Nokian Renkaat Oyj

Good afternoon from Helsinki and welcome to Nokian Tires Q2 2019 results conference call. My name is Päivi Antola and I am the Head of Investor Relations in Nokian Tires.

And together with me in the call, I have Hille Korhonen, the President and CEO of Nokian Tires and Teemu Kangas-Kärki, the CFO. As usual, we will start the call with a brief presentation by Hille and Teemu and then continue with a Q&A.

So Hille, please go ahead.

Thank you Päivi and thank you all for joining us today. Let's start by summarizing the key takeaways from the first half of the year 2019.

As we have stated, the challenges in European market continued also during the second quarter in 2019, impacting our passenger car sales. In total, we are flat year-over-year, supported by growth in Russia and North America as well as good growth continuing in heavy tires.

Despite of these market uncertainties, we continue to pursue our strategic agenda going forward. And clearly, our focus is continuing to execute our strategic initiatives, especially the U.S.

factory ramp up in Dayton. Then let's take a look at the second quarter, which was somewhat different compared to the first quarter.

Net sales declined in second quarter compared with strong second quarter in 2018 in passenger car tires. This volume decline was partially offset by improved price and mix.

We have been able to increase our average sales prices in all our core markets, except Central Europe. Slight price increases have been implemented both in Nordics and Russia.

And in North America, we see now the price increase impact from last fall. Operating profit was impacted negatively by volume decline, which is mainly coming from Central Europe and Nordics, material cost increase, which has not been fully compensated by price increases and also increased activities related with our strategic projects in terms of planned OpEx investments, for example, in R&D, recruitment of the first production teams in Dayton factory and ramping up other activities in support operations, for example, in IT.

During the second quarter, we have been focusing also on efficiency improvements and adjusting cost base in general. And I give you a couple of examples.

For example, the structural change we did in the Nordics when combining Norwegian and Swedish organizations, that's bringing some cost benefits for us this year and also there will be some additional cost savings coming in the coming years. We have been doing some savings in other operational activities and also we have been adjusting the capacity in our Finnish factory in Nokia to lower demand through temporary layoffs.

And at the same time, it's good to remember that we are the most profitable tire manufacturer. And having said that, we are quite pleased in everything we are doing.

So there are no huge savings opportunities in other parts of the company. When summarizing the first half in total, we are on previous year's level in net sales.

Net sales growth coming from Russia and North America and good growth continuing in heavy tires. And it's good to mention that this growth in heavy tires is primarily driven by agri and forestry applications, which are our focus segments.

And also the production volume has been growing accordingly and supporting this growth. Operating profit during the first half declined compared to the previous year.

We had a negative currency impact, especially during the first quarter, coming mainly from Russian ruble. We have been having higher material cost coming from two components, raw material costs increase and product mix and also higher production costs due to ramp-up of Dayton and higher share of production in the first quarter in Finland.

Positive thing is that profitability in Vianor continues to improve. We have been going through rationalization activities in Vianor network earlier and now the focus is keeping the operational efficiency on a good level.

Then if we look at different markets, what comes to Nordics, new car sales has been significantly down, except for Norway and the positive figures in Norway are mainly driven by Tesla availability improving during this year. We have strong position in car dealer business and therefore the new car sales has a direct impact on our sales in the Nordics.

So when people buy new cars in Nordics, they buy a set of winter tires, as the new cars come with only summer tires. Car tire sell-in has continued to decline and is now minus 4% down compared with previous year.

In Vianor business, we see the sell-out in budget segments growing in summer tires and overall the consumer visits declined. In the Nordics, we have continued to focus on profitability over volume with implementation of slight price increases.

Central European market, in terms of total replacement market, is down by 2% and the share of Asian imports has been growing. And when we look at the sell-out, for example, in Germany, it's down by 6% for summer tires.

The market continues to be highly competitive with oversupply as OE business is down and there continues to be more supply in replacement market. In spite of the negative market sentiment, some segments are clearly growing, larger sizes and all-weather.

And when we look at the pricing it's, of course, a very competitive market and the prices, especially in the larger sizes, have been going down. Looking at the sales mix.

Our sales mix has been improving compared to the first quarter and we have been increasing the share of SUV tires, where the ASP is higher. Positive thing is also that we have been gaining market share in summer tires with our new products that we have been launching for August season.

When we look at the European, Central European market, there are differences in countries. There are markets where our shares have been clearly down and we have been also growing, for example, in France and Poland.

When we look at the inventory situation, the inventories are on a higher level compared to normal and this means that our customers will be ordering closer to the season when we are entering the winter tire season. North American market, the replacement market is still growing and this year, we have been growing more in U.S.A.

due to somewhat higher inventories in Eastern Canada due to weak winter. So the weather situations have been quite different if we compare the Eastern or Western side of the country.

In Russia, the new car sales has been declining more than 2% during first six months due to low economic growth, declining consumer purchasing power and increasing credits of customers. Government has been relaunching subsidies for lower priced cars targeted to increase their sales of new cars during the second half.

But based on the first half year development, we have been updating our outlook for full year sales of new cars being flat in the most positive scenario. When we look at the total replacement tire market sell-in during the first half of 2019 in Russia, it has been slightly declining, with a sharp decrease in summer tire sell-in and robust growth in winter tire sell-in, mostly driven by the accelerated timing of deliveries of our products.

The summer tire sell-out season in Russia has proceeded normally with the sell-out volume remaining flat compared to 2018. So as a result of that, the summer tires stocks in distribution, they have decreased compared to 2018 because the sell-in has been on a lower level.

And as you remember, we started earlier deliveries of winter tires this year to compensate the decline of summer tires and we have continued to deliver winter tires during the second quarter as well. And as a result of that, the total inventories are now on a higher level compared to the previous year because there are more winter tires in the channel at this point of time.

When we look at the full year, the total replacement tire sell-in in Russia is expected to slightly grow between 0% to 3% versus 2018 with winter growing and summer tires declining. When we look at the mix, this segment has been stronger and we have actions in place to improve sell-in and sell-out of A-segment in order to improve our sales mix for the second half of the year.

And when we look at the rest of the year, our sales volume in Russia is expected to be on the previous year level, but net sales is expected to increase due to better mix. And now I am handing over to Teemu to look at the numbers, key figures more in detail.

All right. Thank you Hille.

Hille covered already the group net sales and operating profit figures so I will go straight to the first half profit for period, which was EUR267 million and reminding you all that there we can see the positive impact of the rulings of the tax disputes that is now final and the amount in our operating profit is about EUR150 million. The comparable earnings per share for the first six months is EUR0.86.

And our cash flow for the first six months was negative approximately EUR90 million. If we look the comparison figure from previous year, EUR150 million, there we can see, again, the positive impact of the tax ruling.

We got the money already last year and now this year, when the decision is final, we booked that result. And therefore, these figures look like they are this year compared to the previous year.

Then going to the interest-bearing net debt. At the end of Q2, our interest-bearing net debt is on a level of EUR252 million, of which half of the increase is coming from the IFRS 16, the leasing liabilities that are now booked to the balance sheet.

The CapEx spending in the first half was on a level of EUR140 million, of which about 70% related to these strategic projects like the Dayton factory, heavy tires investments and the Spanish test tracks. Then moving to the passenger car tires business.

In the first half, our comparable growth, topline growth was minus 1.5% due to the lower volume. Our gross average sales price with comparable currencies increased slightly due to both mix and prices.

Our operating profit was on a level of EUR143 million and it decreased due to lower volumes, higher material costs and currencies, especially in the first quarter as well as we have increased spending relating to the North American projects. As said earlier by Hille, we have adjusted our production capacity utilization rates in line with the market demand.

And in the second quarter, our Russian production was more or less on the same level as in the second quarter 2018. And we have several activities ongoing that was already mentioned by Hille in order to be better aligned with the new requirements of the markets like the Nordic structure and then we are having more focus in the Central Europe for that new kind of market situation that we are facing.

And here, you can see the first half passenger car tires bridge in terms of net sales and EBIT. Volume down 2%, positive price/mix 0.5% and then the currency impact negative about 0.5% point.

And there, in terms of EBIT, you can see the drop in volume, increased material costs and then other costs, where we can see our projects that are ongoing, contributing to the higher cost base. Here now for the first time, we have prepared this slide that you have been asking from us.

There you can see the trends split into volume, price/mix and currency components. And if I start with the currency component, you can see that towards the end of first half, the negative currency impact has been turning, so we are expecting for the full year, more or less neutral effect from currencies.

And then in terms of volume, you can see that the growth looked different in the first half last year. And now clearly, there are more headwinds, especially in the European market.

Here you can also see that the price/mix positive impact in the second quarter where we had a negative impact in the second quarter in Central Europe, but then in other business areas we had a positive impact. Moving to heavy tires.

The topline for the first six months was on a level of EUR96 million. The growth with comparable currencies for the first six months was on a level of 7.2%.

In the second quarter, the growth was 2.6% and there were some deliveries shifting from Q2 to Q3. And as we have been indicating earlier, the sales of agricultural tires and forestry tires have increased, in particular.

And looking to the Q2 results this year, there is a clear increase, which is due to the sales growth. But I also want to remind us that last year in the comparison period, we had some negative inventory valuation that we are then burdening the result in Q2 2018.

And then last week, we acquired Levypyörä, a smaller acquisition, annual net sales of about EUR18 million and this company supports the heavy tires strategy and enables a good service for our customers in the short term and in the long term. And then the last business unit in our portfolio, which is the Vianor.

There, we have been progressing according to the plan. And for the first half, the topline growth has been on a level of 1.4% growth.

And the operating losses has reduced to the level of EUR2.6 million in the first half. And as you remember, the profits are then generated in the latter part of the year.

And in the first quarter, we had an early start for the season and therefore, the second quarter is slightly weaker. But on a first half year basis, it is in line with the expectations.

Then let's take a look at the outlook. I would like to repeat some of the assumptions we have regarding the markets.

European replacement tire market is expected to be flat compared to previous year and our updated view on Russian market is that new car sales will be lower or on previous year level and replacement tire markets will grow slightly, declining in summer tires and with some growth in winter tires. We are keeping our guidance for the full year unchanged.

So net sales with comparable currency is expected to be slightly higher compared to previous year, driven by some volume growth and some positive price/mix impact during the second half of the year. Operating profit is estimated to be lower compared to previous year.

And we are expecting less currency impact during the second half. Material cost for the whole year will be increasing 3% to 4% and we will be carrying additional operating cost as we are ramping up the North American factory.

And this is also including some cost savings from other operating activities. And our strategic journey continues and it's realizing through our strategic projects that are supporting the future growth.

And if I would summarize all of them, they are all proceeding according to the plan and according to the cost budget. And here, you can see on the picture, clear evidence of the first tire produced in our North American factory in Dayton and the local team and support teams from Russia and Finland are very proud of the achievement and it was exactly on the date that we had set as a target.

And in addition to the physical building and construction works we are doing in North America, we are doing a lot of activities to create the goal and demand from the market. And as you might know, most of our growth during the past five years has been coming from growing with existing customers.

And that is also part of our plan moving forward. We will continue to grow in winter tires.

Our focus is still Canada and northern areas of U.S.A. We still have one big province there, Ontario, which is to be conquered and then we will be growing with existing customers in U.S.A.

by adding North American specific sizes and products. And I can confirm that the new products and sizes are in our R&D pipeline already.

And additionally, we will be developing focused all-season offering for selected niche segments and also adding and building new customer relationships in the areas where we are not yet present. And we are tracking this development.

For example, in 2019, we have been adding quite a few new customers and increasing the number of point of sales where we are selling our products. And in marketing, our focus is on point-of-sale marketing and supporting the sell-out of our products and training the counter people how to sell our tires.

So we are moving ahead according to the plan also in the market. And let me remind you of our three-year plan, which we have been communicating in Capital Markets Day in November and it is still very valid and we are moving ahead with all of these activities.

Good. Thank you Hille.

Thank you Teemu. And now operator, we would be ready for the questions from the audience, please.

Thank you and hi, everyone. I have a couple of questions and starting on the inventory situation in Russia.

Could you please help us a bit here elaborating on, if we start with the summer tires, you mentioned that it's slightly lower compared to last year. Would I draw it too far going conclusion if I assume that, that means that it will not be a limitation when it comes to the sell-in in the later part of the year when we arrive to the summer season?

I will pause there for the next part.

Yes. Thank you for the question.

It will not be a major limitation. However, when we look at the total inventory levels, there are still plenty of additional winter tires.

So we are also then dependent on how fast the winter tires sell-in is proceeding during the season. But I would say that it's not such a big limitation compared to previous year.

Okay. That was actually the second part of this question because when you talked about selling more winter tires during the first half of the year to compensate for the lower summer tire sales, it does sound like this will sort of cannibalize some of your usual H2 sales, which I think that you more or less talked about here.

But finally, a question for Teemu. You mentioned on the conference call in June after you had lowered the guidance, where you gave us more flavor on the EBIT for 2019 where you said that the lower guidance reflected a single digit decline year-over-year.

Would you say that this still is valid?

Yes. The guidance from June is still valid and no change in the view.

Okay. Thank you.

Thank you. Three from my side.

First one, again, on volume and coming back to the production in Russia for Nokian in the first half and how that, even I am struggling to understand how there is more growth in the second half after, as you mentioned, you have been pre-selling winter tires already in the first quarter. Can you explain how you are looking at growth in the second half?

A bit more details around that? The second question is on the free cash flow.

Working capital has been a bigger drag this year. Does it relate to the ramp-up in NAFTA?

And how are you thinking about free cash flow for the full year? If there is any guidance, Teemu, on that, please?

And the third question is can you quantify the ramp-up costs that you have already incurred in Q2 in NAFTA, please? Thank you.

So thank you. If I take the first question regarding the growth in the second half, we are expecting some volume growth during the second half.

And it's, of course, when we compare it with the previous year's second half, the comparison level is quite low. And we are expecting some growth from North America, some growth from Central Europe compared to previous year.

And improving mix in Russia with some minor volume growth.

And then if I continue with the working capital components for the first half. So first, we need to exclude the tax dispute effect in last year and this year.

So if we look at the change or the delta on comparable basis in the first half this year, the delta is negative of EUR86 million, of which about 60% or EUR53 million comes from increased receivables and the majority of that is coming from Russia and especially early deliveries of winter tires.

Okay. And just on the ramp-up costs in NAFTA, if possible?

The ramp-up costs, they are included in our operating profit. Some impact also in the working capital.

But that is not, at the group level, a major factor. Naturally, in the cash flow, the CapEx has a big impact and as we have been indicating for the full year, the CapEx spending is on a level of EUR300 million, of which EUR148 million was already spent in the first half.

Okay. Thank you.

Yes. Hi.

This is Artem from SEB. A couple of questions from my side.

I will take one by one. The first one is relating to sales mix, which was improving in Q2.

Could you maybe comment whether the mix has been quite normal in the quarter? And maybe if you can provide some comments relating to second half and how we should be seeing it about mix.

Because you mentioned about Russia, but what will be happening in other regions mix-wise?

So the sales mix during the second quarter was improving compared to the first quarter, where we had higher sales of B-segment in Russia and also selling out some inventory of older products. So I would say that the second quarter was more kind of normal.

And when we look at the rest of the year, the sales mix is expected to improve in Russia, where we would be selling more A-segment compared to B-segment. And also in other markets, we are focusing on selling more SUVs, where the ASP is higher.

Okay. And then maybe the second question is relating to cost initiatives, what you mentioned, gave an example relating to Sweden and Norway, basically sales organizations being consolidated.

Could you maybe talk about what type of magnitude we are talking about here, when you are focusing more cost side as well right now? Is it some single million euros on full year basis or a more substantial number?

Well, you are spot on, on the magnitude. So single.

So it's something, all right. All right.

Very clear. And the last one is to Teemu relating to ramp-up costs for 2019.

Is the number what comes to U.S. ramp-up still roughly EUR20 million as a negative impact?

Or should it be more or less?

That is still valid.

Very clear. Thank you very much.

That's all from my side.

Hi. Thank you very much.

Actually just a follow-up on the point on the ramp-up costs. Can you sort of outline a little bit how much of those EUR20 million we have gone through so far this year and how much you are expecting in the second half?

And that's, in particular, in light of your guidance, you are down now about 13% year-over-year. Yet you say you want to get to the mid-digit point for the full year in terms of your guide, which implies a flatter market in H2 whilst I think you were guiding to increasing ramp-up costs.

That was the first one. How does that sort of square up?

And then the second point was actually coming back to the point of Akshay. With your deliveries into Russia, you mention on your working capital, you have had increased receivables as you have done already early deliveries of winter tires into Russia.

Just to come back to the point, obviously those would have been booked in your sales now and wouldn't then come through in H2. What replaces those volumes that you did now in Q2 that you would really need in terms of to get your sales guidance and your earnings guidance?

Okay. In terms of the ramp-up cost, as we have been indicating already earlier, so the costs are geared towards the second half, but already in the second quarter, we started to incur, especially costs from the Dayton factory.

Then in terms of, just to reminding all of us about the receivables, how they will be developing, so we are peaking our receivables in October. So that is the time where we have the highest receivables on our balance sheet and then gradually going down.

I would like to comment still the Russian receivable situation. So we are basically having a business model where we are financing the pipeline and as Teemu stated, the receivables are highest in October and we will be collecting all the receivables in Russia by year-end.

That's very helpful. I am not so much about the receivable collection.

It's more a matter of if you have already sold the tires now and recorded the sale. Is that something that we are then missing in H2 that we have planned with before?

So that has been the normal practice. So there's no change in that.

No change.

Okay. Perfect.

Thank you very much.

Thank you.

Thank you. I just wanted to ask about the outlook for the Central European volumes in the second half.

Some of your peers have mentioned that dealer inventories for winter tires are fairly low and they sounded quite optimistic on the winter season despite all the gloom in the market. So are you seeing the same?

And how do you see the winter season in Central Europe? Is that the reason why you are expecting volume growth in that market?

Thanks.

Yes. We have the strongest position in winter tires in Central Europe.

And we also have the view that the winter tire inventories are kind of normal. So no big, big worries about those and we are expecting normal winter.

And it's good to remember that the normal winter for Central Europe means that the snow should be falling down by end of November and that's when the tire dealers are then starting to sell-out and replenish their own inventories. And it looks like the market is such that when the summer tire inventories are on a high level, they practically have less space than earlier years.

So it means that they are ordering later and closer to the season than normal.

Okay. Thanks.

Can I just have one follow-up to the previous one? I think winter tires are 70% of your total volumes.

Is that the same number in Central Europe? Or is it a lot different from 70%?

I would say it's very close to it.

All right. Thank you.

Hi. Thank you.

I was also going to ask about the working capital. I think we are almost at, if I could just clarify again, the walk, Teemu, that you did, that was just the difference between the H1 number this year and the H1 number last year, adjusted for the EUR148 million.

Is that correct? And then you attributed the difference to the early sell-in in Russia.

Just so I understand correctly?

Yes.

Okay. Great.

And then in terms of the collection, just to confirm again, there is no concern at all on your part that the collection might be any more difficult than in previous years. I think you have indicated before that Russia is maybe a little bit difficult in terms of the economic environment.

In the past, there were sometimes issues with debt collection in Russia. No recurring or returning concern there at all?

Not in terms of Russia.

Okay. Great.

And then finally, on the free cash flow for the full year. If you could just remind us if with this sort of working capital effect in the second quarter then, the tax effect is completely digested.

So if we make the same adjustment that we do for the second quarter to get to a full year free cash flow number with 2018 as a base, that's the right way to think about it?

Yes. So the tax benefit impact is now fully in our cash flow figures and that won't change during the balance of the year.

Okay. So I take the full year 2018 free cash flow number minus the EUR148 million minus a little bit for a tiny, little bit lower EBIT contribution and that gets me to the number very simplistically, right?

Yes. If you talk about the cash flow from operating activities.

Yes. Okay.

That's perfect. Thank you so much.

Thank you. If there are no additional comments, then it's starting to be time to finish the call.

Hille, anything you would like to add to the end?

Thank you. I would just like to conclude that the challenges in European market continued during the second quarter and we see that the market will be kind of flat for the rest of the year.

And in total, we have been growing in Russia and North America during the first half and having good growth in heavy tires and looking at the outlook and market situation and our own plans, we are keeping the guidance unchanged.

Thank you Hille. And thank you all for participating and have a good day.