Pirelli & C SpA
MIL:PIRC
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Pirelli & C SpA
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Ladies and gentlemen, welcome to Pirelli's conference call in which the Pirelli top management will present the company's first quarter 2020 financial results. A live webcast of the event and the presentation slides are available in the Investor Relations section of the Pirelli website. We would like to inform you that Pirelli top management is connected from different venues since the company is encouraging homeworking as a safety measure against COVID-19. We apologize in advance should any technical inconvenience occur.
I would now like to introduce Mr. Marco Tronchetti Provera. Please go ahead, sir.
Thank you. Good evening, ladies and gentlemen, and welcome to our first quarter results conference call. I give you an overview of what we expect for 2020 and our compass to navigate the current crisis. Mr. Casaluci will comment market trend and Pirelli performance and actions, while the financial results will be illustrated by Mr. Sala.
Last time we met, we were in Milano for the presentation of our industrial plan just before the outbreak of the COVID-19 pandemic.
We are witnessing an extraordinary emergency and unprecedented health crisis that is causing a deterioration of the global economy and the deep change of the scenario which was the basis of our 2020-2022 industrial plan. It was recalled as a consequence.
The experience, be it in China where the virus first emerged, allowed us to promptly react to the new global context and rapidly define a very detailed action plan to protect the company profitability and cash flow. This plan was announced on April 3. So far, we are the only player in the industry with a clear outlook and the guidance that we are confirming today. For the full year 2020, we will foresee a 20% drop in tire demand, with High Value proving again to be more resilient than Standard, which is the foundation of our strategy. Against this backdrop, our safety measures are giving the first results. We are fully on track with the 2 sets of programs: the cost competitiveness action plan and the COVID countermeasures launched in the first quarter. Finally, even if the second half 2020 will show market improvements and China is recovering fast, also thanks to massive subsidies and incentives, it will take time to fully recover 2019 levels. For this reason, we are already working on a more radical transformation so as to make Pirelli a lighter and faster player.
Let's move now to the outlook. So this slide shows how deep the crisis have reached compared with the scenario we consider for our plan. 18 million less cars produced, 390 million less tires in the market, about 19% lower Pirelli volumes. This serious crisis is going to bring about structural changes in the industry.
Coming to the 2020 scenario, the outlook we gave you on April 3 has been confirmed by recent data and in industry commentaries: minus 22% drop in car production confirmed by the latest figures from Global Insight, such fall is mainly driven by Europe and North America, minus 20% both, less pronounced in the Prestige segment with few order cancellations and where COVID-19 is considered more of a supplier shock; minus 20% the total car tire market, now a consensual scenario with a very challenging quarter in second quarter and optimism for the second half, driven by China recovery and better Europe trend.
Moving to the next chart. In this scenario, High Value has confirmed there's really resilience versus Standard segment. The less pronounced decline, minus 15% in High Value versus minus 21% in Standard. High-teens volume decline for Pirelli, mitigated by its exposure to High Value. As Mr. Casaluci will illustrate, the expectation for a tough second quarter in line with the market and a better trend for the second half of the year where the Replacement demand improving.
In this tough market environment, cost flexibility is crucial. At Investor Day in February, we presented a cost competitiveness program, aiming at optimizing variable and fixed costs and producing gross benefits for EUR 180 million or EUR 110 million net of inflation for 2020. We are in line with our expectations except for some projects in the manufacturing area affected by the slowdown in production due to the COVID emergency where we had to freeze about EUR 20 million in efficiencies. The benefit expected to the year now EUR 160 million or 3.6% of 2019 cost base. However, the EUR 110 million of benefits net of inflation are confirmed, being the impact of the inflation now estimated at minus EUR 50 million compared with minus EUR 70 million on the previous indication.
To limit the effect of production lockdown and fall in demand, Pirelli also launched a second cost containment plan, COVID Actions, announced on April 3, 2020. This plan equal to a total of EUR 120 million for the year, includes short-term action Mr. Casaluci will talk about. These savings will offset the cost impact slowdown estimated at around EUR 90 million in 2020. Overall, the combined benefits of the 2 plants amount to about EUR 280 million, around 6% of the 2019 cost base, or EUR 140 million net of inflation and slowdown, around 3% of 2019 cost base. In the first quarter of 2020, the net benefits of the 2 plants amounted to a total of EUR 33 million, EUR 64 million gross, or about 25% of full year target. In details, around EUR 16 million from the competitiveness plan, in line with the plans forecast for the first quarter, benefits of about EUR 31 million gross of inflation equal to minus EUR 15 million, around EUR 17 million from the COVID Actions, about EUR 33 million before the impact of the slowdown of EUR 16 million.
We expect market to start recovery in second half 2020 with China leading the way and benefiting from government aid to the auto industry. Should Europe and U.S. be able to count on government support, their markets could also recover as quickly. However, if not aids are given, markets will take 2 years to go back to 2019 level. With this perspective, Pirelli is using this time to transformation into a leaner and faster-moving company, also leveraging on the lesson learned during lockdown. In order to be leaner, we are pruning products more than expected in February industrial plan, moving our processes to digital backed by more automation and data insight, simplifying the organization's architecture, changing our way of working with savings in office space, energy and travel, mothballing capacity, creating regional service centers. Whilst to be faster, we are connecting directly to consumers and to customers, pushing collaborative forecasting and replenishment. All these actions will reduce stock, reducing plant throughput time, reducing product time to market with virtualization and simulation. All the benefits of this transformation will be captured on our new 2021-2023 plan.
Let's now move to the guidance we gave in April: Revenues between EUR 4.3 billion and EUR 4.4 billion; adjusted EBIT margin between approximately 14% and 15%; investment of around EUR 130 million, 57% less than the February guidance, consistent with the new market scenario and capacity utilization level and postponement of some projects; financial position confirmed of around EUR 3.3 billion, with net cash generation of approximately EUR 230 million to EUR 260 million. We confirm this guidance. But being realistic, as the second quarter is expected to be the worst of the year, we feel more confident with the low range of our targets.
The next 2 of 3 months will be crucial to understand, based on the health crisis evolution, what the consumption recovery trend can be. We remind you that our balance sheet is solid and further strengthened by recent refinancing operation, as Mr. Sala will detail later on, with the liquidity margin worth EUR 2.1 billion, covering for debt in the next 3 years.
Before concluding, I'd like to give you a very brief update on the ongoing negotiations between Camfin and Longmarch that started early April. Camfin is expected to finalize and soon the partnership anticipated on April 1 last. Longmarch is owned by a Chinese family Niu, having industrial relationship with Pirelli since 2005 when the group first factory in China was established through the creation of a joint venture that contributed to the development of Pirelli's factories in the country -- in the county of Shandong. The partnership between Camfin and Longmarch to a newly incorporated entity whose covenants will be held by Camfin itself is aimed at developing private equity investment. Longmarch also holds, through a repurchase agreement, the potential participation with the right to repurchase approximately 7.68% of Pirelli, increasing from 5.19% announced on April 1. The agreement accounted under the negotiation would provide for prior consultation between Camfin and Longmarch before the shareholders' meeting of Pirelli, and the rightful Camfin to provide voting instruction for such meetings. In this context, Camfin confirms the solidity of the long-term partnership launched in 2015 with ChemChina and the stability over time of the current governance structure which aims to preserve Pirelli's entrepreneurial catcher.
So now I leave the floor to Mr. Casaluci. Please, Mr. Casaluci.
Thank you, Mr. Tronchetti, and good evening, ladies and gentlemen.
Let's start focusing on market dynamics and Pirelli performance.
COVID-19 emergency heavily impacted car tire demand in first quarter with a 20% drop in volume, affecting both the Original Equipment and Replacement channels. On the Original Equipment side, minus 22.7%, the decline mirrored the car production trend, while without precedented downturn in Replacement demand, minus 19.3%, occurred due to mobility restrictions. The fall in the demand was more pronounced in the Standard segment, minus 22%, while the High Value was more resilient, minus 11.6%. Pirelli performance in the High Value segment has been characterized by outperformance of the market in Original Equipment, minus 9.5% versus a minus 16% of the market, thanks to the widening of the customer base in North America and Asia Pacific, already underway since the second half of 2019. Underperformance in Replacement channel, minus 18.1% versus a minus 8.2%, caused by the significant exposure on 18 inches and above within the Chinese market, in which Replacement has been down around 50% year-on-year in the first quarter. It is worth mentioning that April data showing general recovery of the market. The choice to support our main distributors in Europe and North America in keeping low stock levels in order to be best prepared for a quick recovery. In the Standard segment, Pirelli performance, minus 22%, was pretty much in line with the market. And our focus has been maintained over the reduction of the exposure to less profitable sizes.
Let's have a look now to the expected market evolution throughout the year. Outlook for the full year is confirmed, with a tire demand down 20% year-on-year. For the second quarter, we now project a more severe downturn, with the tire market at around minus 40%, particularly negative in the Original Equipment where OEMs are slowly ramping up production after lockdowns. Assuming no second waves of COVID-19 spread and success of government restrictions loosening, partial recovery is expected to bring second half demand to single-digit decrease. As mentioned by Mr. Tronchetti, the next couple of months will be crucial to understand the consumption trend.
The outlook differs region by region. In Asia Pacific, China has broke down first quarter market figures, but is clearly recovering in second quarter, where we are cautiously optimistic after getting good signs in April. Other countries in the regions such as Japan, Singapore and Malaysia are still facing instead lockdowns restrictions. In Europe, now activities have restarted, but the productivity, both in Original Equipment and store traffic in Replacement, are still far from normal level. In North America, some Original Equipment factories are currently not running, and second quarter market trend is expected to be very tough. The recovery of consumer demand is expected to lag Europe as the social impact will probably be more severe. In standard regions, in South America, second quarter is expected to be severely hit, but Replacement demand should catch up quicker, while Original Equipment will remain depressed throughout the year. In Russia, lockdowns impacting second quarter demand are coupled with the economy difficulties with low oil prices and currency devaluation.
As already said by Mr. Tronchetti, in this tough market environment, we are further optimizing our cost baseline with a gross efficiency plan of around EUR 280 million in 2020. This program is combined -- combination of the competitiveness plan announced in February, which is now worth EUR 160 million, and a second cost containment plan of around EUR 120 million to limit the effect of the production lockdown and falling demand. The 2 projects are working on the same streams. And in most cases, the latter represents an enhancement of cost competitiveness actions.
Let me now give you an update on each stream. On product cost, which is now equal to around EUR 60 million, we are performing in line with expectations, continuing to streamline the entire product range toward a value-based portfolio, working on tire structure simplification and weight reduction, and accelerating the vehicle design process and material portfolio decomplexity to face the impact of slowdown. Some projects in the manufacturing area were affected by the slowdown in production due to the COVID emergency. We had to freeze about EUR 20 million in competitiveness efficiencies. But in response to production slowdown, we are further focusing on flexibility and factory flow optimization and activating additional short-term actions on fixed costs and especially on variable costs, mainly consumables, auxiliaries and direct materials, and energy consumptions. COVID Actions equal to EUR 40 million, of which 60% variable cost. The manufacturing stream is now worth EUR 60 million.
On SG&A, which accounts for 40% of 2020 efficiency, we are deeply reviewing marketing, communication and motorsport activities as a consequence of the lockdown at worldwide level, supporting more digital activities. To protect margins, we also increased the target reduction of discretionary costs through a further belt-tightening of professional services, travel and overheads. Moreover, leveraging on procurement renegotiations and stock reduction, we continue working on optimizing distribution flows and reducing warehousing costs. The SG&A stream is now worth EUR 110 million.
Finally, we are working towards a leaner organization that will bring about a cost saving of around EUR 50 million. We are completing the footprint rationalization in Latin America, developing our existing shared service centers in that region and Europe, and working on a more pervasive pay-for-performance system more closely linked to functional objectives, improving the effectiveness of the schemes.
During this period of emergency, we have also let people work from home to protect their safety first. Smart working has proven to be very effective in terms of results. And now we are trying to implement it in a more structural way, with benefits already visible in the near future.
COVID slowdown is forcing the tire industry to deal with rising unabsorbed fixed cost given the lower utilization rates. In this context, we are putting all the effort needed to contain production, slowdown costs. We are adhering to government's social safety nets in Europe and South America since March, a key support to our employees. We keep reducing the complexity in our plants' operations to maximize efficiency and enhance our quality. In the second quarter, we will face very low utilization rate. As a countermeasure, we will increase mix rotation to provide optimal customer service and stock reduction. We are speeding up reallocations of the standard sizes ranged to low-cost footprint regions. To keep stock curves aligned to the evolving production requirements, the purchase of raw materials has started to slow down already in mid-February, also thanks to an enhanced MRP system. Finally, we took lockdown restrictions as a chance to step up our Smart Manufacturing digital training for the workforce and further integrate data platforms.
In order to face the current market scenario, we have defined several commercial actions to mitigate the negative impact of downturn and be prepared for the market rebound. We balanced our commercial actions with the need to lower our distribution pattern stock to ensure rapid orders inflow when consumers will be back in stores and to keep under control any potential financial risk with trade.
We keep investing in Chinese market, which has already started to regain traction, with positive feedbacks from April figures. Online business is growing at a fast pace, and we are exploiting this trend, forecasting in 2020 almost 10x the volume done in 2018 through this channel. Our exposure to China will support the next quarter's results. We have been very active in trade channels, accelerating new customer acquisition in Europe, and expanding franchising and affiliations to cope with the new scenario in distribution. We keep on broadening our geographical exposure in the Original Equipment towards North America and Asia Pacific.
Finally, as for new products, we have just launched the new CINTURATO P7 flagship high-performance product in China, but also in Europe, together with new offering of 18 inches up self-sealing sizes. Between third quarter and fourth quarter, we plan to anticipate the launch of new regional lines in North America and Europe, thanks to the improvements in our development simulation tools.
Let's finally move to the operational drivers of our guidance. For what regards revenue drivers, we foresee High Value volumes around minus 14% year-over-year. For Standard, we forecast a more severe decline, about minus 26%, keeping pruning the exposure to the less profitable products. The combined trend of High Value and Standard will bring group volumes between minus 18% and minus 20%. Price/mix improvement is expected at about plus 2%, driven by the improvement of both channel and regional mix already from the second quarter. ForEx, at about minus 2%.
Moving to profitability. We expect Pirelli adjusted EBIT margin to be in the range of approximately 14% -- 15%. We confirm the following drop-through, 42% on volumes, around 50% on price/mix and about 15% on ForEx. Our competitiveness plan is expected to deliver about EUR 110 million benefits net of inflation. In addition to that, to compensate for the slowdown deriving from the COVID-19 emergency, we implemented additional cost actions which should bring extra net savings for around EUR 30 million.
As already pointed out by Mr. Tronchetti, we feel more confident with the low range of our targets. The next few months will be important to understand what the recovery trend in consumption will look like.
I'll now leave the floor to Mr. Sala.
Thank you, Mr. Casaluci, and good evening, ladies and gentlemen.
We ended the first quarter 2020 with net sales in excess of EUR 1 billion, minus 20% from the same period of 2019. This trend was mainly impacted by the drop of volumes by minus 17% at group level, reflecting the general slowdown of demand.
High Value volumes recorded a minus 14%, and the same did the 18 inches and above volumes where Pirelli performance varied in the OE and Replacement channels, as Mr. Casaluci already explained. Standard volumes decreased by minus 20% in the quarter, in line with the market. In this segment, we kept reducing our exposure to less profitable rim sizes.
Price/mix recorded minus 1.3%. Pricing was in line with previous quarters. The OE business was a bit more negative, discounting the indexations to raw material prices in the OE contracts. The Replacement was a touch less negative. We still see some price competition, but the sector has shown a price discipline, especially in High Value, a segment well protected by technology, content and brand. Mix, basically flat in this quarter, affected by temporary negative regional mix, particularly due to the drop in sales in China, characterized by an average selling price higher than Pirelli average. April data are encouraging, with general recovery of sales. Regional mix is expected to rebound in second quarter, thanks to the demand recovery in China and the lower contribution from South America and Russia. It was affected also by negative channel mix, with a more market drop in Replacement sales compared with OE, and this trend is rebalancing in the course on second quarter. And finally, positive product mix, but with a lower contribution versus previous quarters, considering the more contained performance of High Value versus Standard. And finally, negative ForEx of minus 1.5%, affected by the weakness of currencies of emerging markets.
The efficiency and cost-cutting actions in connection with the COVID-19 emergency contributed to contain the impact of the tough external scenario, the weakness in market demand and the pressure on prices, and the increase in the cost of production factors.
In more details, the cost competitiveness program generated structural efficiencies of EUR 31 million, 2.9% of revenues, by offsetting the inflation of cost of production factors, minus EUR 50 million; the temporary negativity of the price mix, minus EUR 50 million; and the exchange rate impact, minus EUR 1 million. These efficiencies mainly concern the cost of the product, optimization of specifications and rationalization of components, the organization with the reengineering of processes, and SG&A costs with a strict control of overhead.
The cost reduction plan linked to the COVID-19 emergency equal to EUR 33 million for the first quarter, offset the impact of the slowdown, minus EUR 60 million; and higher cost of raw materials, minus EUR 3 million. Cost reduction measures were carried out with regard to discretionary costs, SG&A, the review of marketing and communication activities, the renegotiation of contracts with suppliers, the prioritization of R&D investments and the efficiencies for the distribution channel. The impact of volumes in the end was negative minus EUR 95 million, while the item amortization, depreciation and other costs was positive to the amount of EUR 4 million.
We ended the first -- the quarter with a net debt of about EUR 4.3 billion. In the first quarter of 2020, net cash flow was minus EUR 754 million, in line with the trend of the first quarter 2019, where lower investments, CapEx and financial investments, together with an improved financial management, mitigated the impact of the operational performance. More in details. The cash flow from operations was negative for minus EUR 697 million, and reflects CapEx for EUR 57 million, with investments mainly directed to the High Value business; continued improvement of the mix and quality in all factories; higher rise of use IFRS 16 for EUR 23 million, deriving from the application of the new IFRS 16 principle and relating to the new leasing contracts entered during 2020; and the usual seasonality of the working capital, with a negative cash absorption of minus EUR 861 million, slightly higher than in the first quarter 2019; and discounting the increasing stocks, raw materials and finished products caused by the production slowdown and following closure of plants due to COVID-19 emergency. The company has also taken actions leading to the normalization of stock's levels in the course of this year.
As of March 2020, our gross debt of EUR 5.6 billion lends to a net financial position of EUR 4.3 billion, thanks to EUR 1.3 billion in financial assets. Our liquidity margin at EUR 2.1 billion is very sound and covers forthcoming maturities into first quarter 2023, thanks to the possibility of extending our bank debt expiring in 2022.
In the first months of the year, our actions were indeed aimed at maintaining an adequate level of cash. I remind you that in March, we subscribed at a very favorable tier-terms EUR 800 million loan with a maturity of 5 years. And this financing also represents our debut in the sustainable finance space as it is linked to the group's ESG and circular economy targets. And we extend also the maturity of a EUR 200 million bilateral financing originally due in June 2020 and now postponed to September 2021. More recently, in April, we have also exercised the sole borrower discretionary option we had on the tranche of our main bank line coming due in June 2020. EUR 259 million are, therefore, now postponed to June 2021.
It is also positive from the cash level perspective that we are easily renewing our local short-term lines. In the current environment, we have also considered it prudent to proactively approach our lenders and gain flexibility on those financial covenants, which, at a certain point in future, and with a prolonged lockdown, might go under pressure. The process will be closed in the next days. Finally, let me spot the positive trend of our cost of debt, which benefit from a lower exposure to high-yield countries and now stands at 2.54% versus 2.83% at year-end.
And before ending my presentation, I want to thank you all in advance. After over 10 years as Chief Planning and Controlling Officer, I'm going to take on new responsibilities within Pirelli, and in place to pass the baton to Mrs. Leone, wishing her the best of success.
And now I leave the floor back to Mr. Tronchetti.
Thank you, Mr. Sala.
This ends our presentation, and we may open the Q&A session.
[Operator Instructions] The first question is from Kai Mueller with Bank of America.
I hope you're all well given the current times. The first one is really on your tire demand. You mentioned obviously on your Slide 10, when you look at your outlook, that you actually expect Replacement demand to pick up slower than OE. What is really the driver there? And that's, I think, especially in terms of some commentary, what we've heard from your peers, that have seen really Replacement demand in China, in particular, but also in Europe, picking up quite strongly with people switching from winter tires into summer tires. Maybe as the first one. And as a second point, just trying to understand, on your replacements demand forecast versus -- achievement in Q1 versus the market, what we can see on Slide 9 is you've done much better on OE, but you underperformed the market in the High Value space in Replacement. What has been the driver there? Is it the distribution mix? Or is there anything you can add to that?
Thank you. Mr. Casaluci, please.
Thank you, Mr. Tronchetti. So starting from the expectation of the Replacement demand. First of all, this is a period of uncertainty, but we have one sure effect which is coming from the recovery on China, occurred in April. The first signs are positive. We don't have final figures of the market, but we can say that we are low single-digit decrease in the entire market and that we see a positive trend on the 18 inches up, which is performing better than last year in Replacement. So it goes without saying that the reaction of China is positive and strong, but we do expect the same trend, with a delay of 1 month, 1.5 months also occurring in Europe. Individual mobility will increase after the COVID-19, and this will support the consumption of tires. On the other hand, cars has been stopped for 2 months, 2.5 months, and they had not -- the tires is not utilized. So the 2 effects we expect will be compensated. But all in all, the recovery that you show -- we show on Slide #10 of our presentation is forecasting a recovery in the second quarter of the Replacement.
Second question, what occurred in distributions? As I said before, in the first quarter, we decided to reduce our stock position in the trade, mainly in Europe and North America because in a volatile context as this one, we do prefer to stay on the safe side as far as the exposure, and we want to support our partners in distributions. In Europe, there is also a change in the go-to-market and in the state of distribution, mainly in Germany and in Italy, as you know. And we are redesigning our go-to market, enlarging our presence in the retail channel and relaunching our franchising program.
So one more comment. So we -- in the first quarter, we destocked. The sell-in was low than the sellout. Sell-out was in line with the expectation. Sell-in, we reduced just to reduce the stock. We anticipate also the slowdown in our factory, taking into account the experience we had in China. Thank you.
That's very clear. And maybe just one follow-up on your price mix and it was slightly negative. Obviously, you see that still at plus 2% for the year. If you think about the cadence throughout the year, is it really a turnaround already in the second quarter? Or do you think it's coming towards the back end of the year? Because obviously, with those volumes, people would be more concerned about pricing down more and it's not such a big mix benefit.
So before leaving the floor to Mr. Casaluci. I had to say that price, minus 1%, is in line with previous quarters. Mix, flattish, minus 0.3% due to temporary effects, negative China and regional mix. So we had a lower -- obviously lower sales in China, where we have the highest mix within our markets. And there was also channel mix that affected us related to the Original Equipment that overperformed the Replacement. If we look to the second quarter, we see a rebound in price/mix, driven by the regional mix supported by China. Price will continue the trend of minus 1%, consistent with the full year guidance.
But Mr. Casaluci, please.
Thank you, Mr. Tronchetti. Nothing to add. Just saying that the first result of April is already showing the expected rebound, supported by the positive regional mix. Just to give you a number, the weight of sales in China in the first quarter has been half of the average we normally have. And the average selling price in China is roughly 20% higher than the average of our global average price. That's the reason why we have been affected negatively by the region mix. And the recovery is expected and already visible starting from the second quarter.
One last comment. So we see second half -- because we see the resilience of the 18-inch and above, we see what is happening in China. So we expect the second half confirming the trend and the resilience of the High Value compared to the rest of the market.
The next question is from Monica Bosio with Banca IMI.
The first one is once again on China. According to other premium players, China might end the year with a minus 10%, minus 12% downside in car production. And expectation for the next year could be in the region of plus 3%, plus 4%. I know that it is too early to say this. But just a view, if you are going to share this view. And what is your feeling on the speed of the recovery for the rest of the market? Do you expect NAFTA will recover faster and stronger than Europe? Just some flavors on this.
And the second question is on the benefits from the cost savings plan. In the first quarter, the benefits were, just let me check, EUR 30 million, EUR 31 million. Do you expect the same amount in the second quarter or maybe a much higher amount of cost savings, both from the competitiveness and the COVID Action? And as for the price/mix, 2% for the full year of 2020, in the initial plan, the price/mix was expected at plus 3%. Just to check, is that due only to the pricing, not to the mix? Is it correct?
Starting from China. China, we see the market recovering well. Considering the 2 months of shutdown, what the market is expecting is in line with what we expect. What we see is the resilience of the Premium segment, which obviously is our segment. The other countries, it really depends on the actions that will be taken by government to support the industry. We -- for sure, the resiliency of the High Value segment is, for us, support to our results. But we have to see which will be the tools that will be given to the automotive industry by mainly U.S. and Europe.
The cost savings. Cost savings, we see that the largest part -- still the largest. We have a quite distributed gross savings. You saw that we were able to deliver EUR 64 million gross in the first quarter. We expect to have also in the second quarter a gross effect that will be, on global, another 28%, 30%. Net will be less in the second quarter because the slowdown will affect much more. So the real bad quarter is obviously the second quarter in terms of net costs, in terms of our costs. And we expect to have the other 50% at a gross level in the second half, which it should be 60% considering that the slowdown will not affect as it is affecting in the second quarter. So these are the -- what we have in control on the cost side.
Going to price/mix. Yes, you are right. Mr. Casaluci can elaborate on it.
Yes. Thank you, Mr. Tronchetti. Yes, you are right. We are moving from a plus 3% to a plus 2% in our guidance. This is driven by 2 effects. First is slightly mix. And second is price on the Original Equipment due to the cost metrics logic because the reduction of the raw material cost is affecting through the cost metrics mechanism, the price on the Original Equipment, while the price environment in the Replacement we see for the time being is of global discipline of the industry, mainly in the High Value segment. So we don't see changes for the time being the price environment in all the High Value market. Thank you.
The next question is from Martino De Ambroggi with Equita.
Yes. Sorry to bother you on the price/mix once again. But just very roughly, could you split a bit more the mix effect because you mentioned several different variables? OE aftermarket, different products, High Value, Standard, different regions. Just a sort of what were the most important...
Can you please -- sorry, but we cannot hear well.
Your mix and trying to isolate the China...
Can I -- sorry, can you please repeat because we couldn't hear well?
Okay.
Thank you. Sorry.
Can you hear me better? Now can you hear me? Hello? Can you hear me better?
It's fine. Thank you.
Okay. So the first is still on the price/mix, because you mentioned the several components, aftermarket, Original Equipment, different products, different regions and so on. Just to have a sort of classification of what were the most important and the less important components in the first quarter. And just to double check if what I understood is that China, isolating China would be the, by far, the most important element in Q1 and should drive the recovery starting from Q2.
So in general, China, we see that it is recovering. And the last data showing that the Replacement is performing better than last year in the month of April. So that is what we see in China happening. Also, in Original Equipment, it's moving fast because of the incentives that we mentioned.
I think that Mr. Casaluci can elaborate more in detail about the first quarter mix effects.
Thank you. So try to simplify. The performance was minus 1.3%. As Mr. Tronchetti mentioned, price impact was roughly minus 1% and mix, flat. Now we go inside the mix. We have 2 major effects. The positive effects coming from the product mix, which is the usual performance of roughly 2% positive impact due to the positive product mix, reduction of Standard, increase of value in the total weight and micro mix. Then we have a negative impact of 2% leading to the neutral total effect, which is coming from the regional mix that Mr. Tronchetti mentioned before.
Why? Because the weight of China on our sales in the first quarter was half of the normal, and we sell at an average price in China that is roughly 20% higher than the average of the other markets.
Because of the mix.
Of course, because of the mix. Second negative effect is the channel mix. Again, the weight of the Original Equipment on our sales in the first quarter was 3 percentage point higher than the average. And this is because the slowdown started from the Replacement, while the effect on the Original Equipment arrived later. These 2 negative effects, regional mix and channel mix, will rebound with a positive impact in the second quarter because we see that the restart of sales starting from Replacement, with the pace of recovery higher than the Original Equipment, and China started sales with positive signs already coming from April results.
The second question is on the free cash flow, specifically on the net working capital. So just what you see right now in the market, in your dealer network, considering that in the past you suffered sometimes some cash absorption just to change the payment terms for some regions for your dealers?
Mr. Sala.
For low cost of working capital, we are adopting a very cautious view for low cost in receivables, a very cautious approach in this current moment of the market. And also, a cautious approach work for concerned payables. What we are envisaging, what we guided also in the presentation of the 3rd of April in terms of worsening working capital is only a temporary worsening because it's connected to 2 major elements. If you compare what is our projection of cash flow now versus the projection that we presented in 19 of February, practically, we are guiding with a net cash flow that is, if we take the floor, EUR 230 million net versus EUR 220 million that was forecasted before in 19 of February. That was related to EUR 400 million net of dividend -- gross of dividend, minus EUR 180 million of dividend.
The advantage that we are having are coming from the fact that we are not paying dividend by EUR 180 million. We are lower -- we have lower investment for EUR 170 million. We have lower taxes with the lower results for EUR 70 million. And this is more than compensating the EBITDA that, if you take the floor, is negative by EUR 330 million. And finally, also the worsening of the working capital in the region of EUR 80 million. But this worsening is coming from 2 temporary effects. The fact that the reduction of investments is not generating a full impact of positive cash in 2020 because one part, the last quarter, will be paid in 2021, and finally, also, the cancellation of short-term incentive will generate lower payables. So these are temporary effects. For your concern, the other elements of working capital, we're working by reducing the stocks and with a stronger action that already will generate reductions starting from the second quarter. So not major elements, negative on working capital.
Okay. A very last question for Mr. Tronchetti. If someone do suggest to you a merger with Brembo, what would be your reaction?
[Foreign Language] Sorry. It's a very interesting question. I think this is time to work hard on costs and be very careful. Merger, I don't think now are in the agenda. Anyhow, I'm always ready to analyze any proposal. I always, in my life, done the same way. So nothing have to be refused before analyzing, but nothing is on the agenda and nothing is on my desk.
The next question is from Gabriel Adler with Citi.
Gabriel Adler from Citi. My first one is on CapEx. And the CapEx cuts of about 70% this year is quite significant. I know that you're already carrying to CapEx a lot when you announced at CMD that it was coming down, but it's still quite a large decline compared to peers. So could you give us some more details on way of finding these additional CapEx savings from? That's the first question. My second is on dealer inventory because you mentioned that you were destocking in Q1. Can you just confirm whether dealer inventories are now at a normal level at your dealerships in Europe and North America? And my last question is on cost savings. Could you explain please in a little bit more detail where the additional EUR 20 million of lower inflation costs coming from in order to offset the EUR 20 million of manufacturing costs that you now don't expect to achieve this year?
Thank you. So first, on CapEx. We -- obviously, with the slowdown, reduction of production of EUR 50 million year-end expected, we were able to drastically reduce starting mostly in March and going on in the following months. And so we continue to make investments in technology upgrade. Let's say that the largest part of the investment will be in technology upgrade. And then business continuity, obviously, is much less considering the freeze of production. And capacity, obviously, is the other investment that we have been able to cancel. So we reacted quite fast, thanks to the -- China was helpful in that scenario because we could foresee the damages that net COVID could have given to the other markets, and so I think we have reacted quite fast.
On -- Mr. Casaluci, if you want to answer to the other question, please.
Yes. Thank you. As far as the stock is concerned, the stock level is more or less in line with -- compared to 1 year ago. It means that despite the reduction of the demand without precedent, we were able to slow down the production in order to maintain the same level of stock of last year. Our plan for the coming 2 quarters is to reduce the total level of stock, and the first important step has been done during the month of April of roughly 14% in value.
As far as North America is concerned, it is the region where we have to reduce them all because it's not optimized as we would like in this moment. But within the end of the second quarter, we will be in the target position we want to reach, and will be part of the global plan of reduction of stock.
For your concern, the third question, on inflation. We guided at the beginning of the year with an inflation of minus EUR 70 million. Now we are guiding with an inflation of minus EUR 50 million. This is composed by 3 major elements: labor cost, energy, and transport and logistic costs. Consider the current oil scenario, the current oil scenario is not impacting positively, only in raw material costs, but also in energy, and also in transport costs, international transport and local cost. And in term of labor cost, we acted with negotiation by reducing what was our initial assumption of increase of inflation. So practically, this is impacting positively versus the initial assumption by EUR 20 million. It's improving, for this reason, the production cost.
Could I just follow-up on the inventory question? I was more referring to inventory levels in the dealer network. And any comment on the dealer network inventories would be helpful.
Sorry, we have lost you. We didn't --
I wasn't sure whether your answer on inventories was referring to your own stock level or the dealer network. I wanted to better understand how you see inventories within the distribution network.
Sorry, the question is related to the trade stock level. Okay. I answered on our stock position. So trade stock level. In Europe, after the first quarter, the stocking is now at the normal level for the season. While in North America, in the trade, the stock position is still higher than our target. And so we plan to reduce the stock position also in the trade during the second quarter.
The next question is from Thomas Besson with Kepler.
I have a few questions as well. Can I please start with a simple one? Can you remind us how much China accounts for your 18 inches and above business, please, in OEM replacement?
18 on 18.
18% share?
Hello? You asked for 18 inches? I'm sorry. But the line sometimes comes and goes. You asked about 18 inches in China?
Yes.
It accounts for 12% of our sales.
Sorry, can you say that again, please?
18 inches, it accounts for 12% of our sales.
Another question on the volumes, please. You had a bigger volume decline than most of your competitors. Mission accomplished. But your drop-through on volumes was only 42%, while it was, for instance, 45% last year. Can you explain how you managed to reduce the drop-through despite the increase in volumes, which normally tends to increase drop-through?
Sorry. The line comes and goes. As far as I can understand your question, our reduction, Mr. Sala.
We -- but we guided with a 42% of drop for your concern on volumes. 50% --- around 50% for your concern on price/mix, around 15% for your concern on ForEx. Practically, the drop volume, 42% is in line versus the drop volume of last year.
Okay. Can you comment on industry pricing in March and April? And what you assume for the rest of the year in the 18 inches and above business, knowing that everybody in the industry now has excess capacity? Do you expect the industry pricing to remain as disciplined as possible? Or do you anticipate that pricing will become more complex?
No. I have to say that we see a price resilience. We don't see any price erosion in the industry. I think there was an erosion last year, and now we see that the price discipline doesn't have a sign of weakening.
Okay. Last question, please. In Q1, you explained that geographic mix and the willingness to cut inventories explain your underperformance in Replacement in 18 inches. Can you confirm that you are now happy with inventories? And that Q2, Q3, we should see clearly 18 inches in Replacement perform at least as well as the market, please?
No. We -- in sell-in, we mentioned before, we destock, and so we -- the sell-out was in line with our market share, but we reduce the sell-in just to reduce the stock in the market. Now we see a situation that we remain flattish looking forward. At the end of the year, we will have a total effect of destocking. We target around EUR 2 million in destocking by year-end.
The next question is from José Asumendi with JPMorgan.
I was just wondering if you could give more details behind the COVID Actions on Slide #11, especially a little bit more around manufacturing and SG&A. And the timing of those gross benefits, what do you think we will see the bigger benefit coming? Is it between the second and the fourth quarter? Which quarter roughly do you think we will have the biggest benefits? That's the first thing. And second, I know you commented on CapEx and you've cut the guidance for the full year. How far can you bring CapEx down in Q2? That's the second question.
On CapEx, one second. Second quarter, we should have half of what we had in the first quarter. So considering the EUR 130 million, we have -- we expect around EUR 27 million, EUR 28 million of CapEx in the second quarter.
And Mr. Casaluci, for the other questions.
Yes. The net impact, that benefit of the 2 actions on cost competitiveness and COVID is expected to be 60% in the second half and 40% in the first half as net impact. Why is less? Because the negative impact of the slowdown is affecting mainly the second quarter.
A quick follow-up. Very interesting discussion on the last time we met at the Capital Markets Day. I would love to hear from you, like what was your reaction when you saw that Brembo was interested in buying a stake in Pirelli? I would love to hear from you your view and your reaction when this happened.
Sorry. Can you please repeat because we lost the last part of your question?
Simple question. When we saw Brembo buying the stake in Pirelli, I'd love to hear from you, what was your reaction? Obviously, I heard some of the takes from the Investor Relations team, and we had the discussion back at the Capital Markets Day around this topic. So I'm just thinking, what was your reaction when you saw the new shareholder coming into your -- into Pirelli?
We saw what was happening in Europe. Having the experience in China, I have to say that China had a strong staff reaction, shutting down everything. So in economic terms, the result was the same. So we had a shutdown. In Europe, it took -- in Italy -- a bit less because we started first and then the other countries follow. And so I think now Italy is restarting. The others are restarting. So I think we were selling new. And the reaction here, obviously, at the beginning, with many uncertainties, we added the -- let's say, the disadvantage to have the experience in China. And then we saw Europe coming to the same nightmare. And so -- but now I think the situation is more and more known. And when we know something, we react more rationally. And it seems that everywhere, the reaction now is more rational. And so that's why I expect that the second half in any scenario would be much better because the entire world is prepared, and from the health system, to the political systems in every country. And we, as citizens, we are learning how to live with. And this conference call is the example. So we talk normally, which is fine, I mean. And we know that we are changing also our way of doing business, which is saving a lot, really a lot of time and money. And so I see looking forward an opportunity for all kind of activities to be handled in a better way.
The next question is from Gianluca Bertuzzo with Intermonte SIM.
Just a quick question is on the guidance. During the opening remarks, you said that you are more confident on the low end of the guidance. I wanted just a confirmation. If this means that you're looking for revenues of EUR 4.3 billion and an adjusted EBIT margin of 14%. This is just my only question for today.
Yes, yes. We confirm the low end. That is around the figures that you are considering as realistic. We consider realistic to stay in the low end of the range. I profit of this to underline something. I wanted to underline before -- for the previous answer in the previous question. So what was the core of our reaction? And I think what has been creating a positive momentum, and we learn it, obviously, thanks to China. It was the care of people. So in China, we learned how -- the reaction of people was really to feel lost. And so we try to, in many ways, to help the institutions acting to make it the most possible normal, what was happening, anticipating the risks, and anticipating also what people could have had as worries. And I think what we implemented, we can advance some actions with our people in Europe and in the rest of the world. And that has been, let's say, very positively perceived.
I have to say that I have been connected in the last 2 months with 6,000 people every day in video calls. And we have been working day and night because the so-called smart working is too smart sometimes. And we are connected even for too long. That has been also a way to fight against the virus. So what's our way to fight against the virus? 2 drivers: one, taking care of people and the second was to work harder for the people that could work. There were people in the factories that had to stay home. We also organized training, mindfulness, organization. So we try to stay close to people. So that's the only way to have the company being able to react and to be stronger after this experience. Sorry for the long. But it's an experience I want to share with you because we learn everything -- every day something about people and about ourselves.
Mr. Tronchetti Provera, there are no more questions registered at this time. The floor is back to you for any closing remarks.
So thank you. Thank you for attending this, let's say, unusual meeting.