Continental AG

XETRA:CON

Earnings Call Analysis

Continental Reports Challenging First Quarter but Reaffirms Annual Guidance

Continental started 2024 with a challenging first quarter, posting sales of EUR 9.8 billion and an adjusted EBIT margin of 2%. The company faced weak markets, particularly in Europe, and negative FX effects across all sectors. Despite these hurdles, Continental remains optimistic, reaffirming its full-year guidance. The Tires and ContiTech sectors are expected to rebound in the second half, driven by cost-saving measures and pricing negotiations. This optimism stems from anticipated tailwinds and a confirmed guidance corridor for the full year across all sectors.

Introduction to the Earnings Call

Continental AG's first quarter of 2024 presentation, which was held by CFO Katja Garcia Vila, detailed the company's challenging start to the year. Factors such as weak markets, primarily in Europe, and adverse foreign exchange (FX) effects burdened the results. Despite this, the company is optimistic about the year, expecting improvements and confirming its guidance.

Group Financial Performance

The company reported sales of EUR 9.8 billion with an adjusted EBIT margin of 2%. However, the free cash flow was around minus EUR 1.1 billion, affected by a one-time payment for the repurchase of ContiTech AG shares. The adjusted EBIT margin and sales were particularly hit by FX and unfavorable market conditions across various segments.

Automotive Segment Insights

For the Automotive sector, the top line was negatively affected by volume, pricing, and FX leading to a negative organic growth of 2.4%. The adjusted EBIT margin was significantly impacted by pricing issues and labor inflation. Delayed ramp-ups and ongoing price negotiations with customers were key factors. Despite this, the company remains confident that extensive measures and operational enhancements will steer them back into the guidance corridor for the year.

Tires Segment Performance

The Tires segment experienced headwinds from FX, lower volumes, and mix effects resulting in lower sales of approximately EUR 3.3 billion and an adjusted EBIT margin of 11.7%. Even though fewer working days compared to last year due to calendar effects impacted performance, the company is confident about the second quarter and expects to be within the guidance range for the first half.

ContiTech Segment Review

ContiTech also faced a challenging first quarter with weak industrial and automotive markets, combined with FX and pricing effects leading to a 5.4% adjusted EBIT margin. The company anticipates that self-help measures in the second half of the year will help achieve the guidance despite the difficult start.

Operational Strategies and Measures

Continental AG has laid out several strategies, including establishing fair pricing negotiations, improving R&D efficiency, and reducing fixed costs to achieve its targets. A key measure is the ongoing fixed cost reduction program, which aims to optimize administrative and R&D functions, affecting approximately 5,400 positions globally.

Future Outlook and Confidence

The company affirmed their confidence in meeting the annual guidance across all segments. The expectation is that improvements driven by operational measures, cost efficiencies, favorable pricing negotiations, and market recoveries, particularly in the second half, will align with their strategic goals for the year.

Earnings Call Transcript 2024-Q1

[Anna Fischer, executive]

Thank you, operator, and welcome, everyone, to our first quarter 2024 results presentation. Today's call is hosted by our CFO, Katja Garcia Vila. A small reminder that both the press release and presentation of today's call are available for download on our Investor Relations website.

Before starting, we'd like to remind everyone that this conference call is for investors and analysts only. If you do not belong to either of these groups, please kindly disconnect now.[Operator Instructions]

With this, let me now hand you over to Katja.

[Katja Durrfeld, executive]

Thank you, Anna. A warm welcome to you all. It's good to be here with you today.

Now let's jump straight in on Page #3. Starting on Page 3, as you saw with our pre-release on April 16, we had a soft start to 2024. Our results although expected, were burdened by weak markets, especially in Europe and FX effects across all sectors. Automotive was impacted by the significant portion of agreed 2023 pricing not rolling over into 2024. Our negotiations here are currently still ongoing. We see first progress. We target to finalize the agreements as soon as possible without sacrificing quality. Of course, we are aiming to have them agreed on a sustainable level, but this is something we can only comment on once we are done and the agreements are signed.

Despite the weak first quarter, we are confident that the year will play out like it has over the last 2 years with improvements through the year, negotiation results reestablished in our prices and our cost-saving measures kicking in. On this basis, we confirm our guidance.

For Tires, we see the chance to be in the corridor for H1 as a whole. While for ContiTech, we expect the second half of the year to bring the tailwind from our self-help measures, enabling us to achieve our guidance.

With that said, let's look at a few of the numbers. On a group level, we came in at EUR 9.8 billion sales with an adjusted EBIT margin of 2%. Our free cash flow on the year-on-year comparison showed some improvements in working capital while being burdened by the special onetime effect of the payment for the repurchase of the ContiTech AG shares, which happened in Q1, bringing us to the approximately minus EUR 1.1 billion result.

To our last topic on the page, I am pleased to reiterate what we have announced on the 25th of April. The public prosecutor's office of Hanover has closed the time proceedings against Continental AG. Continental accepted the decision and will not be taking the matter to appeal. The fine will not lead to any significant additional impact on earnings in fiscal 2024, thanks to a provision set aside for this purpose process in previous years.

On the basis of and in accordance with the existing contractual provisions, Vitesco Technologies is in this respect, generally obligated to indemnify Continental AG against the ensuring costs and liabilities. This follows the principle that our opportunities as well as risks from the transfer business are passed to the Vitesco Technologies as part of its spinoff. By this I am pleased to say we complete the investigations and can now pivot our focus to our daily business, which includes the continuous strengthening of our integrity pillar throughout the organization.

Now let's move to the details on each sector level moving now to Page 4. Beginning with Automotive. Here, the year-on-year comparison, we see the top line burdened by the effects I mentioned. Volumes, pricing and FX, resulting in a negative organic growth of 2.4%. The adjusted EBIT margin was particularly hard by the pricing topic as well as this year's labor inflation effects which is bundled into the pricing negotiations.

Now to Tires on the sales side, we also came in lower than the comparative quarter with a negative organic sales result stemming from the headwinds of FX as well as volume and price mix effects. On the adjusted EBIT side, we were also below the comparative quarter 2023, coming in at 11.7%.

For ContiTech, the top line was burdened by weak industrial and automotive markets as well as negative FX and pricing effects showing in the organic growth versus the comparative quarter. The adjusted EBIT margin was burned accordingly as well as by the mix effect and labor inflation, which led us to a 5.4% result. Not satisfactory at all even if we did anticipate the challenging start to this year.

Let's look further into the [ best ] sector detail, starting with Automotive on Page 5. As a reminder, we do not report on our business areas smart mobility anymore. Last year, in our Capital Markets Day, we announced this dissolution explaining that a considerable amount of its sales, roughly 50%, would go into autonomous mobility was the rest being split between Architecture and Networking, receiving around 30%, and Software and Central Technologies receiving around 20%. On this basis, we report our Software and Central Technologies business area for the first time. To support a like-for-like comparison, we present the first quarter 2023 figures also following the new structure on a pro forma basis.

On the top line, Autonomous Mobility and Architecture and Networking delivered solid organic growth year-on-year, while Safety and Motion was down in line with our market exposure. In the Software and Central Technologies and user experience business areas were impacted particularly by the geographic mix and unfavorable customer call-offs. This, and ramp-up delays or some of the softer start than anticipated, led to less content delivered in the quarter versus the comparative period. And thanks for [indiscernible] we're burdened for all sectors.

For Automotive, we had a negative 1.6% impact. For the quarterly comparison, we see especially the burden from pricing. Compared to the first quarter 2023, we could, unlike this year, already report on at least some concluded agreements. Finally, the regionally weighted global market development as well as delayed ramp-ups combined led to an overall unfavorable dynamic.

On the adjusted EBIT side, while we benefited from small improvements in premium freight versus the comparative quarter, the result was neutralized by the R&D net base effect as we did not have the same pull in our R&D reimbursement payments in this quarter. Finally, the price drop-through effect and additional labor inflation effects weighed us down in the first quarter.

Despite this difficult start to the year, we are confident in our plan and that our extensive measures will bring us into the guidance corridor for the full year. On that basis, we confirm the guidance for Automotive. How will we achieve it?

Volumes in the second quarter weighted for our regional footprint are expected to positively contribute. And for the self-help, I would like to reference to the bridge we gave you back in March. This is our road map for how we will get it done.

Firstly, starting with operating leverage. Here, we have two levers. We are working with, firstly, establishing against, fair pricing with our customers for our solutions through negotiations, which includes the additional labor inflation that we anticipate this year. We have started the negotiations with our customers, and even though they are tough, we are confident that we will solve these issues with our customers in a satisfactory and sustainable manner.

Secondly, through outperforming the market with our solution mix. Despite the cooler than expected ramp-up of new vehicles in the first quarter, we still expect those platforms to go into production, though it's too early in the year to be able to give more information. Perhaps a tangible example here can help to underline this confidence.

We have just published a press release on our extensive technological contribution to the new Mercedes E-Class. From our leading smart digital access system, to our powerful long-range radars, our telematics control unit that manages the communication in and out of the vehicle and a lot more. Even the tires and interior surfaces come from us. All that shows we are a strong partner to our customers' ambition for smarter, safer and more autonomous driving.

Then to operational excellence, where improvements will continue to come from our radar sharp focus. Our incremental efficiency improvements in manufacturing and overall stabilizing supply chain enables us to continue to influence positively premium freights. [indiscernible] improvements also in this quarter. From today's perspective and on our current assumptions, we are confident that we will achieve the savings as planned.

And finally, to our last bridge element, our fixed cost reduction program. On February 14, we announced that we are consolidating our footprint in the Rhine-Main area to further optimize and streamline administrative and R&D functions. This is part of the overall fixed cost reduction program, which will affect a total of around 5,400 positions worldwide. The complete program is in the execution phase. We also announced our automotive program to improve R&D efficiency with the reduction of 1,750 positions worldwide. Additionally, we will increase our efficiency and pool our research and development activities to improve our long-term competitiveness and achieve our R&D to sales target ratio of 9% midterm.

Although we will not yet see significant savings in the R&D efficiency program this year, rather from 2025 onwards. We do anticipate already high double digit to a low triple-digit net effect from our administrative streamlining project in 2024 with the rest of the savings in 2025.

Now to Slide 6. Let's look at how we performed market by market. European production was particularly weak in the first quarter with key customer vehicle launches delayed further hindering our performance in the region. However, we still came out slightly ahead.

In North America, we see two factors affecting the majority of our performance here in addition to the negative ramp-up, ramp-down situation, which we already addressed. The first being customer affordability where the combination of pricing, interest rates and credit levels are affecting vehicle equipment with latest technology. Secondly, market inventory levels are nearing target volumes so the potential volume upside is reduced.

China produced a stronger market growth. However, on the automotive electronics side, we can only benefit to a limited extent from this market dynamic given the customers driving this growth. We do have solid sales with both Chinese and international OEMs in China including being in the ramp-up phase with another Chinese OEM and the strategic high-performance computer business.

Looking to our future on Page 7. You can see we achieved an order intake of EUR 4.6 billion for the quarter. Starting with our strategic growth business area, Autonomous Mobility, of the EUR 1.9 billion in total, the majority of which is attributed to one large win for our next-generation surround radars which also includes the additional software functions of rear cross-traffic assist, including braking, sideline zone alert, including trailer extension, door open warning and lane change assist.

In our other growth area, Architecture and Networking, our team demonstrated our technology leadership in the area of smart device-based access and vehicle start solutions with wins totaling approximately EUR 1.6 billion across several customers.

And finally, we'd like to highlight the awards of our Safety and Motion team, bringing in close to EUR 1 billion worth of new business in solutions such as airbag control units and latest generation brake systems.

Now let's move to Tires on Page 8. The numbers show an overall muted performance for this first quarter. Our sales of approximately EUR 3.3 billion were affected by headwinds from FX of approximately negative 2.5% and from lower volumes. We experienced continuing weak developments in truck and passenger car OE markets, especially in Europe.

In the first quarter, we had fewer working days compared to last year due to an extra weekend in March and the Easter break in Europe had significantly impacted our sales. We do this effect see reversing in April though. Finally, negative effects from cost indexations in the quarter coupled with the weak truck market led to slightly negative contribution from price mix. So as you can see, it was a rather tough environment for the first quarter.

Looking to the adjusted EBIT side, we had negative drop-through from the FX, cost indexation and volume effects by having a slight tailwind from material, which compensated for the inflationary effects on the cost side.

Looking towards the second quarter, we see already a strong April and thus do foresee higher sales and margin. H1 overall looks promising to be in the guidance corridor. With the current view and assumptions in mind, we confirm our guidance for Tires for the full year.

Finally, let's check in now with ContiTech and their first quarter performance on Page 9. [indiscernible] were not immune from the challenging start to the year. Weak industrial and automotive markets, combined with an unfavorable geographical mix for the business and FX effects of negative 1%, led us to the sales result of EUR 1.6 billion for the quarter. Similarly, on the bottom line, we had a drop through from the negative volume and mix effect as well as burdens from labor cost inflation.

I would like to adhere that during this year, we do expect the inflationary effects to be compensated by results coming through on the cost management side. We will keep you informed on that as the year progresses. Also here, despite the challenging start, we are confident to capture on the back of a potential recovery in the industry in the second half of the year as well as from overall self-help improvements, particularly on the automotive side of the business. However, these cost efficiencies and negotiations will show their effect only during the course of this year. Consequently, we confirm our guidance also for ContiTech.

Now let's move on to our first quarter results for adjusted free cash flow on Page 10. Important message here is that we improved operationally in the quarter-over-quarter comparison. The overall result includes the onetime special effect of the ContiTech AG share repurchase. This EUR 500 million effect is included in the total EUR 1,086 million negative. So overall for us, a good result for the first quarter of the year and fully in line with our own expectations. We are on track, and I confirm our full year guidance here, too.

So let's move now to the outlook for our main markets on Page 11, and let me start with the statement that based on today's view, we confirm all market guidance. Perhaps, let me just say a few words to some of the topics on the page.

Firstly, to the North American passenger vehicle replacement tire market, which you can see was well ahead in the first quarter this year. We do, however, anticipate that when looking at the full year, our corridor still looks reasonable.

Secondly, to commercial vehicle production. We adjust our outlook range for Europe to the weaker-than-expected outlook by minus 1% in the midpoint. While for North America, we adjust to the more positive outlook of the market to the new range of minus 1% to plus 1%.

Finally, to truck replacement tires in North America, plus 16% in the first quarter. Here, the market was [indiscernible] by imports from Asia in advance to the change in antidumping duties anticipated to come into effect around the summertime. [indiscernible] we will closely monitor the markets as they each develop this year.

Finally, to our guidance for 2024 on Page 12. Even with this challenging start and difficult market environment, from today's perspective, we, the Continental team remain confident that our self-help measures will have the needed effect, and therefore, for the group as well as for each individual sector, we confirm our guidance.

So with that, I'd like to now hand over the rest of the time to you. Operator, could you please open the line for the Q&A?

[Operator]

The first question comes from Horst Schneider, Bank of America.

[Horst Schneider, analyst]

I have got a few, of course, the most interesting for me is also Automotive. I mean, we were all a little bit shocked about this Q1 results. So therefore, I mean, first of all, I would be curious to know if that hit you by surprise? Or basically is Q1 something that was in line with your expectations so that you can also stick now to the guidance?

So the other question then, of course, would be -- if -- do we talk now really still about the guidance range? Or you rather hope to achieve the lower end of the guidance range after the rather weak Q1?

And then lastly, it would be helpful basically to understand the year-over-year changes, maybe also sequential changes. I mean I'm just seeing on your slides that [ UX display ] was pretty weak. So there were some subsegments, which had pretty weak, revenue growth. I understand there was also a pricing element but that we get a little bit better feeling for the bridge basically from a year-on-year perspective. Was it all price or was it a mixture of volume price and maybe also cost to some extent still?

[Katja Durrfeld, executive]

Okay. Horst, nice to talk to you. Let me start with your first question on the Automotive result.

I think if you recall it, already in Q4, we told you that our expectation for the year 2024 would be to follow pretty much the same structures that we already have seen in 2023. So we already indicated that we expected the first quarter to be the weakest quarter of the year 2024.

The total amount that we are facing now, I wouldn't say it was a surprise to us, but a lot of things came together at that point in time. For example, delayed ramp-ups in the production at our customer sites, which we did not exactly at this point in time that we would have to renegotiate pricing. We also said that clearly at our annual press conference that there would be a significant portion that we would have to renegotiate not rolling over from 2022. So that was an expectation for us.

So overall, the magnitude was for sure not entirely foreseen for the first quarter. But overall, the effect that we saw certain expectations we had around it.

Coming to your question regarding the guidance range, we confirm the full range of the guidance was because we do see that we have a lot in our portfolio at the moment to be able to confirm the guidance to its full extent also towards full range extent. We are in good pricing negotiations with our customers at the moment. We do see some positive market developments, our mix will develop positively. And we always said that the second quarter would be the strong -- would be stronger than the first -- the second half would be stronger than the first half anyway. This is the reason why I'm really confident to be able to confirm the full guidance range also for the Automotive side despite the lower start.

And your second question was about the changes, what happened year-over-year. I think for user experience, it is really visible that especially in that area where we are facing a lot of ramp-ups of our new technology in the vehicles. We are also over proportionally hit by the delay of the ramp-up or slower-than-expected ramp-ups on the user experience. So that was one of the reasons for user experience. And the quarter-over-quarter comparison you already indicated during your question, is that pricing definitely does play a role.

In the first quarter of last year, we already had some agreements fixed for the year. This time, we were not able to do that. So we are in negotiations now, and I look positive to the results of these negotiations, but that was definitely also a quarter-over-quarter difference.

[Horst Schneider, analyst]

But you didn't book additional provisions, Katja, right? So that was a special element in Q1. That's not the case.

[Katja Durrfeld, executive]

We didn't book any special provisions in the quarter.

[Horst Schneider, analyst]

Okay. And when we now look at the range and you say that the 3% to 4% is still achievable, Q2 stronger than Q1, understood H2 stronger than H1 also understood. But does that mean basically that as of Q3, for sure, you will be at least again, within the range, respectively, in order to achieve now the upper end of the range, you, of course, need to be above it, right? So -- but that's the way how we should think about it, correct?

[Katja Durrfeld, executive]

Well, Horst, if you compare the development of the past years [indiscernible] always in that we had always a stronger, and stronger, and stronger development that manifests. I can't tell you exactly what and when to expect the exact amounts and figures. But what I can say is that looking at the current development and looking at all that we have seen in the past, it's exactly what we expected for this year and that we are on a good way to work our way through the year.

[Horst Schneider, analyst]

Okay. I keep fingers crossed for you. Thank you. Good luck.

[Katja Durrfeld, executive]

Let me just say one more thing because I was wondering why you asked about provisions. Booking provisions is something that we do on a regular basis, yes? So there were no special things beyond anything else that we haven't had in prior quarters during the course of the last year.

[Operator]

Next question comes from Sanjay Bhagwani, Citi.

[Sanjay Bhagwani, analyst]

I have three questions. The first one is actually a follow-up to Horst's question. So maybe if you could please provide a bit more color on -- so if I understood it correctly, the pricing of the last year are not rolled over. So that means this year, you negotiated the prices which were the inflation of the last year and inflation of this year. And on the top of that, maybe inflation also was a bit front-loaded this year. So maybe can you please provide some color on if there is some magnitude of impact in this Q1 margin, if you can help us quantify a little bit of range here that how much of that is to do with this timing of the cost versus pricing negotiations?

And then how are you seeing the progress so far in Q2 on pricing? And are you going for a bit more sustainable price increases this time or not. So that is my first question, and I'll just follow up with the next one, if that is okay.

[Katja Durrfeld, executive]

Okay. That was a very long question. I hope I can get it all, Sanjay. So we already said in the fourth quarter results presentation that, and we will have a significant portion of pricing agreed in 2023 that would not roll over into 2024. This is exactly what happened. And this is a major effect in the first quarter.

In addition, we also said that we would have approximately EUR 500 million of cost inflationary headwinds, mostly coming from wages and salary increases. And out of that, approximately half of it is attributable to automotive. And this already has to a quarter manifested in the first quarter. It will probably be stable quarter-by-quarter to achieve the overall EUR 250 million. So all of that has hit us in the profitability in the first quarter comparing to the Q1 of last year.

What we are doing at the moment is that we are back in negotiations with our customers, and I would say we are in a good way. Our target is for sure to establish a satisfactory and sustainable pricing moving forward.

[Sanjay Bhagwani, analyst]

So if I understood it correctly, this year, we are talking about Q1 base inflation, which is roughly 1/4 of the EUR 250 million, maybe more like EUR 62 million or something like that. And plus you had to negotiate the inflation of last year, that was somewhere around EUR 250 million. So that's probably the gross inflation in Q1. And then on the top of that, the pricing pass-through, we have not seen any or you have already seen some pricing pass-throughs?

[Katja Durrfeld, executive]

I have not understood everything. So the EUR 250 million will be evenly spread more or less across the quarters of the first bid and was definitely there, plus the effect from the not rolling over price establishing from last year. Yes.

[Sanjay Bhagwani, analyst]

Okay. So maybe coming on the second question. So understood Q2 margin is better than Q1, and then H2 better than H1. But a bit more color on this, if you can provide. Can you already see the Q2 margins being at least in the positive territory based on the negotiation as we stand now?

[Katja Durrfeld, executive]

I really have a little difficulty in understanding because of the line you're in. I think you asked if the Q2 will be better.

Yes, the Q2 will be better, and we are definitely working hard on getting it into the expected level, which also means a significant improvement compared to the first quarter.

[Sanjay Bhagwani, analyst]

Actually, my question is that Q2 margins could already be positive territory. They can be above 0?

[Katja Durrfeld, executive]

Depending on the outcome of our pricing negotiations, I would say, yes.

[Sanjay Bhagwani, analyst]

And just a final question on the organic growth outperformance. So user experience and software technologies is somewhere we have seen underperformance? How should we think of that? If you can provide some example on other specific regions or customers where there are these ramp-up delays? And overall, on the group automotive organic growth outperformance, do you still think that core is possible from around 3% to 5%, in line with your midterm targets?

[Katja Durrfeld, executive]

So I think for user experience, I already said that this is really burdened that, that was especially burdened by the ramp-up and ramp-down effects. So that was definitely on the user experience side with the delayed ramp-up of new vehicles. This is an effect that we've seen in the first quarter, but we do expect that effect not to stay in the during the course of this year.

With regards to Software and Central Technologies, there were some service contracts were a little down in the first quarter, but also here, we do have a pretty strong portfolio to offer in that area, which is very much demanded in the market at the moment. So I also do see that not to be a sustainable effect throughout the year.

[Operator]

The next question comes from Ross MacDonald, Morgan Stanley.

[Ross MacDonald, analyst]

It's Ross at Morgan Stanley. Three questions for me, please. Firstly, on inventories. Could you please provide some color around how you see inventory levels at the group progressing from here, whether there's still some scope for further destocking?

And then specifically on semiconductor inventories, there has been a destock happening in the industry. would that be a theme that's in play for Continental and whether you see a further destock of semi equipment moving forward?

[Katja Durrfeld, executive]

Okay. So starting, that was just one topic. So you've seen that on a quarter-over-quarter comparison, we've really significantly improved also on the working capital side, and that contributed to the, let's say, operationally at cash flow performance in the first quarter, and we do see further opportunities here and work hard with our smart inventory program to continuously work on an optimal -- I think is the optimal setup of our working capital moving. So yes, we do see more opportunities on that side for us in Continental AG.

[Ross MacDonald, analyst]

Sorry, I left the space there. I'll give the next two questions, if that's okay. The second question is on Tires. Just be curious on the truck market, in particular, if you're seeing any green shoots in that market. would support the recovery from here? And perhaps you can remind us what share of truck revenues -- of Tire revenues, sorry, you expect to be coming from trucks this year?

And then final question, just on the product sold really that's coming in, in the second half. A lot of OEMs talking about this rich pipeline of new products. Can you potentially remind us how Continental AG is reimbursed by OEMs if the take rates are actually lower than it's being forecast by the industry. Are those reimbursements something that is formulaic in nature? Or is that something that also has to be renegotiated every year?

[Katja Durrfeld, executive]

Okay. So let me first start with the truck market. So the truck market is currently a very difficult market, and you saw us also being muted on our sales side in the truck market in the first quarter. So far, the market we expect to stay more difficult, in fact, during the course of this year. So there is no, no specific jumps that I can give you yes.

I have to admit that with regards to the revenues that we expect from the trucks business overall this year, I don't have a final figure for you at the moment. I have to admit that I don't have a final figure on the contribution -- expected contribution during the course of this year on the sales side. Sorry for that.

And have the reimbursement in the delay of the product launches, that is a difficult topic. In some contracts, there are already fixed ranges until when you get compensation for shortfalls in the volumes. Sometimes they are limited to the entire lifetime of the contract. Sometimes they are on a yearly basis. Sometimes you have to negotiate them. But overall, I think that is something that we are pretty experienced now and that we know how to do it and how to deal with the respective customer that might be affected by that. So it depends on so.

[Ross MacDonald, analyst]

Maybe just a follow-up on the Tires piece. If I could reword the question then. It seems like the recovery you're expecting in Tires is mostly a replacement passenger car from here, is that be fair?

[Katja Durrfeld, executive]

That will be a fair statement, yes.

[Operator]

Next question comes from Monica Bosio, Intesa Sanpaolo.

[Monica Bosio, analyst]

The first one is on the Automotive business. You confirmed that your organic growth outperformance target in the range [ 3, 5% ]. I'm just wondering, do you expect the outperformance will be more back-end loaded? Or can -- could we imagine some outperformance already from the second quarter of the year, and if yes, can you elaborate more on this?

The second question is on Tires. You're expecting a reversal of the negative effect in the first quarter already from April, mainly due to the less working days. But I'm just wondering, do you expect positive volumes for the second quarter for Tires? Also on the back of what you have just said on the truck tires business?

And what about the price mix? Should we expect a positive price mix already from the second quarter as the impact of indexation will be over?

And very last question is on the reduction on premium freight. You had a small part in the fourth quarter. How can we imagine the reduction of premium freight across the next quarter?

[Katja Durrfeld, executive]

Okay. Let may see. Will the outperformance be more back-end loaded. So I would say, looking also at the market expectations in the different markets, I would say that we'd rather have a stronger performance in the second half of the year. And we will see where within this outperformance rate, we will find in the end. We do see us outperforming the market, but to what extent exactly in what quarter? I'm sorry, I cannot give you any details on that.

With regards to the Tires side. I already told you that we have seen a strong April, but I have not guided for the second quarter so far. So the April, we do see catch-up effects coming from the March topic. Yes. So this working day topic that you just said. And as I said, we do see stronger markets moving onwards.

What exactly the full Q2 figure will be, we will see after we finalize the Q2, but I'm confident that we are moving definitely into the right direction.

And then let's see price/mix positive, potentially already in Q2. We will still see impacts from the cost indexation in the second quarter this year. But overall, moving on forward for the full year, we should progress in that arena.

And the last question was the premium freight. Also there, I don't guide on the quarterly basis, but I can tell you that the expectation for the year was to end of the year better on the premium freight side, then we ended the last year and we already made progress in the first quarter of this year, and we'll continue to see continuous positive effects during the next quarters to come.

[Monica Bosio, analyst]

Will it be more back-end loaded or also on the premium freight reduction? I know that you do not guide quarter-by-quarter, but should we expect a major impact in the second half?

[Katja Durrfeld, executive]

I would say no special additional impacts. We are moving more or less in line. And by the way, there was earlier a question on the truck tire sales. You can expect about 20% of Tires sales being related to truck tires. I'm sorry, I couldn't give you the exact figure for this year, but sorry, yes.

[Operator]

The next question comes from Jose Asumendi, JPMorgan.

[Jose Asumendi, analyst]

A couple of questions, please. When we look at the Automotive business, excluding the investments you're doing on AM and the losses you're generating there as a result of the R&D expenditure. You guide for 3% to 4% auto margin in '24. If you exclude the losses you're making in AM, am I right in understanding that the margin -- the adjusted auto margin would be probably 4% to 5%, and we actually have quite a healthy automotive margin. That will be the first question. Or am I being too optimistic on my assumptions?

[Katja Durrfeld, executive]

You're asking question by question, okay. Sorry. Jose, I think it is clear, and we've also indicated that during our Capital Market Day that our expectation for 2023 was that AM would be in the loss-making territory. And so -- but we do not guide on the A level. So I'm sorry, I can't really make this statement so far. When you look at 2023 and looking at the Capital Market presentation, you could assume that in 2023, the margin would have been better without the investments in autonomous.

[Jose Asumendi, analyst]

Got it. And then I mean it's quite difficult to navigate the Automotive margin on a quarterly basis. But where are we on these the famous 3 buckets, the operational excellence, the fixed cost reduction and the R&D efficiency on auto. How is this seeing through this year, next year as we look forward to seeing that automotive margin growing and improving in the right direction?

[Katja Durrfeld, executive]

I think when you remember the bridge that we provided also at the Capital Markets Day, we had given you the contribution for bucket more or less. What I can tell you is that we are our way and fully in line with the targets on the defined measures that we have. So with regards to the fixed cost reduction program, I can say that our expectation for this year is a low digit -- low triple digit, I'm sorry, I ran over myself, a low triple-digit million contribution already this year and with the full contribution of around EUR 400 million being realized by the end of 2025.

We do see that with regards to the R&D efficiency improvement program, which will contribute short term up to 1%. We are also moving into the right direction. We will see a reduced R&D to sales ratio for this year as we have indicated. So also there, we are moving into the right direction. We also said that we would benefit from lower premium freight. We're already confirmed that we've seen, in fact, the first quarter and in the next quarters to come.

So what we are doing at the moment is renegotiating the pricing side. That is also one of the levels that we announced specifically. And there, I would say, we have not signed any agreements in the first quarter, yet we are in good negotiations moving forward.

[Jose Asumendi, analyst]

And final one. If we think about this margin sequential improvement in auto, which is going to be extremely steep in Q3 and Q4, I mean Q2 is basically breakeven slightly positive, and Q3, Q4 needs to be very, very strong margins. That sequential improvement, is it, as you think about this 1/3 volume, 1/3 cost savings, 1/3 pricing? Or do you think pricing will be the majority, price negotiations with probably 3/4 of the margin improvement in Q3, Q4?

[Katja Durrfeld, executive]

I don't think we've ever broken it down specifically on how much the pricing individually will contribute. But if you take into account, we'll see that I said that a significant portion of the price agreement of last year did not roll over into this year plus the additional cost inflationary headwinds, you can definitely see that the result of the price negotiations will be a major driver again on margin improvements during the course of this year.

[Operator]

Next question comes from Christoph Laskawi, Deutsche Bank.

[Christoph Laskawi, analyst]

The first one would be just a clarification question on what you said on the Q2 margin. In the absence of any pricing, could the margin be positive? The way I read your statement, it's not the case and pricing would lift it over the breakeven line. Is that correct?

And then the second question would be on essentially your restructuring pay back, you highlighted that you have closed a couple of things also in Germany. Could you comment just roughly where the visibility on that sits, on the guided, call it, EUR 100 million. Do you have good visibility on the phasing and achieving those EUR 100 million already, call it like 80%, 90%? Or is there still plenty that you need to close with the unions or other parts that could prevent reaching the EUR 100 million?

[Katja Durrfeld, executive]

Okay, Christoph, so coming to your first question, we do need some pricing to become positive on the Automotive side, yes. Because as I said, we do already have effect from the inflationary headwinds of this year, yes. So looking at Q1 and Q2 in total, we would have half of the negative effects from the labor cost inflation is already realized there, which would be already a significant impact. So we do need some pricing to get positive. But as I also said, we are in a good way. So let me say it like this.

So we are in good negotiations with the customers. They value our products and our content and also our partnership when it comes to new strategic projects. So as during the course of the last year's I'm positive that we will come to a satisfactory and sustainable agreements there.

With regards to the restructuring payment I would say, we do have a very strict program and also very to program management on the implementation of our cost-saving measures, which include the administrative cost side but also the R&D side, and we do have a pretty good visibility of what and when it still comes.

For sure, we are in -- also in constant exchange, I would call it exchange with our social partners, which means the unions. But also, please keep in mind, Christoph, that the program is not only targeting to Germany. I think that's very important to keep in mind. We're a global company. We're globally adapting our processes on the administrative side, and therefore, the effects will not only come from German employees.

[Christoph Laskawi, analyst]

Just a follow-up to that then. Obviously, the non-German part of the program are easier to conduct, if you can say it that way. So that means for '24, you wouldn't see a risk of delays because of negotiations with anyone in the program?

[Katja Durrfeld, executive]

I would say when you look at the past, and also when you look at our transformation program that we had in the market, we've always been able to find solutions with our social partners. So I am so far confident, and I'm also happy with the progress that we have made so far. And I'm positive that we will find solutions because in the interest of the whole company and all its employees.

[Operator]

Thank you very much. Before we go to the last question, we have two questions in the queue. [Operator Instructions] So the next question comes from Thomas Besson [indiscernible].

[Thomas Besson, analyst]

I guess it's me. It's Thomas Besson, Kepler Cheuvreux. I have a few questions, please. First, Katja, personal question. Could you update us on your succession plans. I understand it's been launched, but I don't think we have heard anything. Do you have any visibility on the time line for that change? And can you explain how long you're going to stay once a new person has been appointed in your position eventually? That's the first question.

The second, there's a lot of changes that have been pitched in your December CMD. All of them are taking a little bit of time due to carve-outs and planning, et cetera. Can you update us on the timeline for these changes and the cost of implementation you're going to bear in '24, please?

And lastly, more virtual question, I'm sorry. You need to have compensation from your clients to turn positive in autos. But I mean your head count has got declined in autos, and your R&D has jumped when it's supposed to decline. So how should we see this basically on a like-for-like basis, should we expect head count in Automotive to be down 5% or more on a like-for-like basis without any adjustments? Or is it going to be still the same? And when should we expect R&D to eventually decline in Automotive?

[Katja Durrfeld, executive]

Okay. I try to answer the first question first, Thomas. So with regards to my succession, there is nothing I can share with you at the moment. And this succession is not decided by me, but it will be decided by the Supervisory Board who is -- was for sure, evaluating potential candidates for the position. And as soon as they've taken a decision, and this will also be communicated into the public.

What I said Thomas, I do have a contract, and the contract expires on December 30th. So this is still a pretty long way to go. And I'm fully committed to Continental AG during that time. I have a lot of personal relationships in this company. I still feel very connected to this company. So it's on me and it's my responsibility to continue to drive this company into the right direction and into the future, and I will fulfill my duties to its full extent.

And as soon as a successor will be announced, we will define the time line until when a proper handover will have taken place because that is also important to give stability in this company to manage a proper handover and then we will see how things progress. So nothing to update you about. And everything is still on the run, and you will have the pleasure to talk to me until December so far.

The decisions from the CMD take time. That is definitely true. We informed you at the CMD that we are -- have taken the decision to carve out, so to legally carve out two business areas, the user experience business and the original equipment solutions business from ContiTech. Both carve-outs are running according to plan. We are a little bit more progressed with the original equipment solutions business because we've taken the decision earlier. But both carve-outs are running according to plan and what we have also communicated to the market is that we expect an impact from carve-out costs for this year of around EUR 200 million for the 2 carve-outs. I think that spread is what it is. And everything is going according to plan in the 2 carve-outs.

With regards to the R&D topic, I think what we have always said is that we do not necessarily see reduction in absolute R&D spend -- R&D net spend that -- but we do see a decline year-over-year from R&D targeting on the long term to R&D and the net percent of sales ratio of around 9%. And there, I can say, Thomas, we are exactly on that track and on that path. We've also shown that during the course of the last 2 years that we've reduced the R&D net percent of sales, and we continue to move forward into this direction.

And if you refer to the quarter-over-quarter comparison with last year, it seems that we do have higher -- also relative R&D in percent of sales. This is due to some cutoff dates on the R&D reimbursement side, but this is just a let's say, a rolling effect. It's not an absolute effect. And our expectations of this year are fully in line, and we do progress as planned.

[Thomas Besson, analyst]

Okay. So just to confirm the R&D ratio despite being up in Q1, it should decline in '24 versus '23 so what's your ambition. And I had a subsequent question on the head count of actually has not declined as fast as your revenues in Automotive in Q1.

[Katja Durrfeld, executive]

Okay. So to the first question, yes, you should see a decline compared to prior year, again when we conclude the year 2024, and the second one, the ramp down of head count is not linear to not necessarily linear to sales. We are targeting to reduce our administrative personnel significantly. And we've also announced the figures or people that are affected overall. And this is not linear to the sales development in the first quarter, and you will see more effects coming in, in the second half of this year.

[Operator]

Next question comes from George Galliers, Goldman Sachs.

[George Galliers-Pratt, analyst]

The first one I wanted to ask was whether there was any way to strip out from the Q1 auto EBIT, the inefficiencies associated with the ramp up of the new products as well as any detrimental impact from the delays you mentioned in order to just help us understand what the Q1 margin might have looked like on an underlying basis? I don't know if that's possible or you can just give some color in that direction.

The second question I had was just again coming back to the guidance. I think to reach the low end of your guidance, you need to see something in the ballpark of a EUR 450 million improvement in auto EBIT year-over-year. Obviously, part of the EUR 450 million is coming from the EUR 400 million cost reduction measures that you highlighted at the CMD. However, following on from your response to Jose's question, is my correct understanding that the rest or a large part of the rest of this improvement is expected to come from price renegotiations?

And again, just to be very clear, that would be incremental benefit versus the price renegotiations you achieved last year, which don't carry forward.

[Katja Durrfeld, executive]

Okay. So maybe the first one on the Q1 performance. It's that some contracts with our key customers are phasing out or were phasing out at the beginning of this year, so in Q1, which could not be fully compensated by ramping up other projects. And overall, therefore, we also saw a negative mix effect in the market, yes. So that is -- that was definitely how much that has really contributed to the overall muted performance. I really can't quantify that to you. But that's definitely a hit that we have seen.

We do expect that not to fully reverse. That will be wrong, but we do see positive trends that can help us to partially stop this negative trend, yes? So that is the topic on the mix ramp-up, ramp-down topic for the first quarter.

So for the guidance and price, price will be a major driver, as I said. We will -- we did not have all the pricing rolling over from 2023. So we -- so that is definitely -- and that was also an effect now in the first quarter. So concluding those price agreements as satisfactory and sustainably will definitely be a driver for the margin improvement overall on the automotive side, despite the -- and as I said, that small triple-digit million expectations that we have from the fixed cost reduction program. But we also -- and I mean let me just emphasize that, we are also expecting some positive contributions from us growing better than the market and also growing with good products in the market during the course of this year.

[Operator]

Next question comes from Michael Aspinall, Jefferies.

[Michael Aspinall, analyst]

Michael Aspinall from Jefferies here. Just one follow-up on Tire margins. As I believe you had a comment that 1H Tire margins could be within the corridor of 13% to 14%. Just to get to the bottom of the corridor for the first half, 2Q margins would need to be kind of more than 14% which would be the highest since 1Q '22? What are the key moving pieces that would see Tire margins rebound so strongly in the second quarter?

[Katja Durrfeld, executive]

Well, the first thing, and I think I indicated that already as we -- in April, we have more working days than we had in March. So also that effect, we do see to manifest. And yes, there is a chance that, overall, we will be in the range of our guidance with Tires in H1. And it's the volume topic that is definitely coming in that will help us in the Tires replacement market.

[Michael Aspinall, analyst]

Okay. So it's mainly volume not much comprising raw materials that they're kind of largely flat into 2Q?

[Katja Durrfeld, executive]

It is volumes overall, I would say. The major driver is volume.

[Operator]

Thank you very much. Right now, we have no further questions. Back to you, Anna Fischer.

[Anna Fischer, executive]

Thank you, operator, and thank you, everyone, for participating in today's call. As always, the Continental Investor Relations team is available for you for any remaining questions. With that, we would like to conclude today's call. Thank you so much, and goodbye.