Continental AG

XETRA:CON

Earnings Call Transcript 2021-Q4

[Operator]

Dear ladies and gentlemen, welcome to Continental AG Preliminary Results for the Full Year 2021. And our customers request this conference will be recorded. [Operator Instructions] After the presentation, there will be opportunity to ask questions. [Operator Instructions]

May I now hand you over to Bernard Wang, who will lead you through this conference. Please go ahead.

[Bernard Wang, executive]

Thank you, operator. And welcome, everyone, to our FY 2021 results presentation. Today's call is hosted by our CEO, Niko Setzer; and our CFO, Katja Durrfeld. Also here in the room with us is Stefan Scholz, Head of Finance and Treasury. If you have not done so already, the press release and presentation of today's call are available to download on our IR 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.

Now let me walk you through our agenda on Slide 2. Niko will start off with main messages and business highlights, then Katja will review financial highlights for 2021 and close with our expectations for 2022. We'll then conduct a Q&A session for sell-side analysts only. [Operator Instructions]

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

[Nikolai Setzer, executive]

Yes. Thank you, Bernard. Let me begin today's presentation from my side on Slide 3, starting with a review of 2021 and our priorities for 2022.

So despite all the challenges in 2021 from the continued pandemic to a significant volatility in our end markets as well as the ongoing industry transformation, I'm very proud of what our global team -- our global Continental team has accomplished.

This includes 2 major milestones: the successful completion of the Vitesco Technologies spin-off and the implementation of new structures for the group and for automotive. Another important milestone in 2021 for our long-term sustainability path, our annual sales for emission-free mobility has reached roughly EUR 1 billion sales for the first time.

Diving deeper in our businesses in automotive technology, supply chain constraints were the dominant topic, constraining volumes and affecting profitability through volumes, premium freight and more expensive semiconductors. On one -- on the other hand, our restructuring program is progressing as demonstrated by the year-on-year decline in headcount by 3%. Order intake also was a highlight, with EUR 18.6 billion in new bookings to drive growth in [ indiscernible ] years.

In Rubber Technologies, we demonstrated our operational excellence in manufacturing and distribution, achieving both a solid volume recovery as well as gains in price and mix. And like in automotive, restructuring at Tires and ContiTech is also progressing, with headcount down 2% year-on-year.

While these achievements were not enough to mitigate the significant cost inflation in raw materials, energy, labor and logistics [indiscernible] half of last year, they were sufficient to support a year-on-year increase in both the Tires and ContiTech margins.

Looking ahead, even though we are not quite [indiscernible] with living and operating with COVID, our top priority [indiscernible] for the people. Putting people first is even more relevant now due to geopolitical [ crisis ] and risks, which we are doing with our support for the people of Ukraine. In Russia, we will be stopping production in our Kaluga facility until further notice, while continuing to support our 1,300 employees over there.

Outside of Russia, the geopolitical situation is also already making operations more difficult in numerous ways, from procurement to logistics. We have put in place adept teams and specialists to assess the situation and responsive countermeasures to minimize disruptions.

Aside from this, our focus is firmly on improving performance from the strategic management of semiconductor related constraints to the continued implementation of our structural program. Also crucial to our performance is the implementation of sustainable pricing measures to mitigate the broad inflationary headwinds.

In terms of portfolio, with the realigned automotive organization in place, the priority is on leveraging its combined strength in technology such as high-performance computing as well as in operations. In addition, we will continue carrying our portfolio actions in line with our growth and value strategy.

Last but not least, our long-term priorities and technology and sustainability. This includes not only winning orders for and launching innovative new products, expanding revenue streams through new business models, more on this shortly. We also will continue expanding our activities and offerings for emission-free mobility.

So on this slide, Slide 4. Before turning to our strategic priorities, let me address the dividend on that chart. As addressed at our 2020 Capital Market Days, we are committed to distributing a dividend commensurate to the development of our net income. This underpins our dividend of EUR 2.20 for fiscal 2021, corresponding to a payout ratio of 30%, [indiscernible] the upper end of our target range.

Let me now turn to business highlights with [indiscernible] on Slide 5. We are pleased to see that our newest display solutions for Renault and BMW have received very positive reviews, not only for our displays themselves, but also our Cockpit HPCs, High Performance Computers, that power the user experience.

Further new display solutions, such as the ones shown here for [indiscernible] will be launching soon. We acquired more than EUR 3 billion in 2021 alone [indiscernible] with a total backlog to more than EUR 5.5 billion, with several SOPs starting already in 2022. These launches will boost our outperformance, especially in the second half of this year.

Our newest innovation and winner of the CES 2022 Innovation Award, the ShyTech Display keeps us at the forefront of user experience. The ShyTech is an alternative to large visible display and designs, a screen that appears only when it is needed as if by magic, seamlessly integrated into the surrounding surface, visually as well as haptically. Business acquisition of ShyTech are already underway with the first launches planned for 2023, it means next year.

On the next slide, we are going to High Performance Compute (sic) [ Computers ]. This covers our latest development in this area. You're already familiar with our first-to-market in-car application server, the ICAS for [indiscernible]. As the digital heart of around 500,000 vehicles in all major [indiscernible] and ICAS is not only a successful product, but also a growing installed base for additional value as we continue to deliver software maintenance and functional improvements to these vehicles.

With around EUR 5.5 billion cumulative order intake since 2018, our installed base for HPCs, High Performance Compute, will further grow in the coming years, including our latest order for [indiscernible] the body HPC for a second Chinese customer the SOP in 2024.

In parallel, we are working with customers on the next generation of HPCs that involves cross-domain solutions with our -- with over 15 active acquisitions in progress. Here, our competitive advantage is our complete portfolio and our newly realigned automotive organization through these aspects, we can combine our technologies and expertise across multiple domains to offer our customers unique, innovative and cost-effective solutions across the entire hardware and software stacks, not to mention unlock more future value streams across the vehicle life cycle.

Slide 7 shows our Tire highlights. Starting with the chart on the left, this shows our significant growth in scope for our business, EV, electric vehicle, tire business. We are now qualified to be sitting on around 300 different homologations covering many of the world's most successful global EV manufacturers. Given the more challenging requirements for EVs, the growing homologations show the trust that these customer plays in our technologies.

On the right chart, you can see the 2 further drivers of our mix improvement. One is the ongoing expansion of ultra-high-performance tires in our passenger and light truck mix, who's growing share of sales has well outpaced unit growth, demonstrating the over proportional growth contribution from UHP. Also contributing to mix are cutting-edge technologies like ContiSilent and ContiSeal as well as our advanced compounds for increased mileage. These examples demonstrate the core of our value over volume approach to driving growth and profitability.

With this, I would like to hand over to Katja for the financial review.

[Katja Durrfeld, executive]

Thank you, Niko, and also a warm welcome from my side.

Let me now review our performance KPIs for fiscal year 2021 on Slide 8. Reported sales came in at EUR 33.8 billion, up 6% year-on-year on a reported basis and 7.4% higher organically growth. The sales increase was the main driver behind the increase in adjusted EBIT to EUR 1.9 billion and the improved margin of 5.6%.

Unlike in past years, when special effects included goodwill impairments and restructuring charges, this figure in 2021 was positive EUR 123 million. The figure benefited from onetime effects, including the disposal of business activities in ContiTech and the reintegration of our Osram joint venture.

The higher EBIT and more favorable special effect figures supported the EUR 2.5 billion year-on-year improvement in net income to EUR 1.5 billion. Trading ROCE also improved significantly, reaching 10%.

Free cash flow before acquisitions, divestments and carve-out effects reached the upper end of our guidance coming in at EUR 1.2 billion. Cash flow in Q4 supports a sequential decline in net debt, which was roughly EUR 3.8 billion at the end of the year.

Let me now move on to the Q4 performance by group sector on Slide 9. The substantial decline in light vehicle production due to the semiconductor shortage caused the year-on-year organic sales decline of 13.8% in Automotive Technologies, as well as the corresponding margin decline of 310 basis points to minus 3.2%.

In Rubber Technologies, organic growth of 4.4% reflected strength in replacement tire markets and ContiTech's industrial business, which together more than compensated for the weakness in OE volumes. Despite this organic growth, adjusted EBIT decreased by EUR 253 million year-on-year, weighed down by more than EUR 375 million in cost increases related to raw materials, energy and logistics.

Finally, contract manufacturing declined year-on-year by 32% organically, restrained both by soft vehicle production volumes as well as the gradual phaseout of its business with Vitesco.

Let me now review organic sales performance for Automotive versus regional vehicle production in the fourth quarter on Slide 10. Segmented by region, automotive organic growth was able to significantly outperform vehicle production in our important European market, while our organic growth in North America matched local vehicle production.

Our underperformance in China was due to customer mix as our customers were disproportionately affected by the ongoing semiconductor shortage. Taken together, Automotive slightly outperformed its regionally weighted average by 250 basis points.

Now continuing to a review of the individual business areas, starting on Slide 11 with autonomous mobility and safety. AMS reported sales totaled EUR 2 billion, impacted by organic growth of negative 15.7%. This was driven by the considerable volume shortfall in all product areas especially in North America and Europe.

The adjusted EBIT margin for AMS decreased substantially by 580 basis points to a margin of negative 1.4%. In addition to the volume decline, semiconductor cost increases, higher R&D expenses for ADAS and premium freight were the main causes for the lower profitability.

As for order intake, a strong fourth quarter in business acquisitions resulted in bookings for the period totaling EUR 2.9 billion. The product categories where the biggest contributions were electronic braking as well as ADAS, which recorded the first business win with our joint venture partner, Horizon Robotics for the Level 2 Plus capable smart camera solution.

Vehicle Networking and Information is covered on Slide 12. Organic growth at VNI was negative 11.7% in the fourth quarter, constrained by continuous semiconductor shortages and the resulting production stoppages in particular, in Europe and North America. In spite of the headwind, VNI was slightly ahead of last year's level in terms of adjusted EBIT.

This improvement was achieved through a significant higher level of R&D reimbursements compared to the year ago quarter. As for the order intake, the value of EUR 2.6 billion included the first order from a Chinese customer for a second-generation HPC platform. As part of our commitment to the Chinese market, its development is supported by our newly founded development center in Chongqing.

I will now cover Tires on Slide 13. Tire sales ended the year on a strong note. Reported sales increased by 11.3%, organic growth was up by 9.3%. While overall volumes were down 1.5%, caused by OE weakness, replacement volumes were near 2019 levels in all regions. Price/mix remained very strong at 10.8%, with about half attributable to pricing, predominantly from our replacement tire business in Europe and North America.

Despite the strong sales increase, adjusted EBIT was down nearly EUR 200 million against an extraordinary strong Q4 2020, equating to a margin of 11%. Price/mix was insufficient to compensate for cost inflation in raw materials, logistics and energy of more than EUR 300 million. In addition, labor costs and labor-related capacity constraints were also headwinds to profitability.

Moving on to ContiTech on Slide 14. ContiTech sales in Q4 recorded organic growth down 5% year-on-year. On the OE side, volumes were sharply down, with declines in Europe and North America. In contrast, industrial and aftermarket developed well, supported by solid growth in Surface Solutions and Power Transmission. Sales were only minimally affected by the disposal of business activities in December, with annualized sales of around EUR 150 million.

This effect will be more noticeable in 2022. Profitability was challenged by lower volumes, volatile demand as well as inflationary headwinds of EUR 70 million -- EUR 75 million from raw materials, energy and logistics. Positive contributions from pricing activities as well as capacity adjustments were only partly able to compensate.

Let me now continue to the overview of free cash flow for fiscal year 2021 on Slide 15. Operating cash flow was up versus 200 -- versus 2020 by EUR 240 million despite higher inventories, reflecting higher material prices as well as higher stocking level to support upcoming volume growth. It also included cash outflows for restructuring of EUR 355 million as well as a positive contribution from discontinued operations of EUR 464 million.

Investing cash flow, excluding an inflow of acquisitions and divestments was negative EUR 1.8 billion. The figure includes an impact of negative EUR 162 million from discontinued operations. However, it excludes the inflow of EUR 343 million, resulting from disposals of business activities as well as of a minority stake in financial investment. The resulting free cash flow before acquisition divestment and carve-out effects, thus amounts to EUR 1.2 billion.

Let me now move to our market expectations for 2022. Our expectations are based on currently foreseeable effects related to supply chain challenges primarily for semiconductors. However, our expectations do not include potential effects related to the current geopolitical crisis, in particular, in Eastern Europe. Should the situation remain tense or even worsen, it could result in lasting consequences for production, the supply chains and demand. Depending on the severity of the disruption, this may result in lower sales and earnings in all group sectors as well as for the Continental Group compared to the prior year.

Given these assumptions, we are anticipating a year-on-year increase in light vehicle production by 6% to 9%. For passenger car replacement tires, we expect demand to be minus 1% to plus 1%. For commercial vehicles, we anticipate that production in 2022 will decrease by 0% to 3% globally, driven by a strong decrease in the China market. Meanwhile, truck tire replacement volumes in Europe and North America are expected to be up 0% to 2% year-on-year.

I'm now on Slide 17. As shown on the previous slide, we expect volume growth in all our underlying markets, though the fragility of the supply chain and geopolitical risks may be restraining factors. We also expect above-market growth in all group sectors. Driven by business mix, regional mix and sustainable pricing measures, we expect automotive sales to substantially outperform light vehicle production.

We also expect Tires to record sizable outperformance, predominantly from continued advancement in price and mix. ContiTech should also outgrow its markets in terms of volumes and pricing, although, the business disposal in December last year will have a negative impact of about EUR 150 million for the full year.

Lastly, assuming that the exchange rates at the start of the year persist for the entire year, we expect a sales tailwind from FX of about 3% for Automotive and 2% for Tires and ContiTech. Combining these elements result in a sales expectation of EUR 18 billion to EUR 19 billion for Automotive, EUR 13.3 billion to EUR 13.8 billion for Tires, EUR 6.0 billion to EUR 6.3 billion for ContiTech. This sets up to EUR 38 billion to EUR 40 billion for the group.

Moving on to the EBIT bridge on Slide 18. Overall, we expect a group adjusted EBIT margin of 5.5% to 6.5%, a similar margin compared to 2021, but representing an absolute increase in adjusted EBIT by about EUR 450 million at the midpoint. In terms of the individual sectors, starting with Automotive, improved market conditions, outperformance and cost savings from the structural program will support a year-on-year improvement in EBIT.

On the other hand, we also expect inflation to drive costs higher by about EUR 1 billion versus 2021, mainly due to higher prices for semiconductors and other components as well as higher energy and logistics costs. Meanwhile, just as in 2021, we also expect that the difficult state of the supply chain will require a similar level of premium freight expenses of about EUR 200 million.

Please note that neither of these estimates account for potential effects from geopolitical risks. In addition, R&D expenses for autonomous mobility are expected to increase by about EUR 100 million. Taken together, we expect Automotive margins of between 0% to 1.5% for the year.

In Tires, though we expect sizable top line growth, we do not expect that adjusted EBIT will grow at the same rate, predominantly due to an expected inflation effect of around EUR 1 billion from raw materials, energy and logistics, but excluding potential effects from geopolitical risks.

On the other hand, we are very active with pricing attainment, having already adjusted pricing in key markets in both January and March, while market conditions currently remain favorable for further adjustments.

Based on these price actions as well as continued improvement in volume and mix, we feel confident that we can more than compensate for this inflation in absolute terms, though margins are expected to be diluted by the higher sales. This is premise behind our expected Tires margin of between 13.5% and 14.5%.

The situation in ContiTech is similar to Tires. Here, we expect inflationary effects of around EUR 300 million, also excluding potential effects from geopolitical risks. We expect to be able to compensate for this at the absolute EBIT level through sustainable pricing measures, volume growth and mix optimization, albeit with a slight dilution in terms of margin. Based on this, we are expecting ContiTech margins for 2022 to be between 7% and 8%.

Continuing on to our expectations for cash flow on Slide 19, again, excluding potential effects from geopolitical risks. While we expect upper end of free cash flow to be approximately at the same level in 2022 as in 2021, there are many moving parts.

First, please note that 2021 figure included a onetime positive net cash flow of around EUR 300 million from discontinued operations. The year-on-year improvement in EBIT should be supportive to cash flow, while a restructuring outflow of around EUR 300 million is expected, slightly below the outflow of EUR 355 million in 2021.

And just as in 2021, working capital may have a noticeable cash effect depending on demand trends and input cost inflation. As for investing cash flow, we expect higher capital expenditures than in 2021, but below 7% of consolidated sales, including leasing.

Tires is the primary business sector behind this increase, driven by a brownfield expansion of our capacities in China as well as tooling for further mix enhancement. Automotive investments will be focused on growth businesses and in ContiTech on investments for the industrial and aftermarket businesses. In total, we expect group free cash flow before acquisitions and divestments to be between EUR 0.7 billion and EUR 1.2 billion.

Slide 20 covers the remaining elements of our expectations. While the provisioning for the structural program and carve-out effects now behind us, we anticipate special effects to be about negative EUR 150 million. Likewise, PPA amortization is also expected to be negative EUR 150 million. The financial result is expected to be below negative EUR 200 million, while the tax rate is expected to be around 27%.

This concludes today's presentation. Operator, could you please now open the line to questions?

[Operator]

[Operator Instructions] And the first question is from Tom Narayan, RBC.

[Gautam Narayan, analyst]

Yes. Tom Narayan, RBC. I have two. The first one, if I take the midpoint of the 2022 operating income margin guidance at 6% and if I add back the EUR 2.3 billion in higher procurement and logistic costs, I get a 12% margin, but your medium targets are calling from 8% to 11%. Wondering, if the medium targets include some higher procurement and logistic costs? And if not, why they wouldn't be higher?

And then the next question on Russia, Ukraine. I understand the guidance does not incorporate this, but it would appear that there is a very real risk that global auto production could go below your market guide. I think some 90% of Neon gas, for example, for semiconductors is sourced from Russia, Ukraine, also palladium is used for chips. We've already seen what limited chip supply can do to auto production.

Just wondering, if you could comment at all on what you're hearing on further semis-related production cuts as a result of what's happening in Russia, Ukraine?

[Bernard Wang, executive]

Tom, it's Bernard. Let me just clarify your question. The first question is about the -- how you can connect our expectations for 2022 to the midterm guide, right, and whether factors that are included in our '22 expectations are also included in our midterm guide.

And the second question is regarding the risks from Russia, Ukraine, whether we see that affecting our semi supply. Maybe Niko, pass it on to you?

[Nikolai Setzer, executive]

I'll start with the second one. I mean, obviously, yes, we are -- Neon gas, palladium and as well other raw mats, which might affect not only the semis, but as well others. And as you -- rightly as the semicons are already in a critical situation that might have effects on supplies.

So far, we have no indication from our semicon suppliers that there's any material risk happened. So far, however, still too early to judge. Let's remain -- monitor the situation as well by risk management and let's see what can be done. So far, we don't have an indication that anything material is there at the horizon.

The second question was whether our midterm guidance have included those substantial increases in raw mat as well as in logistics costs. I mean at the time where we established the midterm target December 2020, obviously, the world was still different than its current year right now. So one of our large challenges for this year is obviously as well to establish sustainable pricing.

We are in constructive discussions with all partners or be it on the automotive side, on the industry or on the consumer side, and we are what you see as well, which is substance of our guidance, for sure, before the geopolitical risk, which we cannot quantify so far. We are confident that we are capable via a partnership solutions with our customers to cover and cope with those price increases sustainably going forward. That's why we believe that our midterm targets are still valid.

[Gautam Narayan, analyst]

I guess, what I was getting at is if the procurement and logistic costs, if I just -- if we're assuming those go away, the margin should come in above the 8% to 11% range. Is that a fair way of thinking about it?

[Nikolai Setzer, executive]

I mean, you know how the market works. First of all, once we sit here in the current situation, and that's why we put the risk disclaimer. So far, we don't see any short-term, midterm view that those costs might ease. Looking in particular on semicons going forward, that might be the case depending on demand and supply. But again, we have no indication that this should come soon.

On the one hand -- on the other hand, if there should be a market which is getting long again, obviously, we are in a competitive environment. We have to assume that other market players have as well to play according to those. And that's why we still believe that an overshoot in this respective would be by far too progressive right now, we see it's still rather cautious than optimistic.

[Operator]

The next question is from Thomas Besson, Kepler Cheuvreux.

[Thomas Besson, analyst]

I have a few, I would say, general questions to start. There has been press reports that your Chairman is looking at the potential for spin-offs, while you seem to be supporting the current structure of the company. That's what I understood from the press call this morning.

Niko, could you clarify on that point, whether it still makes sense as the company has said over time to keep rubber and automotive as different businesses with different cycles? Or whether you think that eventually, like in the case of, Powertrain and Vitesco, there could be more pillars? That's the first question.

The second is about the dividend. I think 15% to 30% has been your message, but you have distributed more 30% most of the time over the last decade apart from 2020, when you had to cut it. But basically, my question is, do you indicate that there is a decent chance that it could be closer to 15%? Or is there no message at all intended in that reiteration?

And thirdly, not too far from Tom's questions earlier. It's clear that European production is not going to go up 15% to 20% in 2022. So could you just give us an idea of the sensitivity of your earnings if, for instance, European production is up by 1 point less, 5 point less, 10 points less than you currently assume? Because we're already seeing a lot of Northern German plants closed for [indiscernible] or other issues. So I think it makes some sense to give us some sensitivity to European volumes, given the current context?

[Bernard Wang, executive]

Thomas, just to reiterate your questions, let me start with the dividend first. The payout ratio, 15% to 30%, is the 30% that we have this year should be something be seen for the next year, I think we'll give that Katja.

And then the other questions regarding the press reports, regarding spin-offs and such and as well as the sensitivity to auto production, European auto production that we have in Automotive, that, we'll hand this over to Niko. Katja?

[Katja Durrfeld, executive]

Okay. So as you already said, the dividend proposal that we have laid out is fully in line with our current dividend policy of 15% to 30% of our net income. And we do not see any reason to deviate from this policy in the upcoming years.

[Nikolai Setzer, executive]

Okay. Coming to the spin-off part, which you could read in the press. First of all, typically, we don't comment rumors in the press. You know very well that we have used last year to strategically align Automotive and the group. First, Automotive, which was speculated in the press, autonomous mobility, but you could see it as well on architecture networking means high performance compute, both areas are an integral part, help our strategy, in particular, with this structure, which we put in place, market-oriented now our structure follows clearly the strategy. And we see in the interplay of those [ 6 ] action fields which we have, the core strength we have.

So there is no strategy right now or no plans to go for one area solo or having any plan, therefore, further spin-off. In fact, we want to use and leverage our organization in order to get stronger going forward as one automotive.

If it comes to group, we see in the group with our markets, which we serve on the one hand, the automotive. On the other hand, the fleet management and the industry and consumer business, in particular, on the two last part, fleet management, consumer business, strong synergies on the technology, on customer side, on talent use on interplay between the different sectors, beside the fact that obviously we can profit as we did as well last year from the different cyclical cycles -- cyclical cycle, sorry for that, in those different businesses, which clearly helped us to still invest and do our portfolio management, clearly invest into the growth part, allocate our resources on those areas such as autonomous mobility going forward, and by strong performance of our value business.

So the last part -- so again, there is no plan of spin-off. And going forward, the group as well is foreseen to perform as is better going forward. With regard to sensitivity, very honestly, still all too early. We see so far that a customer call us in the short as well in the mid and the longer term, relatively stable. They have one or the other going a bit up and down or down, but you see as well others going up. There are different mix in terms of region. So far, we are not able to give any indication how the geopolitical situation will affect the vehicle production. Obviously, if Europe should produce less car, we are exposed, and our European exposure is known to less sales. But again, so far, we are not capable to perform any scenario, as mentioned before.

[Operator]

The next question is from Horst Schneider, Bank of America.

[Horst Schneider, analyst]

It's Horst here from Bank of America. The first one is also a little bit regarding your midterm targets in Automotive. So can you please remind us what level of light vehicle production these targets require? And if now the market volume is going to be structurally lower because we have got general inflation in the industry, and that could also curb demand? Is there may be a need to enforce restructuring going forward? That's number one.

And then number two is about cost inflation. So I understand that you cannot yet incorporate the current geopolitical conflict, but can you maybe provide a split of this cost inflation in the guidance that you have provided, what are the various factors, for example, in automotive driving and the cost inflation that we can maybe calculate ourselves what the impact would be right now after the recent surge in some prices?

And on the back of that as well, what is the negotiation with the carmakers? I mean, if we see now the cost inflation surge, it takes now again something like 6 months, 9 months before you can [indiscernible] pass on to the carmakers or has the contract structure that you have changed by now?

[Bernard Wang, executive]

Okay. Horst, let me summarize. First is about the midterm targets, what level of vehicle production are -- would be needed to the targets? And if any restructuring would be needed to achieve the targets? Second question, cost inflation. We can give more detail and color on that and how we -- and when we could be able to pass that on to customers. Maybe the first one on midterm targets to Katja and the second one on inflation to Niko?

[Katja Durrfeld, executive]

Okay. Yes. Thank you, Bernard. To be able to achieve our midterm targets, we anticipate the car production to come back to around 90 million -- yes, pieces, to around 90 million pieces. This is the basis for us to be able to achieve our midterm targets with regards to volume.

The other element of us achieving our midterm targets are sure the execution of our transformation program. So increased performance also by higher R&D efficiencies and in addition, continuous working on a differentiated product portfolio.

[Nikolai Setzer, executive]

The question was as well in enforce restructuring and may I...

[Katja Durrfeld, executive]

Yes, so far, not. Yes.

[Nikolai Setzer, executive]

Yes, exactly because though the greater than 90 million cars you have seen. But again, this is all before the current situation that IHS was still suggesting in 2024, 2025, to have similar vehicle production as before. So based on those scenarios that the recovery comes under them, so far, there is no additional transformation measures necessary, obviously, or the other...

[Horst Schneider, analyst]

But Nikolai, if now the forecast from IHS was coming down, it could not be ruled out. Of course, if the market is structurally lower, you have to do more, that's right, correct?

[Nikolai Setzer, executive]

If the market is structurally much lower, I mean, you answered the question already on your own, we have to review our situation. Our capacity and as well in terms of mix, in terms of product and then we have to be agile ended up. That is, I would say, in general, correct.

The split of cost inflation. I mean, looking on the Automotive side, a large portion is coming from the semiconductor products as well known. Another, and this affects even more the Tires and the ContiTech part as we are more energy intensive, is the energy part, which is strongly as well on the logistics part. So those and are still referred to the material increase, which we have in automotive at the semiconductors are on the Automotive side, a bit lower on the Tire side, in particular, as you have more heavy products are there and more energy-intense more on the higher side.

If it comes to negotiations, we have to split our business, obviously, in those different customer bases. You have seen that in particular, on the more B2C markets such as Tires where we are directly selling, so to say, we have applied already several pricing measures, and there are, as we speak, next price increases going on in the market in order to cope with those increases.

We have as well on Tires as well as in some business on the Automotive side, raw material indices, which means that they are following with a certain lag, time lag the raw material part and they are getting then effected in the pricing for good and for bad. Right now, obviously, it goes rather upwards than downwards.

And with regard to the semicon and those substantial material increases and which we have on the automotive side, we are in constructive discussions with all our customers. And we are confident to close those. However, so far, we are not yet far enough in the process that significant effects are visible in the first quarter of this year.

[Horst Schneider, analyst]

I just want to get a feeling of the mechanism, right? So if there's no unexpected increase of steel, of aluminum or some other precious metals. So there is a kind of automatic pass-through. And just when it comes to freight cost and labor, that has got to be extra negotiated and can probably be compensated more in 2023. That is correct, right?

[Nikolai Setzer, executive]

That is correct. Raw material indices are mainly and those automatic price adjustments for clear indices, which are linked to raw mats or very specific materials those materials, which are labor or energy costs, which are now rising have to be negotiated with the customer individually. That's correct. And which are right product as well very individually depending on content.

[Operator]

The next question is from Gabriel Adler, Citigroup.

[Gabriel Adler, analyst]

I wanted to stay on the point of the relationship that you currently have with your customers in the OEM because I think it's an important one. And then we're hearing from some of your customers now there are suggestions that the suppliers need to be sharing more of the industry content costs that we're seeing from the EV transition in addition to the cost headwinds that we're seeing elsewhere in the industry. So I'd love to hear your thoughts there on whether you think that the suppliers and yourselves are already sharing that cost efficiently or if you agree with that statement some of your customers?

And the second question is on the software opportunity. We hear a lot again from the OEMs about long-term opportunities from software-enabled revenues, but there is a real concern among investors that we speak to. But the Tier 1 auto suppliers are going to perhaps end up playing a less important role in the future when it comes to providing innovative software solutions.

So Niko, I'd be really interested in particularly hearing your thoughts on where you think Conti will add the most value to its customers, when it comes to the automotive software opportunity over the next decade?

[Bernard Wang, executive]

Gabriel, so question number one, customer relationships, whether suppliers should share more of the burden of the transformation of the industry. And number two, the software opportunity whether or not Tier 1s will be able to continue to contribute value as the software-defined vehicle becomes more the norm. I think both should go to Niko.

[Nikolai Setzer, executive]

Yes. I mean, coming to the first one, you know our results and you know how much burden we can take on. So with no doubt, and that gets us well into the direction of the second one, software defined vehicles and high performance compute and those software-centric vehicles.

Obviously, there is a high level of resources needed. That's why and we mentioned this before, as well as different business models might be needed in the future in terms of software as the product on the one hand. On the other hand, on how to share [ Conti ] those development costs and those -- establishing those platforms.

So as you've seen, we are in discussion basically along with OEMs, how can we find right partnership and cooperation models in order to apply for those, knowing that with the higher complexity of software, and we've seen it as well on the ICAS project, which we have there, we have to find good ways to be efficient on the invest side and on the software development side, getting scale and finding them a platform, which we can use as well along with others in the market.

As for E transition, as you mentioned, cost efficiency can only be come if platforms and partnerships have been found and we are able to scale those solutions rather than having always individual solutions, which are not for us and for the customer really affordable.

[Operator]

The next question is from Sascha Gommel, Jefferies.

[Sascha Gommel, analyst]

I've got three as well. The first one is on your kind of, let's call it, legacy restructuring program. Can you update us how much have you achieved in '21? How much is there to come in '22 and '23 in terms of benefits? Because I understand the headwinds, but there should be some tailwinds from that.

Second question is on Tires. Your guidance implies that you also stepped-up CapEx spend on Tires. And when we listen to key competitors in Europe but also the U.S., everyone is talking about a significant step-up in Tire CapEx. Are you worried that this kind of leads back to an environment with overcapacity in Tires and therefore, more price pressure?

And then the last question quickly on Q4 in Tires. I understand the input cost inflation, but even if I take that and your top line drivers, there still seems to be a bit of a mix exaggerated drop in the margin. Was there any special effect on top of that in Q4 in Tires?

[Bernard Wang, executive]

Gabriel, (sic) [ Sascha ] I didn't catch the first question, but you can repeat again. Second one was talking about tires and the competitive pressures there. I'll tell you the first one is restructuring, right?

[Sascha Gommel, analyst]

Yes.

[Bernard Wang, executive]

The cadence of restructuring this year and next year. And the second one is Tires competitive pressure. Are we seeing any changes there? The third was the margin in Tires in Q4. Any reason that it was sequentially weaker than in Q3. So maybe Katja, you can take the first and the third?

[Katja Durrfeld, executive]

Okay. So let me first -- let me start with the first one with the restructuring with the status of the current program. I think I already mentioned that the current programs running according to our plan. And we remain on track to generate the gross savings of EUR 850 million. There's a step up in 2022, which will be bigger than the one in 2021 and the step-up in 2023 will be higher than in 2022. Sorry for not mentioning exact figures on the impact in the individual years, but I think this already gives you a flavor how we are progressing with regards to our program at all. And the third question?

[Bernard Wang, executive]

With the Tires margin Q4 versus Q3?

[Katja Durrfeld, executive]

Okay. So for the Tires margin, we're basically impacted by additional raw material headwinds that intensified during the course and also with regards to additional headwinds that materialize for energy and freight. And the pricing was sequentially better than in Q3, but the increase was insufficient to compensate for the increase in raw material, energy and logistics.

[Bernard Wang, executive]

Sascha, your question, number two is about the competitive pressure in Tires, if we're seeing any changing dynamics there given all the different factors that are at play at the moment.

[Nikolai Setzer, executive]

Sure. So far, we don't see this. So we've seen as well 2020 with the pandemic, obviously, certain investment CapEx have stalled, and we see some recovery, but the recovery less on the volume part more, and you've seen it on our base, we have strong mix improvements and mix improvements for the same amount of capacity in terms of tires or amount of tires, pieces of tires. It needs more capacity, more machinery in order to be capable to deliver those UHP tires.

Same was true for electric vehicle tires, which are larger, which are more difficult to produce. You constantly have to invest in those new machinery in order to keep up upscaling your plant, and that holds us to majority for our invest, which we are seeing going forward that we see a substantial amount for new materials, new mix improved invest.

We have to assume that the competitive field does the same. So you have to account a high portion of future CapEx, which has been announced and seen, which goes rather into mix than into volume. So Tire business will be competitive as well going forward. However, we don't see in any region right now an overflow in terms of pieces, I have to say, in tires.

[Operator]

The next question is from Victoria Greer, Morgan Stanley.

[Victoria Greer, analyst]

Three questions for me, please. And the first one is on the supply chain for Tires. I think you do source some carbon black and other raw materials for tires and from Russia. Can you talk about whether you're seeing any pressure there? And how easy it would be to switch around those tire raw materials in Europe if you needed to? That's the first question.

The second question is really about mix for tires. You showed us the UHP share for your passenger tire business. How much higher do you think you can push this? And presumably, actually, it would even have been even higher in 2021, if OE had been as strong as replacement? Yes, so perhaps you can talk -- speak to that a bit and also a bit generally about your expectations for mix for tires in 2022?

And then the third thing, just a small thing, really, but the contract manufacturing, you've guided to 0% to 1% margin. I think previously you've been expecting around 4%. So just an update on what's happening in that business, please?

[Bernard Wang, executive]

Victoria, so thanks for the questions. Maybe we start with your last one first, contract manufacturing. I'll pass that on to Katja. And then for the two tires questions regarding the supply chain, the risk we see from the current geopolitical crisis, what our alternatives. That's the first one. The second is how high can the tires mix. So both those two to Niko.

[Nikolai Setzer, executive]

Can you start Katja?

[Katja Durrfeld, executive]

Yes, I can start. So on contract manufacturing, there's -- I don't know where you got the 4% from. So in general, our expectation on contract manufacturing on the declining part of the business was always around 0% to 1% in general, and that is also where our expectation comes from, it's basically part of the business model that we do not expect higher margins on this business.

[Nikolai Setzer, executive]

Okay. For the supply chain tires, you mentioned carbon black, but that includes as well as certain synthetic rubbers, which are coming out of those regions as well as some steel cord. So our risk management teams, our task forces are looking day and night for alternative supply, which is for all items possible. However, it has to be collected by different regions and being available as well as to demand. The teams are on it. Obviously, it all depends how the situation how further continues, but we have alternatives, and we are working on them, and we are ordering already in order to mitigate potential risks of disruptions, which comes -- if this comes from other places might result as well in higher costs.

With the mix, how much can the mix further go on, you've seen -- there is still some room for improvement to further increase on UHP. And you might remember that not long ago, for us, UHP has been greater than 17-inch on Pascal tires. In the meantime, we start with 18-inch and maybe the next time it will be 19, so the inch size might move upwards because clearly, the performance and the technologies and EVs, you have another trend, the technology which is needed in order to produce our tires and thereby the additional value contribution, which can -- which it's adding into our P&L and for the consumer is still further growing.

So for the time being, for the next 5 years, and we cannot look much, much forward, we see that there is a constant trend that the mix which we had typically in the years depending on a 2% to 3%, 4%, 5% area, depending on as well where the mixes are and how the EV will accelerate, we assume that this continue as well in the future.

[Operator]

The last question for today is from Tim Rokossa, Deutsche Bank.

[Tim Rokossa, analyst]

Before I come to my questions, I'd just like to say something to Bernard, and that is Bernard. I was -- we will speak anyway again, but I was asked by many clients today to express what I also feel and that is that you will be truly missed by the capital markets community. You and I, we were very often in a bit of a disagreement as to how much high-tech a certain product is. But as I already told you, and I've actually heard it from many clients today, you brought a very refreshing perspective and some very impressive technology know-how to this discussion that will surely be missed, and you are simply a really nice guy to work with. So thank you very much for that, Bernard.

And then if we do come to my questions, please, that would be three. And I'm afraid it's a little bit into a direction that we've already touched on. Niko, I think it's fair to say that it's very rare to think about a CEO joined in more difficult times than you to the group structure. And I mean, you had COVID, you had the semi shortage, you have a war in Europe now. So I can understand where some stability is important to you and to Conti. But with everything that's going on in the automotive world right now, and also that you are saying that agility is very important to you, why do you rule out there could be a major change to the group structure that may be beneficiary for everyone involved? Or was that just a misunderstanding how we really understood your quotes here?

Secondly, Katja, we already met a couple of weeks ago. Back then, we started to touch on this now. This is your first earnings call. So welcome and also, we knew Mr. Schaefer for many years already, he was a very stable guy, very focused on free cash flow. What do you see as your priorities? And how should we think about the KPIs that you put most focus on going forward?

And then lastly, Ukraine, Russia, the guidance impact, sorry, Niko, I know this is a bit annoying, and I don't want to be in your shoes right now, having to put out a guidance. But obviously, we need to understand how you actually mean this. And when we think about just how your situation is right now, if the war in Russia was to stop immediately, is the guidance that you gave us today still the right guidance? And how does your supply chain look like is just-in-time delivery is still working outside of the chips, do you still get all the components that you need?

[Bernard Wang, executive]

Tim, thanks for the nice words. I can reflect that the same is likewise on my end, you and all the other analysts on the line and all the investors.

Now to your questions, I think the first and third questions are clearly for Niko. So why rule out structural change. And then guidance, is it still valid or how valid would it be if the war were to end tomorrow. And the second question very clearly for Katja, and her priorities. So Katja, maybe would you start?

[Katja Durrfeld, executive]

Yes. Tim, nice talking to you again. So yes, I think there are clearly three things that I have in mind when I look at my current job. And the first one is performance. I think I've mentioned today also during the call that we are not satisfied with the current financial performance of our group and that we are not satisfied with the current financial performance of Automotive. And driving up this performance consequently and sustainably is the most important thing that I have in mind at the moment.

The second thing that is a high priority in my job is the portfolio topic. So to differentiate our portfolio is a pillar of our strategy for Continental, and we are definitely reviewing our current portfolio and working on the portfolio differentiation according to growth and value quite heavily.

And the third priority that I have is related to our people. Yes, we are undergoing a fundamental transformation in our industry. And this also means that we have to take care, that the people are able to drive this transformation to be able to emerge as a winner from this transformation. This is the third priority that I have.

I don't think this will change the way how we measure our performance of Continental. I don't think that I will come up with a totally different set of KPIs, but I will make sure that we follow on the KPIs and also on the reliable reporting of these KPIs to the capital market.

[Nikolai Setzer, executive]

Okay. Then to the two others. I mean first of all, is obviously [indiscernible] However, to change into opportunities, we are happy to have Anna and Katja with us and the opportunity going forward. So nothing is more sure than the constant change that comes as well to the answer to your first part. I mean what I rule out, I have not ruled out that the group will be in this shape forever.

I mean, we changed a lot in the years, there will be most likely as well certain changes to come. However, what I want to say that the current rumor, there is nothing planned currently, and we just started in the structure. Going forward, our full priority is now gaining profitability, gaining speed, going towards our profitability midterm targets and getting there.

Obviously, we monitor constantly our structure of whether this is value accretive, whether we add value as a group and we will do this going forward. And we prepare as well as -- we are prepare as well announced we apply carve-outs of our automotive as well as our autonomous mobilities. And so we adjust the legal structure to our organizational structure, which increases optionalities going forward, but my comment was clearly currently nothing is planned. However, we have to prepare for potential optionalities going forward.

And the last question of you, if clearly, if we should not see any effect of the current geopolitical situation. And so far, you heard me saying before, we still see the call-offs going and everything which is coming on the raw material is a risk going forward. So if there is no effect, then clearly, our guidance is valid. Yes. However, it's speculation to say whether that is not realistic or not realistic in the current given situation, you may understand that we are in a position like we are.

[Bernard Wang, executive]

Okay. I think that was the last question. Thank you, Tim. Maybe it's my pleasure to close the last analyst call I have to do it here at least on this side of Continental.

So thank you to everyone for your questions today. I know that we have not covered all the requests that have come through. But please feel free to call us thereafter, myself and on the rest of the IR team. I also ask that everyone supports Anna and the team just as you guys have supported me over the last years. And let me just finally say please stay safe and healthy.

Thanks again and signing off from Hanover. Bye-bye.