Compagnie Generale des Etablissements Michelin SCA

PAR:ML

Earnings Call Transcript 2019-Q4

[Florent Menegaux, Chief Executive Officer]

Ladies and gentlemen, good evening. I am very pleased to welcome you tonight for result presentation. Let me just start by expressing the challenge in the environment we have seen in 2019. We have clearly seen in 2019 a shift in the mindset of most people around the world, around several issues.

The first one is the climate change. It is obvious that something is happening and we saw that with extensive fires in California and then Australia, with storms, hurricanes and tsunami’s of any kind of sort and what is new is that these things did not happen before is the frequency has increased a lot and now is it impacting heavily everywhere.

And the second thing we have observed in 2019 is that socially there are a lot of – there is a lot of unrest, which means that people around the world, whether in Chile, in Hong Kong, in other places with the gilets jaunes manifestation in France, we clearly see that there is a fraction of the population that today does not feel at ease with the way the world is going and where we are projecting the world.

So, why are we starting with that? Because we think that 2019 was very acute and we have evidence that now there is a level of consciousness on these issues that have risen sharply. In this environment of course Michelin did not wait for 2019 to act and we've been precursors in these events and anticipating a lot in this changing world and we have been active in many different areas.

One is of course pushing the long lasting performance and making sure that we have rules of the game for fair competition around the world based on usage rather than being based on tax burden at the borders. We have also pushed innovation and we have our latest baby here, with Uptis, which maybe – mean a revolution for autonomous vehicle and urban mobility of fleet activities.

We have also inaugurated our first zero emission plant in very close to Clermont-Ferrand, Les Gravanches, which is the first of its kind around the world in the tire manufacturing space and we are also pushing our innovation in the hydrogen space. We are absolutely convinced that hydrogen is an energy of the future and hydrogen fuel sale should resolve a lot of the issue related to full battery autonomy of electric cars. And at the same time, we are very active in developing biosource materials and very active in developing new kind of glue and you have an example of a very new type of adhesive resin that not only glues, but without any side effect in terms of volatile substance that the glue today emits.

So, why are we saying that is because in this ever-changing world, there is something that doesn’t change in Michelin is we are constantly innovating and constantly anticipating what will happen in the future? So, in this context, of markets very covenant, very degraded in 2019, Michelin has shown historical results. We have been able to have operating income – segment operating in excess of EUR3 billion, exactly according to what – the guidance we gave last year, an increase of EUR179 million, one-third of which is organic, two-third of which is due to acquisitions at constant exchange rate, and we have been also able to generate a cash flow – structural cash flow in excess of EUR1.6 billion.

So, in this turbulent environment with shrinking markets, especially in the second half of the year, the group has improved its performance and we have been one of our kind in our industry making sure that we have a very rigorous steering of our operations. Especially, on price in this type of environment, you have to be very rigorous on how you manage your prices in this environment, and we have demonstrated that in 2019.

The SOI at constant exchange rate rose by EUR180 million, and our margin held firm at 12.5% with a slight delusion effect due to the acquisitions, but very – exactly where we were expecting it to be. The integration of the main acquisitions Fenner, Camso, but also Multistrada and Masternaut are going very nicely. We are expecting the synergies we want to extract and the integration is in line with all our expectations.

Our structural cash flow is strong, this cash flow, and Yves will come back to the detail on it, includes the new IFRS 16 regulation, but there’s still a strong progress in our cash flow this year, especially in the steering of our inventories, and that’s why we are recommending dividend increase of EUR3.85 per share, which is a nice increase and that demonstrates our confidence in the future of Michelin in the years to come. And of course, we are continuing aligning our group to stay modern and there is a big difference between being modern and being fashion. Michelin is not fashion; Michelin is modern, which means that we are in sync with our time and we are constantly managing and steering operations to make sure that Michelin has a sustainable future.

And without being longer, I would leave the floor to Yves, who is going to present you more details on our results.

[Yves Chapot, General Manager and Chief Financial Officer]

Good evening, ladies and gentlemen. So, I will walk through our 2019 performance, and of course, 2020 guidance. So, the performance start of course with the markets. We have operated in 2019 in market that has been weaker-than-expected at the being of the year. And if you look through all our business segment, they are all characterized by weak OE pattern.

We knew already at the beginning of the year that the automotive original equipment market will be degradated, and it has been confirmed with the decrease of the market of 6% over the year, and it has been confirming Q4 despite the Chinese market started to improve in Q4.

On the replacement side, the demand had been trending upward in North America, but we have also seen some signs – all the signs in Europe – week winter market, both in Europe – and in Europe for example, while at the same time, the replacement market in China is all quite pretty firm. So, overall, we estimate that the Passenger car and Light truck market has been decreasing by 2% over 2019.

The truck market has seen a switch during the year, particularly on the original equipment, which has seen a downturn during the second half of the year. The demand has fell with a fast drop during the Q4 with North America when the replacement market has been a little bit more resilient, but not extremely well oriented. So, we estimate that the truck and bus market has been decreasing overall by 3% during 2019.

As far as Specialty markets are concerned, we consider that they have been already – overall flat. Mining was increasing by 3%, but momentum showing some slowing done during the Q4. The Off-the-road tires off-highway division has seen a sharp decrease in the OE demand, particularly in construction and agriculture. That's a sign that we have already mentioned during our half year and third quarter presentations. And two other market that two-wheels and aircraft are pursuing their growth trend.

In this context, the result that Florent just disclosed has been achieved, thanks to our pretty well balanced business modem, both from geographical standpoint and you will obverse that now in term of sales, North America has an equal weight than Europe in a our turnover and that our different businesses are relying on very different underlying growth drivers.

Original equipment for passenger car accounts for 11% of our overall turnover. The market that are driven, let's say, by conceptions represent around 40% of our sales, and the B2B markets that are characterized either by, let’s say, manufacturing GDP for transportation or commodities represent the other half of our sales.

So, our sales overall in 2019 has been growing by 9.6%. If we take out the exchange rate effect, the growth was 7.8% and basically 6.8% was coming from the acquisition made in 2019 and 2018 and 1% due to our organic growth. Our volume has been decreasing the by 1.2%, but it has been composited by a very strong price and mix effect of 2.2 point.

You will observe that if you look at these figures of the third quarter, you’ll see that the fourth quarter of volumes, the activity has been weaker, but we have delivered our constant price mix effect and it has been even stronger during the second half of the year than during the first half.

So, how do we deliver this improvement in our segment operating income by [EUR179 million]? Basically, the activities has produced a negative output of EUR86 million, which is EUR127 million coming from the acquisition positive and a negative volume effect of EUR230 million. I just want to draw your attention of the fact that half of this volume effect is due to the underabsorption of the fixed costs and you will understand later when you will see the free cash flow and the way we manage of our inventory, part of the reason why we have such effect.

Regarding, the price mix raw material effect, it has been extremely positive [EUR324 million]. We consider that raw material has increased overall by EUR120 million. On top of that you have add EUR30 million of custom duties for the cost of acquisition of raw material has increased by EUR153 million. And at the same time, we have delivered EUR248 million of mix, plus EUR230 million of price effect.

And last, we have very strong competitiveness actions that have started to produce good effect during the year, EUR61 million. The three main drivers are all the work we are doing on our SG&A and structural costs, the improvement of productivity in our factories and the way we manage the cost of our models and all work done by the teams to find the best sourcing in terms of raw materials.

At the same time, we have an increase in the start-up cost due to the start-up of mostly two of our factories, synthetic rubber factories in Indonesia and passenger car tire factories in Mexico plus the increase of amortizations. So, we end the year with a segment operating income of EUR3 billion. This performance has first allowed us also to deliver our stronger free cash flow.

The structural free cash flow, where we, of course, take out the acquisition effect plus the working capital impact of our raw material, which is very tiny in 2019, so we have a structural free cash flow above EUR1.6 billion. So, it has been partly helped, of course, by the implementation of IFRS 16, but – and if you look at the different effect, the improvement year-on-year, if you take out this IFRS 16 effect, strong work on the inventories.

Our inventories at the end of the year has decreased by EUR147, some is coming from the cost of raw material, but we have more than EUR100 million of saving on inventories, so there is a strong, let’s say, organic effect plus the contribution of our acquisition to our free cash flow.

Regarding the inventories, we have taken several actions regarding sourcing mostly operational excellence. Walking – I was saying earlier, a good supply chain process start with good forecast, so we have put some pressure on the teams to try to operate with very balanced forecast. Industrial flexibility, of course, is part of it and all the work that we are doing on our supply chain model to adapt our supply chain model to the needs of our customers.

If you look overall by average, our average inventory has decreased by 0.1 point, which is – seems not very impressive, but our inventory at the end of the year were at 19.5%. So, we have clearly taken action, importantly in the second half of the year to monitor and better master our inventory. The plan we have started to implement already few years ago, have started to deliver results during the second half of this year.

Now, breaking down our operating margin of 12.5% by segment, I would just first mention that in this – at the group level, we have a dilution effect linked to Camso and Multistrada of around 0.3 point. So, our operating margin, which has decreased from 12.6% to 12.5%, is including this dilution effect.

Now, looking per segment, you observe that SR1 has been decreasing by 0.3 point, which is entirely due to Multistrada and if we take out the effect of the ramp up of the factories that I mentioned, in fact, this segment has improved its performance.

Regarding the second segment, it has been strongly hurt, particularly during the second half of the year by the volume effect and particularly the original equipment market. The third segment is showing 18.7% operating margin, and here also the decrease of 1.4 point is more than explained by the dilutive effect of Camso on this activity, which is close to 2 points. So, in reality, if you take out the Camso effect, it means that the organic activities of our third segment has delivered better operating margin, both in volume and in percentage than in 2018.

If I now zoom on each of these segments, in automotive, the group is committed to constantly innovate and bring product into market that will satisfy our customers both on original equipment and replacements. In 2019, the share of our sales represented by, what we call, premium segment or tires above 18-inch, is now 43%. It’s an improvement of 4 point versus last year and you see for 18, 19 and 20-inch segments, the loyalty effect on the first replacement that we have overall in the different – in Europe. I can just mention that this percentage was higher in less mature markets such as China than they are in Europe.

On the truck market, which is facing some challenges, we believe that on the long run, thanks to particularly the new demanding environmental standard that will be imposed to the fleets and to the OEMs on one side and the need of the customers that are more and more looking at fuel efficiency, the pricing, the risk of shortage of drivers and sometimes fitting machine tires on the trucks help increase the royalty of drivers, and of course, managing as much as they can their assets. We believe that Michelin offer that are totally centered on the total cost of ownership for providing the tires that have the best usage – the cost usage and the innovative solutions that we are providing both on product and services will help us in the coming years.

The SR free market and particularly the mining and OHT market are of course mostly cyclical because they are linked to commodities, but at long run, they are tied to a very strong megatrends, humanization and population growth.

So, in this market, Michelin is committed to continuously improve our product and services, and when I mention services, it means – which is a system, which allow the monitoring of the tires and big mining facilities or ZEN@TERRA, which is a system that we provide to farmers to monitor their tire pressure when they are either on the road or in the field. So, our commitment is to offer to this segment of the market the solutions that will them to improve the operations and to make the operations more sustainable.

Last, looking at our different segment of activities, I would like to make a zoom on our high-tech material activities that are basically addressing two huge transformation, the transformation of manufacturing through our JV AddUp, which is specialized in additive manufacturing of 3D printing for metallic product and the transformation of mobility with JVs that we have announced last year regarding hydrogen fuel cells with Faurecia. These two ventures are really the answer we are providing to the transformation to these two industries.

On the other side, we continue invest in our flexible composite activities, which includes the rubber goods of Fenner, but also the investment that the group is doing in order to improve the bio-sourcing of its raw material up to now the main renewable product that we are using in the tire, our natural rubber, but we are making great efforts to find new solutions in order to build source some of the raw materials we are using beside natural rubber. And I shall also mention the effort we are making in order to reuse the tires not only collect, but also recycle and reuse the tires in the production of the new tires.

Camso and Fenner are integrating pretty well and we have – today we’ve seen very strong synergies of our – the conveyor belt activities of Fenner with our mining efforts. Regarding the advance engineers product of Fenner that are mostly belt and sills, we are working very closely with them, and there is lot of cross-fertilization in R&D. And the Camso has merged with our off-highway transportation division, which is now headquartered between Clermont-Ferrand and Magog, close to Muriel, in order to form the leader in the off-highway transportation market.

We are starting – we have started in 2019 to see the emergence of synergies between these activities and group. We consider that at the end of 2019, we have achieved 93% of the synergies that we were looking to achieve in 2019, which is a good rate given the fact that these acquisitions were pretty recent.

Regarding competitivity, you know that between 2017 and 2020, the group is looking to achieve EUR1.2 billion of savings and at the end of 2019, we are very close. We’re on the road map with EUR891 million of gains. Taking into account that if you look at this period, the inflation has a tendency to decrease versus the previous year, and looking specifically at 2019, we have achieved EUR61 million of saving at the end of the year.

This saving, I mentioned it, are partially due to our manufacturing organization and it's just a reminder to say that when you look on the long run, improvement in manufacturing, of course, link to our footprint, but mostly due to continuous improvement and process standardization – the deployment of empowerment in our factories, the simplicity project in order to differentiate our product at the latest stage in the production process and digital manufacturing also varies from driver for our productivity improvement.

Regarding our CapEx, we ended the year with CapEx of EUR1.8 billion, which is, let’s say, similar to last year taking on account that we have around – a bit more than EUR120 million coming from the CapEx of the new companies that we’ve acquired during 2018 and early 2019. The key message here is to understand that we are shifting our priorities from capacity, CapEx oriented to around more productivity CapEx, and that's – that will translate in further gain in the future of productivity in our factories.

At the end of December, our net financial debt was around EUR5.2 billion, which is an increase of close to EUR11.5 billion. This is the figure we published at the end of 2018. You have to remember that at the end of 2018, we closed the acquisition of Camso in 18 of December of 2018, so Camso was consolidated in just one line in our balance sheet, so we reopened the year and we split all the element of Camso balance sheet, so we have an increase of debt of [EUR337 million] due to the Camso price purchasing allocation.

If you look now at the remaining increase, which is EUR1.1 billion, you will we see that most of it is coming from non-cash items and particularly the effect of IFRS 16, which translates in an increase of our debt of more than EUR830 million.

Structural free cash flow has contributed to decrease our debt by $1.6 billion. We have spent $500 million in MA& plus I should have the EUR249 million of the debt of the company we acquire, so all together, M&A has contributed to increase our debt by EUR771 million and we have, of course, the effect of the dividend, EUR676 million and of the share buyback, EUR141 million. So, overall, we have a debt of EUR5.1 billion, which means the gearing of 39% and net debt to EBITDA ratio of 1.09, which is very close to the one we and last year.

In this context, and our long-term rating has been confirmed at the end of last year by all the three rating agencies with an A minus at S&P, A3 at Moody's and A minus at Fitch. So, as was already mentioned by Florent, we have – we will propose to our next shoulder meeting the payment of a dividend to EUR3.85 per share, which represent a payout ratio of 37.6%, which is in line with the commitment we have taken, an increase of 4% just as last year, which is in line with the increase of our net results. The group net consolidated result was EUR1.73 billion, which is EUR9.69 per share.

So, that’s all for 2019, and now I would like to share with you our guidance for 2020. Regarding the market, we consider that the market will remain oriented relatively downward, partially because we consider that original equipment market should not recover in 2020. So, looking segment-by-segment, we believe that the automotive original equipment market should be down around 3% in most of the geographies. The replacement market will remain stable, of course, with a shift both in OE and replacement between, let’s say, standard versus premium tires, so we consider that 18-inch and above tire demand should remain steady at plus 10%. So, we’ll continue to benefit from this mix effect, but overall, we believe that consolidating original equipment and replacement, the automotive market should be flat or slightly decreasing.

The truck market is characterized by, as I said, decline that we have observed during the second half of the year. Just to remind you, at the end of June last year, the truck market was growing in North America and it has completely flipped down during the second half. So, we expect further decline both in Europe and North America and a market that will be probably slightly growing in emerging regions.

The replacement market will be up slightly, lift by the fact that there will be less new truck on the market and the freight is not, let’s say, declining at the pace of the original equipment market of course. So, we consider that the replacement market should be overall slightly up in most of the regions. I just want also to remind you that we will have in this segment, a geo mix that will be probably unfavorable as we almost exposed to the European and the Americans both North, Central, and South markets.

As the specialties are concerned, regarding mining what we observed is that mine output is pretty stable, so we consider that the construction of tires in the mine will remain stable, but as the – let’s say the economy is not at all well-oriented, we consider that most of the [indiscernible] will look very closely to their inventories and we believe that we might have to deal with a decrease of inventories of couple of week or a bit less than one month at the mine, which should lead to a slight decrease of the mine tire demand – mining tires demand.

Regarding off-road, although we believe that replacement markets will be slightly up, we consider that both agricultural and construction markets will continue in original equipment to show a downward pattern and we believe that both two-wheel commuting and aircraft segments will continue to grow. So, overall, we bet on the specialties markets demand declining by 3% strongly pulled down by off-highway transportation, but with a – let’s say a timid evolution of the mining segment.

So, our guidance will be based on the following scenario. We believe that the cost of raw material price and custom duty should have a positive effect on our bottom line, but at the same times, and I put above the effect of the currency effect. At the same time, we consider that price and raw material should be overall a neutral.

We have part of our business that are based on long-term contract that are indexed and of course this indexation clause will apply and in this case the selling price will decrease, but we are betting overall on the price raw material effect which will be neutral, but of course we will do our best to retain all the mix effect that we are expecting both from the market. We observe, let’s say positive effect of between original equipment and replacement and of course the product mix particularly on the SR1.

And regarding the competitiveness plan, we are committed to continue to deliver what we have delivered in the previous year, which will lead us to 1.2 billion saving over four years and it should translate into a positive effect probably at least 50 million in Euro in 2020. So, in this context, I am sure that you will have a question about the small asterisk, which is on the title of this document. It is extremely difficult to assess what could be systemic or potential systemic effect of the coronavirus crisis in China, but in this context if we put that part we should have our volume evolving in line with the markets to the volume we will have negative effect and thanks to the action on the competitivity, the mix, the synergies that we are starting to extract from our acquisition.

We bet on very slight decrease of our segment operating income at constant exchange rate in 2020 versus 2019. While we will continue to deliver a very stronger structural free cash flow, which will be at least EUR1.5 billion, keeping in mind that in 2020 we will have to be the cash out of the restructuration that we have announced during the last second half of 2019.

So, that’s for the guidance for 2020, and Florent if you want to make a conclusion.

[Florent Menegaux, Chief Executive Officer]

Thank you, Yves. So, what we have seen is that very much in line with the purpose of our company we have steered our business in a very tough environment in 2019 and we project to do the same in 2020. Of course our sector is still highly competitive. We still are – have customers behaviors that may change over the time, so what we need to remember in this environment is the capacity of Michelin to deliver very strong result in a very volatile environment which is think is the testimony to the quality of our teams and the quality of our offers and thanks also to the commitment of our customers. We are able to do that.

So, now we are open to all the question you may have and so we can proceed. Unfortunately I don’t see [indiscernible]. Question from Thomas Besson.

[Thomas Besson, Kepler Cheuvreux]

Hello. Thomas Besson, Kepler Cheuvreux. Three questions please. I like to start with restructuring; you’ve announced three plant shutdowns over the last 18 months. First, could you tell us if you are happy with the setup of the organization after this, or whether we could believe there may be more given that end markets continue to be complicated in 2020 and can you just help us understanding the sequence of cash outflows between 2019, 2020, and 2021 for the three plants that have been announced? That’s the first question. Shall I say – I’ll give you the other ones. The second, you’ve mentioned pricing being sometimes complicated. I think it’s been a factor for all passenger automakers notably in Europe, can you tell us what are your assumptions for European, passenger car pricing in 2020, is there any chance to improve with inventories still high in most segments? And third and last question please, on guidance, I know you always like to be cautious, but Yves you’ve just said, we expect a very slight decrease in operating profit. I think most companies would have said, we expect flat earnings, is that what you really mean and then the mid-term guidance, I think when should we expect that to come out, is that going to be in Q4 and what format is it going to be on Investor Day or is it going to be just new targets? Thank you.

[Florent Menegaux, Chief Executive Officer]

The first question about the restructuring, we’re never happy with restructuring. It is always one of the most difficult decision we are to make. However as an industrial company we constantly have to adapt to our environment and sometimes when we come to the conclusion that a site may not be in a position to readapt to new markets or where the cost of restricting decide or transforming the site is more expensive than building a new plant we take the conclusion that we may have to close it down.

The closures – decisions have been made on few sites, we don’t have a plan, but we are constantly monitoring the efficiency of our industrial set-up we have very clear target in terms of competitivity that we share with you and to achieve this competitivity we not only have to close sites, but also as Yves mentioned it, to really put more emphasis on the productivity investments and we have made clearly a shift last year towards putting more emphasis on productivity investment rather than new capacity build-up.

Now, as far as new plants, we are constantly monitoring what we do and we will not disclose plants, but I must also to add up on restricting before leaving the cash flow projection for the three sites to Yves, we have negotiated for the three sites, Dundee, Bamberg and La Roche-sur-Yon. We have really negotiated very responsible deals with the people that have been affected by those plant closures and we have finalized the negotiation at La Roche-sur-Yon.

96% of the people involved in the site have voted for the plan we are proposing, which is a very cumbersome plan for everybody. At Dundee, already half the people concerned by the closure have already found a new job either better paid or equal to what they had at Michelin and we have extremely good relationship with the Scottish Government, but the way we handle, how we are going to recreate new additional jobs in the place where we are living. So, I must say that we handle this in a very responsible manner. As far as the cash flow projection...

[Yves Chapot, General Manager and Chief Financial Officer]

Yes. Most of the negative cash flow effect is due to – occur in 2020, because it is linked to either we try to offer systematically for example in France a position to each employee, but we know that some people will not necessarily accept to move to another city, so either the cost will help them to move to another mission site or the cost to prepare themselves to find another job. So, most of this cost will occur in 2020.

[Florent Menegaux, Chief Executive Officer]

As far as the pricing assumptions are concerned, we do not price according to our competition. If that were the case, we would not have seen the price gap between our main competitors increase over the past years. What we have demonstrated in 2019 in this, even though the price gap has increased, we have not lost market share, which demonstrate the power and weakness of our customers to pay for a differentiated and offer of Michelin. We sometimes in our industry, we think is not very mature, as far as pricing is concerned. So, we try to be more mature on this aspect.

Now, as far as what will happen during the year, I don't have a crystal ball. So, I don't know. In this environment, we have said to all our teams, this is not a time where you want to discount prices to attain marginal shares. The only thing you do is you destroy your margin and you don't get any additional volume. So, we are – we have said that to all our teams, so it is very clear.

As far as what the rest of the – our environment will do, I don't know. As far as the guidance is concerned, of course, very slides of – slides is always a question of appreciation. And yes, of course, every – behind every word, you may put any imagination you may have. And I leave now the floor to Yves, who is going to give you what it means.

[Yves Chapot, General Manager and Chief Financial Officer]

No, we consider that we should have – we should face a slight decrease in our operating margin. We are in January – between February and honestly, with a trend of the particularly with the original equipment market volume during the Q4, particularly in B2B, we consider that our role is to be prudent regarding 2020. We will do our best to deliver what is in our hand, but we are not mastering the market, unfortunately.

And the second question is that for the mid-term guidance, I would like you to be a bit patient. You'll have to wait the – till the 8th of December of this year, 2020. So, we’ll invite you for Capital Market Day at the end of the year to share with you the long-term group strategy and our, I’d say relatively more mid-term targets.

[Thomas Besson, Kepler Cheuvreux]

Thank you.

[Operator]

Gaetan Toulemonde.

[Gaetan Toulemonde, Deutsche Bank]

Gaetan Toulemonde, Deutsche Bank. I want to come back on the Thomas question on the – this restructuring. What is the order of magnitude of the saving we should expect this year and next year? I think this year; we should have mostly the UK plant payback and next year, France and Germany. Can you give us an idea of the savings automated?

[Yves Chapot, General Manager and Chief Financial Officer]

We don't disclose precise numbers. So, yes, in 2020, we get the benefit of the Ballymena plant closure and then the benefit will come in 2021. And you're going to see benefit of La Roche-sur-Yon and Bamberg between 2021 and 2022, 2023. That's where you get the full benefits of these restructuring, but we don't disclose the precise amount of how much we gain per plant closure.

[Gaetan Toulemonde, Deutsche Bank]

I have a second question regarding the volume effect, if I understood well, last year you had two negative impact: number one, the volume; and number two, the destocking impact, which cost you more than 200 million overall. In this current week volume environment, should we expect none absorption of fixed cost on top of the negative volume? Or you consider that the decline of volume will be good enough not to make an effort on this talking on top of?

[Florent Menegaux, Chief Executive Officer]

I will leave you, Yves to answer, but some of the – we have ended the year at an appropriate level of inventory. Like what Yves mentioned, we have really [stirred our], in the second semester our inventory down. So that we – because we knew the year 2020 would be difficult. So, if the market environment does not move too much from the assumptions we’ve made, I think, we would have a better industrial performance versus this year.

[Gaetan Toulemonde, Deutsche Bank]

So, if understood well, the production should not be too far away since the destocking of last year’s non-recurrent?

[Florent Menegaux, Chief Executive Officer]

Yes. We are also driving our inventory down structurally. As we've mentioned, we have this target to extract 500 million out of inventory. So, apart from that, which is the normal saving we do out of the continuous progress on reducing structural inventory, yes, your assumption is right.

[Gaetan Toulemonde, Deutsche Bank]

Okay, perfect. Last question on the others where you have depreciation increase last year, where you have the startup cost, this bucket this year should be what small negative, or can you help us here?

[Florent Menegaux, Chief Executive Officer]

Yes.

[Gaetan Toulemonde, Deutsche Bank]

Thank you.

[Florent Menegaux, Chief Executive Officer]

We should have less startup costs. We’ll have bit of remaining startup costs in Mexico and in Thailand, but we should have less startup cost and we will still continue to have a slight increase in the depreciation, because depreciation is not yet at the level of the CapEx, but we are nearby, I’d say closing the gap between the two, but not yet in 2020. That's why we’ll have a slight increase in depreciation.

Then maybe we can take a question on the Internet.

[Operator]

First question from Mr. Kai Mueller from Bank of America Merrill Lynch. Please go ahead.

[Kai Mueller, Bank of America Merrill Lynch]

Thank you very much for taking my question. The first one would be on your free cash flow. Obviously, you are quite confident also going into 2020, again, on your above 1.5 billion. I'm just trying to understand a little bit you’re still guiding a CapEx level of 1.8 billion, despite your acquisition of Multistrada, which should give you some savings. What is that that you’re still investing so heavily in, i.e., flat year-over-year, despite obviously that weaker volume backdrop? Is there no chance to reduce that or what leeway do you have on that, as the first one?

Second one on your scope, you’re guiding for the EBIT slightly down x scope access x, how much scope, which we – should we still expect from Multistrada and your other acquisition that should be coming in this year, which is the Masternaut? And then, as a third question, just to sort of square it up, I think, it follows up from the previous ones. But you obviously target positive price mix versus raw material. You said, you want to get about 50 million of competitiveness savings as well, at the same time, you guide EBIT down. So, following up again from [indiscernible] as well is, would we expect on the weaker volumes again a very significantly negative drop-through, or should you normalize that to the more normal volume drop-through you've shown in the previous years?

[Florent Menegaux, Chief Executive Officer]

Yes. Thank you for those questions. So, I would take the first one and then, Yves, if you take number two and number three. About the free cash flow, and our level of investment. In our investment as was briefly [ph] mentioned, by even, we also now have the investment due to our new activities. And in those new activities, the growth is good. So, we have overall reduced sharply our investment in the – I would say the traditional perimeter.

As far as further efforts are concerned, we have – we are reducing to the minimum any capacity investment. However, you need to factor into your competition the fact that when we make restructuring, we also have to displays production and we have to reindustrialize production in other places, plus the mix effect is not for free. The mix, you also have to readapt your production capacity.

And that's why the level of investment has been set at 1.8 billion, which is a reduction on the historical perimeter, taking those three factors into consideration. But we are confident in our capacity to generate cash flow like we did in the previous years. With our structural savings we're doing, tight steering of accounts payable, accounts receivable and inventory, we are improving every year on this. And level investment is necessary to be able to achieve our competitivity gains and also to nurture our new businesses.

As far as the scope, Yves, you want to take?

[Yves Chapot, General Manager and Chief Financial Officer]

Yes, maybe I can just add, the investment in percentage of our sales has decreased in 2019. Regarding the scope, Multistrada has been acquired 3rd of March 2019 and Masternaut at the end of May, so the scope effect will be very minimum. We don’t expect a huge scope effect during the year. Regarding the different element of the margin, we expect a positive price-mix raw material effect. Competitivity should deliver, we believe at least EUR15 million, we are aiming for EUR15 million. We are relatively prudent regarding the volumes.

As we said earlier, partly the B2B original equipment markets were not very well oriented during the last quarter of the year. So, there is some prudence. If I take the SR2, we mentioned market overall going between minus 2 and minus 3, but we know that we have geo mix, which isn’t favorable. So, you can guess that on SR 2, our volumes will be less than these figures.

[Kai Mueller, Bank of America Merrill Lynch]

And is it fair to say that the drop through is basically, if you think about how, that you have an issue on the fixed cost absorption, we should expect some of that also in 2020 as you outlined for 2019?

[Florent Menegaux, Chief Executive Officer]

It will depend of the level of inventory at the end of year. Gaetan already asked the question. We have – we would end the year with an inventory level which is at 19.5% of our sales. So, we have made an acceleration if I say during the second half, but we know that we have constantly to work on the structural measures in order to improve our supply chain and have a healthier inventory level.

[Kai Mueller, Bank of America Merrill Lynch]

Okay. Fantastic. Thank you very much.

[Florent Menegaux, Chief Executive Officer]

Thank you. The next question on Internet?

[Operator]

Thank you. Next question from Gabriel Adler from Citigroup. Please go ahead.

[Gabriel Adler, Citigroup]

Hi. Thanks for taking my question. Just one question on working capital. You discussed the improvement that you are seeing on inventories in great detail, but there is also clearly scope for improvement on payables. And the increase in reverse factoring in 2019 was very, very modest at about EUR5 million, is there scope to increase your reverse factoring program further in 2020 and is there another way that you will look to optimize working capital in the future? Thank you.

[Florent Menegaux, Chief Executive Officer]

You are referring to factoring program. We hardly use factoring programs, but not …

[Yves Chapot, General Manager and Chief Financial Officer]

Yes. We have some reverse factoring program. If you look for our payables we have that, in terms of days we have around close to 71 days, so we consider that we are at very healthy level. Our receivables are - let’s say in the benchmark. We have made very specific efforts to monitor over dues during 2019; it has been translated into free cash flow that we delivered in 2019. And so, we consider that our main focus is on inventory.

[Florent Menegaux, Chief Executive Officer]

I think we have made a very strong improvement in accounts payable and we think we are at the appropriate level now, overall.

[Gabriel Adler, Citigroup]

Okay thank you that’s clear.

[Operator]

Thank you. Next question from Martino De Ambroggi from Equita. Please go ahead.

[Martino De Ambroggi, Equita]

Thank you. Good evening everybody. The first is on the mix effect, which was particularly stronger in 2019, particularly in the second half. Could you elaborate a little bit more breaking down the main drivers for this performance? And also, expanding this expectation for the current year on mix, specifically stand-alone. Thank you.

[Yves Chapot, General Manager and Chief Financial Officer]

In fact, there is three kind of mix effect. The first is product mix. So, the – within a given business segment, we have historically a very strong mix effect in the SR1, both in OE and replacement because of the increasing share of 18-inch and above, the increasing share of tires for electric vehicles that are favorable for our margin. The second mix effect is the mix effect between markets. So, when original equipment market is growing or decreasing when replacement market is growing even faster or stabilizing, we have a structural mix effect, which is also improving our margin. And the third one is the mix between the different business units.

Behind our three segments, we operate today 19 different business units. And of course, they have different profitability level. And of course, we have – we cannot, for example, if I take the SR3 in 2019, we have a strong mix effect within the SR3, thanks to the growth of mining versus a decrease of OHT in volumes.

[Martino De Ambroggi, Equita]

And could you tell me what is prevailing among these three effects?

[Yves Chapot, General Manager and Chief Financial Officer]

I am not sure there is one which is prevailing. There is one that we try to master, which is the first one, which is the product mix. Because we tend, as I said, our mission is to help our customers to improve their performance to sell tires that might be slightly more expensive, but that are delivering the best total cost of ownership. So, this is one is that is in our hand. The mix between the business segments of the mix between original equipment and replacement is a bit out of our control.

[Martino De Ambroggi, Equita]

Yes, very clear. On this issue for the 18 inches and above, some of our competitors are talking about price pressure in specific segments and so on. And on the contrary, you are projecting 10% growth in the next few years, which is unchanged, compared with past indication, despite a worsening environment. And to the price pressure in some segments probably is creating issues or for you is totally neutral?

[Florent Menegaux, Chief Executive Officer]

I think as far as your comments is concerned, I don’t know what the competition has said, but it is kind of a self-fulfilling prophecy. They complain about the prices being down, but if we don’t move they must be doing something. So, somebody must be doing something there. We, so we are not active in this segment. However, we need to also recognize our long-term is that when you have a Renault Scenic that is equipped with 20 inch, 21 inch tires it’s different and 20 inch 21 inch tire on the Porsche. You can – your capacity to extract value is different for this kind of vehicle.

So, we are constantly monitoring this and we are always on the edge. Now, what is for sure is that when people are buying bigger tires they spend more time making sure that they buy the right brand and Michelin has we are lucky and fortunate enough that customers recognize the value what we bring in this segment.

[Martino De Ambroggi, Equita]

Okay thank you.

[Operator]

Thank you. Next question from Sascha Gommel from Jefferies. Please go ahead.

[Sascha Gommel, Jefferies]

Yes good evening. Thank you for taking my questions. The first one would actually be on the Fintyre situation. The German subsidiary, I think went into bankruptcy. I have two questions related to that. Firstly, can you kind of elaborate on the impact and secondly in general what happens and what are your measures when tire dealers go bankrupt, are you buying back your stock from them or is there a risk that the inventory from the dealer gets dumped into the market. And then my final question would be can you comment on the inventory situation at the dealer level and you destocked, but given the mild winter weather, I would be interested to hear about your comments about winter, but also summer tire inventories at the dealership level? Thank you.

[Florent Menegaux, Chief Executive Officer]

So, I would – the first part of the question about Fintyre, Yves will take and I will take the on inventory at dealer level.

[Yves Chapot, General Manager and Chief Financial Officer]

Okay. So, we did not expect huge impact for us regarding the bankruptcy of the German part of Fintyre, as most of our exposure is covered by an insurance. So, at this stage we believe it will have practically no impact on our activity on our balance sheet. Regarding the measure that we are taking most of us we credit management team, which is monitoring very closely the situation of the dealers when they are facing troubles and the second we are it is really case-by-case approach depending of course of the legal frameworks, which is different from one country to another and of course the relationship we have with these dealers. So, it can go up to taking back inventory eventually or finding, let's say, the appropriate measure to help them to go for this kind of difficult periods.

[Florent Menegaux, Chief Executive Officer]

The competent pressure in wholesaling and retailing in Europe is very, very intense. That’s why corporations that do not manage very tightly their businesses, especially on time of crisis and margins et cetera may get into trouble. Now, what is the level of inventory? Our level of inventory are dealer level. We monitor that as well very tightly and we have not seen excessive dealer inventory at the end of the year. We are not pushing tire on inventory of our dealers because we know we will have a ripping effect a few months later.

As far as winter is concerned, in Europe, which is a different situation have you’ve noticed the winter in Europe did not occur and so therefore the winter season has been somewhat strange for that reason, but we have been cautious in making sure that our dealers we are not over stocking our tires. So, we think the situation and is better than what it was two years or three years ago, as far as we're concerned. I cannot judge about the overall industry, but I can only tell you about our inventory with our dealers.

[Sascha Gommel, Jefferies]

Thank you. And I have a quick follow-up. Do you think that there is – that there could be more dealers that could go into financial trouble and given the weakness of the market or you think that was just an isolated case?

[Florent Menegaux, Chief Executive Officer]

There is structurally, in Europe, an overcapacity of dealership. So, now the consequence of that is there is bound to be a restructuring in this industry in the overall market.

[Sascha Gommel, Jefferies]

Appreciated. Thank you very much.

[Operator]

Thank you. Next question from Martin Carter from JPMorgan. Please go ahead. Hello, your microphone is open from JPMorgan.

[Jose Asumendi, JPMorgan]

Thanks very much. It’s Jose from JPMorgan. Just a couple of questions please. On SG&A, as we think about the reduction of SG&A as a percentage of sales, can you comment a bit about the time frame of the reduction of this cost category and also out of the three categories SG&A, which one will have the greatest benefit behind the measures you have outlined. And second, if you can maybe please comment a little bit more around pricing dynamics in passenger car tire in Europe and the difference between original equipment and replacement please that would be much appreciated? Thank you.

[Florent Menegaux, Chief Executive Officer]

Okay. So, Yves, maybe you take the SG&A question, I will take the branding dynamics.

[Yves Chapot, General Manager and Chief Financial Officer]

I think the SG&A, we have announced that our target was within five years to close part of the gap with our competitors and as a part of the gap because we consider that we have also a price premium, which is justified by our R&D’s and our overall structure. So, it’s five years program that we have started to implement in 2019.

Regarding the category of SG&A that will be mostly impacted, I will say all three, but mostly general and administrative cost, of course before we are not looking to sacrifice the innovation potential of the group or our ability to improve the quality of the relationship we have with our customers. So, it’s mostly general and administrative costs that we are going to tackle.

[Florent Menegaux, Chief Executive Officer]

Branding dynamics in – your question is in Europe or worldwide?

[Jose Asumendi, JPMorgan]

In Europe, if you could provide any other color by region, would appreciate it. But I guess, the focus is a lot right on price dynamics?

[Florent Menegaux, Chief Executive Officer]

In Europe is – what we see is that premium brands more or less keep their market share. While there is a fierce battle between Tier 2, Tier 3, Tier 4, where there is a very intense battle, if we can say these are brand dynamics. What we see is that Tier 2 brands are trying to move into Tier 1, but they experienced a lot of difficulties. They have to invest in OE, they have to invest in Racing, they have to invest in branding and it takes a long, long time. And some of our competitors are trying and they have a huge difficulty to be able to do that. And as far as the Tier 3, the brands almost do not exist in the market.

Now, as far as your question about OE, there’s still a strong loyalty derived from OE, especially the Michelin brand. The Michelin brand always has a higher loyalty rate than any other brand in every market and it's also true in Europe.

Now, when we talk – that's in general, but there are some vehicles, where the royalty is higher than other vehicle within the same OE brand. So, it depends on the type of vehicle. So, the loyalty on the Polo is different from or let's take Renault Clio is different from Renault Scenic, for example. So, or a Porsche 207 is different from the Porsche 107, these kind of differences. Actually 208 now, 208 versus 108, so I’m getting older. So, branding dynamics have not really changed and we don't see changes rising majors changes to be noticed at this stage.

[Jose Asumendi, JPMorgan]

Thank you.

[Florent Menegaux, Chief Executive Officer]

Questions on internet, any questions here? Another question from Thomas?

[Thomas Besson, Kepler Cheuvreux]

Yes. Sorry, I'll ask one more question. Your net giving ratio is no loss of one-time EBITDA. Do you consider it's a level that you could go through and eventually make more acquisitions, or eat more time to digest these acquisitions and go through the cash flow for restructuring and take down your debt a little bit before making more moves?

[Yves Chapot, General Manager and Chief Financial Officer]

It's considered by the rating agency as, say, a bearable ratio. That's why we have been keeping this the rating we have as of today. We are at a level when we can eventually afford further acquisition if needed, but we have also to consolidate and deliver all the synergies from the acquisition we made.

So, it will be – we want to keep a solid rating and that's our priority. The ratio, of course, can evolve when you know that the ratio sometimes appreciated differently from one rating agency to the other, but we want to be able to grow the size of the group, which means both organic and potentially acquisition, while keeping a strong balance sheet.

[Florent Menegaux, Chief Executive Officer]

So, it takes a long time to conclude negotiation and to achieve an acquisition. So we have a constant deal flow. And sometimes it's – we are able to conclude. And in 2018 – was a very strong year, where we've been able to conclude many deals, but we started many, many years before to get to that point. And we have a constant deal flow.

When it will eventually materialize, we cannot say, but as you have rightly mentioned we pay a lot of attention to the strength of our balance sheet and we won’t do anything crazy. Let me remind everybody that I am personally liable and definitely on the date of the company and I can tell you that gives you a very tight sense of responsibility there. So, we won’t do anything stupid because I need to take care of my family.

[Florent Menegaux, Chief Executive Officer]

So, if we don't have any more questions. So, thank you for coming to our results and looking forward on next meeting. Thank you. Thank you very much.