Rating Action: Moody’s affirms Continental AG’s Baa2 rating; changes outlook to stable from negativeGlobal Credit Research – 23 Aug 2022Frankfurt am Main, August 23, 2022 — Moody’s Investors Service (“Moody’s”) has today affirmed Continental AG’s (Continental or the group) Baa2 long-term and Prime-2 (P-2) short-term issuer ratings, the Baa2 senior unsecured ratings, the (P)Baa2 senior unsecured Medium Term Notes (MTN) programme rating and the P-2 commercial paper rating. Moody’s further affirmed the (P)Baa2 backed senior unsecured MTN programme rating and the Baa2 backed senior unsecured rating of Conti-Gummi Finance BV. Concurrently, the rating agency affirmed the (P)Baa2 backed senior unsecured MTN programme rating and the P-2 backed commercial paper programme rating of Continental Rubber of America, Corp. (CRoA) and withdrew the P-2 short-term issuer rating. The outlook on all entities has been changed to stable from negative.”The stabilization of the outlook reflects our expectation that Continental’s operating performance will noticeably recover over the next quarters following the recent slowdown caused by rising cost inflation, supply shortages and Covid-19 induced lockdown measures, which hampered car production in the first half of 2022″, says Goetz Grossmann, a Moody’s Vice President Senior Analyst and lead analyst for Continental. “While most credit metrics remain currently weak for the Baa2 rating, expected further price increases to offset cost inflation and benefits from restructuring should yield a visible recovery in Continental’s profitability, leverage and cash flow metrics over the next 12-18 months, even in a weaker macroeconomic environment.”A full list of affected ratings can be found at the end of this press release.RATINGS RATIONALEThe outlook change to stable follows Continental’s publication of its first half 2022 (H1 2022) results, which were weaker than anticipated, while Moody’s recognizes the group’s confirmed guidance for the full year 2022 and expects considerable performance improvements over the next 12-18 months.Continental’s company-adjusted EBIT contracted to 849 million in H1 2022 from over 1.2 billion in the prior year, driven by a 2% drop in global light vehicle production, surging raw materials, energy and freight costs, which could only partially be compensated with price increases. Nevertheless, the group reiterated its 4.7%-5.7% adjusted EBIT margin guidance for 2022 (4.6% in H1 2022), despite an expected 3.5 billion negative earnings effect from input cost increases and a persistent challenging macroeconomic environment. The confirmed margin guidance primarily reflects an expected sequential recovery in car production in H2 2022 on easing semi-conductor and electronic component supply shortages and additional price increases to offset cost inflation. The group also reiterated its guidance for 0.6-1.0 billion free cash flow (FCF) in 2022, after 861 million negative FCF in H1 2022, or almost 1.4 billion on a Moody’s-adjusted basis including dividend (462 million) and lease liability payments. Besides the expected operational improvements, the strong turnaround in FCF in H2 2022 should be supported by a considerable reduction in working capital, which consumed almost 1.5 billion of cash in H1 2022.Moody’s also expects Continental’s profits and cash flow generation to recover over the next 12-18 months on accelerating automotive production, a continuing automotive market outperformance by the group (albeit well below the partly price-driven 8%-points achieved in Q2 2022), further pricing actions and cost benefits from the “Transformation 2019-2029” structural program, which management expects to deliver annual savings of 850 million from 2023.The rating agency forecasts Continental’s leverage and cash flow metrics therefore to strengthen to levels in line with a Baa2 rating by the end of 2023, including a Moody’s-adjusted gross debt to EBITDA ratio of 2.5x and retained cash flow to net debt of over 30%. Considering the group’s materially reduced pension obligations at the end of June 2022, when its total long-term employee benefits declined by almost 2.8 billion versus year-end 2021, debt protection metrics would likely meet Moody’s guidance for a Baa2 rating much earlier, if the increased discount rates in H1 2022 were maintained.Although possibly remaining negative throughout 2022, Continental’s Moody’s-adjusted FCF should turn positive again from 2023, despite still-high restructuring spending of around 200 million (after about 300 million in 2022), according to management’s estimates. Considering the significant build-up in working capital over the last few years and especially in H1 2022, Moody’s regards the potential of working capital releases, further supporting FCF generation over the next two years, as substantial.Moody’s notes the risks from a slowing macroeconomic environment, reflected in weaker consumer sentiment suffering from high price inflation, including higher energy prices, rising cost of living and higher interest rates with a potential negative impact on automotive demand in 2023. Furthermore, uncertain energy supply and likely surging energy costs amid the Russia-Ukraine military conflict could put the expected performance and ratio improvements at risk. Continental’s implemented operating efficiency improvement measures and the group’s disciplined financial policy should support nonetheless a gradual recovery of credit metrics. Should any of these risks outweigh the initiated performance improvements, downward pressure on the rating or outlook could build. Moreover, an inability to progressively strengthen its profitability, exemplified by Continental’s Moody’s-adjusted EBITA margin towards the defined 8%-10% range for a Baa2 rating, would lead to negative rating pressure.The affirmed Baa2 long term issuer rating further takes into consideration Continental’s strong business profile as one of the largest tier 1 global auto suppliers, with consolidated revenue of around 36 billion for the 12 months that ended 30 June 2022; diversification across multiple business areas and product lines; leading positions in both the tire and industry-facing businesses, which reduce its exposure to the original equipment automotive industry; significant revenue from the replacement tire aftermarket, which is less cyclical than the market for new equipment sales; strong positioning to mitigate the disruptive trends in the automotive industry; and good liquidity.Factors constraining the rating include the group’s currently weak credit metrics, particularly as to profitability with a 3.6% Moody’s-adjusted EBITA margin for the 12 months that ended June 2022 (after restructuring costs); its exposure to the cyclical automotive industry and volatile raw material prices and foreign-exchange rates; and high research and development (R&D) costs in the automotive business.LIQUIDITYContinental’s liquidity is good, supported by 1.4 billion of cash on the balance sheet (excluding around 0.5 billion restricted cash) as of 30 June 2022, expected annual funds from operations of more than 3.5 billion and a significant reduction in working capital over the next 12-18 months. Externally, Continental benefits from an undrawn 4 billion committed revolving credit facility as of 30 June 2022, maturing in December 2026.Expected liquidity uses include working cash of 3% of group sales (about 1.2 billion), capital spending of 3 billion (including lease payments) and dividend payments of up to 30% of net income after tax. Short-term debt maturities of 2.9 billion as of 30 June 2022 mainly consist of bank loans and commercial paper maturities.RATIONALE FOR THE STABLE OUTLOOKThe stable outlook reflects Moody’s expectation of sustained performance improvements along an accelerating automotive market recovery from H2 2022, (implemented) price increases and cost savings from restructuring. As a result, Moody’s assumes that Continental will gradually restore its credit metrics towards the defined levels for a Baa2 rating and to return to solid positive FCF generation over the next 12-18 months.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSThe ratings could be downgraded if Continental’s (1) Moody’s-adjusted leverage remained above 2.5x debt/EBITDA for a prolonged period; (2) Moody’s-adjusted RCF/net debt remained consistently below 30%; (3) Moody’s-adjusted EBITA margin did not recover towards 8% on a sustainable basis; or (4) liquidity deteriorated.The ratings could be upgraded if Continental (1) demonstrates sustainable Moody’s-adjusted FCF in excess of 1 billion per annum, that would be applied to (2) debt reduction leading to a decline in Moody’s-adjusted leverage (debt/EBITDA) to constantly below 2.0x; (3) achieved a Moody’s-adjusted EBITA margin sustainably above 10%; and (4) RCF/net debt (Moody’s-adjusted) of above 45%.LIST OF AFFECTED RATINGSAffirmations:..Issuer: Conti-Gummi Finance BV….BACKED Senior Unsecured Medium-Term Notes Program, Affirmed (P)Baa2….BACKED Senior Unsecured Regular Bond/Debenture, Affirmed Baa2..Issuer: Continental AG….ST Issuer Rating, Affirmed P-2….LT Issuer Rating, Affirmed Baa2….Commercial Paper, Affirmed P-2….Senior Unsecured Medium-Term Notes Program, Affirmed (P)Baa2….Senior Unsecured Regular Bond/Debenture, Affirmed Baa2..Issuer: Continental Rubber of America, Corp…..BACKED Commercial Paper, Affirmed P-2….BACKED Senior Unsecured Medium-Term Notes Program, Affirmed (P)Baa2Withdrawals:..Issuer: Continental Rubber of America, Corp….. ST Issuer Rating, Withdrawn , previously rated P-2Outlook Actions:..Issuer: Conti-Gummi Finance BV….Outlook, Changed To Stable From Negative..Issuer: Continental AG….Outlook, Changed To Stable From Negative..Issuer: Continental Rubber of America, Corp…..Outlook, Changed To Stable From NegativePRINCIPAL METHODOLOGYThe principal methodology used in these ratings was Automotive Suppliers published in May 2021 and available at https://ratings.moodys.com/api/rmc-documents/72204. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.COMPANY PROFILEHeadquartered in Hannover, Germany, Continental AG is one of the top automotive suppliers worldwide in the areas of brake systems, systems and components for powertrains and chassis, instrumentation, infotainment solutions, vehicle electronics, technical elastomers, as well as the world’s fourth-largest manufacturer of passenger and commercial vehicle tires. In the 12 months through June 2022, Continental generated consolidated sales of 36 billion. Its largest shareholder is IHO Beteiligungs GmbH, which holds a 10% direct stake and an additional 36% through its wholly owned subsidiary IHO Verwaltungs GmbH (Ba2 stable).REGULATORY DISCLOSURESFor further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. 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