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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you, and welcome to Pirelli's conference call in which Pirelli's top management will present the company's first half 2023 financial results. A live webcast of the event and presentation slides are available in the Investor Relations section of the Pirelli website. I remind you that the Q&A session will follow after the presentation. Now I would like to introduce Mr. Marco Tronchetti Provera. Please go ahead, sir.
Good evening, ladies and gentlemen. The results of the first half of 2023 confirm the resilience of our business model, the performance improving year-over-year. Scenario we expect for 2022 remains highly volatile and is characterized by a slowdown in economic growth, while the main uncertainties concern Europe and China. A high inflation rate, in particular of consumer prices despite the decrease in energy, transportation and raw material costs. The growing volatility of exchange rates fueled by interest rate differentials and economic situation in emerging markets. In this context, we prefer to take a more cautious view on the external scenario, both on high demand where we confirm the resilience of high value and on exchange rates. While we confirm our adjusted EBIT and cash flow targets, thanks to the effectiveness of our internal levers, as we are going to see shortly, our solid price discipline and improving product mix allow us to revise the price mix upwards -- offsetting the impact of volumes in ForEx and upgrading our EBIT margin target.
Our result for the first half of 2023 remain among the best in the industry, 7.5% top line growth year-on-year, supported by the strong improvement in the price/mix and the strengthening on high value, which now accounts for 74% of the group's revenues. Adjusted EBIT amounted to EUR 570 million, with a margin of 15.1%, stable compared to the first half of 2022. Net income of EUR 243 million, up 4% year-on-year. The net cash absorption of EUR 535 million, in line with the usual seasonality of the working capital.
Moving on, I would like to give you an update on sustainability. The group is firmly committed to safety as well as diversity, equity and inclusion of our employees. In addition to the campaign to raise awareness at group level, the reduction of accident frequency and increase of gender balance in managerial positions became part of the objectives in our short-term incentive program for managers. We expanded our welfare portfolio further to include projects in support of parenthood and psychophysical well-being. Regarding product sustainability, in July, we launched the new P Zero E top-of-the-range type for electric vehicles, which received a AAA European label for rolling resistance, wet grip and noise control and contains more than 55% of bio-based and recycled materials verified by third party for maximum transparency, such results have never been achieved before in the UHP market.
In terms of sustainability materials, we also announced the acquisition of 100% of Hevea-tec, the largest independent natural rubber processors in Brazil. This transaction is due to be closed by the end of the year and allow us to launch innovative natural rubber projects to increase the use of non-fossil materials, further improved control over the natural rubber supply chain as well as expand of FSC certification program. Finally, the decarbonization plan progressed more than expected with all our factories involved in the climate chain challenge program. We are also helping our suppliers to reduce emissions in line with our commitment to net CO formalized towards the science based target initiative. I now leave the floor to Mr. Casaluci, please.
Thank you, Mr. Tronchetti, and good evening, everybody. Let us analyze the market dynamics and Pirelli's performance. The second quarter of 2023 recorded an improving trend compared with the first quarter, plus 1% year-over-year versus a minus 4% in first quarter. However, due to the destocking in Europe and North America, together with a slower-than-expected recovery in China, the market trend in replacement was below our expectation. In the first half of the year, the global car tire demand declined by 1.3% with very different dynamics between segments and channels. Pirelli kept overperforming the market, thanks to our strong positioning in the more resilient high-value segment. Positive original equipment market, plus 8.4% was supported by a strong demand increase in Europe and North America.
In 18 inches and above, Pirelli saw roughly 10% volume growth versus a plus 11% of the market with increasing focus on higher rim sizes and electric. In 17 inches and below there minus 6.7% versus a market plus 7.2%, we didn't benefit from the market rebound due to our selective approach in all regions. However, the replacement market remained at weak, minus 4.8% year-over-year, discounting the volatile macro scenario worldwide. In 18 inches and below, Pirelli outperformed the market by 2 percentage points, Pirelli plus 2.9% versus market plus 0.8%, driven by a market share gain. And in 17 inches and below Pirelli minus 10.4% versus market minus 6%. We continue to reduce our exposure to this segment and focus on a mix more oriented towards bigger sizes.
Let's now go through the key programs of our industrial plan as well as the results achieved in the first half of 2023. On the commercial program, we overperformed in 18 inches and above car market and reduced our exposure on the standard segment, which in the first half accounted for 36% of the total car volumes. On the innovation program, 150 new technical homologations focused on 19 inches and above approximately 86% and electric vehicle approximately 50%. We consolidated our position in the electric vehicle segment with a portfolio of approximately 400 homologations and the market share in Premium and Prestige segment, 1.5x that of internal combustion engine. And our focus on sustainability and performance was further improved with the launch of the new Z generation, while new products were introduced in the 2-wheel business based on our racing experience.
On the competitiveness program, EUR 30 million gross benefits were achieved in line with the expectations and project development schedules. On the operations program, the level of plant saturation is of approximately 90%, 95% in the high value. Finally, thanks to the acquisition of Hevea-tec, the leading independent Brazilian natural rubber processing operator, we shall increase the supply of this raw material from South America. In the first half of the year, we increased our exposure on car 18 inches and above by 3 percentage points, which accounts for 61% of the car volumes. In the original equipment, 18 inches and above segment, our performance, plus 10% versus a market plus 11%, is filtered by a growing selectivity focused on the 19 inches and above where electric vehicle accounted for over 27% of the regional equipment volume, plus 11 percentage points versus the first half of 2022. In the replacement 18 inches and above, volumes 2.6% versus 0.8% in the market, growth was mainly driven by new product lines introduced over the past year, particularly in North America and Asia Pacific.
On innovation, Pirelli launched 3 new products in the P Zero family at the Goodwood Festival of Speed of which Pirelli is the exclusive tire partner. This new range of tires developed considering the demand of carmakers and consumers is specifically focused on sustainability and efficiency. These new products were developed in line with our eco-safety design approach and innovative development methodology based on virtualization, which is the outcome of our experience in Motorsport. More in detail, P Zero E is concentrate of technology and sustainability as I'm going to illustrate in the next slide. P Zero R is the ideal choice for the prestige segment due to its sporty performance and driving pleasure. And finally, P Zero Trofeo RS, a top product in terms of its performance on track. This product is also homologated for road usage and was designed for the regional equipment of hyper cars and super cars.
Let's now go into more details about P Zero E. This tire integrates the latest technological innovations developed by Pirelli and was designed for electric and sustainable mobility. It is the first ultra-high-performance tire on the market with over 55% of bio-based and recycled materials and a 24% reduction of the CO2 emissions compared to the previous generations. Both features are verified by third party for maximum transparency. P Zero E features a low rolling resistance, a lower noise, coupled with a consistent performance when both new and warn. It is then the first UHP tire on the market with a triple A on the European level across the entire range. Finally, P Zero E is equipped with the new Pirelli run forward technology that guarantees support after puncture and allows to continue driving up to 40 kilometers at the maximum speed of 80 kilometers per hour, and this technology is specifically developed for electric vehicle cars, which do not carry a spare tire due to their battery on board.
The competitiveness program in the first half of the year recorded gross efficiencies of around EUR 30 million, equal to 30% of the annual target and is in line with the project development schedule. Higher contribution of the efficiencies will be in the second half of the year. More in detail, our main efficiencies come from product cost where we continued our modular design and design-to-cost approach, aiming at reducing the complexity of the structure and the weight of tires. In the manufacturing area, the results of which will be concentrated in the second half of this year, projects to improve the production process are being implemented by leveraging an industrial IoT with particular focus on predictive maintenance and energy consumption. In the SG&A area, logistic and supply chain optimization process continue along their road map. And finally, in the organization area, the process of digitization and staff up skilling follow their schedule.
Finally, I would like to comment on the Hevea-tec acquisition, leading independent natural rubber processor in the Brazilian and our supplier as well. The transaction is expected to be closed by the end of 2023, and it is worth approximately EUR 21 million as enterprise value, with no impact on our 2023 cash flow target. Through the Hevea-tec acquisition, Pirelli will increase its natural rubber supply share in Latin America and ensure continuity of supply in the region and therefore, greater efficiency and benefits in terms of stock management. In addition, the operation will facilitate the launch of innovative natural rubber projects aimed at increasing the use of non-fossil based materials in the production of tires in line with Pirelli's sustainability goals. As just mentioned and always in terms of sustainability, the Hevea-tec acquisition will also enable the company to further improve its control of the natural rubber supply chain, reduce the CO2 emissions, thanks to a local for local supply and launch new FSC certification projects. Thank you, and I now leave the floor to Mr. Bocchio.
Thank you, Mr. Casaluci, and good evening to all. Let's go through the revenue dynamics in the first half of the year. The volume trend, minus 2.1% at group level discounts the weakness of the market demand, especially in the replacement channel. As Mr. Casaluci already explained, we overperformed the market on car 18 inches and above, while further reduced our exposure on standard in line with our strategy. Strong improvement in price/mix, plus 12.5%, expected to be among the best in the industry was supported by a solid price discipline and a continued product mix improvement. The ForEx impact was negative, minus 2.9% in the first half equal to minus EUR 94 million with a worsening trend in the second quarter following the depreciation of the dollar and other major currencies against euro. In the first half of 2023, adjusted EBIT was EUR 517 million with a 7.4% growth year-on-year and a stable margin of 15.1% compared to the first half of 2022. Internal levels more than offset the weak external scenario. More specifically, the price/mix, plus EUR 345 million and efficiencies, plus EUR 30 million more than covered the drop in volumes, minus EUR 29 million linked to a weak market demand, the increase in cost of raw materials for EUR 99 million, including the related exchange rate impacts, input cost inflation, minus EUR 131 million related to energy, labor and transport, the negative exchange rate impact, minus EUR 51 million due to 2 different dynamics.
On one end, the revaluation of the Mexican peso plus 13% versus euro with a direct impact on costs given that Mexico is the production hub for North America. On the other hand, the devaluation of renminbi, Latin American currencies and the devaluation trend in the second quarter of the dollar. Finally, the impact of depreciation, amortization and other costs was negative, minus EUR 16 million and minus EUR 14 million, respectively. The latter were concentrated in the second quarter and relative to marketing expenses, R&D and to stock reduction. Profitability improved in the second quarter, reaching a margin of 15% -- 15.1% in quarter 2 2022, thanks to the strong contribution of price/mix, plus EUR 147 million and the efficiencies plus EUR 21 million, which in total covered 1.4x the negative impact of raw materials, minus EUR 22 million, inflation, minus EUR 62 million and exchange rates equal to minus EUR 36 million.
Let's now analyze the net income dynamics in the first half of the year, a plus 4% year-on-year growth. This trend reflected the already mentioned improvement in operating performance, which more than offset the increase in net financial charges related to interest rate hikes in the Eurozone and the higher tax impact linked to the better operating result with a 28.5% tax rate. The adjusted net income was EUR 298 million versus EUR 288 million in the same period of 2022. The net cash flow in the first half of 2023 was negative for EUR 535 million, in line with our business seasonality. Excluding the impact of the 3-year management incentive plan for 2020, 2022 worth EUR 67 million paid in the second quarter, the net cash flow before dividends was stable year-over-year. The variation of the operating cash flow mainly reflects the improvement of the operating performance, the higher absorption of investment activities and the working capital and other items trend. Let's discuss the dynamics of the latter.
Thanks to a careful stock management, inventories were reduced in the first half of the year, reaching a 20.7% on sales, minus 1 percentage point versus the end of March. The reduction was related mainly to raw material inventories. It should be remembered that in 2022, the high incidence of raw material stocks was due to both rising inflation and actions to contain supply chain risks. Finished product inventories, on the other hand, remained stable. The other elements of the working capital reflected the usual seasonality of our business with an increase in trade receivables to 13% of sales, plus 3.5 percentage points versus the end of 2022 and a reduction of trade payables versus 2022 year-end due to the investment trend and the normalization of raw material stocks. Trade payables on sales is expected to return to around 30% at the end of 2023, in line with previous year.
Finally, we would like to remind you that the nonrecurring impact from the incentive payment was related to the 3-year long-term incentive plan 2020, 2022. This roughly EUR 67 million impact was included under the item other payables from 2024, with the transition to the rolling system, incentive payments will be on an annual basis with a substantial alignment expected between the impact on the net -- on the income statement and cash outflow.
The group gross debt as of June 30, okay, amounted to approximately EUR 4.8 billion. Considering the EUR 1.7 billion of financial assets, our net financial position stood at EUR 3.1 billion. The EUR 2.8 billion liquidity margin allows us to cover the debt maturities up to 2025 year-end. In the first half of the year, 2 new sources contributed to the liquidity margin. The first is the EUR 600 million 5-year bond issued in January, which marked Pirelli's debut as an investment-grade company and represented the world's first sustainability-linked benchmark issue in the tire sector. The second is a EUR 300 million bilateral loan benchmark to sustainability targets maturing in February 2026. This loan as of June had not yet been drawn and therefore, positively contributed to increasing the liquidity margin as undrawn committed line. The utilization of this new bank line happened in July and facilitated partially using the liquidity already available, the voluntary early repayment of EUR 600 million loan maturing in February 2024. We Financing with ESG features now accounts for 58% of total debt. Finally, the cost of debt stood at 4.46%, up 15 basis points from first quarter 2023, impacted by the restorative monetary policy, mainly in the Eurozone. I'll now turn the floor over to Mr. Tronchetti.
Thank you, Mr. Bocchio, let us now turn to 2023 outlook. As already mentioned, the macroeconomic picture is still characterized by volatile and mild economic growth. Major uncertainties concerned Europe, analyzed by the monetary tightening and China discounting is lower-than-expected recovery impacted by a weak foreign demand and low domestic consumption. The situation led the government to launch new measures to support domestic demand at the end of June. In this context and based on the lower-than-expected market trend in the second quarter, we adjusted our outlook on the car tire market. For 2023, we expect the demand will be down 2% with high value and standard following opposite trends. The value confirms its resilience.
The growth rate of 33% in curating interest and above, but as standard due to fall by minus 3%. More in detail regarding 18 inches and above, we expect mid-single-digit growth for original equipment, lower than our previous estimation due to a lower demand in the Chinese market. The car replacement 18 inches and above, we expect a low single-digit growth rate plus 2% against the 3% growth in the previous guidance, a more cautious view on Europe due to the weak trend recorded in the first half of the year and China. Novena, the progressive recovery of replacement is confirmed in the second half of the year. In this context, we confirm our strategy, which aims at consolidating our leadership in the high value, especially in the 19 inches and above, which we show a faster growth in specialties and electric vehicles.
Based on the results achieved in the first half and the scenario just described, we confirm our adjusted EBIT and cash flow targets, although with a different mix and drivers. More in detail, we expect volumes slightly dropping due to the market slowdown with a low single-digit growth of high value and the reduction in exposure to standard. Price/mix significantly improving, thanks to the better performance in the first half. Instead, the ForEx impact reflects the high volatility of the major currencies against euro. Revenues are therefore expected to amount between EUR 6.5 billion and EUR 6.7 billion. Adjusted EBIT margin improving compared with the previous guidance, reaching between approximately 14.5% and less than 15% due to a greater contribution from the price mix.
Adjusted EBIT is confirmed approximately EUR 970 million in the midrange of the guidance, where the price/mix and efficiencies offset the impact of the external scenario. In line with the previous guidance, we confirm investment of approximately EUR 400 million devoted to the technology upgrade of our plants, mix improvement and increase in high value, sorry, increasing high-value capacity in Romania and North America, which is to be completed before the end of 2025. Cash flow before dividends is confirmed between approximately EUR 440 million and EUR 470 million due to the operating performance and an efficient management of working capital. This target includes the amount relative to the acquisition of Hevea-tec announced on 4th July. The net financial position is expected to be approximately minus EUR 2.35 billion with a leverage between approximately 1.65 and 1.7x the adjusted EBITDA, in line with the deleveraging process outlined in industrial plan for 2021-2025 period. This ends our presentation, and so we may open the Q&A discussion.
[Operator Instructions] The first question is from Martino De Ambroggi from Equita.
My first focus is on price/mix. So it's clear, the trend was so strong that you are revising upwards the price/mix expectation for the full year. But what is exactly going better than expected at the beginning of the year? Is it just an adjustment where you have ForEx devaluation what else? And the second question still on prices is can we assume that the original equipment is entirely with automatic adjustments indexed to raw mat? And when do you expect to start to see reduction in prices I suppose this is not an event for the second half of this year. And the third question is on profitability, focusing on standard. If you could share with us what was the profitability in the first half? And what do you expect in the full year, considering that the market is worsening. I understand you are selective, but this business is probably more under pressure compared to high value.
Concerning the price/mix, the improvement compared to the last guidance is around 2 percentage points, so from 5.5% up to 7.5%. I would say half of the improvement is coming from price and half from mix. What is leading the improvement is mainly related to the price discipline. So the Pirelli decided -- all in all, the price discipline in the high value is in the market. We don't see a major movement on price. But purely itself decided to keep as a priority of the commercial strategy, the price discipline. So this is the major impact coming from the improvement of price mix and mainly price. As far as original equipment, Yes, the first negative impact on price will come in the first -- in the second half of 2023. So the price performance on original equipment will be slightly negative in the second half on all the business, which is related to the cost metrics that is more or less 70% of the regional equipment business for us.
The last question, the profitability of standard, but the profitability of standard is expected to be -- I have to say first half was quite positive around 9%. And all in all, we target to have this performance for the full year. So we don't see major differences between the 2 halves. You are right, the price volatility in standard is higher than high value, high value is more protected Nevertheless, the presence of Pirelli in the standard segment is very limited, and we keep our focus only on the most profitable segments of the standards. So the old season, the 17 inches demerged tires. And so we don't -- we prioritize the price discipline and in case we lose as is happening, market share because it's not our focus. We don't reach within 2023, the double-digit profitability that was blended in our industrial plan because of the effect of the Russian operations and the desaturation of the prendBut the target of reaching the double-digit remains, we simply have 1 year of delay.
If I may, just one more on price/mix. So if you could split for your full year projection, what percentage out of the 7%, 8% is price and what is mix.
You can consider more or less 4.5% is the price.
The next question is from Monica Bosio from Intesa Sanpaolo.
The first one is a general question. The replacement market is under pressure a destocking process and we will see...
Sorry, one second. Now we are not listening well...
I'm trying again. I hope it's better. As for the replacement market, when do you expect the destocking process might come to an end. So my question is, can we expect a rebound of the replacement market already from the very beginning of 2024. And the second question is on EV tires in original equipment. I remind that in the first quarter, the shares of EV tires in higher above 18 inches in the original equipment was at 25%. The target for the full year was 30%, if I remember well, if you can give an update on this? And as a third question, as for EBIT in original equipment, what is the share of the local Chinese car players, if you can give us -- thank you.
So I will not talk about the rebound of the replacement market is not expected a rebound so far. It's expected the second half better than the first half, mainly because of the favorable comparison versus last year on the placement and also because the destocking of the train has been more or less all finalized both in Europe and North America. I would see a more stable replacement market all in all. But what is clear is that the resilience of the high value in the replacement market is confirmed. We maintain a gap between the standard 17 inches and below and the high value stable, more or less of 6x faster and more resilient the high value compared to the standard, which is the most important aspect for our business model. Moving on to the electric vehicle, yes, you are fully right, and we do confirm our target of market share in the high value is confirmed 30%, which means 1.5x the internal combustion engine in the premium and the prestige segment. The electric vehicle all in all is today representing around 27% of the entire original equipment volume inside our sales. More detail specifically on the Chinese carmakers, we will provide you after the call.
The next question is from Michael Jacks from Bank of America.
I hope you can hear me clearly. I have 2 questions. The first one on volumes. Your 2 percentage point cut to your OEM channel assumption speaks to a double-digit downgrade for China, if you were double-digit percentage downgrade for China, if you attribute all of that to the region, can you just provide a little more color on that, given that you -- your weighting is more towards the high-value segments and EV tires in that market. And we've seen that the EV car makers in China have been strongly outperforming the domestic market. Secondly, on volumes, would you agree that the comparative base for the overall replacement tire market is quite low from the second half of last year. So would it be crazy to expect some growth year-on-year in that market? And then finally, just on cost inflation, could you share with us your updated assumptions for the year and whether not you've made any changes to some of the individual cost buckets.
Yes. So concerning China, you are right. There is a reduction in the expectation of the market. But generally speaking, when we talk about the 18 inches and above market, which is our target market. Today, on a full year basis, we project the total Chinese market only talking about China of 3.4 percentage point negative, mainly driven by original equipment where we do expect a slowdown of the market in the second half also because of the less favorable comparison versus last year. I do remember that there was a rebound of the original equipment market in the second half, while Pirelli is projecting to gain market share with a plus 1% on sales in the 18 inches and above -- so you are right, the expectation of the market is not as brilliant as was in the previous 3 months ago. Nevertheless, remains more resilient than the standard, and we target to gain market share.
In terms of inflations and cost, generally speaking, what we can tell you is that raw materials that accounts for roughly 37% of our total on sales, sorry, on the total base cost. We had a headwind of around EUR 100 million in the first half is negative because of inflation, and we do expect to have more or less the same amount in positive in the second half. So all in all, the impact of inflation in raw materials is expected to be neutral. While if we move on the other cost, logistics that represents roughly 9% of our total cost, generated a negative inflation around EUR 15 million in the first half, more or less, we expect similar impact in the second half. Energy cost is around 5%, 4.8% of our sales. And the inflation in first half was EUR 52 million negative. We do expect a 38 million roughly in the second half. So still a negative impact, mainly because due to our hedging policy. We bought energy at a higher price compared to the at market price. Also labor cost accounting for around 18% on our own sales, on our cost base as a similar trend of inflation first half and second half around EUR 40 million in the first half and EUR 45 million in the second half. And then we have other inflations for roughly EUR 60 million, half and half in the 2 semesters. This is the general picture on cost base.
If I may just follow up on the volume question. Just to try to understand that you've reduced your assumption for the high-value segment or 18-inch and above by 2 percentage points. Now given you're weighting towards China is less than 20%, a 3.4% reduction in the market isn't quite congruent with the 2 percentage point cut that you've made to the market forecast. Where is the rest of that cut coming from?
So the total 18 inches and above market at the global level for 2023, is expected -- is projected in our estimation, around 310 million is growing at 3.2%. That was the number in our presentation as expected volume, total and growth at global level, 18 inches and above total market. In China, the market is counting 43 million tires. So it's a bit above the 10% on the around 12% weighting on the total market and is expected to be negative 3.4%.
Maybe I should take this offline afterwards, but I was referring to the OE channel, which you've cut to 5% versus the previous 7... The next or... Yes. Original equipment out of the EUR 310 million global, EUR 125 million is the original equipment. If we move to China out of the EUR 43 million, EUR 31 million is original equipment and is expected to decrease around 6%. So the weight of the regional equipment in China market is higher than the average of the global market because it's still a young car park. And so the weight of 18 inches in the region equipment is on average higher than the global picture.
The next question is from Akshat Kacker from JPMorgan.
2 questions from my side, please. The first one on your high plans saturation when it comes to high value capacity. To what extent does the 95% capacity utilization restrict or contain growth in this segment as we think about growth into 2024, please? And can you also remind us on your current CapEx assumptions for 2024? And the second question is more of a medium-term question. In your view, what protects the higher margins of bigger rim sizes in the medium to long term? Is it more down to technological and material know-how -- or is it a structural course advantage versus your competition? Or is it just a function of relatively low competition in the space right now?
So in terms of saturation, as we mentioned in the presentation, we have a 90% of global situation, out of which 95% in the high value. There is all the necessary capacity in our plan to catch all the demand opportunity for the coming years because I always remind that at least 10% of our capacity in a high value that represent 3 million tires more or less is used to produce standard tires. This is the way we keep always the spec capacity to catch in advance the sales growth. So 95% of our high-value capacity is saturated means that we have 5% spare non-used, plus 10% used for standard. In terms of CapEx, 2024 we don't have already in numbers ready to be communicated. Anyhow, we target to maintain a ratio around 6% on sales, which is our ratio of the last years. And we do consider this is a well-balanced target, considering that more than 50% of our CapEx are and will remain concentrated in a technological upgrade, sorry, mix improvement, digitization of our factories. That remains our main target. 25% is capacity increase 100% high value and 25% is baseload and business continuity. The answer to your last question is always the same pushing on innovation, pushing on innovation, pushing on innovation is the way we raise the barrier and we protect our mix and our positioning in the most important premium and prestige carmakers in the world.
The next question is from Ross MacDonald from Morgan Stanley.
Ross MacDonald, Stanley. I'm just looking at Slide 32 in your presentation pack, and you state that raw material costs are now 34% of revenues, which is down from 36% in the first quarter, I believe. So costs -- raw mat cost obviously coming down quite quickly. What do you see as a normalized level here for raw materials as a percentage of sales? And is that 34% number actually quite low now versus history? And then my second question, just thinking out loud, -- you have lower raw material costs, you have a cost-cutting program that's accelerating in the second half, and it doesn't sound like you're going to cut tire prices. Now that sounds like a very cash generative period for Pirelli. So I'm just curious what factors offset those positives and keep the free cash flow guidance flat? And then final quick question just on FX. Just so I understand it, your FX assumptions for a 6.5% drag on revenues, is that just assuming that the FX rates remain unchanged from their current levels for the rest of the year?
Okay. Thank you for your questions. I will answer on the raw material environment, and then I will ask Mr. Bocchio to answer on the ForEx side. So raw material impact, as I said before, is normalized around EUR 36.5%, 37% on sales. and this is a normalized impact. We had a negative headwind of EUR 100 million roughly in the first half, and we will have a positive impact of around EUR 100 million in the second half. That's the reason why it's a flat impact on a yearly base. And this is 100% related to the raw material markets and the commodity markets because there is a reduction on the inflation that started months ago, and now we have the impact on our COGS starting from the second half. Mr. Bocchio?
Yes, I will take the one on the FX, as we said, our renewed guidance is taking into consideration an impact of ForEx between minus 6% and minus 7%. And we are considering a devaluation of the United States dollar, meaning that in second half, we are expecting the U.S. dollar to remain in the range of EUR 110 million to EUR 112 million. So a devaluation compared to the second half of previous year of about 9%. Same 9% devaluation we have expected from the Chinese renminbi to stay in the second half in the range between EUR 770 million to EUR 790 million. So this gives another 9% evaluation obviously, we are assuming a higher volatility on the Latin America currencies, which will represent a significant part of the impact of the FX and then some uncertainty on the Russian ruble, but reasonably stable compared to the evaluation that we have had on the market in these last few weeks.
Maybe I could just rephrase my second question. A lot of investors are expecting price cuts, just to be clear. It sounds like that's not your intention. So with these lower raw material costs, would it be fair to say that this is a very cash generative period for the tire sector?
Okay. Thank you. No, we don't plan any price reduction. We keep the export price positioning. We don't have any more opportunity to increase pricing in this environment, both because of raw material and also because of the reduction on the demand and the lower expectation on the market. So we don't plan to increase price anymore in the second half, but we don't have any plan to reduce price. We keep the price discipline as far as the replacement channel is concerned. As far as original equipment, as I said before, because of the cost metrics mechanism, we do expect the price reduction, which is already included in our numbers and in the contracts we have with carmakers that will be in the range of 1, 2 percentage points in the second half.
The next question is from Philipp Koenig from Goldman Sachs.
I've just got a question on the new margin guidance. I know that you obviously listed it, but you did over a 15% margin in the first half, and inflation is improving, pricing is remaining stable. And it seems like the volumes in the replacement market, especially in the high-value and also recovering. So I'm just wondering why even the mid or the high point of your guidance would still imply the second half margins to be lower. I know there's a bit of an FX headwind here, but there seems to be quite a bit of offsets from deflation and higher efficiencies. So is it just the FX? Or is there anything else?
Okay. I'll take this question. Related to the second half profitability that is implicit in our guidance. We have to say that it is discounted some cautiousness on the external scenario, as we said, related to demand and to the ForEx. So the volumes are expected to decline year-on-year in the second half. And even for the ForEx, especially it is expected to deteroriate and have a higher devaluation of the dollar. As we said, the renminbi, the volatility of the currencies of the emerging markets jointly with a revaluation of the Mexican pesos, as we said at the beginning. All of these impacts jointly with the inflation headwind will be offset by the price mix and the price discipline that we just mentioned. -- whose contribution at the end will be lower compared to the first half given then the base obviously is getting higher and higher and then efficiencies and raw material tailwind. Overall, at the end, this is the input that we are including in our second half implicit guidance.
Could you maybe answer what type of drop-through are you assuming on the FX?
You're asking about the FX on the second half, right?
Yes. And they drop through into the operating profit.
Okay. Drop through. Yes, the drop-through that we are expecting for the second half is pretty similar with what we are experienced in second quarter. So it will be about 40%. And the currency movement as what we said on U.S. dollar, we are expecting to stay between $110 million to $112 million in second half. So with a devaluation of 9% compared to second half previous year, a weakening of the Chinese renminbi, that is to stay in the range of EUR 770 to EUR 790. So again, roughly 9% of the valuation second half of 2023 compared to second volatility of the Latin American currencies, especially on the Argentinian pesos and then some uncertainty on the Russian ruble, but we are considering about to stay more or less at the level that we are expensing in these last few weeks.
Gentlemen, there are no more questions registered at this time so back to you for our closing remarks.
Well, so thank you, everybody. The concludes today's program. Thank you for your attendance, and have a good evening.
The conference is now over. You may disconnect your telephones.