing activities looks higher in 2014 and 2013 by roughly €150 million. Please take into account though that last year and the first half of the year we had the sale of our stake in SY and some other M&A effects, which overall led to a relief in the cash flow used for investing activities of €160 million, if you correct for that, basically same level. So, finally outcome is the free cash flow, which is €575 million in 2014 compared to a slightly negative number in 2013.

I move on to the outlook, we have looked at the passenger car and light truck production by quarter. And on Page 19 left side Europe, right side North America. If you have a look at Europe after the strong first quarter, where we saw growth always compared to the 12 months before, strong growth of 8% to 5.2 million cars produced as the second quarter already saw only an increase of €0.9 million. Second quarter was basically on the same level as the first quarter in 2014, but the first quarter of 2013 at a much less sales in the second quarter of 2013. So, it’s a base effect.

Ending up in the H1 with plus 4%, we do expect the third quarter production be on the same level as 2013 and we do expect basically the same for the fourth quarter. So, overall, H2 will be on the level of H2 of 2013. Different expectations for the U.S. after the growth in Q1 and Q2 of 4.7% and 3.4%, we do expect quite a strong Q3. This is what we can see in the call-offs which we are now getting in for the at least first part of the Q3 and Q4 should be then back to our goals of 2.4%. So, Q3 expected at close to 9%, Q4 at 2.4% should leave second quarter with a growth – second top of the year in the U.S. with a growth of 5% to 6%.

This leads then to an outlook on Page 20 for our markets, with Europe 2% growth very much driven by the growth in the first quarter as I was just discussing, NAFTA up 5%. The stronger third quarter should help to get the growth of the market to €17 million compared to the 3% growth we had predicted or expected in the month before, we are now to a growth of 5%. South America, the minus 4% we had expected after the first quarter of last year – after the first quarter of this year is now down to minus 10%, as we do see the markets reduced in the first half of the year by far more than 15%. Asia up 4% in line with what we had expected before, driven again very strongly by China, with an 8% to 10% growth over the year.

Passenger car and light truck replacement tire markets, a little bit stronger than we had expected before 3% in Europe and North America, where we had expected 2% before, so a slight increase, you saw the numbers by month delivered stronger than we had expected, which leaves the overall world market increased by 3%, as South America though not growing a strong anymore in the replacement tire market still having a growth of 2% this year.

The commercial vehicle production in Europe will be down due to the pre-buy effect we have seen in the end of last year, Euro 6. North America, up a little bit stronger up than we had expected before, South America down overall increased by 1%, and the replacement tire markets for the trucks is expected to increase by 4% in 2014 compared to ‘13.

And this leads me to the outlook for the Continental Group. We expect the sales volume to increase to €34.5 billion compared to the €35 billion we were communicating up to now. This is now including €1 billion negative FX compared to 0.7%, which we had seen before. So, basically, the reduction is getting out of the FX development and this is what you see as well on our sales expectation for the Automotive and for the Rubber Group, each of them reduced by €200 million to now €20.8 billion and €13.8 billion respectively. Again, FX is the main and basically only driver for that.

Adjusted EBIT margins for the group up to 11% – to around 11% guidance, now as we before said more than 10.5%, this is the change in our expectation for raw material prices, up to €160 million from the €80 million, which we had guided before. And that’s where the productivity development in the first half of the year, which was better than we, originally had expected. We do expect special effects to be around €100 million, as we had already the €34.5 million for the acquisition of Emitec, which I mentioned before adjustment of the book value of 50%, which we headed in our books already before.

Net interest expense below €400 million, I would add now clearly below €400 million and the tax rate below 25% due to this tax effect, which I was mentioning for Germany before in the first half of the year, CapEx around 6% of sales, PPA around €190 million, no change to what we had guided before. Free cash flow now was a good development in the first half of the year, guidance up to €1.5 billion always before acquisitions.

Now, this concludes my presentation. And we are open now for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Mr. Philip Watkins, Citi. Please go ahead sir.

Philip Watkins - Citi

Hi, good afternoon. It’s Philip Watkins from Citi. I don’t know if I could just ask two. Firstly, on Powertrain, could you just update us on your latest thinking about achieving the 8% margin and when that’s going to be achievable? And just specifically, I noticed in the interim report there was – I think there was some weakness for injectors and pumps. Well, what was – what do you think was going on there in terms of weakness? And in terms of cash flow and M&A, Veyance technology seems to be a large conveyor belt business in there and it’s also relatively weak in ContiTech. How are you feeling about that the acquisition? And are you able to give any insight into how it’s performing? Thank you very much.

Wolfgang Schaefer

Well, I confirmed already achievement in Powertrain for next year. Excluding HEV business, as we have discussed it times before, if the growth is not completely up to expectations where it is, injectors, it is the pumps business, this is true, but again this is nothing new compared to our communication, it’s the engine system part of the business, noting new to the communication, which we had given before. You are right conveyor belts is part of the business of the Veyance Group. Different to our business development, the Veyance Group is showing as far as we know it, and you know, it’s not yet sold, so we have limited access to the numbers. But as far as we know it, it is very much in line with our assumptions when we have signed the contract. There is one difference to ContiTech, which is conveyor belts of Veyance is more in the NAFTA region, while ContiTech is more in Europe and South America and these markets have a different development, Europe and South Europe are weaker than the North American market. But again, for all what we know, business is very much developing according to our assumption for 2014.

Philip Watkins - Citi

Okay, thank you.

Operator

Thank you. The next question comes from Mr. Stephan Puetter, Goldman Sachs. Please go ahead, sir.

Stephan Puetter - Goldman Sachs

Yes, thank you very much for taking my questions. The first one is on the FX side, given the most recent moves we have seen in some of the currencies and I guess in particular euro/dollar, I was a little bit surprised to see you guiding for higher headwind. Can you maybe clarify a little bit what the underlying assumptions are behind that or in other words, the most recent moves and particularly on euro/dollar, have you incorporated those or do they maybe provide a little bit of relief? And then secondly, I would also like to come back a little bit to the divisional margins on the automotive side, I think you gave very good explanations for what happened in the second quarter and maybe specifically related to R&D, but can you give a bit of guidance how you expect, in particular, Chassis & Safety, but also the high margin in the interior business to progress until the end of the year? And then thirdly also a topic which was already touched upon M&A, the balance sheet is obviously in very, very good shape. And yes, you have got Veyance ahead of you and that will provide an outflow, but there is probably a lot more room to redeploy capital and maybe you can recap just your thoughts on the priorities? Thanks very much in advance.

Wolfgang Schaefer

FX, the recent moves as you were assuming are not included in our guidance. Basically, the guidance is assuming that the average FX rate of the first half of the year will be continuing in the second half of the year. If this is not the case or if you have different assumptions on that, I mean do you – this will change the guidance and would probably reduce the FX headwind and by that increase sales. On the expectations for Chassis & Safety and interior, well, Chassis & Safety will continue its high R&D and potentially and it is included in our guidance, as I said Chassis & Safety will basically have the same slight disadvantages or disadvantage on the yen exchange rate. Nevertheless, with the increasing sales, we are confident that the Chassis & Safety margin in the year should move up towards the end of the year. Interior, the advantages I have described, the exchange rates, slight tailwind from the exchange rates, as well as the positive product mix and the restructuring advantages as well should have a lasting impact. So, I think the third quarter again will show a good margin in the interior business.

M&A, we, I mean, do have now obviously Veyance to integrate. Nevertheless, as we have always stated, we would not be afraid to do another acquisition potentially of that size. If there is something we find attractive and we would go for now don’t expect anything over the next month, but no change in our communication, if there is something which fits our target to get the group strength in specifically the non-OE part of our business. And we will definitely have a close look at it and I would not exclude that something within the next 18 months is coming up, which we find attractive and we do investing.

Stephan Puetter - Goldman Sachs

That’s very clear. Thank you very much, Mr. Schaefer.

Operator

Thank you. The next question comes from Mr. Alexander Heisler, Credit Suisse. Please go ahead, sir.

Alexander Heisler - Credit Suisse

Yes, good afternoon. It’s Alex Heisler, Credit Suisse. My first question is on the guidance – on the sales guidance, if I take the €34.5 billion excluding currency, we are at €35.5 billion. If I exclude currency effect in the first half and see what’s left in the second half, this implies basically organic sales growth of €500 million, mainly coming from the Rubber division, can you help me to understand what is driving the sequential growth in the Rubber division or did you include any contributions from Veyance already, that would be my first question?

Wolfgang Schaefer

No. If you want the answer right away, no. There is no Veyance effect included in our guidance. So whenever and whatever we talk about the balance sheet, cash flow is always before Veyance as well on the sales side.

Alexander Heisler - Credit Suisse

So basically you are seeing acceleration in growth in the Rubber division, a sequential growth?

Wolfgang Schaefer

Yes. We do see that.

Alexander Heisler - Credit Suisse

Okay.

Wolfgang Schaefer

We do as well, by the way see some stronger development now in Powertrain. In the first quarter we expect the mining business to get back closer back to previous year’s level.

Alexander Heisler - Credit Suisse

Okay, very clear. My second question would be on the tire business, you have achieved 6% growth in the first half, is it fair to assume that for the full year you may come out at 5% growth. And my follow-up question on the tire business is can you give us an update on the ramp up in Russia and in the U.S. if I remember right, you have indicated 1.5 million units each, how much of that has been achieved in the first half and how much is basically left in the second half?

Wolfgang Schaefer

The ramp up numbers, which you are remembering are those after basically three years period of ramping up the businesses. So for the first year of both of these locations, expectation is – when I say rough numbers now, 1.5 million for each of those locations. We are well on track to achieve that. And though Russia is as a single market now weaker than we originally had expected, there is still more than sufficient volume which we are importing at the moment into Russia, which can be replaced by local production. And therefore, the ramp up in Russia is very much on track and we do have the tires to sell in Russia which are made in this factory.

Alexander Heisler - Credit Suisse

Well, what was the figure for this year on Russian volumes that you deliver from the new plant?

Wolfgang Schaefer

Well, it’s roughly 1.5 million, which we are going to produce in the Russian factory.

Alexander Heisler - Credit Suisse

Okay.

Wolfgang Schaefer

And this is basically reducing the – or it is reducing the imports which we have done into Russia before.

Alexander Heisler - Credit Suisse

If you would split this 1.5, is it fair to say that the first half is less than 40% given the ramp up of the plant, so you get more volumes from the new plant in the second half?

Wolfgang Schaefer

This is yes.

Alexander Heisler - Credit Suisse

Okay. And my last question is on the admin costs in the second quarter. They have been up some €23 million sequentially, is this the figure we should expect going forward as well, or was there something like a one-off during the quarter?

Wolfgang Schaefer

Well, the second quarter always has the variable compensation for our executives and senior executives included. And if you have a look at always years where we had a good year before, you will see this type of seasonal effect. So don’t take this times four, we only pay that once per month, once per year. So it’s not people, yes, like that, no, once per year.

Alexander Heisler - Credit Suisse

Sorry. If I may ask one question on Russia – I forgot to ask it. Did you see any improvement in June, I mean I have heard that June was probably already a better month for the Russian market for the A and B class buyers, so did you see any improvement towards the end of the quarter in Russia?

Wolfgang Schaefer

No, I am not aware of that.

Alexander Heisler - Credit Suisse

Okay, thank you.

Operator

Thank you. The next question comes from Mr. Henning Cosman, Berenberg. Please go ahead.

Henning Cosman - Berenberg

Yes, thank you. Good afternoon. Maybe one question on the retail acquisition in France, if you could just give us an indication about the size or maybe purchase price or sales size of that business that would be much appreciated. And then secondly, maybe, Michelin mentioned the day before yesterday they saw a very strong winter tire market in June in Europe, but a tough pricing environment, so maybe you could comment on how that might have affected you and how that might have affected dealer inventories on the winter tires as we go into that season. And then finally, maybe to comeback on the sequential development and EBIT margins and just to Powertrain again, can you give us maybe some more color on how this is going on or what exactly is going to drive this improvement into the 6.5% area if we do include the hybrid business, is it really a very sudden end office you mentioned with the all legacy contract, because we have seen fairly stable margin development there for the last few quarters, so additional color would be great? Thank you.

Wolfgang Schaefer

Retail acquisition in France, the rough number around €100 million sales, which we have acquired there and winter tire business price is in line with the price breakdown I was giving for the first six months. So, roughly a minus 3% to 4% is what we are seeing and it is indeed that we had a very strong sell-in into the dealers now in the last weeks, stronger than we have seen it in years before. Too early to draw a conclusion that this will be a super winter tire business or season this year, but I mean of course definitely a good start. Prices are in line as I said with what we have seen on the business in the months before. The EBIT improvement in Powertrain is stemming out of growth mix and productivity improvement.

Henning Cosman - Berenberg

Okay. If I can just come back, is that contradictory then somehow to the anticipated volume acceleration in the second half year in the tire business or is it more of the same more winter tires or what’s driving volume acceleration in the tire division? And just, if you could also give us an indication of the purchase price for the retail business in France?

Wolfgang Schaefer

When we say very strong sell-in, this is still numbers which are not so much changing the first half of the year to the second half of the year. There is still a period that June is still a time period where normally quite low numbers go into winter tires into the retailers. And now, it was clearly stronger, but not really changing the picture H1, H2 of the year. The additional information, which I was basically giving, was that even in July this was continuing. So, July as well and then of course, numbers are already normally higher. July again saw this quite good selling into the dealerships. I mentioned on our prices to the whole end and retailers, which are down 3% to 4% compared to the previous year level. I have no indication how this is further transported or transferred to the end consumer.

Henning Cosman - Berenberg

Okay, great. Thanks. And just the purchase price for the French business?

Wolfgang Schaefer

We did not comment on and publish that number and don’t comment on that.

Henning Cosman - Berenberg

Okay, thank you very much.

Operator

Thank you. The next question comes from Mr. Marc Tonn, Warburg Research. Please go ahead.

Marc Tonn - Warburg Research

Yes, good afternoon. Coming back to tires and the pricing trend as you are expecting raw material prices to at least be a bit more stable in the second half or even going up in terms of butadiene feedstock, have you seen any reduced speed of price decreases from the industry already? And perhaps going forward for tires in general, I mean at Continental on a much higher level than at many competitors, but we have seen profitability increasing quite significantly in recent years for this segment. Do you think that this may trigger, let’s say, in additional capacities in particularly Europe within the next years? I know that this needs years to build up, but do you see any steps there which could, let’s say, lead to more capacity going forward and potentially some pressure on prices in volumes? Thank you.

Wolfgang Schaefer

Well, we have – I am not sure if I completely understood the first part of the question right, but the raw material impact in the first – tailwind in the first half of the year was under €110 million expected total year €160 million. So, that’s already in the second half of the year. The price decreases are in line what we see for the rest of the year, as I just confirmed with winter tires, is one example as we have seen it in the first half of the year. And specifically, the first half of the year still saw, if I compare December prices of last year to April prices of this year, saw basically stable development in the U.S. as we had the price decreases last year in the U.S. in the end of the third quarter. And this is what we expect as well as to be matched now. So, overall minus 4% first half – minus 3% to 4% first half, minus 3% to 4% second half, overall year minus 3% to 4% is what we are expecting. Additional capacity in the high-value add – high-performance tires, is what we are observing in the market ourselves. We are building up capacity. We do see though that this segment is growing strongly and we don’t foresee an over capacity building up over the next years.

Marc Tonn - Warburg Research

Thanks.

Operator

Thank you. The next question comes from Mr. Tim Rokossa, Deutsche Bank. Please go ahead.

Tim Rokossa - Deutsche Bank

Yes, hello. Thanks for taking my questions. There will be two left, please. I think you said this morning you are not yet approached by your customers for more than the usual price discounts. But in light of all the announced cost cutting programs these days, do you still expect this to happen or do you feel that with your positioning in product portfolio you would rather see less of this coming through. And then just on the retail acquisition in France, will you continue to improve your market coverage going forward and is the fact that you are capturing a larger part of the value chain and have better control over distribution sustainably positive for your margin that you can generate in this business? Thank you.

Wolfgang Schaefer

To my knowledge, we were not yet contacted with our customers for additional price discounts, but please be assured that I mean basically the discussions with our customers are always on price reductions, fair enough from the point of view of our customers and the prices which we have now already taking into account the degree of differentiation which we can make and the level of benefit we give to our customer compared to the price which we are getting from our customers. So I would not expect that the announced cost reductions which will go on o other customer that I was publicly talking about, that this is having an affect on our price development this year or next year. In addition to the price down, which we do see any every year anyway and we are constantly investing into retailers over the last years and many of them being smaller deals than the one we have done in France therefore we have mentioned at this time. And of course, this is increasing potentially our sales strength over the next years, and controlled distribution, as we call it and we are going on following this path as well. And our estimation is that there is a consolidation in this retailer market over the next 10 years to 15 years which has already started some years ago. And we definitely will participate in this consolidation.

Tim Rokossa - Deutsche Bank

Thank you.

Operator

Thank you. The next question comes from Mr. Thomas Besson, Kepler Cheuvreux. Please go ahead.

Thomas Besson - Kepler Cheuvreux

Good afternoon. Thank you very much. I have two questions please and three if I ask a continue on, I missed the start of the call, the margin guidance around 11% looks slightly conservative to me, given that you achieved 11.8% in the first half, is that still your typical conservative guidance, or are you anticipating something more volatile than we do for H2?

Wolfgang Schaefer

What shall I answer to this, is this your typically conservative margin. This is our best expectation at the moment 11% for the total year and would I exclude that it could come out better I would not exclude this but don’t forget, as we talked about the raw material tailwind was more in the first half. And then in second half, it was always the topic of customer reimbursements, which might be distributed differently from one half to the other. And so our best forecast knowledge at the moment is this 11%, around 11%.

Thomas Besson - Kepler Cheuvreux

Okay, very clear. Second question, on the China continent pricing – it has been the let’s say noisy topic over the last couple of days, could you talk to us whether you think it might have any indirect implication on your OES or IM aftermarket in China or whether you think it’s going to be more concentrated on what the (indiscernible) are doing?

Wolfgang Schaefer

Well, the actions or discussions of the party government, I think, with the OEs are purely among those two groups. We were not approached in this, and our aftermarket business at the moment in China is not very significant.

Thomas Besson - Kepler Cheuvreux

Thank you very much.

Operator

Thank you. The next question comes from Mr. Horst Schneider, HSBC. Please go ahead.

Horst Schneider - HSBC

Yes, I think two questions are left from my side. First of all, related to the automotive guidance, when I look at your production volume forecast by market for Europe and for NAFTA. I mean, it strikes me again that you are forecasting that the production volumes in H2 will be smaller than in H1. At the same time, you assume that the automotive revenues will be more or less as strong in H2 as in H1, respectively H2 maybe even slightly higher than H1.So, the conclusion – I just want to know if my conclusion is right that your outperformance basically will increase in H2. And on top of that, I want to know I mean we have got a quite uncertain global macro environment. And I know when I switch on TV, I get sometimes the impression that the world is falling apart. So, I want to know from your supplier perspective, do you see already that in some regions the orders are getting lower or lower than expected. Have you got the feeling that risk regarding production volumes for H2 have rather increased? So, that’s question number one. And question number two is we see increasingly more from some comic announcements on additional cost-cutting programs and one element of each program is cutting purchasing costs, reducing complexity. I just want to know if you got already the feelings that the price pressures from the OEMs is increasing? Thank you.

Wolfgang Schaefer

First, your assumption on outperformance improved in the second half compared to the good number we had in the first half. And I do confirm this. We do our auto revenues improving, as you have calculated all of the numbers. And I have, I think given the details on our expectation on the world car production, which by the way is strong in China and in the U.S. from our expectation. And this is what we do see in colors which are already, of course, attaching on the third quarter. And there is – I feel quite okay with this guidance.

Horst Schneider - HSBC

Sorry. In which region, do you outperform in particular then, obviously outperformance increasing in particular, so maybe by region and by segment?

Wolfgang Schaefer

No, I don’t have these and now for the first half of the year.

Horst Schneider - HSBC

No, for H2, for the outlook, so when you say the outperformance is increasing…

Wolfgang Schaefer

We don’t give an outlook on outperformance. I can provide those numbers in March of next year. And the cost-cutting of the OEs, as I said we have a constant discussion with our customers on prices. They always try to get the best price from their side. We have strong discussions with them about what we deliver in value, what they want to pay in price for that. We don’t expect that the public discussion now from the – from our customers – where they talk about further improvement of their margins is changing our price position towards them this year or next year.

Horst Schneider - HSBC

Okay. Okay, thank you.

Wolfgang Schaefer

Yes.

Operator

Thank you. The next question comes from Mr. Christian Ludwig, Bankhaus Lampe. Please go ahead.

Christian Ludwig - Bankhaus Lampe

Yes, good afternoon. Two additional questions from our side. First of all, coming back to Russia, I mean, if we would assume a worst case scenario that due to all these political issues, the Russian nationalized international investment. What is the risk that you currently would be facing if your investment there would be taken over by the government? That will be one question. The second question is on your areas, you mentioned that you are investing very heavily on R&D to get the sales up to €1 billion, when should we see that ratio coming back to normal levels already in 2015 or is that back ended towards 2016? Will we see a jump from €500 million to the €1 billion in 2016 or should we see a continuous trend through ‘15 to ‘16?

Wolfgang Schaefer

To start with the second question, this will be a continuous – it’s pure mathematics – a continuous process. The more the actual sales are growing, the less the relative growth rate will be from one year to the next and less with effect of R&D, which is based on a different sales level than you actually have in your book is a topic. So, this is not one day to another, this is going – it’s a continuous process where the R&D quota should then get to a more normalized level. While Russia worst case and I think you are rightly saying the worst case will be we are losing our assets in Russia. And at the moment, the assets are around €250 million to €300 million, it’s basically our tire factory which we have built up there. Sales volume, by the way, is well below 1%, clearly below 1% of the total sales of the group, so as well around this level €250 million to €300 million, now obviously a little bit less, because of the weaker markets there. And so both are numbers which are of course not nice should they materialize, but both are numbers which can be very well carried by the book.

Christian Ludwig - Bankhaus Lampe

Okay, thank you very much.

Operator

Thank you. The next question comes from Frank Biller, LBBW. Please go ahead.

Frank Biller - LBBW

Yes, hello, Frank Biller from LBBW. Just one question left on my sheet here, it’s concerning the tax rate. So, after this recognition of deferred tax assets in the second quarter, what is the assumption for the years to come from ‘15 onwards? Is it below 30% or what is the number here?

Wolfgang Schaefer

Yes, the tax rate for Continental with the actual split of our profits throughout the world is below 30%, it’s around 28%.

Frank Biller - LBBW

Okay, thanks.

Operator

Has your question been answered, Mr. Biller?

Frank Biller - LBBW

Yes, answered.

Operator

Thank you. The next question comes from Mr. Philippe Barrier, Société Générale. Please go ahead.

Philippe Barrier - Société Générale

Three questions, if I may. First question, again on the guidance on the tire business, actually, on the rubber business as a whole, you maintained the guidance of margin above 16%. Actually, you are largely hurt on the first half of the year. I would like to know if there is some seasonal impact which may lead to lower margin in second half of the year. But looking at your guidance in term of tailwind, also looking at the good figures expected, I would say, on the winter tires, I don’t see any reason to see decreased margins second half of the year on the rubber business?

Second question is regarding the CapEx, it seems that in the first half of the year the CapEx level is largely below the full year guidance of 6% of sales. I would like to know if there is some strong increase to expect in second half of the year regarding the CapEx or different expenses. And the last point is regarding the financial charges. Actually, you are guiding to net financial charges below the €400 million mark. On that point, you are also ahead of expectation. I could understand that we submit first points or one-off points in the first half of the year, but nevertheless, could we think that we will be largely below the €400 million financial charges or net expense on full year?

Wolfgang Schaefer

First question, no, we don’t have a clear seasonal pattern in our tire and rubber margins. And CapEx, we do have seasonality there and if you see the numbers now below the 6%, we expect them in the second half of the year to pickup. We always do have this trend specifically in quarter three and four to have higher CapEx numbers. And if you look in our – in the history of the company, this is very typical for Continental. And as I know from my experience many companies do have the seasonality, not always logically to be explained I think. And the first – the third question – I mean, we do not see very many special effects in our interest cost over the next months to come. So, when we are talking now of the number below €400 million and your assumption that this can be clearly below €400 million is very right.

Philippe Barrier - Société Générale

Okay, thank you very much. Just another question, if I may regarding the Chassis & Safety division, actually, any cost is quite high for the time being. I suppose it largely taking to account the high expenses on the active safety system. Actually, when could we see some positive impact from the R&D in term of profitability? You mean that we may assume that the new kind of businesses may lead to higher R&D forever or could we just think that with a kind of milestone and that group will roughly benefit from the expenses which have been – will take place in 2014?

Wolfgang Schaefer

You do see already that the business, which is now helping – or is now supporting the growth of Chassis & Safety obviously has a higher margin before fixed cost because the 0.7% increase in our share of R&D only leads to an 0.2 percentage point of reduction in the margins. So obviously the, if you want to call it gross margin of the business is already improving due to the new orders we are getting from the others business, meaning that we have a little bit of change here in the nature of the business we taking on board. We are more moving to software, where the hardware part of the total thing is reduced. But therefore, the fixed cost R&D part of the total product is partly increased. And you do see this already at the development of the cost structure of chassis and safety but still somewhat distorted because as we have discussed now before, the percentage of the business which is already this new business with higher raw margins and then as well higher fixed cost is still smaller in the sales chain while the R&D cost is already on the level of higher sales.

Philippe Barrier - Société Générale

Okay, thank you very much.

Operator

Thank you. The next question comes from Mr. Paul Hartley, Merrill Lynch. Please go ahead sir.

Paul Hartley - Merrill Lynch

Good afternoon. Just one question from me, really on the production outlook for the second half, your expectation that that will be flat year-on-year, from our perspective as analyst, it looks as though sales could show some modest growth in Europe in the second half and exports have clearly been quite positive in H1 and mostly expect that to continue. So I was just wondering what you are seeing in your production schedules or what you have seen in recent months to drive that assumption that production will be flat in Europe in the second half?

Wolfgang Schaefer

Actually, if you look at the second quarter, the sales increase in Europe compared to the second quarter 2013 was only 0.9%. So we had this very strong increase in the first quarter of 2014 which was due to the very low volumes in the first quarter of 2013. We had increase in 2013 in Q2 to a level which is basically the level we have seen now in the second quarter of 2014 and this is what we expect to continue. And please take into account when we talk about Europe, this includes Russia and this includes Turkey. So this includes Israel, markets which at the moment are either like Turkey, basically stable, not growing strongly or markets like Russia, which we expect to decline of 10%.

Paul Hartley - Merrill Lynch

Okay. Thank you. And just one follow-up on that, I think SKF made some comments that they are seeing a sharp deceleration in production activity towards the end of June, can you confirm anything that you have seen?

Wolfgang Schaefer

Who was seeing that deceleration I am sorry I couldn’t understand it?

Paul Hartley - Merrill Lynch

There was comments made by SKF?

Wolfgang Schaefer

No, I cannot confirm that.

Paul Hartley - Merrill Lynch

Okay, thank you.

Operator

Thank you. The next question comes from Ms. Kristina Church, Barclays. Please go ahead.

Kristina Church - Barclays

Yes. Thanks for taking my questions. Alright, coming back to China, I just wondered when you think sort of replacement demand for tires from the European makers might take off more strongly, is it a case of sort of when CapEx – when the plants come online or is it more a consumer taste difference in China that they are using (indiscernible) players, if you could comment on that. And then coming back to the HEV business in Powertrain, are you expecting the losses from that business to widen further from here or what should we expect for that in terms of the drag on margins for the Powertrain business? Thank you.

Wolfgang Schaefer

Now we do expect for the second half of the year basically the same profit situation or loss situation in HEV Powertrain as we have seen it in the first half of the year. And we do not expect a dramatic change unfortunately for the year 2015. Replacement tire demand is well for the high performance tires or high value-add tires in China. It’s already growing strongly, though this is still a smaller segment of the total market, of course, as the car park with cars which are using these high performance tires is still smaller but growing very strongly. But we do see a growth in the replacement tire and high performance tire segment as we do see it in the total market.

Kristina Church - Barclays

Thank you.

Operator

Thank you. There are no further questions at the moment.

Wolfgang Schaefer

Very good. Then we thank you very much for these very interesting and very good questions. We hope on that every one of you can enjoy at least a short summer break. And we are very much looking forward to talk to you again latest on November 4 when we will report on our nine-month results, which will be in Regensburg. Thank you very much and have a good afternoon.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!