Outlook for the Continental Corporation


Forecast process
Continental reports its expectations regarding the development of the important production and sales markets already in January of the current fiscal year. This forms the basis of our forecast for the corporation’s key performance indicators, which we publish at the same time. These include sales and the adjusted EBIT margin for the corporation. In addition, we provide information on the assessment of important factors influencing the earnings before interest and tax (EBIT). These include the expected negative or positive effect of the estimated development of raw materials prices for the current year, the expected development of special effects and the amount of amortization from purchase price allocation. We thus allow investors, analysts, and other interested parties to determine the corporation’s EBIT. Furthermore, we publish an assessment of the development of the net interest result and the tax rate for the corporation, which in turn allows the corporation’s net income to be determined. We also publish a forecast of the capital expenditures planned for the current year and the free cash flow before acquisitions. In February of the current fiscal year, we supplement this forecast for the corporation with a forecast of the sales and adjusted EBIT margins of the two core business areas: the Automotive Group and the Rubber Group. We then publish this forecast in March as part of our annual financial press conference and our annual report for the previous year. The forecast for the current year is reviewed continually. Possible changes to the forecast are described at the latest in the financial report for the respective quarter. At the start of the subsequent year, i.e. when the annual report for the previous year is prepared, a comparison is made with the forecast published in the annual report for the year before.

Since 2015, Continental has compiled a medium-term forecast in addition to the targets for the current year. This comprises the corporate strategy, the incoming orders in the Automotive Group and the medium-term targets of the Rubber Group. Accordingly, we want to generate sales of more than €50 billion and a return on capital employed (ROCE) of at least 20% in 2020. These medium-term targets were confirmed again after the review in 2016.

Comparison of the past fiscal year against forecast
We did not achieve the adjusted EBIT margin of the Automotive Group specified in our forecast compiled in February 2016. This was due to several independent and singular events, which required the outlook for the adjusted EBIT margin in the Automotive Group to be lowered from more than 8.5% to more than 6.5% on October 17, 2016.

Potential negative effects totaling approximately €390 million were attributable to the Chassis & Safety and Interior divisions due to warranties for products, the majority of which were supplied between 2004 and 2010, and due to potential expenditures for pending antitrust proceedings. As a precautionary measure, provisions were made as at September 30, 2016, for these potential negative effects. These costs will largely be paid in 2017.

Moreover, the situation at one microcontroller supplier deteriorated as a result of several earthquakes in the Kumamoto region of Japan in fiscal 2016 to such an extent that the Interior division was hit by lost sales of at least €100 million in the year under review. Special cargo deliveries, product adjustments and increased manufacturing costs had a negative impact on EBIT of around €50 million.

In addition, higher-than-expected outlay for research and development negatively affected the Interior and Powertrain divisions by a total of around €60 million.

Only a small portion of these negative effects could be compensated for. All in all, the aforementioned events had a negative impact on the Automotive Group’s reported and adjusted EBIT of around €480 million in total. However, the sales forecast of around €25 billion was still achieved. Before negative exchange rate effects, the Automotive Group’s sales amounted to €24.9 billion.

Comparison of fiscal 2016 against forecast

Comparison of fiscal 2016 against forecast

By contrast, we comfortably achieved the other targets from our forecast (see table). Consolidated sales amounted to €40.5 billion and were influenced by negative exchange rate effects of €827 million. The corporation’s adjusted EBIT margin was 10.8%. The Rubber Group’s sales were over €16 billion, as planned, and the adjusted EBIT margin of 17.8% exceeded our forecast of August 2016 by 0.8 percentage points.

The negative net interest result was better than expected thanks to the good development of free cash flow, the overall positive valuation effects from changes in the fair value of derivative instruments, and the development of exchange rate trends. These two valuation effects alone had a positive impact of €90 million on the negative net interest result in 2016. The tax rate was slightly below our forecast of approximately 30%. The free cash flow before acquisitions was €2.3 billion despite the high capital expenditure ratio and thus comfortably above our forecast of at least €1.8 billion.

Order situation
The Automotive Group continued to experience a positive trend in incoming orders in the past fiscal year. All three Automotive divisions considerably increased their goods on order compared to the previous year. All together, the Automotive divisions Chassis & Safety, Powertrain, and Interior acquired orders for a total value of more than €35 billion for the entire duration of the deliveries for the vehicles. These lifetime sales are based primarily on assumptions regarding production volumes of the respective vehicle or engine platforms, the agreed cost reductions, and the development of key raw materials prices. The volume of orders calculated in this way represents a reference point for the resultant sales achievable in the medium term that may, however, be subject to deviations if these factors change. Should the assumptions prove to be correct, the lifetime sales are a good indicator for the sales volumes that can be achieved in the Automotive Group in three to four years.

The replacement tire business accounts for a large portion of the Tire division’s sales, which is why it is not possible to calculate a reliable figure for order volumes. The same applies to the ContiTech division, which comprises nine business units operating in various markets and industrial sectors, each in turn with their own relevant factors. Consolidating the order figures from the various ContiTech business units would thus be meaningful only to a limited extent.

Outlook for the Continental Corporation
For fiscal 2017, we anticipate an increase in global light vehicle production (passenger cars, station wagons and light commercial vehicles) of 1% to nearly 94 million units. We expect demand on Continental’s key replacement passenger tire markets – Europe and North America – to grow by a total of 10 million replacement tires or 2% in each case. Based on these market assumptions and provided that exchange rates remain constant, we anticipate an increase in consolidated sales to more than €43 billion in 2017.

We have set ourselves the goal for the corporation of achieving a consolidated adjusted EBIT margin of more than 10.5% for fiscal 2017. With regard to the development of the adjusted EBIT margin, the lower expectation in comparison to the previous year is mainly attributable to the expected additional expenses due to the rising prices of raw materials in the Rubber Group. For the Automotive Group, assuming constant currency exchange rates, we anticipate sales growth of 6% to approximately €26 billion with an adjusted EBIT margin of around 8.5%. For the Rubber Group, we expect sales to grow to more than €17 billion and the adjusted EBIT margin to be more than 15%.

In 2017, we anticipate a negative effect of approximately €500 million from the rising prices of raw materials in the Rubber Group. This is based on the assumption of an average price of U.S. $2.25 per kilogram (2016: U.S. $1.38 per kilogram) for natural rubber (TSR 20) and U.S. $2.45 per kilogram (2016: U.S. $1.13 per kilogram) for butadiene, a base material for synthetic rubber. We also expect costs for carbon black to increase by more than 20% compared to the average prices in 2016. For the Rubber Group, every U.S. $10 increase in the average price of crude oil equates to a negative annual gross effect on EBIT of around U.S. $50 million. The average price of North Sea Brent was around U.S. $44 in 2016.

We expect the negative net interest result to be around €200 million in 2017. The year-on-year increase is because we do not expect the previous year’s overall positive valuation effects from changes in the fair value of derivative instruments and from the development of exchange rates to recur this year. The tax rate should again be less than 30% in 2017.

For 2017, we expect negative special effects to total approximately €100 million. Amortization from purchase price allocations, resulting primarily from the acquisitions of Veyance Technologies (acquired in 2015), Elektrobit Automotive (acquired in 2015) and the Hornschuch Group (acquired in 2017), is expected to total approximately €200 million and to affect mainly the ContiTech and Interior divisions.

In fiscal 2017, the capital expenditure ratio before financial investments will increase to around 6.5% of sales. Approximately 57% of capital expenditure will be attributable to the Automotive Group and 43% to the Rubber Group.

The largest projects within the Chassis & Safety division in 2017 are the global expansion of production capacity for the MK 100 and for the MK C1 brake generations in the Vehicle Dynamics business unit. In addition, major investments are planned for the global expansion of capacity for long- and short-range radar sensors and multi-function cameras in the Advanced Driver Assistance Systems business unit. In its Transmission business unit, the Powertrain division is investing in new production capacity for fully integrated transmission control systems (automatic transmission) in Sibiu, Romania. The Engine Systems business unit is investing primarily in the global expansion of capacity for gasoline high-pressure injectors and gasoline high-pressure pumps. In addition, production capacity for gasoline turbochargers will be expanded at the locations in China and North America. Further investments are also planned in the Hybrid Electric Vehicle business unit for 48-Volt Eco Drive projects in China, Germany, and North America. Investments in the Interior division will focus on the expansion of production capacity for central displays in Germany and North America.

In the Tire division, investments in 2017 will focus on the expansion of passenger tire production in Eastern Europe, China, and North America. In the area of commercial vehicle tires, the emphasis will be on the expansion of production capacity in North America. In the ContiTech division, investments this year will concentrate on the relocation of a plant in the Mobile Fluid Systems business unit and the expansion of production in the Benecke-Kaliko Group business unit in China.

As at the end of 2016, Continental’s net indebtedness amounted to €2.8 billion. In the future, we intend to continue strengthening industrial business in particular, in line with our objective of reducing our dependency on the automotive original equipment sector. The acquisition of further companies for this purpose has not been ruled out. Another focus will be the selective reinforcement of our technological expertise in future-oriented fields within the Automotive Group. For 2017, we are planning on free cash flow of approximately €2 billion before acquisitions. One reason for this year-on-year decrease is an increase in the capital expenditure ratio. Another reason is that a larger portion of the negative effects from warranties and potential antitrust fines provisioned for in 2016 will result in cash outflow in 2017.

The start to 2017 has confirmed our expectations for the full year.