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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome everyone to our first quarter 2019 earnings presentation. Today's call is hosted by our CFO, Wolfgang Schäfer. Also here in the room with us are colleagues from Investor Relations, media relations and finance and treasury. If you have not done so already, the press release and presentation of today's call are available for you to download from our Investor Relations website. Before starting, we'd like to remind everyone that this conference call is for investors and analysts only. If you do not belong to either of these groups, please kindly disconnect now. Following the presentation, we will conduct a question-and-answer session for sell-side analysts. [Operator Instructions]With this, I would like to hand you over to Mr. Schäfer.
Thank you very much, Bernard. Welcome from my side. Before I go into the presentation, like I always like to do, I will offer some brief observations. As expected, the market conditions in the first quarter of this year were very similar to the second half of last year, specifically fourth quarter of last year. In the first 3 months, global vehicle production was down by more than 6% year-on-year with all major regions experiencing declines. Even in this challenging environment and with over 70% of our sales coming from automotive OEs, as you all know, we were able to outperform our biggest underlying market and deliver organic growth of minus 2%. This demonstrates the resilience of our business portfolio.As mentioned during our call in March, we have taken appropriate cost actions to adapt to the situation. Variable production costs wherever possible have been adjusted to meet the lower demand environment. And as an example, let me state the number of blue-collar employees which are down by about 1% versus the prior year in line with the sales development adjusted by FX. Cost reduction programs for selected businesses are on track to realize targeted savings this and next year. And on a group level, we have initiated further programs to address cost capital employed and investments.Looking forward, we expect business conditions to remain challenging in the second quarter. Although we continue to expect a market upturn in the second half of the year, the market environment remains uncertain in many of our important markets, most notably in China. In addition to managing the current downturn, our teams continue to work on the transition to our new group structure for the planned partial IPO of the Powertrain business. It is expected that the necessary conditions will be fulfilled toward the end of the year so that the additional detail can be provided to the capital markets. Once further technical and regulatory requirements have been completed and depending on the market situation, we expect the partial IPO to be finalized from 2020.For the automotive area, the management team, under the new automotive board, officially started their work on April 1. The team is now fully engaged with the definition of the future automotive technologies area to better leverage divisional synergies, speed up decision-making processes and maximize potential profitable growth opportunities.Having said this, I would like to move to today's presentation. Those of you who have followed us already for a while, might notice that we have changed some of the presentation slides. No content has been lost. We only streamlined the flow. And I start with Slide #3. Reported sales in the first quarter of 2019 came in at EUR 11 billion, flat versus the same period of last year. Excluding exchange rate effects of EUR 186 million and changes in the scope of consolidation, organic growth was minus 2.1%, as mentioned already. The adjusted EBIT declined year-over-year by 17%, impacted by lower volumes as well as increased depreciation expenses. The resulting adjusted EBIT margin achieved 8.1%. The decrease in EBIT is also the main reason for the decline in the net income of 22% versus last year's level.Moving on to a free cash flow before acquisitions and carve-out effect. This figure was minus EUR 579 million compared to plus EUR 186 million in last year's comparable period. The main drivers of this decrease were lower EBIT and an unusually high buildup of working capital and higher CapEx, while the first-time adoption of IFRS 16 had a positive impact on depreciation of EUR 78 million. I will cover all this in more detail later in the presentation.IFRS 16 also affected the gearing ratio and ROCE as well through an increase of net debt by EUR 1.8 billion as of March 31, resulting from the required recognition of all leases in our financial position. As for other highlights in the quarter, order intake in the Automotive Group was about EUR 9 billion in lifetime sales, equivalent to a solid book-to-bill ratio of 1.4x. We also successfully placed a short-term loan or promissory note of EUR 500 million split into maturities of 3 and 5 years with a fixed rate for 76% of the coupon. Last but not least, the acquisition of Kathrein Automotive GmbH was officially closed, and Kathrein became consolidated starting on the 1st of February. Also, the acquisition of the anti-vibration systems business of Cooper-Standard Automotive was closed at the end of the quarter and becomes now consolidated starting on the 1st of April.Slide 4 is showing that consolidated sales was around EUR 11 billion. It's at the same level in 2019 as it has been in 2018 and 2017 despite the lower absolute level of vehicle production. The lower amount of adjusted EBIT versus prior year was mainly driven by a decline in the Automotive Group, which I will explain later.Moving on to Slide 5. As mentioned, global vehicle production declined by more than 6% in the reported period. The upper left column show that in the most relevant markets for Continental, our Automotive Group generates about 85% of its sales mainly in Europe, North America and China. Light vehicle production came down by even more than 7%. Despite these challenging conditions, organic growth in our Automotive Group was only minus 4%. ContiTech, the upper right numbers, was also burdened by the weak production of light vehicles more specifically in the business area of Mobile Fluid Systems, power transmission and Benecke-Hornschuch. On the other hand, positive macroeconomic conditions supported good organic growth in its industrial businesses, such as Air Spring Systems and Industrial Fluid Solutions. All in all, ContiTech's organic growth was minus 3%. Moving on to our Tire division, lower left part of this chart, our tire volumes for passenger vehicles and light trucks was at a comparable level to last year. Our OE tire sales experienced slightly negative volume growth due to the weaker vehicle production environment, while the replacement tire sales growth was in line with the flat market in Europe and solidly growing market in North America. In commercial vehicle tires, on the lower right, our volumes grew by 6% versus the prior year period. In North America, our volumes growth outpaced the minus 8% growth of the replacement market. Likewise, we outperformed in Europe with positive volume growth versus the minus 5% development on the regional replacement market.Slide 6 is showing that at our Automotive Group, organic growth was minus 4% versus Q1 2018, as mentioned already, and the adjusted EBIT margin was 5.4%. Negative volumes together with an increase in R&D were drivers behind the year-on-year margin decline of 280 basis points. R&D capitalization was up about EUR 60 million versus the prior year period due to a higher share of software in our portfolio. We expect the level of capitalization to be lower in the next quarters and, on a full year basis, slightly higher than the level of last year. In the Chassis & Safety division, organic growth was minus 8.4%. Higher unit sales of ADAS systems could not sufficiently compensate for lower volumes in other business units, specifically for electronic and hydraulic brake systems. The main reason for this volume decline is the weak Chinese market. The Chassis & Safety has the highest share among our automotive division together with the volume decline of the sedan business of a major braking systems customer, as we have reported already in the last 2 quarters as well. The latter development is not expected to reverse and will therefore burden the Chassis & Safety growth for another quarter. The adjusted EBIT margin came out at 6.3%, declining year-on-year by 380 basis points due to lower volumes and higher R&D expenses.Powertrain division organic growth was minus 0.6%, and the adjusted EBIT margin was 3.9%. HEV sales amounted to EUR 60 million in the quarter. If HEV were excluded, Powertrain's adjusted EBIT margin would be above 8%. Volumes for HEV emission control sensors and SCR systems grew positively. Volume growth of injectors, pumps and transmission control units was negative. Interior division volumes for multimedia and connected products were higher, while volumes in the Instrumentation & Driver HMI business were lower. In total, organic growth was minus 1.4%. The adjusted EBIT margin achieved 5.5%, declining year-on-year by 260 basis points due to lower volumes and negative FX transaction effect mainly from the weakening of the euro versus the U.S. dollar and Japanese yen, mainly exports which we are buying in the yen area for displays and other electronic components.Slide 7 is giving an overview of the organic sales growth of Continental's automotive area versus the world car production. I mentioned already the Automotive Group outperformed global vehicle production by about 200 basis points. As expected, this figure is below the total outperformance of 300 to 500 basis points due to the negative comparable growth of the braking systems business in Chassis & Safety, as explained before. This headwind from braking systems is expected, as well mentioned already, to annualize in the third quarter of this year. The other 2 divisions outperformed global car production by about 500 basis points.I continue with the Rubber Group on Slide 8. Despite the challenging market conditions, our Rubber Group delivered a solid result. The Tire division achieved strong organic growth, 3.8%, and an adjusted EBIT margin of 15.1%. While organic growth and FX were margin-accretive, raw material headwinds and increased expenses related to our new plants in the U.S. and Thailand were dilutive. The net year-on-year margin decline was 10 basis points. I'll get to the top line bridge on the next slide. As mentioned, ContiTech organic growth was burdened by tepid vehicle production but supported by industrial business. The resulting organic growth of minus 3.2% was a material effect behind the margin decline of 150 basis points versus Q1 of last year. ContiTech is also on track with its margin enhancement programs, and we expect to see some benefits from this in H2.Now Slide 9 showing the tire sales transition, the bridge of the top line. Organic growth in tires was supported by higher volumes of 1.1% and a positive price/mix effect of 2.7%. And you should note here that from now on, we switch to an average sales price weighted volume calculation, meaning the volume increase in truck and specialty tires were primarily behind the overall volume growth. Had we used our previous pure unit-based calculation methodology, the volume effect would have been only plus 0.3%, obviously the only difference included in price/mix. We believe that this new method is more accurately reflecting volume and price/mix effect. In addition to organic growth, FX and consolidation effects contributed EUR 31 million and EUR 65 million, respectively. Consolidation predominantly resulted from the acquisitions of the Australian retail organization, KTAS.Raw material expectations are shown on Slide 10. For natural rubber, we expect the current trend of rising prices to result in an average increase of 8% on a full year basis. We also expect prices in carbon black, chemicals, steel cord and textiles to be above the prior year's average. The price of synthetic rubber is expected to be stable on a full year basis. Taken together, our expected headwind from raw material of about EUR 50 million in 2019 is unchanged to our previous guidance. Now moving to other group topics, indebtedness and cash flow, as shown on Slide 11. As previously guided, the first-time adoption of IFRS 16 roughly doubled the net debt from the level at the end of 2018, shown here with EUR 1.73 billion in this chart. Further outflows include EUR 640 million for CapEx and EUR 129 million for acquisitions mainly related to the Kathrein Automotive business. The seasonal outflow of working capital amounted to EUR 1.2 billion. I will comment on that on the next slide. Finally, the sum of inflows from depreciation and amortization and other cash flows was about EUR 1.1 million. The result is a net debt at the end of Q1 2019 of EUR 4.3 billion. This is equivalent to a gearing ratio of 23%.This leads to the breakdown of the free cash flow, next page. Operating cash flow adjusted for carve-out effects came in at EUR 53 million, EUR 581 million lower than the same period of last year. The reduction was caused by lower EBIT and an unusually high level of working capital. Inventory levels were above the normal level due to lower volumes. The accounts receivable were affected by the reversal of the unexpectedly good payment behavior of our customers in Q4 last year, and accounts payable were of the usual level. We do not see actually structural elements in any of these numbers. The -- I mentioned already the first-time adoption of IFRS 16 had a positive impact on depreciation and amortization, resulting in a benefit to operating cash flow of EUR 78 million. Investment cash flow, adjusted for acquisitions, came in at minus EUR 633 million, EUR 184 million lower than Q1 last year due to higher CapEx for equipment needed to start the production of new orders in the Automotive Group and for the new 2 plants in the Tire division in Thailand and the U.S. The resulting free cash flow before acquisitions and carve-out effects was minus EUR 579 million.Historical development of the net debt is shown on Page 13. As mentioned, the increase in net indebtedness and the gearing ratio is mainly due to the first-time adoption of IFRS 16. Outstanding bonds are shown on Slide 14 by year of maturity. On February 19, we redeemed a EUR 500 million bond. That's only 2 bonds with a total volume of EUR 1.35 billion due in 2020 remain outstanding today. As for the current liquidity situation, this stands at EUR 5.7 billion, as you can notice in this number block on the right side of the chart.Slide 15 gives our current expectation for the vehicle production in our most important markets. As anticipated, trends in Q1 were negative in all regions though the extra declines in North America and China were slightly worse than we had expected at the start of the year. As mentioned earlier, we continue to expect a moderate market upturn in the second half of the year in Europe and China though we expect production in both markets to remain below the levels of 2017. However, for the time being, this is our expectation only since customer call-offs only provide some visibility for up to 3 months. Visibility into trends beyond the second quarter remains challenging.Slide 16 provides a summary of our 2019 overall market outlook. Despite the weak trends in Q1, we assume that the anticipated H2 recovery will result in full year worldwide car production to be broadly flat versus last year at about 94 million vehicles. For commercial vehicle production, we have upgraded our expectation for North America after the strong growth in Q1 but otherwise maintain our full year expectation of a 1% decrease in worldwide production. In PLT replacement tires, our market outlook is unchanged. And in commercial vehicle replacement tires, in the lower right bar, we have lowered our 2019 worldwide market outlook from plus 2% to 0%. This is a result of a significantly lowered market expectation for North America from plus 2% to minus 5% and a slight downgrade for Europe from plus 2% to plus 1%. However, we anticipate that we will be able to outperform in both these markets on a full year basis just as we did in the first quarter.And this leads to the last slide of the presentation, our outlook. We maintain our annual guidance for sales and adjusted EBIT margin for the corporation, Automotive and Rubber Group. As stated, our projected raw material cost impact is unchanged and our expectation for free cash flow before acquisition and carve-out effect of between EUR 1.4 billion and EUR 1.6 billion is also unchanged. As mentioned, this includes a positive impact from the first-time adoption of IFRS 16. All elements of our guidance are unchanged, as originally anticipated in January.And with this, I conclude today's presentation and I open the line to your questions.
[Operator Instructions] And we've received the first question. It is from Raghav Gupta of Citi.
Can we please start with the automotive margins which came in even weaker than Q4? I guess I was really surprised by the magnitude of the decremental margins given the resilience or relative resilience you showed in Q4. Can you just talk a little bit about this? And what gives you the confidence that auto margins in Q2 and Q3 will improve such that you can meet your 2019 guidance?
Was it a question on R&D reimbursements in Q4? Or could you repeat? It was hard to understand.
No. The question was regarding the decremental margins in Q1. So why would the operating leverage was much worse than what was observed in Q4? And I was just wondering if you can talk a little bit about that. I'm talking about the automotive division.
Okay. Sorry. What we saw, on the one side, the effects of the lower volumes obviously in all 3 automotive divisions, where nongrowth together with price down to the customers on the one hand side and cost increases from wages and salaries specifically in the emerging countries plus 10% and more were a factor which obviously were eating into the profitability plus some increase in R&D costs partly due to lower reimbursements if you compare to Q4, as you rightly stated, which are always the higher concentration in Q4. These are the main factors, and I think division by division, these factors have a different magnitude but in the end are valid. Obviously, in the Chassis & Safety division, the sales reduction is stronger than the leverage effect on sales. It's the one which is highest.
I guess just to follow up on that. The price down to customers, I guess, was the really interesting kind of point and something that has been talked about a little bit on kind of your competitor and customer calls. Are you seeing this at a magnitude which is higher than usual? Or is it because the volumes are lower, which kind of -- is what makes it worse? So I guess the question is the price downs that you've seen that customers have kind of presented to you. Is that higher than what you would normally see?
No, it is more from the volume side, the effect on the volume side. And one effect we did mention, which is mainly Interior -- is the FX effect in Interior. Well, I think I briefly mentioned Interior is affected by FX effect because they use from suppliers in dollar and Japanese yen quoted electronic parts and this is specifically displays and as well electronic boards. And there, the FX effect was negative to Interior. You might remember that last year, we had this effect positively for that division, and this is an effect which had to be mentioned as well.
So I guess putting together what you're saying about wage costs, price downs and lower volumes, is it fair to say you're confident in being able to meet the guidance for the auto division margin for the year is based on volume improvement as we go through the year? Is that essentially kind of the way to read it?
Yes. You're a little bit hard to understand, but I answer what I think your question was. The guidance for automotive is confirmed. We see we're on the right track. The divisions -- all of them are working on further cost downs. I mentioned already that on the blue-collar side, as an example, given only the adjustments are visible, I mean, for the rest, it is hard obviously for you to look in the different P&L lines but this is visible. They are working on it. This will improve in the course of the year. And yes, we are confirming the guidance level which we have given based on the volume assumptions which we have stated before.
Okay. Hopefully, you can hear me. Just 2 quick accounting questions. The first one is on CapEx, which stepped up in Q1. When I look at the cash flow statement, CapEx on intangible assets rose EUR 60 million. Is this entirely related to capitalized R&D? And if so, can you confirm that this flatted your automotive margins by around 90 basis points? And then the second one, I'll just ask them both at the same time. I just wanted to understand what's driving the eliminations in the EBIT line? It improved considerably year-over-year and seem to account for, I guess, the majority of the beat versus consensus in Q1.
The 90 basis points are confirmed. And the second question was on the -- now I have to ask you probably again.
Eliminations in the EBIT line, just what does that relate to? It seems to have improved quite a bit year-over-year.
Yes. It -- while the main topic there was reserves which we have built into Q4 for variable payments, bonus payments and actually with the business situation of last year, those reserves were not fully needed. And by that, we basically transferred from some profit basically from Q4 to Q1. This was actually -- I mean, when we guided the market towards the margin of the first quarter, we guided somewhat lower. We only, quite late, got aware of this effect because part of this variable compensation is not just automatically done, but in some countries, this requires negotiation with the worker side and these negotiations were taking quite long. And this is why we, only ourselves, finally were sure that we had some reserves out of it, which we, in the end, put into Q1 and had to improve Q1.
The next question we've received is from Kai Mueller of Bank of America Merrill Lynch.
The first one, coming back to your overall volumes, you said obviously that Q2 will still be challenging, but you said you're hoping that H2 gives you that recovery that you're baking in. Can you give us our latest -- your latest thoughts on the Chinese market going into Q2, i.e. how have the call-offs developed so far into May? And then also on another market, German production data has been particularly weak or Europe overall. What do you think are the drivers there? Is there a lot of inventories at dealers that are being sold out because the car sales are actually holding up better than production? And how do you think that changes going into the rest of the year? And then on your cash flow, you mentioned obviously the heavy increase in working capital. Has there any structural change been that you've seen in -- with regards to the payment behavior for your OEMs now in Q1? You said you -- it was better in Q4 than you had expected and that's flowing out now. And to what extent -- if you are getting paid later by the OEMs, to what extent can you pass this on through the chain onto your own suppliers?
So China expectation for Q2. Well, I could say if you had asked me mid of March, I would understand why we are seeing the first months, which is getting stronger in China. This was March. Unfortunately, in April, the first numbers I saw are already weaker. And actually, this was confirming through the months of -- I think the message is it is still quite volatile and it is clearly not anything to be seen at the moment, which is directing that [ for any ] business, automotive car production in China is moving up. Again, as I mentioned in my brief presentation, guidance, our call-offs are for 3 months. So we are not yet in a position to see specifically the important months of the second half year, which start with -- after the vacation months through September. And so it is a volatile environment in China which, at the moment, is not showing more significant signs of recovery. And inventory levels in Europe, for us, no reliable number available. So actually, I don't want to comment on that. We don't have -- we see different numbers. I think we have discussed it sometime and I have no clear indication on which level Europe is. I did not hear from some side that it is on a specifically high level, but again, no numbers available. The working capital increase, as I mentioned, we don't see a structural topic developing out of that. Your question if the payment behavior of the OEs would significantly change, what the answer would be this would need a change in our payment terms, negotiations with the OEs. And I'm not aware of any discussion with any of our major customers, which is going in that direction. What we noticed at the end of the year 2018 was that surprisingly -- from our point of view, surprisingly good payment behavior and payment of our customers, which then relates to the EUR 1.9 billion free cash flow generated last year. We mentioned this in January that this was the reason why it came out a little bit higher than we had expected, and this is something which then automatically reverses in Q1 if this does not -- payment behavior does not continue, and it did not. It did not go to any level unseen before on the negative side, but it was still baked to a more expected normalization. And just to add this, on the side accounts payable again, we don't see any structural change in these numbers. So it should normalize over the rest of the year.
Okay. Then just a quick follow-up. So on production in Germany or in Europe that has been weaker, what's sort of your view over the next quarters? I know you obviously have your full year outlook, but do you think that it's going to pick up in the second half just on the ContiTech? Or is there something structurally changing? And then just a clarification on that R&D capitalization that was asked earlier, the 90 bps in Q1. You mentioned that the level for the full year is only slightly up year-on-year. Can you give us a little indication what that -- what you mean with that in terms of the implication and the support to the margin, which -- obviously that means it falls away in the other quarters?
So Europe, Q2, our expectation is similar as Q1. And if you have a look at our numbers broken down by the market, you would see that Europe in H2 is not very much helping to get to a flat market. It is more -- our expectation is more on the Chinese market. We -- on level of capitalized R&D, as I mentioned, this was a spike in Q1. The R&D capitalization always takes place when a project achieves a certain project status, and we are not trying to manage this in a way to manage our quarterly results. And there was 2 orders which still were capitalized at the end of the first quarter. As I mentioned, we don't expect the level to be significantly, for the total year, above the level of 2018. We still try to keep it as low as possible, unchanged, positive, which we have. With more software overall we saw this last year, the level is slightly increasing versus prior year.
Okay. Can you clarify, was it about EUR 160 million last year for the full year?
I have to check. Yes. Yes. It's right, yes.
The next question is from Thomas Besson of Kepler Cheuvreux.
I'll start with group SG&A, please. If I look at it correctly, they seem to have gone up about 7% while the headcount have gone up about 2%. So can you help me understand what I'm missing specifically? As you say, you have started taking cost out and it looks like -- or the timing at least, part of the [ selling ennui ] is really with expenses [ often ] is going up.
I'm just looking at which line -- oh, selling and logistic expenses.
If I sum up the EUR 667 million and EUR 291 million and compare it with the previous year, EUR 608 million, EUR 287 million so that kind of an approximation of SG&A. They seem to be going up a lot more than you had counted or maybe that includes some logistics expenses as well. I was a bit surprised to see lines continuing to go at this point.
Well, this is right. This includes some logistics expenses, which we saw higher in the Q1, which, I think again over the year, should not be. This includes as well some of the carve-out costs, which I included in that, which were not reported for in Q1 2018. And this is, I think, the major part of this increase.
Okay. Great. On another topic, on the tire side, several companies, Michelin, Marciano have talked about a fairly challenging environment in Europe notably linked with an unusual weakness in the German passenger tire replacement market. Can you talk a bit about that with the pricing in environment and how you've managed to have flat volumes for your passenger tire business despite your natural exposure to Germany?
Well, I agree with the European market overall. The -- I would not only limit it to Europe -- to Germany. The European market overall was the more challenging market, which we have seen. This is true for volumes, and this is true as well for prices. And we -- on the overall replacement tire market, we compensated this with quite an okay development in the U.S. North American market.
Okay. Great. Last one, if I can. I mean we've talked about the decremental margins in the automotive business. The one division that developed a bit less well than the others is Interior. On a very small decline in organic growth, profitability dropped quite substantially. Can you give us an idea of the share of FX in that drop and the share of the evolution of the geographic mix in that decline, please? And should we expect profitability in Interior to improve sequentially more than in the other division as a result?
Well, the bigger part of the -- what we saw in FX, I mean I can -- I think the number was about EUR 25 million or so, which was burdening Interior, and this is a number which -- at the moment, we don't see that the FX effects are changing and that this number should change over the next -- at least not in the second quarter. So this is a burden which seems to continue at least for the first half of the year. And I mentioned the reasons behind it, I think, electronic component.
Okay. And Interior geographic exposure was the other factor behind the higher decremental margin?
No. No. I just tried to clarify. The...
It's Bernard here. I think Thomas, you're about -- talking about the geographic exposure of our purchasing volumes, right?
Yes. Yes.
Which is not only very highly dependent on the dollar and the yen because electronics components we buy from chips to displays are priced in those currencies. It would derive a lot of our sales also in euros and other currencies, which have depreciated again.
The next question is from Henning Cosman of HSBC.
Maybe on this last point with the sequential margin development not only on the Interior division but more generally. If I understand you correctly, I'm not prepared -- I'm not sure if you prepared at this point to give a bit of an indication or steer into Q2, as you've done last time for Q1. But from everything that you're saying, it sounds like you're not really expecting a significant pickup in margin quarter-over-quarter for the second quarter, seeing that most of the drivers are still remaining rather weak and that most of the pickup will only come in the second half. That's the first question. If you could please confirm that. Then secondly, on the one-offs themselves, positive one-offs, if you like, I understand that the reversal of the provision for the employee bonuses that was in the mid-20s of Euro million. I think the sort of overall beat, if you like, at the time to -- the range that you had indicated was more in the 50s. I think there was a perception in the market that a lot of the beat had also come from a reversal of -- or write-up of tire inventories. I think that was a lot smaller. At least you haven't mentioned it so far. If you could please also clarify that. And if possible, I mean if you're thinking about it in the dimension of explaining roughly EUR 50 million beats, where consensus was, or your earlier indications, where the remainder has come from. If you could break it down into inventories, FX and reversal of provisions, if that's possible at all. And then finally, just to understand the free cash flow a little bit better. Is it possible at all for you to give us a normalized level of net working capital to work with so that we can almost eliminate that from the way we think about free cash flow so we can have a better way of almost modeling the free cash flow?
To start with the first question, assumption is right that quarter-over-quarter, we see in the second quarter sideways development and pickup is expected to come in the third quarter. And the one-offs we mentioned is a bonus payment which was the biggest part out of these EUR 50 million, and then for the rest, there were other smaller things which add up to this amount. The Tire division, I think this was part of your question. The Tire division, I understand it as referring to last year where we had, in Q1, inventory valuation and FX effect. The FX effect in the end stayed on last year's level though in a somewhat different currency mix, but the principle that those countries where we don't have production, smaller countries, although we import tires to there, in the end, we had this negative currency situation. So not again a hit of EUR 50 million like last year but now reversal of it. Either for the topic of raw materials and inventory evaluation, which we had last year as well, we had a slightly positive effect of [ building the ] Tire division, which was in the level of something like EUR 10 million to EUR 20 million, so not -- by far not on the level of what we had seen last year. And yes, this was positive in the Tire division and this helped somewhat for the tire profitability. And normal level of working capital, I mean if you take last year's level of working capital, this should be the expectation which you can take as well and put in the ground for 2019.
Even though you had the benefit of this earlier than normal payments, you would want us to think about a level of around about 11% of revenue?
Yes. About, yes. And you always -- I mean, Cosman -- you cannot -- you always have this effect of the EUR 200 million more or less payment of the customers at the year-end and, as we noted, very hard to predict.
Okay. And if I can squeeze in one more on HEV. The losses haven't really improved. Are you expecting this to pick up now with a more significant rollout of hybrid parts on part of your OEM customers?
Expectation is that this improves specifically starting next year, as we mentioned I think already in earlier quarters. And the volumes really pick up at the moment. We are ramping up many programs. This is still burdening some of the profitability, but yes, we clearly expect this to improve significantly in '20 and '21.
The next question is from Frank Biller of LBBW.
The first one, coming back to this electrification, speed of transformation, maybe you can give us a view on how is the speed there in hybrid electric vehicles, battery electric vehicles? It seems to me that the speed -- it speeded up a bit in the last couple of weeks or months, especially coming from governmental purpose this year. Second question is on IFRS 16. Maybe you can give us here an effect on the earnings line, EBIT or EBITDA? Was there a small positive impact? And how much was this? And the last one is, can you confirm the target for net indebtedness for fiscal year '19? Earlier, it was mentioned -- so to double this EUR 1.7 billion to EUR 3.4 billion. Is this still the expectation for fiscal year '19?
Well, the IFRS effect, to start with that, on EBIT is basically not mentionable. We have an overview in our presentation and the backup for the IFRS 16 effects on Page...
25.
25. So I think this should answer your question. HEV, hybrid, we don't see structural -- versus our expectations from quarters before, we don't see a structural -- a stronger change at the moment in call-offs and, anyway, orders but in call-offs from our customers between hybrid on the one hand side and electric on the other hand side. The customers have made decisions on which path to follow mostly already last year because then time is starting to run out for finally getting into production. And we did not see the bigger shift from the one to the other recently. While -- and the target for the net indebtedness, as you know, we don't give a guidance for the net indebtedness number, but I mean if you take those outlook numbers together, I think you can get an idea. Or this effect of IFRS 16, this EUR 1.7 billion to EUR 1.8 billion is a number which will stay until the year-end. This number is not expected to move or change very much during the year.
And no big impacts coming from acquisitions or these new structural things?
No. We don't foresee from the structural things a bigger effect on the indebtedness and M&A. Obviously, it's always a topic which, when it occurs, would be something which affects the net indebtedness.
The next question is from Tim Rokossa of Deutsche Bank.
I would have 2 questions, please. The first one is on your second half confidence. I think it is very easy to see how markets have very low confidence in recovery. And we also see this in your production estimate. But when we look at the outperformance in Q1, it was also relatively low. It mainly has to do with Chassis & Safety probably where you should have these problems fading out towards the second half. Is your confidence in H2 simply based on the fact that you expect markets to recover although you also see your outperformance going? And can you just confirm that the problem in Chassis & Safety is basically fading away in H2? And then secondly, when we think about the full year estimates -- and I think, Mr. Schäfer, we had always this discussion in the past that the margins in tires are unusually high and would have to come down and -- but the automotive margin is limited because of rising R&D spending, for example. But when we just look at your absolute EBIT and free cash flow, you are now targeting EUR 1.4 billion to EUR 1.6 billion free cash flow on EUR 46 billion of revenues and EUR 4 billion of EBIT. When we look at the numbers 5 years ago, you made EUR 12 billion lower revenues but you had a higher absolute EBIT number and a EUR 400 million higher free cash flow. Is the main reason for this development the investment need? And will we come to a point where the free cash flow and the absolute EBIT will revert again and increase more in line with revenues? Or is this level just a level that if you're comfortable with and whatever you make on top of that in cash and earnings, you will just invest into growth?
The guidance includes as far as the outperformance is concerned in the first half of the year, a number which is somewhat lower than in the second half of the year because, as mentioned as well in the presentation, we expect Chassis & Safety basically having this base effect of the lower Chinese volumes and the one customer to [ fade out ] -- to annualize and from then on growth rates automatically from a lower base do look better. To the margin and cash flow development, we had -- I think the -- you were referring towards -- when the Tire division was having 20% plus profit margin. This is down now to a level of 15%. And I will say the EBIT in Tire was one-to-one linked with cash generation. So as long as we are on this lower level of the 15% in tires, a big part of the free cash flow will not be back. Working capital, I think we've mentioned before that the working capital level of last year is quite a good indication. And our guidance for the investments, capital expenditures, which is about 8% of the sales, including IFRS, if you take IFRS out, this is closer to 7%. This as well is something which we foresee at the moment for this year and probably not significantly different next year.
So it much rather has to do with the fact how your business mix is rather than the fact that you have maybe defined a level of EUR 4 billion of adjusted EBIT and EUR 2 billion of free cash flow as sort of the comfort level, and anything above that, you would just continue to spend into growth but it's much more about how much tires contributes this year and how your business mix [ would change ]?
This is -- and this is the biggest part of it. Yes, correct.
The next question is from Sascha Gommel of Credit Suisse.
The first one would actually be on the upcoming CO2 targets and how that impacts your Powertrain division. Do you see any OEMs that are kind of a bit more desperate coming to you because they realize the targets are a bit more challenging with the falling diesel share? And also, how do you foresee the profitability of potential new products that are ramping up over the coming quarters? And the second question would be on your market outlook. I think most suppliers these days are kind of downgrading their numbers a bit, particularly because China is performing in Q1 a lot worse than expected. You maintained your outlook at flat, which is probably now the upper end. What gives you the confidence that this is the case? And what would it mean if the markets would indeed be a lot weaker? Will we see more restructuring for you?
Well, mainly we notice that customers are asking more for nondiesel and diesel products because their share is on a lower level than it was 1 year before. We don't expect this at the moment and don't see any indication in our call-off that this is going to change partly sometimes even just the opposite of further reduction. Our outlook for the year is positive in the second half of the year, and our guidance is including that this would not happen and that the markets would slightly decline on a total year basis. And I think if you just look at the numbers and our guidance range, which we have given, I'd say, up to 3% downturn of the markets should still be something which is covered in our overall guidance.
Okay. And I sneak in one last one. Do you plan to host a Capital Market Day to explain the new kind of targets for the new division setup at some point?
Do we -- do what on a potential capital market? Could you repeat?
Are you planning a Capital Market Day to explain the strategy post potential carve-out or even for the new structure of Conti at some point?
Yes. It's Bernard here. So those things are maybe coming but nothing has been announced yet at the moment. As you know, for the Powertrain business, we have said that market communications could be basically starting toward the end of this year.
Thank you. As there are no further questions, I would hand back to Mr. Wang.
Thank you, everyone, and thank you again for your interest in Continental. So if you have any further questions, please feel free to reach out to the Investor Relations team. We stand available for your questions. Otherwise, have a nice day.