A core component of our strategy is the ongoing enhancement of the company’s value.
Key financial performance indicators for Continental relate to the development of sales, capital employed and adjusted EBIT margin, as well as the amount of capital expenditure and free cash flow. To allow us to use the financial performance indicators for management purposes as well, and to map the interdependencies between these indicators, we summarize them as key figures as part of a value-driver system. Our corporate objectives center on the sustainable enhancement of the value of each individual business unit. This goal is achieved by generating a positive return on the capital employed in each respective business unit. At the same time, this return must always exceed the equity and debt financing costs of acquiring the operating capital. It is also crucial that the absolute contribution to value (Continental Value Contribution, CVC) increases year for year. This can be achieved by increasing the return on capital employed (with the costs of capital remaining constant), lowering the costs of capital (while maintaining the return on capital employed), or decreasing capital employed over time. The performance indicators used are EBIT, capital employed, and the weighted average cost of capital (WACC), which is calculated from the proportional weight of equity and debt costs.
- EBIT is calculated from the ongoing sales process. The figure is the net total of sales, other income and expenses plus income from equity-accounted investees and from investments but before financial result and income tax expense. Consolidated EBIT amounted to €4.6 billion in 2017.
- Capital employed is the funds used by the company to generate its sales. At Continental, this figure is calculated as the average of operating assets as at the end of the quarterly reporting periods. In 2017, average operating assets amounted to €22.2 billion.
- The return on capital employed (ROCE) represents the ratio of these two calculated values. Comparing a figure from the statement of income (EBIT) with one from the statement of financial position (capital employed) produces an integral analysis. We deal with the problem of the different periods of analysis by calculating the capital employed as an average figure over the ends of quarterly reporting periods. ROCE amounted to 20.6% in 2017, once again significantly exceeding the cost of capital.
- The weighted average cost of capital (WACC) is calculated to determine the cost of financing the capital employed. Equity costs are based on the return from a risk-free alternative investment plus a market risk premium, taking into account Continental’s specific risk. Borrowing costs are calculated based on Continental’s weighted-debt capital cost rate. Based on a multi-year average, the weighted average cost of capital for our company is about 10%.
- Value is added only if ROCE exceeds the weighted average cost of capital (WACC). We call this value added, produced by subtracting WACC from ROCE multiplied by average operating assets, the Continental Value Contribution (CVC).
- In the long term, enterprise value by our definition will increase only if the CVC shows positive growth from year to year.
Our financing strategy aims to support value-adding growth of the Continental Corporation while at the same time complying with an equity and liabilities structure adequate for the risks and rewards of our business.
The corporate function Finance & Treasury provides the necessary financial framework to finance corporate growth and secure the long-term existence of the company. The company’s annual investment requirements will be around 7% of sales in the coming years. The reasons for this are the continuing increase in incoming orders in the Automotive Group and the successful implementation of Vision 2025 in our Tire division, which will mean the expansion of tire production capacity, particularly in North America and Asia.
Our goal is to finance ongoing investment requirements from the operating cash flow. Other investment projects, for example acquisitions, should be financed from a balanced mix of equity and debt depending on the ratio of net indebtedness to equity (gearing ratio) and the liquidity situation to achieve constant improvement in the respective capital market environment. In general, our goal is to continue to keep the gearing ratio below 20% in the coming years and ensure that it does not exceed 60% in general. If justified by extraordinary financing grounds or specific market circumstances, we can rise above this maximum level under certain conditions. The equity ratio should exceed 35%. In the year under review, the equity ratio was 43.5% and the gearing ratio 12.6%.
Our gross indebtedness should be a balanced mix of liabilities to banks and other sources of financing on the capital market. For short-term financing in particular, we use a wide range of financing instruments. As at the end of 2017, this mix consisted of bonds (65%), syndicated loan (0%), other bank liabilities (21%) and other indebtedness (14%) based on the gross indebtedness of €4,090.0 million. The committed volume of the syndicated loan, which consists of the revolving tranche, remained unchanged at €3.0 billion. The tranche will run until April 2021. The financing mix will not change significantly.
The corporation strives to have at its disposal unrestricted liquidity of about €1.5 billion as at the end of the reporting period. This is supplemented by committed, unutilized credit lines from banks in order to cover liquidity requirements at all times. These requirements fluctuate during a calendar year owing in particular to the seasonal nature of some business areas. In addition, the amount of liquidity required is also influenced by corporate growth. Unrestricted cash and cash equivalents amounted to €1,726.7 million as at December 31, 2017. There were also committed and unutilized credit lines of €3,686.8 million.
Gross indebtedness amounted to €4,090.0 million as at December 31, 2017. Key financing instruments are the syndicated loan with a revolving credit line of €3.0 billion that has been granted until April 2021 and bonds issued on the capital market.
The revolving credit line had not been utilized as at December 31, 2017. Around 63% of gross indebtedness is financed on the capital market in the form of bonds maturing between July 2018 and September 2020. The interest coupons vary between 0.0% and 3.125%. The repayment amounts are €750.0 million in 2018 and €500.0 million in 2019. In 2020, the amounts are €600.0 million and €750.0 million. In addition to the forms of financing already mentioned, there were also bilateral credit lines with various banks in the amount of €1,556.5 million as at December 31, 2017. In addition to finance leases, Continental’s other corporate financing instruments currently include sale-of-receivables programs and commercial paper programs.
Continental always strives for a balanced maturity profile of its liabilities in order to be able to repay the amounts due each year from free cash flow as far as possible. Other than short-term maturities, which are usually rolled on to the next year, the repayment of the bonds amounting to €750.0 million and €500.0 million due in July 2018 and February 2019 is on the agenda for 2018 and 2019.
In the reporting period, Continental was rated by the three rating agencies, Standard & Poor’s, Fitch and Moody’s, each of which maintained their credit ratings for Continental AG during 2017.