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Outlook for the Continental Corporation

 

Expected development of business
Based on the assumption that global vehicle production will increase to approximately 77 million units in 2012 and demand on Continental's key replacement tire markets in the U.S.A. and Europe will grow only slightly, we expect the corporation's sales to rise by more than 5% to over €32 billion. Our goal is to match the high level of the adjusted EBIT margin from 2011 in 2012 as well. There are risks arising from a slowdown in global economic growth, and particularly from a significant downturn in economic activity in the eurozone with the corresponding consequences for the assumptions regarding production trends in Europe.

However, if the economic development proves to be more stable than assumed in this report on expected developments, then we should achieve a more significant increase in consolidated sales growth.

We are essentially aiming for sales growth that is roughly 5 percentage points higher than the growth of our reference markets (vehicle production and tire replacement markets worldwide).

In light of this background, we are forecasting sales growth for the Automotive Group of at least 5% to more than €19 billion in 2012. The strongest driver of this growth will be the Powertrain division, followed by the Chassis & Safety division. The Interior division will post the lowest growth of the three Automotive divisions in 2012 due to its comparatively high share of replacement market business.

The Automotive Group's adjusted EBIT is expected to increase further in 2012. However, there will be a serious burden from the expected negative impact of higher prices for rare earths in the amount of around €150 million in 2012. All in all, we anticipate an adjusted EBIT margin of over 8% for the Automotive Group.

In the Rubber Group, we expect sales to climb by 6% to about €13 billion. The sales increase within the Tire division will primarily be determined by price effects from 2011 as well as volume increases and mix improvements in 2012. For the ContiTech division, we expect sales growth of approximately 5%.

Adjusted EBIT is also expected to increase further in 2012. Despite the recent stabilizing of prices for natural and synthetic rubber – at, however, a high level – it cannot be ruled out that we will have to initiate further price increases in the course of 2012 in order to compensate for the cumulative negative impact from 2010 and 2011 of €1.5 billion. With this goal in mind, we already raised prices for summer tires in the European replacement market by between 3% and 5% early in January 2012. For 2012, we expect an average price of $4.10 per kilogram for natural rubber and $3.00 per kilogram for butadiene, a base material for synthetic rubber. All in all, on the basis of these assumptions we anticipate an adjusted EBIT margin of over 13% for the Rubber Group. Opportunities will arise for the Rubber Group in particular if the prices for natural and/or synthetic rubber fall significantly below the average prices that we have assumed for the year.

For 2012, we anticipate special effects of approximately €50 million. As a result of further progress in reducing indebtedness, we expect interest expense to decrease further in 2012 to just under €600 million. The development of individual currencies can heavily influence the net interest result in 2012. In 2012, amortization from the purchase price allocation of the Siemens VDO activities in 2007 will remain roughly at the level of 2011 (€436 million). It will decrease substantially starting in 2014 and will not occur from 2015 onwards. The tax rate will increase slightly to around 32% in 2012.

Capital expenditure in 2012 will amount to more than 6% of sales. The main focus within the Automotive divisions will be on expanding our manufacturing capacity in Asia. The boosting of production capacity for high-pressure gasoline injectors in Changchun, China, in the Powertrain division, and the establishment of new manufacturing capacity in Wuhu, China, in the Interior division will be among the largest investment projects. The Chassis & Safety division will invest approximately €150 million in expanding manufacturing capacity for the latest generation of ESC and ABS systems (MK 100), particularly at the locations in Mechelen, Belgium, and Morganton, U.S.A. Within the Tire division, investments will be made in boosting capacity in Eastern Europe and in Asia. The largest single investment here is the expansion of truck tire production in Puchov, Slovakia. In the ContiTech division, the addition of a calender in Northeim, Germany, for the production of printing blankets is also worthy of mention.

Reducing net indebtedness continues to take high priority. The goal is to reduce this figure to under €6.5 billion in 2012 despite resuming payment of dividends. In total, we are planning a free cash flow of more than €600 million in 2012. After the repayment of parts of the syndicated loan already at the end of 2011, no credit tranches or bonds will fall due in 2012 and 2013 besides standard short-term financing, with the exception of a loan from the European Investment Bank totaling €300 million. There will be no major refinancing requirements until April 2014, when the amounts drawn under the syndicated loan of €5.375 billion will fall due. We plan to begin negotiations for refinancing the syndicated loan in early 2013. The ratio of net indebtedness to EBITDA will fall below a factor of 1.5 in 2012 and the gearing ratio, calculated as the ratio of net indebtedness to equity, will continue to improve towards 70% even though dividend payment has been resumed. The medium-term goal is to reduce this ratio to under 60%.

We expect to continue to create value in 2012. Despite rising capital expenditure, particularly in the Tire division, operating assets will increase proportionally to consolidated sales on average in 2012, meaning that with increasing EBIT there is likely to be a further slight improvement in the return on capital employed (ROCE). Our medium-term goal for the corporation is a ROCE of 20%.

A proposal will be made to the Annual Shareholders' Meeting on April 27, 2012, to distribute a dividend of €1.50 per share for fiscal 2011. In relation to net income attributable to the shareholders of the parent, this corresponds to a dividend payout ratio of 24.2%. The dividend yield in relation to the average price in 2011 is 2.6%.

Start to 2012
According to current estimates, car production will grow by around 2% to over 20 million units in the first quarter of 2012. In Europe, a decline in production of roughly 7% to around 4.9 million units is expected, which will be only partly offset by the increase in NAFTA to more than 3.6 million units. However, we still expect consolidated sales in the first quarter of 2012 to slightly exceed the very good level from the fourth quarter of 2011. In comparison to the first quarter of 2011, this would represent high single-digit growth. We do not expect any significant positive impact in the Rubber Group yet in the first quarter of 2012 as a result of the recent decreases in natural and synthetic rubber costs. Continental will issue the report on its first-quarter 2012 performance on May 3, 2012.

Outlook for 2013 is also promising
 For 2013, we likewise anticipate increases in consolidated sales and adjusted EBIT. The volume of new cars manufactured is expected to grow by around 4% to some 80 million units. The forecast for the global passenger tire replacement markets also remains positive: A rise of more than 4% is anticipated here. The IMF also paints a more positive picture for 2013 after the slowdown of the global economy in 2012. According to its data, the global economy will grow by 3.9%, with the emerging and developing economies as well as the advanced economies contributing to this growth.

If this scenario proves correct, we again anticipate high single-digit growth in consolidated sales in 2013, outperforming the reference markets by about 5%. Adjusted EBIT is also expected to increase in 2013 at least to the same extent as sales. The corporation's investment volume will remain slightly above the target corridor of 5% to 6% in 2013. No significant special effects are currently expected in 2013. Net indebtedness is to be reduced to under €6 billion in 2013.

Within the corporation, we are keeping to our long-term goals for the divisions which were set in 2010. These stipulate that the Chassis & Safety and Interior divisions should generate a double-digit adjusted EBIT margin. The Powertrain division is confirming its goal of achieving an adjusted EBIT margin of at least 8% by 2014 at the latest. The Tire division is aiming for an adjusted EBIT margin of over 13%. The ContiTech division's goal is to stabilize the level of its adjusted EBIT margin at 11% to 12% in the long term. The development in fiscal 2012 will demonstrate that we are well on our way to reliably achieving these EBIT margin goals.

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Continental Value Contribution (CVC). The CVC represents the absolute amount of additional value created, and the Delta CVC represents the change in absolute value creation over the prior year. This change in the absolute contribution measured by Delta CVC allows us to monitor the extent to which management units generate value-creating growth or resources must be employed more efficiently. The CVC is measured by subtracting the weighted average cost of capital (WACC) from the ROCE and multiplying this by the average operating assets for the fiscal year. The weighted average cost of capital calculated for the Continental Corporation corresponds to the required minimum return. The cost of capital is calculated as the weighted average ratio of the cost of equity and borrowing costs.

Currency swap. Swap of principal payable or receivable in one currency into similar terms in another currency. Often used when issuing loans denominated in a currency other than that of the lender.

Defined Benefit Obligation (DBO). DBO is defined as the present value of all vested and non-vested benefits calculated on the basis of estimated salary levels at retirement. The only actuarial method that may be used to calculate the DBO is the projected unit credit method. DBO corresponds to PBO (projected benefit obligation).

Derivative financial instruments. Transactions used to manage interest rate and/or currency risks.

Dividend payout ratio. The dividend payout ratio is the ratio between the dividend for the fiscal year and the earnings per share.

EBIT. Earnings Before Interest and Taxes. EBIT represents the results of operations. Since 2002, when the amortization of goodwill was discontinued, EBITDA has been equal to EBIT.

EBITA. EBIT before scheduled goodwill amortization.

EBITDA. Earnings before interest, taxes, depreciation and amortization.

Finance lease. Under a finance lease, the lessor transfers the investment risk to the lessee. This means that the lessor bears only the credit risk and any agreed services. The lessee is the beneficial owner of the leased asset. Finance leases are characterized by a fixed basic term during which the lease may not be terminated by the lessee.

Gearing ratio. The gearing ratio represents the net indebtedness divided by total equity, expressed as a percentage.

Hedging. Securing a transaction against risks, such as fluctuations in exchange rates, by entering into an offsetting hedge transaction, typically in the form of a forward contract.

IAS. International Accounting Standards.

IASB. International Accounting Standards Board. The authority that defines the International Financial Reporting Standards.

IFRIC. International Financial Reporting Interpretations Committee. Committee that reviews and determines appropriate treatment of accounting issues within the context of IFRS and IAS.

IFRS. International Financial Reporting Standards. The accounting standards issued by the IASB.

Interest rate cap. An interest rate cap sets an upper limit for a variable interest rate in relation to a notional debt amount. To the extent that the variable interest due on the underlying debt exceeds the cap amount, the holder of the cap receives income as compensation in the amount of the difference to the cap. An up-front premium is paid as consideration for the cap.

Interest rate swap. An interest rate swap is the exchange of interest payments between two parties. For example, this allows variable interest to be exchanged for fixed interest, or vice versa.

Net indebtedness. The net amount of interest-bearing liabilities as recognized in the balance sheet, cash and cash equivalents, the positive fair values of the derivative financial instruments as well as other interest-bearing investments.

Operating assets. Operating assets are the assets less liabilities as reported in the balance sheet, without recognizing the net indebtedness, discounted trade bills, deferred tax assets, income tax receivable and payable, as well as other financial assets and debts.

Operating lease. A form of lease that is largely similar to rental. Leased assets are recognized in the lessor's balance sheet and capitalized.

PPA. Purchase Price Allocation. PPA is the process of breaking down the purchase price and assigning the values to the identified assets, liabilities, and contingent liabilities following a business combination. Subsequent adjustments to the opening balance sheet – resulting from differences between the preliminary and final fair values at the date of initial consolidation – are recognized as "PPA adjustments".

Rating. Standardized indicator for the international finance markets that assesses and classifies the creditworthiness of a debtor. The classification is the result of an economic analysis of the debtor by specialist rating companies.

ROCE. Return On Capital Employed. We define ROCE as the ratio of EBIT to average operating assets for the fiscal year.

SIC. Standing Interpretations Committee (predecessor to the IFRIC).

US GAAP. United States Generally Accepted Accounting Principles. These principles are subdivided into binding and guiding principles.

Weighted Average Cost of Capital (WACC). The WACC represents the weighted average cost of the required return on equity and net interest-bearing liabilities.