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

Ladies and gentlemen, welcome to Pirelli's conference call in which Pirelli's top management will present the company's first half 2021 financial results. A live webcast of the event and the presentation slides are available in the Investor Relations section of the Pirelli website. I remind you that the Q&A session will follow after the presentation. Now I would like to introduce Mr. Marco Tronchetti Provera. Please go ahead, sir.

Thank you. Good evening, ladies and gentlemen, and welcome to our conference call. The scenario that is taking shape highlights a faster recovery from the pandemic both in the global economy and in the tire industry, where the high-value demand is already exceeding 2019 levels. The 18 inches and above market in 2021 is now expected to grow at 15% year-on-year, 2 point percent more than the initial expectation. Our Industrial Plan implementation continues in line with the expectation on all programs. Our high value share increased sensibly, in particular in car 18 inches and above, almost 2 share points gained in first half. A further commitment in sustainability is witnessed by the production of the first ever tire made with natural rubber and rayon certified and traced by an important international NGO. The results of the second quarter show the strengthening of our performance, with a 15.8% EBIT margin close to the second quarter 2019 level and a high cash flow generation, 13% of sales. The good result in second quarter and the improvement of the external scenario has led us to upgrade our full year targets on revenues, profitability and cash flow. The economic recovery is accelerating compared with the initial expectations, thanks to the massive government aids and the vaccination plan proceeding at a fast pace. The average yearly growth rate of global GDP is currently estimated to exceed 5% in 2021 and '22, with the major economies on the way to a full recovery of pre-COVID levels, especially in the high-value regions, U.S., Europe and China. The volatility of exchange rates is decreasing and the trend has become clear already in the results of the second quarter. In the tire industry, the expectation for high-value demand has improved. The global high-value market is expected to exceed 2019 levels by 5% for the full year. The view is different according to the channel. Due to the good sellout demand and still limited inventories in the trade, the expectation for Replacement demand are on the rise. Instead, in the Original Equipment channel, expectations are modest due to the uncertain trend of vehicle production caused by semiconductor shortage. And in this context, we keep on monitoring the market to deal with slowdowns and seize every opportunity in the Replacement channel. The price scenario remains favorable. The announced price/mix increases were applied to our sales network in all regions. The levels of trade inventories are normal. This will facilitate the acceptance of the announced price increases effective for Pirelli, for instance, in the United States from July 1, or planned in other regions given the inflationary scenario of raw materials and in transportation. What we aim is the offsetting raw material and exchange rate headwinds over the year through the price/mix increase. First half results reflect the progressive implementation of our key programs in the Industrial Plan. At commercial level, we strengthened our leadership in high value through a product portfolio with high technological content and production and logistic structures that allowed us to fully capture demand recovery. In line with our objectives, we increased our exposure to 19 inches and above that now account for 66% of high-value volumes, plus 3 point percent year-on-year and to new technologies, while the electric business experienced volume growth, equal to 9x of the first half of 2020, which means 4.7% of the 18 inches and above Original Equipment. In these 6 months, we consolidated our leadership in the high end of the market in China, with plus 2.5 percentage point increase of our share in 18 inches and above both in the Original Equipment with a share increase of 2.3 point percent, thanks to our strong exposure to premium carmakers and our partnership with the major local premium producers of electric vehicles. And Replacement channels share, plus 3.4%, where we intercepted demand recovery through our distribution chain and a strong development on the online business, that today accounts for 27% of our volumes. As for innovation in the first half, we completed around 170 technical homologations, exceeding 50% of our full year target, equal to about 330. They were concentrated in the 19 inches and above approximately 85% and specialties approximately 50%. And we launched 4 product lines dedicated to Replacement, 2 lines in Europe and 2 in North America. They expand our all-season offering in the range of tires for the CUV, SUV segment. In the competitiveness program, Phase 2 of the efficiencies plan is proceeding with gross benefits of EUR 83 million, EUR 50 million net of inflation. In the first half, we achieved 60% of the full year target. In the operations program, we completed the reorganization of our plant in Burton, U.K., while the saturation level of the other facilities is improving. On the ESG front, we maintain our commitment to support people and environment. In cooperation with local authorities, where allowed, the initiatives in favor of vaccination of our employees and their families are proceeding with Pirelli facilities made available as vaccination hubs. We intensified our activities for the development of new skills to support our business transformation. In R&D, we started at Politecnico di Milano, a master degree course, to specialize in tire technologies for the development of a new generation of researchers and engineers. Lastly, we started the production of tires certified by the Forest Stewardship Council, FSC, and an international NGO promoting the responsible management of forest in the world. Their certification confirms the sourcing of materials, natural rubber and rayon from plantation that preserve biological diversity and support local communities and workers. The solid performance was achieved in the first half of 2021, with strong contribution from the second quarter. The strong top line growth was supported by marked increase in high value coupled with a sound price/mix. Profitability improved, driven by the strong commercial performance and efficiency gains. Net income rebounded posting EUR 132 million in the first half, 76% of which in the second quarter. And the cash flow generation of EUR 173 million, 13% of sales, was recorded in the second quarter, EUR 100 million more than in the same period of 2019. Let's now review the outlook for 2021. The expectation for the full year market growth are confirmed at 10%. What changed are the dynamics among segments and channels. The very good performance of 18 inches and above segment already in the first half of the year prompted us to revise upward our expectation for the market, plus 15% year-over-year plus 2 point more than our initial guidance. The Replacement channel drives the growth with an expected increase of 18% against initial estimate of plus 20%. More caution is advisable for the Original Equipment channel due to the semiconductor shortage. The growth of the high end in the market is expected at around 10%, approximately 5 percent point less than the initial assumption. In this context, we confirm our ambition to outperform the high-value market. Hence, our target for volumes has been raised as I will discuss in the next slide. Sound performance recorded in the first half, the improved market outlook we just reviewed and a more favorable pricing environment led us to revise upward our 2021 targets. The expectation for the full year are revenues between approximately EUR 5 billion and EUR 5.1 billion, around EUR 300 million more than in the plan. With volume on the rise between 14% and 15%, the old guidance was between 11% and 13% plus. Driven by high-value volumes at 18%, 19%, the old target was plus 15%, 17%. Price/mix improving between 4.5% and 5%. In the plan, the target was between 2.5% and 3% due to the already mentioned price increases and the more favorable channel and product mix. Exchange rates are going to be negative, minus 2.5%, minus 2%, the old guidance was minus 3.5%. EBIT margin between approximately 15% and 15.5%. The previous target was above 14% and around 15%, with an improvement of the adjusted EBIT of around EUR 60 million compared with implicit value of the planned target due to the greater contribution from volumes and price/mix. The latter will compensate for the increase of raw materials cost, mainly oil and derivatives. All the other components of the EBIT bridge are confirmed. Net cash flow generation before dividends is improving by between EUR 360 million and EUR 390 million, and the planned target was between EUR 300 million and EUR 340 million, supported by the operating performance and an efficient management of the working capital. Investments are confirmed at approximately EUR 330 million. And now I'll leave the floor to Mr. Casaluci who will discuss the operating performance. Please, Mr. Casaluci.

Thank you, Mr. Tronchetti, and good evening, ladies and gentlemen. Let's now review market dynamics and Pirelli performance in the first half of 2021. Car tire demand recorded a significant plus 25% growth, particularly marked in the second quarter at 41% year-over-year. Pirelli outperformed the market by approximately 18 percentage points, gaining share in both channels. Total demand, however, remained lower than pre-COVID levels minus 6% versus first half 2019. In the high-end segment, the market grew plus 35% year-over-year, and the demand has already exceeded 2019 levels by approximately plus 7%. In line with our full year targets, Pirelli consolidated its leadership in the car 18 inches and above segment, with volumes growing by 51%. In the rim sizes, 19 inches and above, the increase was even higher at 58%. In Original Equipment, the already constant share increase of 2020 continued with volumes of the 18 inches and above segment growing plus 60%, compared with 37% of the market. This is due to the consolidation of Pirelli leadership in China in the high-end segment and its growing exposure to the electric vehicle market. In the Replacement channel, volumes of 18 inches and above went up 44% compared with 34% of the market. Although inventories are still lower than pre-COVID levels, Pirelli intercepted the demand recovery through its distribution chain and the strong development of the online channel. Pirelli performance above the market in the standard business with volumes at plus 35%, 12 percentage point more than the market, discounts a favorable comparison basis with last year and the share increase in South America concentrated in the higher rim sizes. The share increase in the high-end market, I have just mentioned it, confirms that our commercial plan is being implemented correctly. The more technological part of our product offering keeps on expanding. Over 70% of our growth is concentrated in the 19 inches and above and more than 60% in Specialties. The Replacement volumes coming from OE homologations were fundamental for the growth of pool volumes, especially in Asia Pacific. The new lines exclusively dedicated to Replacement allowed push volumes to perform very well, particularly in Europe and North America. In Original Equipment, Pirelli gained share uniformly in all regions. The company keeps focusing on fitments for electric vehicles that accounted for 10% of the growth. The innovation program proceeds at a fast pace as presented in the Industrial Plan. In the second quarter of 2021, we launched our first high load tire, a new technology dedicated to electric or hybrid cars and SUVs. This new tire is made to support 20% heavier loads than standardized without affecting performance with low rolling resistance and high levels of driving comfort. Lucid Air, the new luxury American electric sedan, is the first car to be fitted with the new P ZERO high load tires developed together with a carmaker and provided with Pirelli Elect technology and Pirelli Noise Canceling Systems. The introduction of this new product contributed to grow our market share in the premium EV business as expected, bringing us closer to our objective of reaching a share in the EV business, 1.5x that of the traditional car market by 2025. We expect that our share in the EV business will exceed that of traditionally powered cars already next year. The ability to combine technologies and processes to develop cutting-edge tires for the electric high value segment is certainly going to be a competitive advantage. After we launched 2 products for the European market, one all season and one summer, in the first quarter, in May, we expanded our offering in North America with the introduction of Scorpion All-Season +3, a new touring all-season tire for crossovers, SUVs and pickups. This new product is, in fact, part of the Pirelli plus line developed to meet the needs of North American drivers. With the new trade pattern, compound and construction, Scorpion All-Season +3 was developed to offer extra mileage with 60,000 miles treadwear warranty, placing it among the best in class in this category. The use of the 3D sipe technology, together with innovative materials, allows this new tire to deliver smooth wear, improved snow traction, excellent wet performance and a comfortable ride with reduced noise in the cabin. Finally, as a witness of the strong attention Pirelli pays to sustainability, I would like to mention that we have recently launched the first ever tire line, certified by the Forest Stewardship Council. These products were designed for the new BMW plug-in hybrid X5 and contain FSC certified natural rubber and rayon. They are a significant milestone towards an increasingly sustainable tire production. The FSC certification guarantees full traceability of raw materials all along the supply chain with plantations managed so as to preserve biological diversity and benefit local communities and workers, one, ensuring economic sustainability. Besides contributing to the environment-friendly philosophy of hybrid and genes, this P ZERO tire was developed by Pirelli accordingly to the perfect fit strategy and ensures a low rolling resistance, A class of the European label with the result in fuel savings and low noise. The competitiveness program is progressing according to our plan with expected gross efficiencies for the full year of EUR 155 million or net EUR 80 million, approximately 2.1% of the baseline. During the first half of 2021, the gross benefits of the competitiveness program amounted to EUR 83 million or EUR 50 million net of inflation, equal to around 60% of the overall target for the year, with the bulk achieved in the second quarter. Getting into the detail of the single projects and product cost, which is worth around 40% of the first half gross benefits, we continue to implement the new approach to modular design and the search of -- for a better efficiency in the purchase of materials. In manufacturing, which accounts for approximately 50% of the first half efficiencies, we progressed in our flexibility increase, digitization and sustainability effort. The reorganization of our U.K. plant in Burton was completed in the second quarter. Consistent with the rebound of volumes and the saturation levels reached in our plants, manufacturing has already reached 80% of its full year target in the first half of the year. In SG&A, we achieved further efficiencies by redesigning the distribution network and with warehousing optimization. Lastly, in organization, we continue digitalizing our processes and upskilling our people. Thank you for your attention. I then give the floor to Mr. Bocchio.

Thank you, Mr. Casaluci, and good evening, ladies and gentlemen. Pirelli closed the first half of 2021 with revenues of around EUR 2.6 billion, up 41.2%. More in detail, revenues grew by EUR 749 million, with a negative impact of exchange rate of minus EUR 74 million, minus 4.1% due to the depreciation of the United States dollar and the major currencies of the emerging countries against the euro. Excluding exchange rates, the organic growth of revenues in the first 6 months accounted for plus 45.3%. Let's give you the single commercial components. Volumes grew by 42.3%, driven by high value plus 46.3%. That climbed back to pre-COVID levels, both in car and in motor business. Price/mix improved by 3%, supported by price increases in the Replacement channel, both for high value and standard and improved product mix with a strong high-value growth, especially in the higher rim sizes and specialties. In the second quarter, the price/mix grew significantly, plus 4%, due to price increases. The already mentioned product mix improvement offset a negative channel mix due to the rebound of sales in Original Equipment after the lows of the second quarter of 2020 and the negative region mix, which discounted the comparison with last year when China was the first country to get out of the COVID crisis. Let's now review the profitability trend. The adjusted EBIT amounted to EUR 377 million in the first half, with a margin of 14.7%. The strong contribution of internal levers, volumes, price/mix, efficiencies more than compensated for the external scenario headwinds, raw materials inflation, exchange rates. More in detail, the improved profitability of the first half reflects the strong contribution of volumes, plus EUR 315 million, the improvement in price/mix, plus EUR 47 million, which offset the impact of raw materials, minus EUR 39 million, and exchange rates, minus EUR 13 million. The implementation of the competitiveness plan with net efficiencies amounting to EUR 50 million, which more than compensated for the reversal impact of the COVID plan of minus EUR 10 million and higher depreciation and amortization, minus EUR 6 million. Lastly, the trend of the other costs. This item includes 3 cost clusters. The first one is made up of R&D, sponsoring activities and marketing, which in the first half recorded an increase of EUR 32 million, EUR 27 million in the first quarter and EUR 5 million in the second quarter. The second cluster includes the provisions for short- and long-term management incentives with an impact of minus EUR 23 million in the first half. In 2020, due to the COVID emergency, management incentive plans were canceled. The third cluster comprises the impact of inventories, royalties and other costs. In the first half, this cluster produced a positive contribution of EUR 21 million, plus EUR 42 million in the second quarter. It reflects the normalization of cost seasonality compared with 2020 but also the positive impact of inventory reconstitution. The overall impact of the 3 clusters on the year is confirmed to be around minus EUR 30 million. Just a couple of comments on the profitability trend in the second quarter of 2021, that recorded an adjusted EBIT margin of 15.8%, close to 2019 levels, which was 16.5% in second quarter of 2019. The improvement of adjusted EBIT, EUR 209 million, compared to minus EUR 74 million in Q2 2020 is to be attributed mostly to the strong contribution of commercial variables and namely volumes, plus EUR 219 million and price/mix plus EUR 31 million. Net efficiencies, plus EUR 36 million, around 44% of the full year target and the already mentioned dynamics of the other costs, plus EUR 24 million. Let's now move to the net income dynamics. Net income showed a strong improvement in 2021, about plus EUR 230 million year-over-year. The trend discounts, the already mentioned improvement in the operating performance, a variation of adjusted EBIT, plus EUR 311 million. Restructuring and nonrecurring costs slightly increasing from the first half of 2020. Results from equity participation was positive by EUR 2 million with a plus EUR 7 million improvement year-over-year related mainly to the results of our JVs in China and Indonesia. Net financial charges were basically flat at EUR 72 million as higher cost for commissions related to the early reimbursement of part of the major credit line were compensated for by lower exposure to high-yield currencies and lower financial charges in Argentina. The EUR 80 million increase in tax charges was mainly related to the greater operating results, while the tax rate remained basically stable at 26%. First half adjusted net income, meaning excluding nonrecurring items and other adjustment is positive for EUR 224 million. Looking at the cash flow. We closed the first half with a net cash flow before dividends equal to minus EUR 481 million, with a strong improvement versus the same period of both 2020 and 2019. The improvement against 2020 was equal to EUR 277 million and mostly underpinned by the already mentioned better operating performance and a lower absorption of working capital and other, mainly in connection with debts that benefit from business recovery with higher investment than in 2020. The EUR 160 million improvement against 2019 is mainly related to working capital management, resulting from a better management of our receivables with improvement in collections and the trend of payable just described. In line with the seasonality of the business, the second quarter showed a net cash flow before dividends amounting to EUR 173 million, 13% of the revenues, up EUR 100 million against the second quarter 2019 due to the dynamics already mentioned. Gross debt at the end of June '21 stood at approximately EUR 5 billion, EUR 1 billion less than at the end of December 2020, thanks to early repayment of financial debt. The liquidity margin amounted to approximately EUR 1.5 billion, and allows the usual coverage of debt maturities for at least 2 years until June 2023. The cost of debt in the last 12 months was 2.27%, a touch higher than in full year 2020 due to the temporary increase of the leverage resulting from COVID effects, only partially offset by efficiencies at the level of local debt. For the full year, we expect the cost of debt to be equal to 2.6%. It was 1.94% in 2020, in line with the planned assumption due to the already mentioned dynamics and the increase in local interest rates, namely in Brazil. Net financial charges are projected to be around EUR 145 million, EUR 50 million less than the planned assumption due especially to favorable dynamics of hyperinflation in Argentina and commercial hedging. Thanks for your attention, and I give the floor back to Mr. Tronchetti.

Thank you, Mr. Bocchio, and now we can open the Q&A session.

[Operator Instructions] The first question is from Gabriel Adler of Citi.

Gabriel Adler, Citigroup. My first one is on imports. How are lower imports supporting the pricing environment in Europe and North America currently? When do you expect imports to normalize? And do you anticipate weaker pricing when this happens? My second question is coming back to raw mat, since you mentioned in the presentation. I might have missed it, but can you please just confirm your assumptions for raw mats for the full year? And if raw material prices do continue to rise, will you be able to put further price increases during the coming months? And then my final question is on M&A. We've seen some consolidation in the tire market this year already. Do you think Pirelli would benefit as part of the bigger group, be that with another tire manufacturer or maybe another auto suppliers focused on the premium segment? I just really want to get an understanding here of whether M&A is a topic of interest for the Pirelli Executive Board currently.

Thank you. I'll answer the second question, and then I'll leave the floor to Mr. Casaluci. We don't have in our plan, M&A. We don't see opportunity around. We are always open to look around, but we don't have anything related to M&A. And now I leave the floor to Mr. Casaluci.

Thank you, Mr. Tronchetti. As far as North America is concerned, we see that today in -- among the high value regions is the region with the highest reband -- rebound in demand. The stock level on the trade is still below the normal -- what we consider a normal level and below the pre-COVID scenario. So we do expect another third quarter with a strong increase in the Replacement demand. And most probably, we will go towards a stabilization within the end of the year, as far as Replacement is concerned. In the Original Equipment, North America is affected, as Europe, by the shortage of the semiconductor. And as a consequence, we are facing some cancellation in the call off of the carmakers. But all in all, is under control also because the carmakers are protecting more the high end of the product portfolio and being Pirelli overexposed in the high end of the carmakers is less affected than others in this period. Concerning price increase, of course, we have announced and implemented price increase all around the regions. And we have, for example, back to North America announced a price increase up to 6% in July. Another price increase in Europe has been announced for August with an increase of roughly 3 percentage points. And the same has been announced for effective April and May in China of around 2%. Thank you.

And Mr. Bocchio on raw materials, please?

Yes. Thank you for the question. Actually, you saw in the presentation that for the first half of '21, we already recorded a negative impact from raw material compared to last year for about EUR 39 million, comprising EUR 10 million in commodities and EUR 29 million in FX -- in ForEx. For the second half, we are expecting a much higher headwind because we see costs rising month after month. The expectation for the full year is a headwind that is weighting around 3% of our full year revenues. Another important point to say is that actually we foresee for the full -- for the second part of the year that price/mix will be able to fully compensate this expected negative impact from the raw materials jointly with an additional small negative impact from the ForEx.

The next question is from Monica Bosio of Intesa Sanpaolo.

Pirelli's pricing power and price increases in the high value segment is evident. I'm just wondering if you can comment on the pricing scenario for standard tires. And if you can give us an indication of the profitability of this segment. I remember that in the first quarter was in the region of 7.8%, in line with your assumption. Just an update on this or if you see some pressure due to raw material. And the second is on the working capital going forward. I'm just wondering if you -- do you expect some impact on the working capital from the supply chain shortages? And that's it for the time being.

First of all, on working capital, no, we do not expect any effect. But I leave the floor to Mr. Casaluci for what concerns the raw material prices.

Yes. Thank you, Mr. Tronchetti. The question related to standard. Well, the price increase are -- has been transferred to standard without major issues because of 2 reasons. In the high value regions, we are following our exit strategy. So we maintain the point of the price increase, managing eventually trade-off between price increase and volume, always protecting the price increase and supporting the exit strategy. While in the standard regions, where the inflation is running high like South America or Turkey, we are able to transfer the price increases supported by both FX raw material and local inflation. So no major issues in the price increase on standard. As far as the profitability of standard is concerned, you are right. We confirm that we are in the direction of the low double digit, which is our target within 2022. And that today, we confirm a high single-digit level of profitability on standard. Thank you.

Sorry, just a follow-up regarding the price/mix effect for the second half. Should we expect a higher impact of mix in the last part of the year? Am I wrong?

Yes. The price performance is expected to improve in the second half compared to the first half because of 2 reasons. First, we continue to implement price increase into the Replacement before I mentioned a couple of cases that will be implemented within July and August. And secondly, even more important, the cost metrics in the Original Equipment channel will start to be effective from second half on. So all in all, the price performance of the second half is expected to be better than the first half.

The next question is from Martino De Ambroggi of Equita.

The first is just a quick confirmation on the price/mix drop-through being roughly 100%. Does it mean it's 100% price while the mix between -- among channel regions products is basically 0?

No, no, no. The price is -- 160% is the drop through of the rest. Mix, 70%. Average 60%.

Okay. Okay. The second question is on the net working capital because in your slide talking about the trade receivables, you specify general improvement in collection. Is it just a matter of a better market environment? Or there is a structural change in the terms of collection or maybe higher factoring and maybe if you can provide the amount of factoring?

Mr. Bocchio?

Yes, I can confirm that it is -- this better collection are related to the better environment that we are experiencing. So both in Europe and in North America, we see that the payment inflow is getting much better obviously than 2020 and even better than 2019 due to the environment. So we are not opening new operations, higher operational factor compared to previous times.

So no change in terms of collection and basically no jump in factoring?

With the previous figure, then we foresee the same trend similar to the past for the second part of the year.

Okay. My last question is on Camfin. Because it is going to round up its stake, 4% now, probably another 3-or-more-percent going forward. So how should we interpret such a move?

[Foreign Language] Sorry. We made this move as it has been explicated in our press release. We have -- we maintained some governance inside Camfin. We enlarge the shareholder structure with a share's fee. We have a different category, so no change in governance. And we are strengthening the role that continues to be kept by Camfin as I think we did in the last 30 years. So we continue to remain co-shareholder within Pirelli.