Schaeffler AG (SHA0) Earnings Call Transcript

Good afternoon, ladies and gentlemen, thank you for standing by. I am Francie, your Chorus Call operator. Thank you. Welcome, and thank you for joining the Group Q4 and Full Year 2022 Earnings Conference Call of Schaeffler AG. [Operator Instructions] It's my pleasure, and I would now like to turn the conference over to Renata Casaro, Head of IR. Please go ahead, ma'am.

Thank you very much, Francie. Dear investors, dear analysts, thank you for joining the Schaeffler Group 2022 earnings call. As usual, our call will be conducted under the disclaimer. Without further ado, I will pass the floor on to Mr. Klaus Rosenfeld, CEO of the Schaeffler Group; and Mr. Claus Bauer, CFO. Klaus, the floor is yours.

Thank you, Renata. Ladies and gentlemen, welcome to our call to everyone on the call and also in the web. You have the presentation in front of you, we will quickly guide you through the main topics and then leave as much room as possible for questions and answers. Let me start on Page 4 with the key messages. The Schaeffler full year 2022 performance is definitely solid in a challenging year, 9.4% growth driven by volume and price, significant positive work on price to make that also sustainable. The margin was 6.6% is in the upper quartile of what we guided for 5% to 7%, so also in line with expectations. I can say that free cash flow with EUR 280 million is also more or less on the spot what the consensus indicated, consensus was EUR 287 million. And here, we can say that if you look into the fourth quarter, there was more CapEx than we expected because we see future growth in the year that we are in. We decided for a dividend proposal of EUR 0.45. That's slightly below last year, but definitely at the upper end of the range was 48%. And I think that's a sign of strength. It reflects the balance sheet, but also our positive expectations going forward. The expectations going forward, I think backed off the business development, in particular towards the end of the year, record order intake in E-Mobility with EUR 5 billion speaks for itself. Robust demand in the Aftermarket. I think you will see also in the first quarter a continuously positive trend in Aftermarket driven by the increasing demand for Aftermarket parts. And also in Industrial, I think we have met expectations for the full year. Certainly, in the fourth quarter, there were some issues that Claus are going to explain that are one-off issues. And that altogether then forms our judgment for '22, solid and delivered what we promised. In terms of guidance, we have decided to be cautious or let me use another word, this is a rock-solid guidance that protects the downside. We have now gone through 3 years of unexpected challenges in a very uncertain environment. That's why we have decided to be transparent with our assumptions. You have them on Page 30. These assumptions are conservative. If the assumptions that one of our biggest customers has laid out yesterday come into place with 10% to 15% growth, then we will definitely benefit from that as well. So read this not in the line of we are shy and we don't know what to do, we know very well what to do, and we want to protect the downside, but we will definitely benefit from the upside if there is growth, in particular in the Automotive area. And let me also say upfront, our transformation approach with a more balanced view on how powertrain solutions will develop over time, I think is absolutely the right approach. We have never said we're going to only bet on E-Mobility. We have always said the world is a global market. There are different trends in the market. And the idea of doing battery-electric, where we made significant progress plus hybrid and also be available for certainly decreasing demand in the combustion engine world, yes, is definitely the right strategy. Let me go to #5, that's the full year guidance. I think you can do that more or less on your own. We met the guidance. And it is -- if I may remind you of what we said in January are definitely in line with our first indications. If I judge the year on Page 6, what is on the positive side, on the positive side is the top line, 9.4% growth, predominantly volume and price driven. And I think I can say, Claus, you can explain that in more detail, our price recovery measures have been successfully implemented. We have more or less closed all the negotiations with our big customers, and we have refrained as much as possible from onetime payments. So this should be something that also helps us going forward, certainly also in the markets with different implications. The structural measures, you saw one of the other big competitors here in Germany announcing something this morning. We have been more proactive on this. We have decided, as all of you know, in November '22 to do more, rightsize and further streamline our overhead in Europe. That is -- was exactly right, and the package is under negotiation. We're expecting a closure in the next months of the negotiations and then the normal speedy implementation according to the experience of the last year's balance sheet, and free cash flow is strong. And we met clearly what we wanted to achieve on free cash flow conversion. If you look at the numbers, I just want to stress here again, the EUR 280 million includes around EUR 300 million restructuring payout. If you add that back, if you look at one of the tables, you see a adjusted free cash flow without these one-offs of more than EUR 500 million. And maybe that helps you to also analyze and understand the free cash flow generation promise that we are making. M&A, again, you know all the things that we have done there, partnerships, collaboration, things like Innoplate and SPT up to [ Container X ], where I think we were successful in the last year here, strong execution and exactly what we promised, no big elephant hunting rather the small things that make a difference. Just want to highlight here and mention the little acquisition we have done in France, you will see that, that will strengthen the Industrial business in the area of condition monitoring significantly. On the negative side, clearly, earnings quality, we are not happy with the 6.6%. This is not where we want to be for the year 2022 with war, China lockdown and significant inflation. That's acceptable, but long term, that's not what we want to see. You all know our midterm targets, and this is what we strive for. So performance management in the company is clearly one of the key things to look for going forward. On the negative side as well is the operational performance, in particular of plants. In such a year, you absorb -- you have to absorb certain costs that we call the stop-and-go cost. It starts from replacing steel from other sources than Russia. It goes into the fluctuations we had. It's related to absenteeism, sickness rates. So all sorts of things. If I have to say the second thing where I'm unhappy is that these -- all these things have led to temporary inefficiencies that we could not compensate for, but that should go away as soon as the environment becomes a little bit more predictable. Now let me quickly run through the divisions. I'm not going to do this long, so that Claus can spend most of the time. You see Automotive on Page 8, a growth of 7.7%. Outperformance was strong in Q4. It was weak, as you know before, so the full year is slightly below the 200 basis points that we promised for this year. The positive price effects have come through. And on the negative side, I would like to just mention China that what you all know, and clearly, also the continuous volatility in markets and material cost inflation. Fourth quarter was in line with expectations with 3.1% and the overall EBIT for the year is more or less on the same level. I already talked about the order intake. I think you have seen that. Automotive Aftermarket is one of the interesting place going forward, because in this environment with inflation being more persistent, it's obvious that people rethink their -- think about their buying power. And many people, that's what we know from history will rather repair cars and buy cars that is good for us. Jens is very well positioned now with this new strategy regarding electrification and digitalization to make use of that trend. And you see when you compare the numbers, there was a little bit of a setback in Q4. That is extraordinary and that Claus will explain. But the overall logic with 7% growth and 12.5% margin throughout the year was definitely pointing in the right direction. If you compare this to 2021, just remember, there was a significant one-off in there. If we take this out, the profitability of the year is more or less in line with 2021. Page 12 is -- 11 is more for illustration purposes. I just want to highlight again that Aftermarket is not just selling some clutches that we have. It is a separate business that we make future-ready with more focus on customers and in particular, on electrification and digitalization. Industrial, Page #12, growth, significant growth in the full year, 14.7%. This is predominantly organic growth, little contribution from Melior Motion, and Ewellix, as you all know, was consolidated beginning of this year. So it shows the underlying growth strength that the business has. We made at the end of the year, 11.7%. Yes, that is slightly below expectations, and that was a, as I said before, a one-off in Q4. 9.1% was disappointing, but it has to do with something that is not going to come back in the year 2023. That's also here in the point with the red dot showing downwards, nonoperating one-offs and some temporary inefficiencies in some of the sites. Don't forget, we have a -- had a massive footprint consolidation initiated in 2020 for the Industrial business, and that was in execution in 2022, and that sometimes leads to such temporary inefficiencies. Industrial sales trend is moving a little bit sideways at the moment, but we think positive also for the -- this year in terms of underlying growth, in particular, as the macroeconomic environment becomes more resilient. 14 is then capital allocation. Also, I think no surprises here. CapEx, a little bit higher than what we guided for or what we indicated. You remember the EUR 750 million, EUR 750 million has become EUR 790 million. That still is a reinvestment rate below 1. So in line with what we said. And you also see that we have the regional split here that says we are investing significant money in Greater China and also America, and that will continue to grow in the future. My last page is then on -- my 2 last pages are on M&A on sustainability. I think I already mentioned the points, 15 has the names, significant activity here. All of these acquisitions well thought through, strategically, very rational. And as far as we know already, in particular, Melior Motion, very well integrated and already contributing to future success. 16 is a page on sustainability. You have the new sustainability report out there. It's a newly designed report, where we have changed the format from 4 action fields into 10 action fields. They are organized along the 3 dimensions of ESG. There's a lot of thought behind this. You may also know that I have decided during the year, together with my Board colleagues that sustainability should in future fall under my responsibility. It shows you that we are clearly committed to make our goals, and that is still a way to go. If you read the report, you see details on CO2 emissions by the different scopes. I can only recommend this. We are demonstrating here also our sustainability strategy. What we do is validated by the Science Based Target Initiative. And I'm proud to say that for 2022, we get the top scores for climate and water. With that, I would hand over to Claus for more detail on the financial results. Thank you very much.

Thank you very much, Klaus. Let's just start with Page 18. Sales, Klaus already mentioned the EUR 15.8 billion for the total year, which is a foreign exchange adjusted growth rate of 9.4%. And on the left side in the top bar chart, you see the Q4 development, all 4 divisions and all 3 -- all 3 divisions and all 4 regions grew with double digits, except Greater China, which we will talk about, in total, the growth for the fourth quarter was 11.8%. You see the regional split in the pie chart. And as I already mentioned, Greater China is the only region that lagged a little bit flat. As you might remember, there was the big COVID infection wave in December happening in China and that definitely impacted us. Well, it also -- has also impacted us into 2023, including the Chinese New Year, all can imagine. But now things completely normalized also in China, and we expect a good growth environment there. On the next slide, you see the gross profit development. And on the bottom -- on the left side, you see the gross margin development from 24.1% to 22.2% year-over-year. But what I think is even more interesting than this percentage development is the gross profit in absolute terms because I explained it in the past, in this environment where we have to recover cost increases with sales price recoveries, the margin deteriorates obviously, because your denominator sales is increasing. But you see with the absolute development of gross profit from EUR 846 million to EUR 893 million, that is a significant growth year-over-year by 6%. In the waterfall columns, you also see between the price and production cost developments, one positive, one negative. The sequential improvement of our price recovery initiatives that Klaus already alluded to, we can report and confirm that we have achieved our targets in all 3 divisions. We said it in the past that definitely in the Automotive OEM environment, this is more challenging than in, let's say, more distribution-oriented businesses like Automotive Aftermarket, but an overall satisfactory result. Maybe if you go to the bottom left -- bottom right side of this chart, then what jumps into the eye on a Group level is the 2 percentage points that we lost quarter-over-quarter and also for the full year. And to some extent, or the biggest impact I already explained is the base effect of the higher sales that are driven by higher cost. So if you now -- if you assume, for example, a 5% cost increase and also then a full recovery in sales with a 30% or with a 25% gross profit that would then be in the range of 1 percentage point that you lose in margin without losing any absolute gross profit. So I think that's very important to understand also for the divisions, which I will comment in a minute. And then as we already indicated in our Q3 call in November, we had to account for the collective bargaining agreement in Germany, where you had this very complicated mechanism with onetime payments. And this accounting actually accounted for a loss of 0.4 percentage points in margin in Q4. On the next slide, on the overhead side, you see with -- in the fourth quarter with 16.1% in the range. Also here, obviously, due to the wage development in Germany, what I just explained with the collective bargaining agreement, you lose another [ 0.2 ] percentage points here in the overhead expenses. But I think with that total year ratio of 15.8%, we are on the right track. You see it compared to last year, that is an improvement of 0.6 percentage points. The number that is obviously to be commented here is the selling expenses, which significantly increased over last year with EUR 296 million. And that is due to higher volume. Remember, especially in our 2 divisions with significant sales growth, Automotive Aftermarket and Industrial, we are carrying most of the shipping and logistics outbound costs, and these would be reflected here in the selling expense category. So there's a huge volume impact on the one side and obviously also due to higher logistics costs, especially freight, also some price impact as well. On the next slide, we will look at EBIT. Klaus already mentioned it, 6.6% for the total year, a little bit weaker in Q4. Remember, around 0.6 percentage points here, 0.4 percentage points coming from gross profit and 0.2 percentage points coming from the overhead expenses are related to the collective bargaining agreement in Germany and the accounting of it. That would almost proportionately impact all 3 divisions. And therefore, then if you look at the margin development for the entire Group on the bottom right side would be a significant portion of the year-over-year minus 1.6 percentage points development. The rest again, I'm repeating myself is then the base impact based on cost inflation on the one side and price recovery with sales on the other side. I will not comment now on the divisions you see on that slide, but obviously go into the detail on the following slides. First, Automotive Technologies. You see on the right side, the development that Klaus already commented on a high level. There is some margin deterioration, but nothing out of the unexpected, it was all expected and also indicated in our last call already. And the big drivers for the 1.6 percentage point difference here is, again, the base price impact and then 0.6 percentage points for the collective bargaining agreement impact that I also already explained. Interesting on that slide on the left side is the outperformance. Klaus already mentioned the 1.5 percentage points that we achieved for this year. You see also at the bottom of that segment, the 4.3 percentage points that we achieved last year. We always said that this indicator is a little bit statistically volatile, especially if the base data is volatile as you understand that obviously, production volumes have been volatile, especially with the China lockdowns during the year. And therefore, we always guided that our outperformance of 2 percentage points to 5 percentage points is not necessary to be delivered every quarter and not even every year, but on average over a longer term. And if you take full year '21 and '22 together, you are safely in the range that we think is realistic. If we look a little bit still on the 2022 development. So you see that in 2 of our most important regions, Europe and the Americas, in that regard, we outperformed significantly the production volumes, and the issue has been already last quarter that we face here is the underperformance in China. You -- and we explained it last time already that obviously with the product mix shift in China, very strongly towards battery-electric vehicles of the first-generation and then mainly the domestic brands, we have been a little bit underrepresented in this market segment. We think that will normalize itself once we go into the second-generation E-Mobility in China, even with the domestic producers where we are then much stronger represented than in the first wave. On the next slide, we will look a little bit deeper on Automotive Aftermarket. I'll start again with the EBIT development on the right side. And you see here, year-over-year, the EBIT for the fourth quarter didn't change much. That obviously doesn't look strange, but you also have seen and Klaus already mentioned it that our Q4 was definitely weaker from a bottom line margin standpoint as the prior quarters would have indicated, that is mainly due to an onetime reorganization effect. We moved some real estate property in Germany from one legal entity to another just to clean up the setup internally and that impacted mainly Automotive Aftermarket legal entities. And therefore, we had to absorb around EUR 6 million in real estate transfer tax, German real estate transfer tax. And you can easily calculate that amounts to around 1.2 percentage points that this singular onetime impact had on the margin for the fourth quarter for Automotive Aftermarket. So intrinsically, everything is going strong. And I think, Klaus, we can report that the first few weeks in 2023 would confirm very strong Automotive Aftermarket performance. Industrial is the third division here. If you look at the EBIT development with 9.1% for Q4, definitely lower than the underlying performance. I think you got the hint that I tried to make already in our Q3 earnings call, where we had an outstanding EBIT, if you remember, of over 14% for Industrial, and I explicitly said don't carry that forward. There's some product and customer mix shift between Q3 and Q4. We had a very strong regional mix for the stronger margin areas and also for the customers, very strong distribution sales in Q3, much more than [ normally for ] Q3, you would see a much bigger impact with heavy stocking orders from distribution customers in Q4. And there was some mix shift and margin shift between the 2 quarters. If you take both quarters together, then you will be in the range of 11.5% to 12%, definitely something more in line with what the real performance level of this division is. And if you then take on top of that, this base effect with the price recovery that obviously was very strong in Industrial. If you take that into consideration, which would be another minus 1.5 percentage points. And then on top of that, the collective bargaining agreement accounting in Germany, which impacted our Industrial division in the single quarter by another 0.7 percentage points, then you are in a range, which we think will be indicative of what is achievable going forward. With that, I'm coming to the dividend proposal. I think Klaus already mentioned it, EUR 0.45 is our proposal to the general shareholder meeting, which is in line with prior years, except 2020, that the high point of the COVID impact. And with a payout ratio of 48%, we are in the target corridor at the upper end. And I think a very attractive dividend that we propose to be offered. You see maybe on the bottom right side, also the payouts in euros, not just as payout per share. And I think over the last 5 years, with EUR 1.4 billion in dividend payouts, a pretty convincing argument for our cash generation power. And I think Klaus also mentioned that 2021 and 2022 were challenging years. So we have proven also in challenging years to be an attractive dividend payer. On the next slide, I think I don't need to comment very much. This is all following what I already said. It's pure math with the earnings per share and then also the ROCE. So let's go to the next slide, which is free cash flow. The free cash flow was, as I think we also clearly indicated in our Q3 call, already strongly positive. You see Q4 was the best quarter of the year in regard to cash flow generation that had to do also with the timing of net working capital. We told you in the first half of the year of 2022, we technically increased inventory, partly to also offset the volatility of our customer call-offs, but also, of course, to manage pricing impacts. And I promised you at the half year time that, that will now reverse and lead to a strong cash flow conversion in the second half of the year. And I think the chart on the left side is testimony to that delivery. And as Klaus already said, on the bottom right, you see the -- what we call underlying free cash flow, and you see it for, I think most interesting is the full year here on the prior to last column, and if you take back the restructuring payouts with EUR 287 million, which were almost at the same level as 2021. If you would take it out, then we have a free cash flow before M&A and these special items of EUR 525 million. Now take into consideration that we also invested around EUR 120 million more than last year. And we also invested in working capital still. I told you we managed inventory down, but nevertheless, sales increases and nominally, our sales increased by 14%. That also means higher receivables and still also from at least valuation standpoint, higher inventory values, and that's another EUR 250 million there. If you add that back, then you are definitely in a range that should make us very confident for the future. And my final slide then also talks a little bit about our balance sheet and the strength of our balance sheet. You see that -- and we already reported that in our Q3 call, but we refinanced our revolving credit line, increased it a little bit to EUR 2 billion, secured a EUR 500 million 5-year term loan for the Ewellix acquisition. And last but not least, we have no maturities coming up this year. The earliest maturity is March 2024. Obviously, we have to take care about the refinancing program for that this year, but this should be doable. The leverage ratio with 1.1x is speaking for itself a very strong position. You see then calculated down at the right side together with the cash and the unused committed credit lines, we have, and that's now excluding the term loan for the Ewellix acquisition. The term loan is not drawn by the end of the year, obviously, because the closing was early in January. So it will be drawn, but we already excluded it here in that calculation. And with that, we have 18% of the last 12 months of net sales in liquidity at our hand, clearly a sign that we will be on the path of looking out for interesting acquisitions, as Klaus already said in his M&A monitor and radar. And this page here indicates that we have the financial strength to execute on this. With that, Klaus, back to you.

Thank you. Let me finish with the -- very quickly with what I said before. You have on 30, the market assumptions. Again, these are conservative assumptions. We have discounted the number from S&P, 85 million a little bit. When you think back what happened in the years before, our discounting logic always proved to be a good indicator. In last year, we said 81.8 million at the upper end, it was 82 million at the end of the day. So again, we started the year with conservative assumptions. Let's see how the year unfolds. Aftermarket here is the key indicator, the global car parc growth also rather conservative. You will see that, that is something that we can definitely beat. And Industrial, given the fact that there is still a mild recession to be expected, and the Fed is still working on their -- how to get the inflation out of the system, also here a little bit more cautiousness. You have that on 31 with the numbers. I think you saw this. I don't think I have to comment on this more. 32 is then the summary. I do this very briefly, solid delivery. I think we explained this. The usage of cash is exactly in line with what we always indicated. We are focusing on executing what we have promised in terms of portfolio, structural measures, footprint and also headcount. Sustainability is a super important topic for us and I don't have to repeat that our guidance for 2023 is on the conservative or let's say rock-solid side. So that's it for the presentation. Next page is the Financial Calendar. Roadshow start tomorrow, extend into London and then we follow up in March and in -- with a roadshow in Frankfurt and also a virtual one in the Americas. With that, thank you very much for listening. I hand back to Renata and the operator for questions.

[Operator Instructions] We have the first question from Christoph Laskawi from Deutsche Bank.

The first one will be on the message of one customer that you already touched on briefly. Considering that customer might be right, could you comment on if you are able to quickly upscale the capacity? I mean the store capacities there, but managing up the volumes there quickly? And do you think that the supply chains overall for the industry would actually be able to cope with the sudden upswing of that magnitude? And the second question would be just on the Auto Technologies guidance for the margin. Could you give us a bit more detail around what kind of cost headwinds that you're factoring there on energy and wages and if there is a certain pass through assumption that you brought into the margin outlook? And then lastly on Industrial, the growth outlook, when we look at the order book, it points to around 5% end of Q4. Could you comment on the order intake momentum at the start of the year and how you expect that to develop?

Okay. Let me -- Christoph, if I understood this correctly, the line was a little bit blurred. Your first question was on, if there is a more positive market development, can you scale up? The answer is yes. We are invested for definitely more than 85 million cars, so if this would go even higher that should not be a problem. It certainly depends on where the growth is coming from and which area, because if this is a big reversal in transmission or classical combustion engine versus E-Mobility, that's a different situation, if this is significant E-Mobility growth. So let's see what that -- what that means, but there is a certain buffer here definitely built in that would help us to grow with the market if it's more by end. Supply chain, I don't see a problem there. The supply chain has more and more normalized. We're not so much dependent on chips and other critical materials on the steel side. I don't see any shortage that we should not be able to overcome. So yes, if there is upside, we'll definitely benefit from that. In terms of the cost end with -- maybe Claus can do this. Industrial growth, you said 5%. You saw the guidance that we laid out for Industrial with 9% to 11%, I think that tells you that we are positive on Industrial. It's slightly less than the 14%, that also includes to some extent the acquisitions, we should not forget this, because if Alex is coming onboard -- onboard, but that only explains a certain part of the 9% to 11%. So the underlying growth coming from the key sectors that are growing in particularly Industrial Automation is definitely intact and let's see where the -- where the first quarter ends, but 9% to 11% is what we -- what we promise. And Auto maybe, Claus you want to talk about the cost part?

So in regard to the price pressure, I mean the mix is definitely different this year than it was last year. It's more focused on wage inflation and indirect materials, especially energy cost as you already mentioned. But we are going about these cost inflation topics exactly the same way as we did for the mainly steel driven impact of 2022. Also and Klaus mentioned it in the very beginning, it's also important to understand that our 2022 pricing initiatives have been in the manner that it's sustainable price increases, it's not one-time payments that we asked for and then have now to start from a new for this year. So these main portion of these price increases will impact 2023 going forward. And now your next point might be about what does it mean when steel prices are going down, which they seem to have done over the last quarter or so. But then as we explained in the past, especially with our own -- our Automotive customers, we always go there with a complete evidence book and cost driver evidence book if you will. And therefore it's not so much what the spot price for steel does, it's where we have locked in our prices year-over-year and there is not much a difference in our -- in our price for 2023 versus 2022. So everything that we achieved in 2022 is sustainable and carried over into 2023 and we will fight with exactly the same approach then for the further cost increases in mainly wage and energy cost.

The next question comes from Akshat Kacker from JPMorgan.

3, from my side as well, please. The first one on the Auto Tech guidance, I think we all completely get the reasoning behind the cautious guidance that you've laid out, given the uncertain macro. However, what has raised a few concerns this morning is the 2% floor in that guidance range. So can you please explain, what needs to happen for the division to make 2% margins? Is it based on your current set of assumptions on the market out performance, inflation, et cetera.? Or is it based on completely different bearish assumptions? That's the first question. The second one on total cost inflation, just to get some numbers around the element and following up on Christoph's question, across all key elements, raw materials, labor, energy, et cetera, you talked about a 450 to 550 basis point gross inflation impact in 2022. Where did the year end up finally? And what do you expect that gross cost inflation headwind to be in 2023, year-over-year, please? And the last one on free cash flow guidance and the cash conversion. So in 2023, you are again guiding for a 30% conversion on EBIT. Can you just talk about your working capital assumptions in that forecast and also the measures that you're taking to improve that conversion ratio going forward, please?

Maybe I take the first one on the guidance for Auto and Claus takes the 2 other ones. It's a very fair question and I can tell you, we have tested the ranges. And the last point you made was even more conservative or bearish assumption is what led to the 2%. So let's think about a scenario where volume is even below 2022. That's where we said we get into such territory. The plan internally doesn't point for 2%, it's the even more cautious side on the margin. And again don't forget, there is, yes, a little bit clearing up, but we don't know yet how the environment is going to react to this inflation that is coming up. The car business is a consumer business and we need to see what's happening here. So that's what explains your 2%, definitely not what we're shooting for. We're shooting for more, but we decided to give you ranges as we did in the previous years before COVID and that's what we put out 2% to 4% for the time being. Claus, you want to do the other ones?

Yes, sure. I start maybe with free cash flow and it's assumptions. You might have seen back in the appendix that we want to further increase our CapEx this year to level around EUR 900 million. So that's another EUR 100 million to EUR 120 million more than this year. Why is that? Obviously, we will -- we understand that especially if our cautious assumptions will come true, it will be another more challenging year. But we also decided intentionally in our budgeting that despite the challenges, we will not sacrifice our future opportunities. 2023 will be a year with significant investments in E-Mobility launches and we will continue our digitalization and sustainability efforts as well. So therefore the EUR 900 million, that takes away a little bit maybe of what you -- in your consensus also thought possible from a cash flow generation standpoint. I think the underlying cash flow generation is exactly as you all projected and forecasted, it's really the investments that we will -- and plan to do this year. The underlying assumptions for working capital from a structural standpoint to stay in line with what we have achieved in 2022. That of course means with a significant top line growth also and proportionate growth of our accounts receivables balance inventory, we think we are in a place that is sustainable. Now, let's see how volatile -- customer call offs will develop in 2023. There might be also some tactical inventory place again, but the general assumptions is that inventory will increase not as much as our top line will increase. So little bit relaxation from that standpoint. I think your other question was in regard of price pressure and inflationary pressure. We -- obviously, if you would have asked me that question 2 months ago then I would have had a different mathematics than today. And the most prominent reason for that is the volatile energy market. I said it in the past that energy was at some point before or the inflation was around 2 percentage points of sales and now you can apply whatever factor you want. I mean at some point, last year we had price increases 3x that way, so that would have been 400 basis points of margin there. That's not our assumption today, it's more normal. In total, together with wage inflation and stable steel prices and again remember what I said before, stable steel prices means, what our locked in price on average is. We think that the cost inflation impact will be lower, will be significant, but lower than in 2022.

The next question comes from Sanjay Bhagwani from Citi.

So I've got a few follow-up. First one is, I think you just mentioned about this -- this inflation divergence that some of your peers have also talked about. So basically, as you mentioned, right, like the steel prices that you would be paying for '23 will be basically not a big change, although the LME price of the steel have gone down. So if I understand this correctly normally customers look at the LME prices and they tend to apply these automatic price downs to the -- on the contracts, because the LME or the exchange price of the steel is going down, but at the same time, as you mentioned the price that you end up paying is not going down that much. So could you please provide some color on this that are you working with your customers to basically, let's say, change the benchmark here to more like the invoiced price versus the LME price? That is my first question and I'll just follow up with the next one, if that is okay?

Sure. I will try to answer this one first. So I mean, there is different pricing negotiations that are involved. I think we said in the past and obviously I know what I'm talking about because I was for a long time in the U.S. With U.S. customers, we have had since a long time index-based material clauses. In that regard, you're absolutely right that prices would be impacted by -- spot price is based on whatever index you agreed on. And that then would have the effect that you described. In our broader scheme though, it's -- as I explained, you go to your customer into negotiation with an invoice price. So it's really invoice price based and not index-based and therefore, obviously the customer was happy in 2022, that you didn't pay the high prices on the spot market, but we are locked in for a better price and now the reversal comes in 2023 when you still pay the same price and not get the price reduction from a higher spot price of the last year. That doesn't mean that we are paying with our locked in prices this year higher than spot prices. It's just we pay a lower rate with locked in prices for 2023 than the highest point of the spot price in 2022 would be. So there, I don't see any impact of a price reduction pressure. It's the same negotiation strategy and actually we are already -- I mean we are already in agreement with the biggest customer in that regard, it's the invoice price that is relevant. And now I forgot your other question, what was that?

No, I didn't ask the second question. So that's -- second question is basically -- so if I understand it correctly, now this year again you have started the negotiations, where you basically produced invoice for the steel prices and also the wages and energy. So maybe just as a follow-up to Akshat's and Christoph's question, could you please broadly like -- communicate what was let's say the gross inflation and net inflation last year? And can we expect some -- some -- like, I mean in terms of the pass-throughs? And can we expect somewhat similar level of pass throughs this year as well? Or it could be probably lower this year, because now the inflation is coming from wages and energy, which is not part of the contracts, if my understanding is correct?

Yes, I mean we -- I think we explained to you last year, almost every call that we would not publish what our recovery targets were and we would stand by that principle. We think clearly that if you would publish anything that would reduce our negotiation leverage, therefore, please understand that we would also not be exact in that regard. We always said that it's a continuum if you will between the highest price recoveries in the markets, where you have distribution business based on catalog products because also from a mechanism, it's very effective you increase your catalog prices and if you are still within the market your product is needed for and then you implement the higher price, that's on the one end of the continuum. And on the other end, obviously, is the Automotive OEM, where you have to come with a big evidence both tell the customer what is your cost impact and then negotiate based on that evidence and it's a high recovery rate also with Automotive OEM customers, but I think I can say, it's not 100%. And we would go with the same approach, we are already in the middle of the same approach with the other cost drivers that are -- as you said correctly not normally a basis for negotiations. The general assumption is that your indirect material process -- material like energy and especially wage increases are offset with productivity gains. And I think that the last 10 years with low inflation environment was a reasonable assumption. However, I think it's clear along the supply chain that with the cost increases in these areas that -- that cannot be maintained. Remember also that in your normal Automotive OEM contract, you have price reduction, contractual price reduction and that price reduction, obviously is also based on the idea of productivity gains. And I think that is exactly the approach that we'll be successful in saying to offset the indirect material and productivity and wage inflation, plus now price reductions that are contractually agreed in a normal environment that we have experienced the last 15 years, that is not the way that we can execute in 2023. So I think there is always also with the OEMs easier to avoid price reductions, then really go for a positive price increase, but in general I think we will have the same price effectivity as we have seen in 2022.

And maybe Sanjay to add one thing, in the year 2022, we had to cope with volatile steel prices. The only positive thing about increasing labor cost is that you can calculate this in a much more accurate manner because you know when -- at least in Germany you know when the contracts fall due and don't forget that is something that rolls in parts of the one-off we have already taken, that's one of the reasons why Q4 was slightly lower than you expected and we'll see what we can do there. Don't forget this is predominantly a German or the European issue, it's not a global issue. You have different labor markets in China, you have different labor markets in the U.S., so that effect is something that we also need to understand from its regional implications.

I just have one final question on China, if I may?

Sure.

Yes. So I think you mentioned that the part of the reason for the underperformance in China is because you're underexposed to let's say the domestic producers, who basically are rising quite a lot on the EV side. And you mentioned that it normalizes in the next generation of products. So is this -- is this next generation more we are talking about, let's say, during the course of '23 or this is more of, let's say, H2 '23 or after that?

I can -- just because I made the observation, I mean it's -- it's phasing in, I mean it's not that you switch off the BYD models that are on offer in the market right now. And do you switch them off at June and then the next generation comes in, so it will be a phase-in. It will be not a matter as I said already in the last quarterly call. It will not be a matter of now going from underperformance to overperformance in a matter from one quarter to the next. It will be a phase in, over the next 4 quarter to 6 quarters.

The next question comes from Horst Schneider from Bank of America.