Preliminary 2018 Elringklinger AG Earnings Call
Dettingen/Erms Feb 22, 2019 (Thomson StreetEvents) — Edited Transcript of ElringKlinger AG earnings conference call or presentation Wednesday, February 20, 2019 at 9:00:00am GMT
TEXT version of Transcript
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Corporate Participants
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* Stefan Wolf
ElringKlinger AG – Chairman of the Management Board & CEO
* Thomas Jessulat
ElringKlinger AG – CFO & Member of Management Board
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Conference Call Participants
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* Akshat Kacker
JP Morgan Chase & Co, Research Division – Analyst
* Christian Ludwig
Bankhaus Lampe KG, Research Division – Analyst
* Christoph Laskawi
Deutsche Bank AG, Research Division – Research Analyst
* Daniel Kukalj
Quirin PrivatBank AG, Research Division – Financial Analyst
* Harald Eggeling
ODDO BHF Corporate & Markets, Research Division – Analyst
* Henning Cosman
HSBC, Research Division – Analyst
* Marc-René Tonn
Warburg Research GmbH – Senior Analyst
* Sascha Gommel
Crédit Suisse AG, Research Division – Research Analyst
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Presentation
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [1]
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Well, thank you very much. Good morning, ladies and gentlemen. Thank you for joining us this morning for our conference call. Let me start with the headlines for the fiscal year 2018, respectively, also for the fourth quarter. The strong organic growth slowed down a little bit. Nevertheless, we ended the fiscal year with the sales plus of 2%. That’s related to 2018. The group sales stood at EUR 1,697,000,000 in the full year. And they’re up EUR 429.8 million in Q4. As expected, EBIT, pre-PPA was down versus the prior year. Earnings were affected by numerous internal and external factors. We come to that later in this call. And came finally in at EUR 100.3 million. That corresponds to an EBIT margin pre-PPA of 5.9%, which is below our originally targeted margin of around 7%.
On basis of these preliminary figures, we, the whole management board, suggest to suspend the dividend for the fiscal year 2018, and I expressly say, once again for the fiscal year 2018.
Mr. Jessulat, my colleague on the management board, our CFO, will now walk you through some figures in more details. Mr. Jessulat, please go ahead.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [2]
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Yes. Ladies and gentlemen, also warm welcome from my side. Let’s have a look on Slide #3.
As mentioned, group sales increased by EUR 33 million to EUR 1,697,000,000. We had to notice diluted effects of foreign exchange translations amounting to EUR 44 million or 2.6%. In addition, we had to consider changes to the scope of consolidation, mainly by the Hug sale, but also smaller impact by the new enerday sale and the acquisition of hofer powertrain products. These changes totaled EUR 45.5 million, or minus 2.7%. All in all, revenues grew organically by EUR 122 million, or 7.3% in 2018. Unfortunately, the strong increase in sales was not reflected on earnings level. EBITDA fell from EUR 238 million in ’17 to EUR 197 million in 2018.
Accordingly, on the next page, EBIT before purchase price allocation was also down to EUR 100 million, which corresponds to a margin of 5.9%. Over the course of 2018, we had a number of factors, external as well as internal, which were heavily weighing on earnings. The Hug sale contributed a positive onetime gain in 2018, and also on the positive side we have to book the optimization on our Swiss site, which reached EUR 8 million, slightly below the planned level of EUR 8 million. The main factors on the burdening side are the costs associated with the demand situation in the NAFTA region and the increased level in raw material prices which reduced earnings by approximately minus EUR 25 million, respectively, EUR 20 million. In addition, we prepared for the transformation process of the industry by hiring a strong number of new engineers for new technologies. Those are items represent an impact of approximately EUR 10 million.
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For the sake of completion, we also had to notice a dip of earnings in the aftermarket business, which is reasoned by the difficult market environment in the Middle East, in Northern Africa and by the market entry in the NAFTA region and China.
On the next slide, looking at the price development of the most important raw materials, ElringKlinger aluminum, steel alloys and polyamide. We had to consider an increase on average price level by more than 10% in 2018 when we compare it to the price levels of 2017. Especially, aluminum and steel were impacted by U.S. tariffs, and here, we saw a stabilization in Q4 on a high level, but not for polyamide, which is still increasing.
We implemented several countermeasures to manage the higher price levels on priority, for example, to extend the penetration rate of price escalation in contracts, and we also renegotiated prices with customers and, of course, we are continuously working on the broadening of range of global suppliers. But these are all measures which will not have an immediate effect but need time to unfold. And we expect first positive impacts on earnings in 2019.
Let’s turn to Slide #6, and let’s talk about the internal factors impacting our earnings situation. Here, we have 2 main issues: Switzerland, which is almost soft; and NAFTA. To address the utilization issue in Switzerland, we initiated a bunch of measures quite some time ago. And now, we can say that the migration of production volumes has finalized since the end of 2018, and we have realized cost improvements of close to EUR 10 million in 2018.
For 2019, we plan to continue the optimization of the fixed cost structure at our Swiss site. This includes, for example, the exploration of the lease contract for storage facilities, and in addition, we plan to adjust the level of staff to the lower output volume. Unlike Switzerland, we still have to notice a very high level of operational extra cost in the NAFTA region due to the high demand situation. This includes overnight freights, extra shifts and external control measures.
As you know, we started several measures to cope with the higher volumes. We started the installation of additional production lines. The adoption and optimization of the corresponding logistics processes are in process, and we continuously hire new personnel. The gradual adjustment of product prices has been and will be on the way in 2019. In the fourth quarter of 2018, we also saw an impact of distressed business earnings; different, as an inventory had to be written-off at the end, and that was, for us, broadly unexpected. For 2019, we plan to further optimize in order to realize savings.
On the next slide, ElringKlinger just concluded a syndicated loan with a volume of EUR 350 million, with a minimum term of 5 years for general refinancing. That means general corporate funding and refinancing of existing bilateral credit lines. This further improves the maturity profile of ElringKlinger Group and gives us a more solid foundation for corporate planning purposes.
And now, I hand back to Dr. Wolf
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [3]
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Thank you, Mr. Jessulat, for the explanation. Well, ladies and gentlemen, based on the group’s preliminary figures, it is, in the opinion of the management board, a quintessential step to deviate from the long-term dividend policy, which included a payment of 30% to 40% of the group net income after noncontrolling interests. And believe it that we had a long discussion about that, but we finally decided, as it is, and as it is published now. It was a real long discussion with the management board and we really did not make it very easy for us to take this decision.
Our essential principle in the short- to medium-term is to bring the group forward with regards to the debt level and also the cash flow situation. Therefore, we put forward a proposal for a dividend suspension in respect of the financial year 2018. And once again, I want to point out, financial year 2018. This proposal aims to strengthen internal financing for the group’s transformation process, and we are in a big transformation process to fuel cell and to battery technology, and this is in line with our list of measures for improving the financial structure.
Yes. If you look on the next slide, you see that we have a pretty high level of uncertainty, due to a real challenging environment. All of you know what’s going on in this world out there. Let me start with geopolitical tensions, higher national interests. We just had the security conference in Munich last weekend, and if you just look at the statements that have been made by leaders of different countries in this world, you see that the trend to protectionism and just to look at the own country and not looking to global situations, is becoming stronger and stronger.
Of course, we have a transformation process in our industry. You all know that the way to e-mobility, be it fuel cell or be it battery technology, is strongly on its way, everybody is working on that, and ElringKlinger is well-positioned with the products that we have on hand here. But of course, this transformation process costs money. It takes time. But we think that we are well-positioned.
We still see some repercussions of WLTP, the new measurement system for exhaust in cars. We still see that there is an influence here. We see strong market risks, for example, especially in China. If we look at the fourth quarter 2018 in China, we had a downturn already. Also in the first quarter, we see a pretty slow start of the automotive market in this very, very important market, China. Of course, in February, we have Chinese New Year that always influences the market in the first quarter. But we have to see how the second quarter is going to develop and to perform. So there is some risk in this big market, China.
Of course, we also see a risk of the general economic down cycle that is something that we just have to consider also in our estimations for how 2019 is going to run. And as Mr. Jessulat already explained, in 2018, we had a very high level of raw material prices, and we see that ongoing. Of course, we work with the customers, and we, of course, try to get money from the customers for this higher raw material prices that we have to bear. But of course, they also have to bear the higher raw material prices. So it’s not easy — believe it or not, it’s not easy, those discussions with the customers and those negotiations with the customers. So that we also see some burden in 2019 from this high level of raw material prices.
And of course, last but not least, those trade barriers and tariffs that is also related to the first point that I mentioned already, the geopolitical tensions. That is something that we see quite strongly in a lot of countries in this world. And that, of course, is not very helpful for the situation. If you run a global company, of course, you have global issues, you have global connections. And that is not helpful if you sell products from one country around the world. So we see here some risks, and that is really a challenge that we have to take in 2019.
Yes. So let me come to the last slide before we go into question-and-answer session. The guidance for 2019. With regards to the top line, we remain confident to outperform the growth rate of global light vehicle production, again, by 2% to 4%. This is our general guidance that we have. At present, we see and we expect the global automotive production to expand by 0% to 1%. So that means, basically, a stagnation of the car production worldwide. With regard to the EBIT pre-PPA, we plan on the one hand, to achieve optimization gains in the NAFTA region, and once again, in Switzerland. We are basically in a good position in Switzerland in the meanwhile, but that is further to improve in 2019. And on the other hand, we have to consider the changed margin environment. I just mentioned, although it’s the challenges that we see, global economic conditions have become more complex and uncertain compared to previous years. Taking into account the general trade barriers, the vehicle-specific trade disputes in our market that is a high market risk and, of course, as I mentioned before, China, where we don’t really know what is going to happen in this year. It seems to be unlikely to fully compensate the Hug proceeds. Therefore, we are planning to achieve an EBIT margin pre-PPA of 4% to 5% in 2019. The positive operating free cash flow in 2019 due to working capital measures and the disciplined CapEx approach, which we really strongly follow here in the management board, that will lead to a positive free cash flow. This is our clear goal for 2019.
And then we see, of course, mid-term, further improvement. We see the light vehicle production at plus of 2% every year. We want to be above global market development. So that means our organic sales are, as I mentioned before, always 2% to 4% above the market performance. The EBIT margin pre-PPA, of course, we want to have a successive improvement. And the operating free cash flow, which we see positive in 2019, of course, also this, we want to steadily improve, and we see good possibilities here when our new products go into serious production, that means products on the e-mobility, business unit, this is fuel cell and battery technology.
Yes. So far, from my side, the explanation to what we see in the future. And Mr. Jessulat and myself are more than happy to take your questions. Please go ahead.
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Questions and Answers
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Operator [1]
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The first question is from Sascha Gommel, Crédit Suisse.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [2]
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The first one would actually be on your cash flow guidance. I think in October, it was, you gave an interview saying that you don’t expect a free cash flow before 2020. At the time, your EBIT margin guidance was 7%. Now, we are between 4% and 5%, but you’re saying you’re going to do a free cash flow in 2019. I struggle a little bit to reconcile that number, so maybe you can explain what you’re changing in terms of your CapEx and working capital assumptions. Because the 2.5%, if I take the midpoint margin deterioration, is more than EUR 40 million impact on your EBIT, so I was wondering where you offset that and then some? My second question would be on the one-offs in Q4. I understand there was an inventory write-down. Maybe you can elaborate on the one-offs. Are there any other one-offs included in the fourth quarter? And then my next question would be on the swing factors in 2019. Can you put a number on the Swiss improvements in ’19? I understand it was EUR 10 million in ’18. So how much do you expect in ’19? What do you see from raw materials, given that especially on the steel and aluminum side, we — the current spot are below the average from ’18. And then lastly, on the U.S., what you expect there in terms of positive contribution? And then my very last question is, I think in the last conference call, you stated that internal measures could lead to 1 to 3 percentage points margin improvement. Is that still the case? And should we take the 4% to 5% margin as the starting point for that?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [3]
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Yes. Thank you for the questions. In terms of cash flow guidance, yes, in 2018, there was — in particular, in Q3, we had a lot of investments and prepayments for equipment, also for battery equipment and other equipment related to growth in 2019. The limitation, the very aggressive limitation, of CapEx is taking place now in 2019, in my opinion. And here, there is a big — relative to the previous periods, I think there is limitation here that we’ll see at the end of the year, for one. Besides the limitation of CapEx for the classic business, we will focus, of course, on working capital items. I see, for the first quarter here, improvements in terms of the payables, because in 2019 contracts, we have reached increasing average payment periods. So this is going okay, in my opinion. On the inventory side, okay, but we’ll do more, and we’ll do also more in 2019 on the receivables. We want to get real aggressive in 2019 in terms of the approach to deleverage the group. And therefore, I’m — in terms of also my outside communication, I want to be a little bit more aggressive on that. One-offs in Q4. There is, in Q4, output-related extra costs that we have seen in the NAFTA region. Towards the end of the year, we have seen higher invoicing rate relative to special freight. And from an internal perspective, we had some inventory topics in the, let’s say, middle area, single digits, EUR 1 million. And this was as a result of operational issues in the NAFTA region. So 2019 swing factors. I think, optimization of Swiss site. We are on track there, and we shoot for EUR 10 million in terms of improvement. Now I mentioned that over a 3-year period, we’d be intending EUR 10 million per year, and this is also the case for Switzerland in 2019. Optimization in NAFTA, expectation would be EUR 10 million improvement. However, in NAFTA, we have — in the first quarter, we have to see how additional tariffs work out with material that needs to be brought into the U.S., which is a risk point, in my opinion. But those are the 2 positive points here, optimization, Swiss site; optimization, NAFTA, for 2019. Commodity price improvements, it’s a little bit of a mixed picture, I’d say. When we look at aluminum, and it points down a little bit. Nickel is heading upwards, to some extent. And plastics resin is staying at a high level. So therefore, it’s mixed. I wouldn’t be too positive on that. I’d say, we carry on with the current levels into 2019. And internal measures, when I said 1% to 3% on the positive side, then I’d say the EUR 10 million optimization in Switzerland and another EUR 10 million in NAFTA is maybe the lower end of that, and that would be the expectation. I hope that answers your question.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [4]
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And I have my follow-up…
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [5]
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One addition. You said — you asked if the 4% to 5% is the starting point. Pretty clear, yes. We see that 2019 is the starting point for the successive improvement of the EBIT margin, based on — those internal factors, also based on what we see end of 2019, beginning of 2020, a changed product mix when those new products related to our E-Mobility business units start to go into sales production. So clearly, it is a starting point.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [6]
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I see. I have a follow-up question on my cash flow question. Does it mean that you — that your CapEx-to-sales ratio might fall actually below the guided 9% to 10%? And then also on the free cash flow, do you anticipate any factoring activities? And is the cash flow guidance pre or post IFRS 16 adoption?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [7]
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The indication is pre IFRS 16. The — what was your first question again?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [8]
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The CapEx ratio…
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [9]
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CapEx ratio, is that changing?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [10]
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It will be below 9%.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [11]
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That is a logical conclusion, in my opinion.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [12]
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But you are not willing to share the new target ratio?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [13]
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Not yet.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [14]
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Not yet. I see. And then on the factoring…
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [15]
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It will be below 9%.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [16]
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I see. And do you plan any factoring to kind of improve your working capital?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [17]
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There is — in terms of working capital, there is a different set of activities behind that. It might be. It might be. But it’s not the main point here. [Nothing I would choose for], to a large extent, organic activities here in regard to working capital, but additional measures, I wouldn’t exclude.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [18]
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Okay. And what is roughly the target rate in percent of sales you are shooting for?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [19]
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Target rate, we always said we wanted to get below 33%, as what we had regarded in the past. And here, we have to go below that sort of rate. [no we’ll] at the end, we’ll give you in March. This is just a quick recap on the preliminary results. On further guidance information, we’ll give more in March, okay?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [20]
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Maybe one addition. We have remarkably reduced our different payment terms that we had with our customers. We had roundabout 165 different payment terms that has been reduced, and more standardized. And we also have a large repayment terms with our suppliers that were too short. The difference — the time difference between when we pay our suppliers and when we get paid by our customers was too big, and that was — has been already reduced remarkably.
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Operator [21]
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The next question is from Akshat Kacker from JPMorgan.
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Akshat Kacker, JP Morgan Chase & Co, Research Division – Analyst [22]
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Two quick ones, please. First is on the syndicated loan of EUR 350 million. I believe most of it is being used to refinance the current existing credit lines. Is there room for more credit lines in 2020 as a part of this new loan agreement? That is the first question. And second one is on the capitalization of R&D. We saw a pick up in rate in the third quarter. Is it something similar in the fourth quarter? And what should we be expecting for 2019, please?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [23]
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Some loans, I remember, that on November 6 last year, we reported open lines in the amount of EUR 192 million, and we are still in the same range as we speak now. So I think we have enough room here, financial flexibility in our commitment from the financing side. So the answer to that is yes. Capitalization rate is something that I would give you more in detail in March.
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [24]
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It is correct, the EUR 350 million have been used mainly to refinance other loans that we had on hand. Now, we have a real good structure in our financing situation. Before that, we had a lot of single loans because we have used short-term loans because the interest rates were so low. But now, this is a structure, pretty clear for the next 5 to 7 years, and so that has been used to refinance those, let’s say, different loan structures that we had.
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Akshat Kacker, JP Morgan Chase & Co, Research Division – Analyst [25]
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Okay, understood. And sorry, just one follow-up on the operating cash flow guidance. In total, net working capital plus tangible CapEx. I think, to get to free cash flow-positive, you need to reduce both of them cumulatively by 5%. Is that a cumulative target?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [26]
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You said — what you say, the 5%, is that the CapEx of sales?
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Akshat Kacker, JP Morgan Chase & Co, Research Division – Analyst [27]
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And as well as net working capital improvement as a percentage of sales?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [28]
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Could be. Could be. This is not a figure that I have calculated. But could be in that range. I would have to calculate it.
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Operator [29]
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The next question comes from Marc Tonn, Warburg Research.
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Marc-René Tonn, Warburg Research GmbH – Senior Analyst [30]
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Just two topics on my side. One would be coming back to free cash flow as a guidance for next year. Is there any possibility that you share with us the figure for 2018? Or could give us some indication whether Q4 was potentially much weaker in terms of free cash flow generation than what you might’ve thought, which could give you some tailwind for the beginning of 2019? That would be the first question. Second question would be on profitability. At midpoint, you are now targeting 4.5% EBIT to sales pre-PPA. I think when you are still targeting 9% for last year, you indicated that you are expecting the successive improvement of margins which are still confirming midterm. You mentioned EUR 10 million positive from NAFTA, EUR 10 million positive from Switzerland for this year. Still, we are now talking 4.5%. Is there anything which went wrong with the contracts you have on hand, which would be with you for the next years, which you could not foresee at the beginning of last year?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [31]
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To your first question, I’d say having in mind some information on Q4, I think we’re heading the right way. When I look at the second question, the 4.5%, I’d say, has an equal risk balance to both sites. Because we have, in 2019 in particular, market risk that we have to take into account that does not have any setting to do with the contracts on hand. But let me say this. From an IFRS standpoint, IFRS 15 will not reflect successes in negotiations, technically speaking, as one-offs on the positive side. IFRS 15 will distribute successes of negotiations, as Dr. Wolf pointed out, along the duration of deliveries under those contracts. So here, we have a little bit technical change that prevents to show it in the short term. So here, we have more like an averaging going forward. But generally saying the 4% to 5%, I say, has a balanced risk exposure, from my understanding.
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [32]
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And maybe to your last question with regards to 2018, what was clearly — what we clearly did not foresee, and nobody did in the market, was the development of the polyamide crisis, of the PA66 which is a very special material that we need for our plastic housing parts for our oil pans and can covers. That really burdened us quite a bit, and it is — the price is up basically 4x higher than what we had in 2017. And you also have to see that the strongest growth that we had in 2018 came exactly from this business unit. So the increase of sales in the plastic housing parts business was the strongest in 2018 compared to all the other business units. And the combination of high growth rate and 4x higher material prices, that really burdens quite a lot.
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Marc-René Tonn, Warburg Research GmbH – Senior Analyst [33]
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Do you have some kind of — sorry to come back to that — some kind of an absolute figure for the polyamide 6.6 burden alone for last year?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [34]
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Not yet, but we can answer this question on the 27th of March when we have our big conference — analyst conference with regards to the results of 2018. But it’s quite remarkable, I tell you.
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Operator [35]
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The next question is from Henning Cosman, HSBC.
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Henning Cosman, HSBC, Research Division – Analyst [36]
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I’m also struggling to reconcile a little bit the change in EBIT year-over-year. When we take EUR 80 million as a midpoint of your 2019 guidance, if I adjust ’18 for the roundabout EUR 20 million inflow from Hug, that’s also 80. So pretty similar in absolute terms, yet you’re looking for these EUR 10 million improvements from each Switzerland and NAFTA. So I am just wondering what the offsetting EUR 20 million are to get to the midpoint of the 2019 guidance? That’s my first question, please.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [37]
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You know, on the positive side, optimization in Switzerland, optimization in NAFTA. On the risk side, incremental threats by terrorists relative to ’18, and market risk.
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Henning Cosman, HSBC, Research Division – Analyst [38]
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Sure. So but at the midpoint of the guidance, you’re basically already factoring in EUR 20 million negative element to your EBIT bridge. That’s baked into the midpoint of your 2019 guidance, which is equivalent to the midpoint of your top line guidance.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [39]
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Yes. This is essentially — you expressed it the right way, the way we think.
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Henning Cosman, HSBC, Research Division – Analyst [40]
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Okay. And second question, please. In terms of the cadence of the profitability, in the course of 2019, Dr. Wolf pointed out the continued weakness of the Chinese market, continued impact from WLTP. I think, even if I adjust for these single-digit million, as you said, one-offs in Q4, I think we’re coming from a point of around 3.5% profitability, which, correct me if I’m wrong, but might not improve too much in the first quarter seeing the market dynamics. So again, to get to the midpoint of the 2019 guidance, the back end of the year would have to be well outside the top end of the range. Is that the kind of cadence you’re thinking about for ’19?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [41]
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First of all, we never made the point of WLTP. We always mentioned WLTP has a limited impact on Argentina, and it was not pointed out strongly. In terms of market development towards the later end of 2019, I understand your question, whether we imply here some improvements, if I understand right, might be that we see something like that, but we have, as per today, high uncertainty in regard to that. So it’s — for me, it’s part market risk.
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Henning Cosman, HSBC, Research Division – Analyst [42]
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Yes. My question was more about the evolution of the margin in the course of the year, with a margin below the midpoint of the guidance in maybe the first and even the second quarter, and above the midpoint in the third and the fourth.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [43]
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Okay. I understand. You say that given Q4 profitability, we are below midpoint, and therefore, we would have to see some evolution here in that regard. I say I would agree to that, but we have to take into account in Q4 some of the year-end effect, so to say. But generally, I would agree with you.
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Henning Cosman, HSBC, Research Division – Analyst [44]
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Yes. Maybe…
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [45]
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You have to see one thing, and I mentioned that, I think, pretty clearly on this slide, with all the external factors. There is just a lot of uncertainties. I’d just take one point. Iran is a very important market for us. We lost remarkable sales in OE business and in the aftermarket business due to these restrictions coming from the U.S. President. Last year, already from the — from August, when we were not able to supply anymore to Iran, and it’s ongoing. Maybe we see that this is lifted in the course of 2019. This, of course, will give us a strong improvement in sales and in margins, but I don’t see it right now. So that is what you have to take into consideration, that there are so many risks so that you cannot just calculate. The external factors are going to be very important in 2019 as well as they were in 2018. So that means that 1, 2, 3 issues that go in one or the other direction can influence everything quite remarkably.
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Operator [46]
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The next question is from Christian Ludwig, Bankhaus Lampe.
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Christian Ludwig, Bankhaus Lampe KG, Research Division – Analyst [47]
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Also 2 questions from my side. And first of all coming back to your guidance. If I take the midpoint for the sales, we’re looking at roughly EUR 60 million of additional sales year-over-year in ’19 versus ’18. And again, taking the midpoint of the EBIT guidance we’re basically seeing no improvement of EBIT. So it kind of implies to me that a lot of the business that you acquired in the past has basically no — low contribution margin. And with the usual 7 years of automotive life cycle that implies that you will be burdened with these kind of sales for quite a while. Is that the right way to look at it? Question number 1. Second question is you mentioned that there will be a stronger ramp-up of the new product starting in 2020. It’s not in your current presentation, but I think on your group corporate presentation. If I look at those numbers, we’re seeing basically more than EUR 200 million roughly in 2020, and then going to almost EUR 500 million in 2021. Now in my experience, ramp-up phases of new products never go along with margin improvements, but rather with margin burdens. So where is the margin improvement going to come from in the next 2 years when you ramp-up a lot of new products? That will be the second question.
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [48]
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Well, let me start with the second question. The ramp — the cost that we have for those new products we had in 2018 and now, of course, we have them in 2019, but when the products go into serious production, of course, we achieved the margin. It always depends a little bit on numbers, sometimes, it starts a little bit, let’s say, with lower numbers than what you expect or what we expect. But I see a good margin improvement once those new products go into serious production because we have much higher margins in those products than in our old products. With regards to your first question. Yes, we have some products where we do not achieve a margin, but we consequently started to approach the customer, and we have been quite successful in increasing prices, not with all customers, we are still working on that. And we are consequently, if a contract expires, we only go into a new contract when the customer is willing to increase the price. This is a clear strategy that we have. If they don’t accept a price increase for products that do not have sufficient margins, once the contract expires, we’re not going forward with this contract — with a new contract. And what we expect — what we experienced is that the customers are not happy with that, but they normally agree because it’s not easy to change the supplier. So I would say in more than 90%, in the cases, we managed to achieve a price increase, but, of course, I have to admit, we have some contracts that will still run for, let’s say, another 2, 3, 4 years, where the margins are not on a level where I want them to be. We, of course, negotiate with the customers and we have some success here with some customers, but we will also see some contracts where we still suffer for the next 2, 3 and 4 years. But that will be compensated by the different product mix that we see at the end of 2019, beginning of 2020.
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Christian Ludwig, Bankhaus Lampe KG, Research Division – Analyst [49]
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Okay. And then one quick follow-up on the cash flow improvement in ’19. And would it be fair to say that 50% of improvement will be from your lower CapEx and 50% from working capital?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [50]
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No. I won’t say it.
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Christian Ludwig, Bankhaus Lampe KG, Research Division – Analyst [51]
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Could you give how the split would be?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [52]
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No. I would not give anything out to you, as we speak today. No.
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Operator [53]
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The next question is from Christoph Laskawi, Deutsche Bank.
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Christoph Laskawi, Deutsche Bank AG, Research Division – Research Analyst [54]
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The first one also on free cash flow. I’m not sure if I didn’t catch it or you didn’t answer the question on the 2018 free cash flow. Do you already have a number or broad range that you…
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [55]
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No. No. I would not give anything to you now. I would give it to you in March.
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [56]
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March 27.
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Christoph Laskawi, Deutsche Bank AG, Research Division – Research Analyst [57]
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Okay. And further on the free cash flow guidance. You said you try to become more aggressive on the receivable side and try to be very vocal about it. Now, every other supplier tells us that actually the OEMs are a bit stricter on cash, and they face some issues to collect the receivables on time right now. So what gives you the confidence that you actually can improve massively on the receivable side than driving your free cash to a positive level. That will be the first question.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [58]
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No. Okay.
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Christoph Laskawi, Deutsche Bank AG, Research Division – Research Analyst [59]
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And then you have elaborated on the potential of appraising new contracts or contract renewals which — for which you see a success rate of 90%, and that in theory, you should — give you better margins. But then again, looking at the last couple of years, from peak margin of close to 15%, we are now at 4% to 5%. So the question will be what was — so to say the internal wrongdoing that you had which drove down the margin? And to what degree was external factors that actually pressured your margins? And if you’re really that successful, shouldn’t we see much higher margins in the future and not only [1%-3%] as you’ve guided for?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [60]
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Christoph Laskawi, Deutsche Bank AG, Research Division – Research Analyst [61]
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A quick follow-up to that, if I may, I appreciate that you need to invest in the future of the business, especially with you setup being geared into the combustion engine. From what you said, it feels like that you’ve become or trying to become more selective in the order intake and only take on projects, which achieve a certain target margin. Shall we expect your performance over production to come down then in the future with these historic levels that we’ve seen, simply because you are more selective in order to safeguard your profitability? Or shouldn’t we expect your performance to come down?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [62]
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That’s pretty hard to say. First of all, one thing pretty clear. We are more selective. And we are also pretty clear for the customer. If they don’t pay the price that we want, we don’t take the project. But in lot of cases, we see that they come back and they say, well, of course, we need you, because the market is so much consolidated. And you have to see that in the gasketing business, and I’m absolutely convinced of that. In the gasketing business, Federal-Mogul and DANA, which is the 2 — of the 2 competitors, they’re not investing anymore. And I assume that DANA is for sale. Everybody knows that in the market, the gasket business of DANA Reinz is for sale. That there is no strategic investor that is going to buy this business. So it’s going to be a private equity. And they normally cash up the company. So that means they do not invest anymore. So our technological advantage will become stronger and stronger in the future. So that means that — and we see that already in new contracts that margins improved quite remarkably in that business. So the structure of our so-called old business will become better in the future and, of course, this will also finance part of the new business that we see strongly — increase in the years to come. So that is the structure that we see. And then, even if we, let’s say, have a downturn in our traditional business, the strategic idea of this new business, of the fuel cell and the battery technology, was always that we can produce in our old traditional production unit, part of those new modules. That means if you look at a fuel cell, a fuel cell, a very important part in the fuel cell is the stack and the stack is chemistry, a membrane, and so called bipolar plates. This bipolar plate is produced in our business units in cylinder gaskets because it’s the same production process. It’s stamping, embedding, heat treatment and coating. So if we, let’s say, lose in the future, what we do anyway, if the combustion engine goes down, of course, you need less cylinder gaskets, then we will even overcompensate what we lose in this business unit of cylinder gaskets by producing those bipolar plates for the fuel cell stacks that we integrate in our complete fuel cell module. So that is the strategic approach of the ElringKlinger Group that we still operate in 10 years, in 15 years, in 20 years our traditional business units, but they produce different products. And they still, of course in 15 years, we still produce cylinder gaskets. I’m convinced that even in 50 years, ElringKlinger is still producing cylinder gaskets because we still have combustion engines in much lower numbers, but we will have them in 50 years.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [63]
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In your first question, you know, the free cash flow goal, it’s not single-sided. We have to reach it through limitation of CapEx, improvement in receivables, inventory and payables. We — I said that in some areas, we have made already some progress, and last but not least, also by improving from the earnings side. Successes, I mentioned, from negotiations, will come through cash flow and not through earnings in the short term. And those are essentially the mechanics in 2019, relative to cash flow.
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Christoph Laskawi, Deutsche Bank AG, Research Division – Research Analyst [64]
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And on a comment on the receivables side, I think, you said that you target improvements as well, I think, just in the given — in the current market environment it’s very tough to reach any improvement on the receivable side simply because the OEMs are unwilling to give you much room or pay you faster, so to say. Do you expect those measures to come through in ’19 already? Or is it more in 2020, 2021 thing?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [65]
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Yes. There is going to be improvements in all of the mentioned areas that I would expect in 2019. I said, I would not be willing to share as per today, how is that going to be distributed amongst the individual positions. But I think this would be too early. I’d report that along with the quarterly reporting, but overall, I said that in 2019 we’ll see improvements in the whole area. Okay?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [66]
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And maybe one addition, of course, OEMs are not happy and not willing in general. In the beginning, they are not willing to do that, to change conditions. But as I mentioned before, we have more and more contracts that are running out. And I just give you an example, if you have a cylinder gaskets contract, and this contract was running for 6 years, the cylinder gasket works. There is no problem with this part. It’s a good partnership since 6 years. And now, if they want to change, just because the payment terms are changed or we increase the price from let’s say EUR 3.80 to EUR 4.50, the — what they have to do is they have to develop a complete new part because we have patented our — our design. They have to run this gasket on a test bench for roundabout half a year to 9 months. They have to pay for new tool, which costs between EUR 350,000 and let’s say, EUR 700,000. So considering all those facts, it is much cheaper for the OEM to accept shorter payment terms or to accept price increase. We are not talking about the price increase from EUR 100 to EUR 5,000. We’re talking about EUR 0.50 to EUR 0.80 to maybe EUR 1. So if you take that all into consideration, this situation — it is normally cheaper for the OEMs to stick with the old supplier where they had 6 years good experience and where everything runs. The tool is in place. The technology is fine, works in the engine, because one thing you have to see if gaskets fail, you have a big problem in the engine. And you have a customer — end customer that drives the car and he is not satisfied. So our position in the future becomes stronger and stronger based on the fact that the market is consolidated, that the change with — for those parts, high-tech parts, but low-priced parts is — that — it’s a lot of effort, it’s a lot of work. It’s a lot of money that you have to invest. And taking all that into consideration, we see already a trend that we have a strong — much stronger position at the customers.
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Operator [67]
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The next question is from Daniel Kukalj, Quirin Bank.
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Daniel Kukalj, Quirin PrivatBank AG, Research Division – Financial Analyst [68]
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Daniel Kukalj from Quirin. I’m just wondering that you came out yesterday afternoon with such a talkative statement more than 7 weeks after fiscal year end. There is such a large deviation from your initial EBITDA outlook. So I assume that you have a well-implemented SAP system. So the questions are why did you cancel it out with this news? And what’s the problem with your controlling system?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [69]
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I don’t think that we have problems with the controlling system. We have, in general, improved over the last years significantly, detailed knowledge in terms of what was going on based on essentially not only, but also on the findings from Switzerland, as lessons learned. Nevertheless, if a company runs on a 7-day operation, at year-end, you might run into some items that you did not foresee. I mentioned throughout 2018 that I see the 7% in a way that company needs to have no surprises and everything needs to go in the sort of improved way. If I look at the sales figures in particular in [crucial], in individual companies in the NAFTA region, and the sales figures were the highest in the full year, no. That means that in particular in Q4, we had releases that were higher than in the previous periods and therefore, we had a lot of output-related cost in Q4, no. So consolidation of 2 figures is making available the information on a group level, and this is part of the financial process. So when I see individual items in individual group company then I don’t have group figures. I have group figures after consolidation. Okay? And this is part of the timing here, and believe me, when this information becomes available, then we act according to law. Okay?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [70]
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And let me say two words to that. First of all, of course, it’s a question of definition, but I would not say that it is a large deviation. There are other companies out there that have really large deviations, EUR 50 million is a large deviation. I don’t want to say anymore to that. And one thing is clear. We want to be sure about the real situation. And if that takes 2 weeks more, I think it’s better for you, for the capital markets, for everybody, to be really precise and not just getting out before we know exactly what — we want to have reliable figures. And once we have reliable figures then we publish them, immediately — immediately after we have them.
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Operator [71]
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The next question is from Harald Eggeling, ODDO BHF
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Harald Eggeling, ODDO BHF Corporate & Markets, Research Division – Analyst [72]
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Basically, we have covered vast area of topics. I think to me the one question basically remains. You stated costs, or earnings improvement in Switzerland and NAFTA, each EUR 10 million in 2019. So could you please elaborate what are your 2 most core measures in both Switzerland and NAFTA, with respect to detailed status quo, and also timing, please?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [73]
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Yes. Switzerland improvement in processes for 1, number 2, consolidation towards the end of the year in one location, as advertised in previous sessions. NAFTA reducing special freight, output-related costs.
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Harald Eggeling, ODDO BHF Corporate & Markets, Research Division – Analyst [74]
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Okay. These were 2 then for NAFTA, right?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [75]
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First one was for Switzerland, second one was for NAFTA.
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Harald Eggeling, ODDO BHF Corporate & Markets, Research Division – Analyst [76]
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Special freight and reducing of outputs costs, you said?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [77]
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Output-related costs. Yes.
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Harald Eggeling, ODDO BHF Corporate & Markets, Research Division – Analyst [78]
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Okay. is this covering the special freight?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [79]
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Yes. When I say output-related costs, it is essentially 7-day operation with surcharges for personnel costs, quality-related cost also, and to bring the company down from 7-day operation to a 5-day operation, the same as what we have accomplished in Switzerland essentially. Yes, so this is key for NAFTA. Yes, it’s the same proceeding here in regards to that, and that is the second [attempt].
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Harald Eggeling, ODDO BHF Corporate & Markets, Research Division – Analyst [80]
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Okay. And with respect to the timing of these measures throughout 2019, is there any indication currently available you could share?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [81]
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No. It’s a gradual improvement in ’19, but I wouldn’t say more at this point.
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Operator [82]
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The next question is from [Peter Hatch] from Market Research.
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Unidentified Analyst, [83]
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My first question is concerning the sales growth. We hear from other automotive suppliers that they reject projects when the price pressure from car manufacturers too high. Does that explain lower margins combined with organic growth?
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [84]
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Yes.
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Unidentified Analyst, [85]
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Okay. And what are the new perimeters for the covenants? Are they in danger again for 2019?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [86]
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I won’t disclose.
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Operator [87]
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The next question is from [Alex Middling,] CCH, GMBH.
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Unidentified Analyst, [88]
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My questions have already been answered. Thank you.
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Operator [89]
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We have a follow-up question from Sascha Gommel.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [90]
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Yes, thank you. Actually, I had a question around the sales mix in Q4. I think, during the Q3 call, we discussed that due to the phasing of tooling sales, there could be a good or bad sales mix in Q4. So I was wondering if you can shed some light on that topic if you had a good or not so good sales mix?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [91]
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That was, you know, in fact, what I mentioned, was more tooling sales also in the fourth quarter.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [92]
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And that was good or bad? Or profitable?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [93]
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I see it as not damaging.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [94]
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Okay. And then, I actually have a follow-up on the profitability across the OE products, so to say. If I do a bit of back of the envelope calculation and try to split out aftermarket and engineered plastics and adjust for the inventory write-down. You probably were barely profitable in OE in Q4. And since you, kind of, indicated that some of the businesses are quite decently profitable, and particularly in the gaskets area and potentially in some other areas as well, I was wondering which products are so terribly loss making that the whole OE division is not earning money?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [95]
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Well, it’s like we mentioned on earlier calls. We have heat shields business in the U.S. where we have 7-day occupation. Cylinder head gasket production, sort of, in the same way. Those are the key areas that give us high amount of extra cost in NAFTA.
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Sascha Gommel, Crédit Suisse AG, Research Division – Research Analyst [96]
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Okay, understood. This seems to be substantial.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [97]
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It is substantial.
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Operator [98]
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We have another follow-up question of Akshat Kacker.
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Akshat Kacker, JP Morgan Chase & Co, Research Division – Analyst [99]
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Just 2 quick follow-ups, please. You are guiding for lower tangible CapEx, but if I look at the near term, can you — you have the order book review with you. Can you confirm that you can sustain sales growth over the next 3 years if you pull back on growth CapEx? That’s the first question. And the second follow-up is can you share the borrowing cost for this new syndicate loan, please?
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [100]
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’18 and ’19 towards ’20, we see significant increase in sales in plastic business. Plastic business sales are going to be lower, going forward, based on limitation on CapEx, and around 2021, a lot of new type of product sales are going to be kicking in. For the new product type sales, we have a lot of startup costs in the group, right now. The new incremental sales from the type is more system type, with a higher sales increment, okay? And therefore, I think, classic business is going to be leveling out at round about EUR 2 billion. And then, we come into a phase where we have systems sales kicking in with higher increments, going forward. Higher increments in the system business is changing the structure of value added in the ElringKlinger Group. It’s changing the mix and that, of course, has an impact in terms of incremental sales relative to incremental CapEx, no. And therefore, I say that based on the projects that we have on hand, I’m pretty confident that if we execute properly on the limitation of CapEx for classics, that we can stay within the limits, so that we improve year base on lower CapEx spending by at the same time reaching sales for the new type of products that we bring to markets. Okay?
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Akshat Kacker, JP Morgan Chase & Co, Research Division – Analyst [101]
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Yes.
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Thomas Jessulat, ElringKlinger AG – CFO & Member of Management Board [102]
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On the syndicate loan, I would not disclose anything as of today. It’s all under confidentiality, and I won’t disclose anything about it.
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Akshat Kacker, JP Morgan Chase & Co, Research Division – Analyst [103]
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Sure. The first question was very helpful.
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Operator [104]
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There are no further questions. I would like to hand back to you, gentlemen.
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Stefan Wolf, ElringKlinger AG – Chairman of the Management Board & CEO [105]
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Okay. Thank you very much for joining us today in this conference. I think, we have good prospective for the future, with our new products and with all the measures that we have taken. So I’m still confident that we will achieve the midterm guidance that we have disclosed today. And so thank you for joining us, once again. And I hope to see all of you on the March 27 in Frankfurt, where we have our Analysts and Investors Conference after we have our — we release our final results for the year 2018. So thank you very much. Have a nice day. And see you in Frankfurt. Thank you. Bye-bye.