SFFLY - Schaeffler AG (SFFLY) Q1 2023 Earnings Call Transcript

2023-05-14 13:51:15 ET

Schaeffler AG (SFFLY)

Q1 2023 Earnings Conference Call

May 9, 2023 04:00 ET

Company Participants

Renata Casaro - Head of Investor Relations

Klaus Rosenfeld - Chief Executive Officer

Claus Bauer - Chief Financial Officer

Conference Call Participants

Christoph Laskawi - Deutsche Bank

Sanjay Bhagwani - Citi

Michael Punzet - DZ Bank

Presentation

Renata Casaro

Dear investors, dear analysts, thank you for joining the Schaeffler Group First Quarter 2023 Earnings Call. As usual, our call will be conducted under the disclaimer.

Without further ado, I will pass the floor over to Mr. Klaus Rosenfeld, CEO of the Schaeffler Group; and Mr. Claus Bauer, CFO. Klaus, the floor is yours.

Klaus Rosenfeld

Renata, thank you very much, ladies and gentlemen. Welcome to our quarterly earnings call for the first quarter. You have the presentation in front of you in a new refreshed format. And I think with some very encouraging numbers for the year 2023. If you follow me please to Page number 4, where you have the overview with the key messages. I think you saw the results already 10.4% growth in the first quarter, all divisions contributing and Region Europe leading with double-digit growth. An improvement in the gross profit margin of 0.5 percentage point over the first quarter 2022, mainly driven by the exceptionally strong quarter in automotive aftermarket and then an EBIT margin of 8.1%, certainly above the guidance range.

Also here, we can say that the 2 automotive divisions contributed most of the improvement first quarter 2022, €6.9 million, so 1.2 percentage points better than previous year. Free cash flow slightly negative. If you include the restructuring cash out €105 million in the German wage inflation lump sum of 35, you see that the underlying free cash flow is positive. It's better than expected. And we see this again as a strong sign for the cash generation power of the organization. We have decided to keep the guidance confirmed, although the first quarter is encouraging and we'll clearly see and wait what the second quarter is how that is going to develop.

One other strong development is from the balance sheet point of view, despite the acquisition of Ewellix, our leverage ratio is definitely in the range that we -- where we want to have it. And we saw Moody's upgrading the rating to investment grade again so strong support from the balance sheet side. If you go to Page number 5, you see the breakdown that you're used to by division and by the different regions. And as I said, all the divisions and all the regions contributed. Then on the next page, Page number 6, some highlights and lowlights. I think on automotive technologies, we can say that our strategy in terms of managing the portfolio, the transformation from mature {Indiscernible] to new chassis is definitely paying off. We saw continued strong growth in E-Mobility and chassis and that is once again exemplified by the order intake in Q1, nearly €1 billion in e-mobility is half of what we promised for the year 2023.

Aftermarket, I think is the star in this quarter, not only with more than 25% growth but also with a superior quality of earnings, 17.7% speaks for itself. It's even above the range for our midterm targets. And it tells us that the hard work that has been done to clean up some of the logistical issues starts to pay off. There was definitely positive development from the demand side because in these times, people tend to repair cars. Our solution offering is spot on and with a solid work on the fixed cost side that then leads to margins like the one that you saw in this first quarter. Industrial is in a slightly different situation. As you know, we closed Ewellix in Q1. And that led to PPAs. You will see this later on, 0.6 percentage points for the divisional results. Ewellix helped to fuel the growth, 13.4% includes the inorganic [ph] portion and that has also supported our industrial automation growth. All the other 3 market classes also grew what is remarkable here and to some extent, not unexpected is the growth in renewables, all regions are growing. So, we feel good about our industrial business and we'll continue to build that forward. The ECO-Adapt little acquisition that we signed and closed is one of the next examples why we will continue to invest into our Industrial division. Free cash flow. I already said this, solid better-than-expected underlying cash generation. And I'm confident that, that continues over the rest of the year.

One of the -- on the negative side, what is concern, add to me, that the outperformance in Automotive Americas, that was an outlier. You saw that in the table. The negative outperformance here has to do with declining raw material prices in the U.S. We have more price adjustment clauses in the Americas and elsewhere and also had to do with transactional FX. Claus will explain this going forward. And for sure, I put this year in the negative, there is more room for improvement, good performance overall. -- but we'll continue to focus on our quality of earnings and see that we execute where possible on further improvement potential.

Let me go to Page 8 and you see the new format is a little lighter than what you had in the past. You have all the key numbers on here. Automotive Technology is 4.3% margin. The sales growth was 6% rather moderate driven by Europe. As I said, there is a negative outperformance in the Americas that Claus will explain in more detail. What we can say and that's more the midterm view, we feel that our position in the U.S. from a strategic point of view is very good, in particular when it comes to the local half and BEV programs One example is the quality award we got from GM, where we see significant future business on their new platforms.

Increase in margin, as I said, is driven by the work that we have done in the past, all the restructuring steps but also by price, volume and better fixed cost absorption. You see the order intake on the next page, number 9, as I said, around €1 billion for e-mobility on track to achieve our annual target. You see 2 of the interesting order intakes, one for e-mobility, one for the more mature business. The one for e-mobility is truly something exciting. We are entering as one of the first foreign suppliers. The Indian EV market with a 2-in-1 e-axle where we got nominated for that project by one of the big players in India. So, EV business is also becoming part of the Indian market. On the other side, second example, a new nomination received with high order intake for an electric chemphaser [ph]. That tells you that also in that situation that we have with all the EU regulation carmakers are still coming to us for mature business. This is a lucrative one and we are proud that we can support our customer with that technical innovation.

Aftermarket, I think I said it already, 3 greens, exceptionally high double-digit sales growth. clearly driven by the low comps but also by strong demand. Then sales growth across the board but in particular, driven by Europe, where we have the independent aftermarket business, as you know and that has been the key driver here. And then the margin, again, several things that come together to the positive. We saw a favorable sales mix. Our price management was exceptionally good and also the operating leverage with keeping fixed cost under control started to drive the margin. I can once again say the hard work in the past that Jensen the presidents have done to clean up, in particular here, the logistical footprint in Europe starts to pay off. 11 is then a little bit more business detail. We think we can claim a leading market position, in particular in Europe. When it comes to innovative repair solutions, we have set this on and on and that is exemplified by a variety of different customer awards, the technical support is seen as a differentiator and also an intelligent pricing allows us to offset or more than offset input cost logistical performance.

We have said this on and on and it's just here to show again AKO is definitely on the right track. 12% industrial, double-digit sales growth. That is more or less half and half organic and inorganic. Ewellix consolidated for the first quarter. And that has led as we indicated to a PPA effect on the margin, -- we have decided not to retroactively adjust the margin for 2022. So, if you compare €11.3 million last year quarter with this year quarter, that's not comparing apples with apples. You need to consider that there is a 60-basis points reduction due to this PPA effect in Q1 that was not there in Q1 2022. That shows margin is also on the right track. In any case, it is in line with our guidance. What we see in Industrial is apart from managing the acquisitions and consolidating and integrating all of that that there is still room for improvement. We have explained that to you already for the full year.

The work in terms of finally integrating the different steps from the 2020/'21 program and the footprint consolidation in Europe, are still underway and we see that there are some of these natural inefficiencies that we can tackle. So that should tell you we are positive on making our margin range. In terms of outlook, yes, for sure. You see this on Page 13. If you look at the order book, the growth dynamic is coming down a little bit but we are still positive in terms of growth. The environment is certainly getting a little bit more difficult here. You saw what happened with the German manufacturing indices and numbers. But in terms of Schaeffler, we are positive that we can continue to outgrow the market. Why? Because we are definitely sitting at the right spots when it comes to the different industries and when it comes to the growth potential, that is in particular, renewables but also industrial automation. So that should help us to continue to grow in the first figures from April point definitely into that direction.

14 is a page that you know. I'm not going to say much more than what is on this page here. We continue to be disciplined on CapEx, €221 million CapEx and the investment allocation, €179 million. The ratios are all in line reinvestment rate below 1 and we continue with our strategic capital allocation framework that is paying off. And you also see that the regional allocation becomes more balanced.

Last page from my side before I hand over to Claus is on M&A. We have done now with Ewellix and also with Melia Motion and the other smaller things enough in the year 2022. It's now time to make sure that all of that gets integrated in a very careful manner. And we signed ECO-Adaptis [ph] is a small deal, just something to mention here. What is more important from my point of view is that we will keep looking for interesting additive M&A opportunities. We will continue to work on collaborations and partnerships but we will, in all what we do, be very careful to make sure that we fully understand risk and only invest where we get the necessary returns.

With that, I hand over to Claus for more details on the financials.

Claus Bauer

Thank you very much, Klaus. Ladies and gentlemen, on Page 17, we are looking at sales. And you see it's the third quarter in a row now with sales above €4 billion. That translates, as Klaus already said, to foreign exchange adjusted growth versus prior year of 10.4%. And Klaus already alluded to the Ewellix consolidation which was consolidated for the first time in Q1 of this year and that has about an inorganic impact on this 10.4% of 2 percentage points. All regions and divisions have been growing and Klaus already said, particularly automotive aftermarket, I will touch on that when we talk about the divisions in more detail.

On the next slide, you see the gross profit, the -- definitely a good gross profit margin development with sustained positive pricing across all regions. You see then on the bottom part of the right side, you see the development by division which I will talk a little bit more when we talk about the divisions, especially obviously, the automotive technologies looks a little strange with a reduction and I will explain that and automotive aftermarket with the volume -- fixed cost absorption impact and also good pricing in the market, very good margin performance, as Klaus already said. On the next page, we look at the overhead.

The overhead cost increase was in line with sales with 10.3%. As you see, the -- if you look at the table on the right side, you'll see a little bit more detail and see it but it's especially driven by the 2 divisions that had significant volume growth, automotive aftermarket industrial and that is obviously then the big impact of selling expenses that are highly variable, especially in these 2 divisions. EBIT margin on the next slide pretty much follows the gross profit development. And again, I will talk a little bit more into the detail by division which leads me to the next slide already diving into the automotive technologies division. Here, you see on the left top side, the sales growth by business division. All business divisions grew year-over-year, including engine in transmissions. You might remember that wasn't necessarily the trend of last year. E-mobility significantly outgrew the other divisions and Engine and transmission actually deteriorated a little bit. So that is already something that you have to consider. It's not unexpected. I think I talked to many of you about the potential mix impact also due to affordability of cars being more important maybe this year than it was last year.

If you look down on the left side, then you see the outperformance and what's definitely catching their idea besides the outperformance globally of 30 basis points. Clearly below our target range between 200 and 500 basis points. And what's catching the eye is obviously the negative outperformance in Americas. That has a few explanations. First of all, as always, it's not so easy to interpret this number really on a quarter-by-quarter basis. You also see the significant outperformance for the entire year 2022 with 520 basis points in that region. And therefore, you have to see the quarterly volatile single data point, maybe more in connection with the longer-term last 12 months period. But the technical impact that we experienced in the Americas right now is, first of all, as I explained in many prior calls, Americas is the region where we have predominantly material price clauses in our contracts with the automotive OEMs. That is different than in other regions and it's actually also a long-term implementation, not just because of the inflation that we have seen in the last 2 years. And obviously, you all know that material prices are relaxing significantly and that then has a -- now for the first time in a long time, a negative pricing impact on our sales number in Americas because now based on these indexes, sales prices are adjusted down.

And the second major impact that we see and that will most likely also continue for the rest of the year, although maybe on a slightly lower level is we transact a big portion of our sales out of our Mexican facilities into the region we transact in U.S. dollars. And you might know that the Mexican peso significantly strengthened versus the U.S. dollar. And therefore, we have a transactional impact on these transactions that is also negative. If we look now at the EBIT bridge on the right side, then obviously, you see despite all what I just said that there seems to be almost no gross profit impact on the EBIT line.

First of all, the transactional foreign exchange impact of U.S. dollar transactions out of Mexico, is impacting that column here negatively. But much more important is -- and you see in the other column, you have a very significant positive impact. And you have to look at these 2 columns in connection because you might also remember last year, we started to include our equity shareholdings in our EBIT divisional EBIT and one of the equity shareholding that was significant is Schaeffler Paravan the steering company. And this, as we also said, in preparation of last year, we'll have a negative margin impact because it's a company that had a negative result.

So now we acquired at the end of last year, the remaining 10% of this company. And now we are fully consolidating and not consolidating equity. And that means that negative result now wonders from the others column because it was in other income and expenses into the full-blown fully consolidated P&L structure. And therefore, now you have this positive impact in the other category and a hidden negative impact, if you will, in the gross profit area because now you're fully consolidating this company. From an EBIT standpoint, it's neutral because we included it already last year. The only additional impact is obviously that we are now including 100% and not just 90% of the EBIT impact but that explains. So, what looks a little strange in this bridge that there is no structural impact on the EBIT. And it comes all out of others. It's really explained by this reclassification of Schaeffler Paravan and therefore, the 0.8% clearly come out of the much better gross profit and operational performance, mainly driven by volume and price.

Let's go to the next slide. Automotive aftermarket which was said already and the numbers are doing the talking here. Double-digit sales growth across all regions. And you see, especially in Europe, there's -- it's even more significant with over 30% of sales growth year-over-year. Klaus said it a little bit due to the low comps of prior year but there's also a catch-up effect. And I think we already prepared you for that when we talked about our annual results last year. We explained that there was a relatively weak sales month in December for automotive aftermarket, especially in Europe. And now you have the catch-up effect here in the first quarter of 2023. And on top of that, as Klaus already said, we have a significant reduction of our backlog due to further optimized logistics.

Both of these effects will normalize some going forward but we still expect, as you see also with the other regions which are not impacted as much by these extraordinary impacts, we still expect significant growth in this division. You see it then in the EBIT bridge, the volume drives with fixed cost absorption also the EBIT. Besides volume, there's also, as Klaus already said, a significant positive price impact in there. And you see then as the negative number, not surprisingly a higher selling expense position since, obviously, you have to ship the higher volume to the customers.

On the next slide, I will then talk to industrial. You see that we have growth across all regions and also market clusters. About half of the growth, a little bit less actually is related inorganically to the first consolidation of Ewellix. And you see that then also somewhat reflected in the lower table with the extraordinary growth in Industrial Automation of 38.2%. A significant portion of that is inorganically based on Ewellix. However, also you see now with €264 million sales -- quarterly sales in that for us, a very strategic and important area. We are clearly delivering on our target and objective to strengthen, as I said, that very strategically important cluster for us. If you look at the right side to the EBIT development, then in the first column, you see the healthy price and volume impact. That's, unfortunately, as Klaus already said, with the purchase price allocation amortization impact of the Ewellix acquisition of around 60 basis points, not translating visibly but definitely operationally into an improved EBIT of if I compare [indiscernible] from 11.3% to 11.9%. But again, it's somewhat not as transparent here in this bridge.

That leads me then away from the divisions back to the group and consolidated financial statements. Net income stands at €129 million for the quarter. Normally, that follows closely EBIT. However, we have one volatile component that we also talked a little bit already for the full year. We have a very significant hedging portfolio for our energy demand in Germany and we have to evaluate this at fair value. And this fair value book now has had a negative impact in the first quarter of 2023 of around €75 million. That is just a bookkeeping, we are intending to completely use our hedged energy and not sell it on the market. So, we will settle all these hedging contracts which will go out up to 3 years. Actually, we will settle the majority of the entire portfolio at the hedge price which is still favorable to current market prices and the minus €75 million of the bookkeeping impact of the quarter only indicates that from the last evaluation of end of last year to now at the end of March, the market price reduced and came closer to our hedging rate.

You see then the ROE [ph] is sequentially improved at 12.5%. And you also are pretty much aware that we paid in April a dividend of €0.45 per preferred share which calculated to €295 million in dividends paid in April. That leads me to free cash flow. And I start on the right side, minus €73 million. You see the development. There are some seasonal normal significant investment in working capital. I think we also prepared you already for that in our year-end conference call. You see also -- and that was also anticipated a higher than last year CapEx ratio. It's -- we expect it to be much more equally allocated throughout the year instead of back loaded like last year.

And then you see on the table below that we already paid out restructuring expenses of €105 million. That's more than half of our planned payout for the entire year. So, you clearly have a front-loading here as well. And you might remember when we talked about Q4 that the German bargaining agreement with the unions had a significant lump sum component which was partly accrued already last year but was then fully paid out in Q1 of 2023. That's another front-loaded onetime impact, if you will, of €30 million. So, if I now look at restructuring and this lump sum impact of €135 million, then I come back to what Klaus already said, cash-generating power is intact and clearly positive year in a quarter where we significantly invested in fixed assets and also net working capital. I said it in our last call, net working capital will come down. Now it will stay stable for Q2, almost stable and then sequentially come down in the second half of the year. So, this financing impact then will be partly reversed later this year.

That brings me to my last slide. Klaus already said it, net leverage ratio of 1.4x [ph]. Clearly, due to the Ewellix acquisition, we have drawn the term loan with €500 million. And that is the consequence. We -- and Klaus already said it, too but I think we have been upgraded by Moody's and Moody's especially explicitly confirmed our excellent liquidity position. So, I think that's encouraging going with this strong balance sheet into the endeavors that lay in front of us.

And with that, Klaus, back to you.

Klaus Rosenfeld

Thank you. Page 28, ladies and gentlemen, is the usual page on market assumptions. They are, from our point of view, broadly unchanged. Yes, we saw a Q1 in terms of production volumes and also with 21.1 million cars that showed some growth, 5.7%. However, we have decided to stay with our assumptions that are, as you know, more conservative. I think for good reason, €82 million to €84 million is what we have behind our guidance. Let's see how the year develops. There's clearly signs that the second half of the year could be more difficult than the first half.

Automotive aftermarket, global car park growth is projected with 2% and again, we'll definitely outperform this significantly. And also in the industrial side, this is a broad indicator of industrial production that is rather slowing down 1.3% expected after €3.7 million in 2022, we will definitely also without inorganic growth, outperform that because we are invested and operating in the right areas like renewables and also industrial automation. Against that backdrop, 29, we have decided to confirm the guidance for 2023 despite the strong and encouraging first quarter. You have this on the table here. and let's see what the second quarter brings and what that means then for the rest of the year.

Let me summarize on 30 very briefly, good Q1 performance. The hard work from the past starts to pay off also in terms of cash generation, Claus explained this. And we will continue to proactively execute on what our strategy says. The road map is our framework and it has proven to be exactly right when it comes to all the projects that are necessary to make Schaeffler stronger. We will give more color on the progress of execution when we invite you for the capital market update in November. In between, we have the strategy dialogue in the summer, as you know and also a strategy meeting with the Supervisory Board, very interesting things going on. So please feel already invited for that capital market update guidance confirmed. And again, in a complex environment where there is sunshine and clouds at the same time, where there is inflation and also, to some extent, recession risk, we feel that a strong balance sheet is positive.

Let me finalize the presentation with a statement on the more midterm. You know our midterm targets. You know what the road map says and we feel that we are on track to deliver exactly these midterm targets to you. And that would then give rise to the next 5-year plan that should drive us then into the second half of the decade. What is [indiscernible] is on 31, ladies and gentlemen, that's the calendar, the colleagues and Renata and the team will go on roadshow tomorrow in Frankfurt then in London. We also do a credit conference and will also be available at the June 6 auto conference, JPMorgan.

That's it for today. Thanks for listening. The floor is open to your questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time, we will begin the question and answer session. [Operator Instructions] And our first question is from the line of Christoph Laskawi from Deutsche Bank.

Christoph Laskawi

The first one would be on the auto margin and how we should think about the shape of the year going forward. I'd say, in general, the perception is in the market that Q1 should be the weakest quarter for the suppliers also related to the pass-throughs which seem to kick in more or less with H2. Is there any reason to think that it should be different for you as a group? And if you could comment on any pass-throughs that you've already signed so far -- that's the first question.

Klaus Rosenfeld

Chris, it was a little bit difficult to understand. But if I understood correctly, you said the expectation is that the margins go further up towards the end of the year?

Christoph Laskawi

It's now a bit clearer. Yes, the question was on the seasonality of the margin because -- in general, I would say the expectation would be that Q1 should be the weakest quarter. Now you already printed a 4.3% margin. Is there anything outside of volumes and potential volume risk in H2 that you highlighted before that we should have in mind that is a risk to margins in -- for example, in Q2 or the next quarter's end?

Claus Bauer

Claus, why don't you do... So yes, I mean, I'm not so sure where why the expectation would be it's the weakest quarter. What we clearly see differently than last year. And we also said that our pricing that we had to negotiate throughout last year and the biggest impact then with retroactive price adjustments only came in the second half of last year now are sustained and already effective also in Q1. So -- and therefore, I'm not so sure whether we see the same seasonal or should expect the same seasonality as we have seen last year. I would say, from a volume standpoint, the -- if I look at IHS, then the growth rates are difficult to judge. But from an absolute production volume standpoint, IHS still expects the fourth quarter being the highest production quarter. Therefore, also depending on the product mix, we would benefit from a positive volume development, as Klaus just said, what is our assumption for the total year's volume, we are not quite following yet in our guidance, this volume profile and would rather see the rest of the year being at similar volumes than Q1. But definitely, if there is a volume tailwind then we would benefit.

As you have seen in the first quarter also which was a volume uptick towards what we have seen in Q1 of last year is especially as it relates to engine and transmission. There is no question that we have available capacity, especially in that segment and any volume uptick in that segment that would not just contribute the normal gross profit but also the fixed cost absorption effect and therefore, have a contribution margin that's significant. So, I'm not so sure whether I completely answered your question but I at least shared what my view is.

Klaus Rosenfeld

Maybe, Claus, Christoph, last year, just to remember everyone of the figures in automotive, 3.5 billion for the first quarter, then a challenging second quarter because of the lockdown situation in China, 0.5%. That's an outlier, 4.8% Q3 and then Q4, 3.2%. I'm not sure what you would -- how would you interpret that seasonality. But what we can say, typically, over the years, Claus, is that the fourth quarter is normally a little bit of a weaker quarter. So, we will -- what -- and that, I think, is the answer that I would stress, we have promised 2 to 4. We have now printed 4.3 and we have confirmed guidance. I'll leave it up to you to interpret this. But I can tell you, our midterm target is 4% to 6%. And that's why the 4 is a very important cornerstone in where we want to be. And whether that unfolds in 3 quarters or in 2 quarters, we will see. But what is important to take away is that we have done significant work in the last years to stabilize the margin and to make sure that we can defend this 4% to 6% on the midterm.

Christoph Laskawi

Very clear. My second question would be a bit just on -- as a follow-up to the other part of the bridge. Given that it's a consolidation effect that we see, should we expect that to be positive in the coming quarters as well, not commenting on the size but just technically speaking.

Claus Bauer

So, on an EBIT level, again, it was included last year. It was just included in one position in the other expense line and not allocated throughout the P&L positions. Therefore, I mean, the bridges will look similar throughout the year with that impact. Maybe we display it a little bit differently because we already saw before the conference call that many people who have been questioning what's going on. So maybe we think a little bit to make it that impact operationally more transparent.

Christoph Laskawi

And then lastly, if you could just quickly comment on North America with regards to customer and product exposure that you have. You stress -- the underperformance was basically driven by the index pricing? And do you see anything which is related to the customer or product mix? Or is that all trending fine?

Klaus Rosenfeld

That is actually all trending fine. And that's what we wanted to express with the second portion of the bullet point in Claus is part of the presentation. And so that's -- we wanted to indicate there is no structural problem. It's really an evaluation problem. That, of course, you never mentioned it when it's positive and then because you don't have the need to explain something. But it clearly is structurally in line. We are strong with all 3 Detroit companies. We are in the new mobility space, very active. Of course, new mobility space will come to volumes, not this year and not next year but definitely for the future, we are gaining and I think we reported on that last year we gained with 2 of the 3 Detroit 3 very significant e-mobility projects in very significant, very significant platforms that might also come to [indiscernible] maybe only next year and then create sales. But structurally, I mean we have a strong footprint in the classical powertrain and we also have set ourselves up to continue the successes with all major Tier 1 and especially the OEMs.

Operator

The next question is from the line of Akshat Kacker from JP Morgan [ph].

Unidentified Analyst

[Indiscernible] from JPMorgan. Three from my side as well please. The first one, coming back on the underperformance in Americas. Could you please quantify the technical elements that drive the slightly lesser growth in Americas this quarter, as you mentioned on raw material indexation and the FX movements -- some amount of numbers here will help us in understanding the underlying trend going forward, please? So that's the first question. The second one is on overall pricing in the quarter. So, you've reported $110 million positive pricing for the group. Could you please just provide us a bit more detail on how that split between automotive, industrial and aftermarket? And finally, on the Industrial division. I know the order book is normalizing which is completely expected across geographies, across your different regions. Could you also please comment on the overall inventory situation in the industrial business and if the price levels are holding up?

Klaus Rosenfeld

Would you take the 2 first ones? Okay. Let me start with the last one. I think you said it completely correctly. The order book was expected to come down. And it's -- that's what I would like to point out, it's a growth dynamic. It's not turning to the negative. Inventory levels are, I would say, okay. There is, to some extent, room for optimization. We don't see a situation where we can't place the products where we want to place them. Our distribution business is clearly one of the drivers of this. There's always room to operationally improve inventory levels and the work that has been done on price adjustment clearly supported. But I can also say it has not been overdone. So, we are optimizing step-by-step but I don't see any risk here that we are sitting on a bigger inventory problem because of market demand. The division is strong enough to adjust that carefully to the current situation.

Claus Bauer

Yes. I try to be as clear as possible but still want to be a little bit {indiscernible] here in answering the other 2 questions. Without the 2 effects, the evaluation effects, one Mexican U.S. dollar driven. The other one, the price development based on index material price classes is significantly negative and would bring us to not -- still not an outperformance in the range of 2% to 5% for that quarter in that region but clearly at the 0% line. So that gives you some orientation about that. And again, prior the price impact by the division, I would stick with our approach of last year to not lose leverage also in the public space and especially with our customers to achieve also our negotiation targets. This year, you can imagine that especially in automotive technologies with material prices where they are and energy prices in Europe, not as escalated as we might have anticipated at the beginning of the year that negotiations are ongoing.

As I said, we sustained all the prices that have been negotiated but it's still an ongoing negotiation. I mean, now we don't have to start from 0 and achieve a price increase. Now we have to support our prices with other cost factors. Labor is still very much as a cost driver impact. And therefore, I would like to stay as... I would be as transparent as possible but also stay as in transparent as possible just to not lose leverage.

Klaus Rosenfeld

Maybe I'll add one more sentence. The guys have done a terrific job in 2022. They have gained a lot of experience how to do this, find the right balance between our customer and our interest. What is most important to me is that the price increases from last year are sustainable. They're not one-offs. They're not paid by -- they're not gained by some sort of payment terms, adjustments whatsoever and that is critical for us. So, I feel good about 2022. And yes, there's always debate with customers in this situation. But on that -- with that basis, I'm optimistic that also for the year 2023 will come to a solid result there.

Operator

The next question is from the line of Sanjay Bhagwani from Citi.

Sanjay Bhagwani

I've got 3 questions as well. And my first one is a bit more strategic question that's on one of the hidden and let's discuss the opportunity within the group. If I look at the market cap of Schaeffler India, this is, I think, I mean, on the back of the envelope calculation, I see that this market cap is higher than what we have for the operating company here in Europe. And Schaeffler owns significant part of this business. So, I've just been trying to understand if there is a possibility where you can monetize some of this value in any way, potential disposals or something like that? That is my first question.

Klaus Rosenfeld

Well, I mean, you know that I -- the -- what I can say here is that we like our Indian entity. We merged it some time ago and formed Schaeffler India out of 3 different entities. It is very well run. It has an external board that overlooks it. And there are no plans to change the structure [ph]. For sure, the valuation environment and the way Indian investors look at that entity is different than overall, we see that gap. But I think we cannot judge the Indian capital market with the same logic as we are judging the whole thing. Again, no plans underway to change what we have there. So rather on the opposite, I would think India is a growth area for us. We are doing work there to better understand whether we can further build our operations -- this is also just to make that remark an interesting aftermarket place. You saw the order that we won on e-mobility. So, we are proud of what we have there and we are not going to -- we don't have any plans to change that shareholding.

Sanjay Bhagwani

That's very helpful. And then coming back on North America. I think you mentioned that -- so let's say, if the commodity prices stay where they are, then the technical effect of, let's say, index commodity price downs and hence negative rising, this will continue to stay for the rest of the year in terms of the underperformance in North America. Basically, how should we think about this for the coming quarters based on your assumptions on the commodity prices?

Claus Bauer

So, it's obviously just a technical exercise as long as your indices lower than prior year's quarter, then obviously, that adjustment mechanism leads to a negative pricing impact on your sales number. I would be happy if I could for cast the steel prices. But I mean, it's conceivable that throughout the most part of the year in the indices will be lower than last year. So, I would say, yes, that technical impact is continuing.

Klaus Rosenfeld

And may I add maybe one word on quarterly outperformance. I mean you have in the deck on Page 40, the quarterly outperformance by region automotive technologies. And you see that there are significant swings between quarters. Americas Q1 2022, 3.9%, 8.4% in Q2, minus 2.7% in Q3, plus 11% in Q4. So don't get nervous about a quarter. Look at this more long term. Yes, there are technical factors as explained but that doesn't change our view that Americas is a very interesting market for us. You know this from also our statement at the beginning of the year that we are looking to expand there. There's lots of positive things going on in the IRA. You all know this. In particular, when you look at the electrification potential of cars and trucks, so don't get this wrong. We are not negative on the U.S. We are very well positioned there. And that there is a situation where a quarter deviates from a long-term trend may be the case but don't extrapolate on this. Let's see what the second quarter and the third quarter is bringing. The guidance is 2% to 5% for the group and we confirm this today, we are positive on what's going to happen in the Americas.

Sanjay Bhagwani

That's very clear. And my last question is on the cost inflation. I understand you may not want to provide all the numbers here. But maybe just a rough idea of what's been the cost inflation in quarter 1? And is it going to be maybe let's say, the pattern similar throughout the year? And then composition of inflation made this quarter was largely, let's say, raw materials and the next one would be maybe the wages and energy. So, if you could provide a little bit details on that.

Claus Bauer

I mean we were very outspoken about that in the last year. And then I was tested every quarter on what I said and I think I wasn't too far away even at the beginning of last year but our approach this year is to be a little bit more restrictive in that. I mean, we said it very clearly at our annual conference that the cost drivers are different. Cost drivers are not always as transparently derivable from a market spot price, especially in steel, we are very -- in very low quantities buying really at spot prices. It's the price that we agreed on a contractual contract with most of our suppliers. And therefore, especially in Automotive Technologies, we have to go to our customers with a very detailed cost breakdown where we are not arguing about indices and spot prices but really what did we pay last year and what are we paying this year. And that might differ significantly from what the spot price would indicate. So, for example, we never bought steel at the peak spot prices last year because we were fixed in contracts. And we never -- we also will not pay this year is for steel at the lowest end of the index development. And again, the exception and I said that all along is the price or the index classes in the U.S. which have been implemented since 2007 and '08. So not a recent development. But other than that, it's really something that you cannot necessarily derive from a spot pricing.

And a second component to that and we also have been clear energy prices will be a cost driver, especially in Europe. -- and labor will be a cost driver labor. The good thing about labor is that it's very predictable. We know now exactly how much and what the cost impact is. And it's also very transparent to our customers. It's difficult because normally it's a cost type that it's not necessary agreeable between the parties that it's a basis of any kind of a price reduction. That's the normal assumption in a normal market environment, where you have maybe 2.5% labor inflation once you hit 5% and 6%, obviously, the discussion has to begin and that understanding is clearly existent along the supply chain. So -- and coming back to energy, energy for sure, does not have the -- or current, I have to say, currently, does not have the super inflationary impact even in Europe that we anticipated. It still has a significant impact but not as severe. But at some point, we are approaching the next winter also. And let's see how the geopolitical situation developed at that point and how that might then impact again, energy prices.

So, I hope you are satisfied with a more qualitative answer to your question but that's, I think, more the strategic approach. We are very agile. We are going for the same recovery rates for different inflationary factors this year as we have been last year.

Klaus Rosenfeld

And maybe I add 2 sentences. I think the company has shown that it's able to manage its cost structure. So, the strategic cost management has proven over years now and you see this also when you look at FTE figures. And the company has shown last year that it's able to manage costs operationally, if there are situations like last year where energy prices or material prices increased significantly. We focus on margin. The margin this year is this quarter is at 8.1%. We already told you that our attempt is to do it on a sustainable basis, no one-offs and whatsoever. So, let's see what the next quarter is going to bring. But I'm positive on the strategic cost management and I'm very proud of what the guys have done last year and what they continue to do this year on the operational cost management.

Sanjay Bhagwani

That is very, very helpful.

Operator

The last question is from the line of Michael Punzet from DZ Bank.

Michael Punzet

Yes, Michael Punzet, I have one question with regard to your energy hedges. Are you able to pass through the hedged prices to your customers? Or are there also some index clauses in the contracts that you might have to book some losses on [indiscernible]? That's a question from my side.

Claus Bauer

Yes. That's -- and that's why we also adjust it for EBIT. Normally, this wouldn't actually hit your books because if you know the IFRS standard, there is a so-called exemption to your fair value evaluation. That's the only use exemption. And therefore, it wouldn't even be visible to anybody. But since we have settled some of the contracts last year, we now are in the fair value evaluation. And why did we settle some last year because obviously, the desire to hedge was very high in that volatile environment. And then also the desire to reduce consumption was very high because it had a big savings impact. So, these are 2 contradictory trends that then caused some overhedging and the overhedging was then settled beneficially obviously. And therefore, we now have to evaluate at fair value. That's a little bit the technical background but it stays technical for us. It has volatility in the net income. And obviously, the EBIT unadjusted reported but it's not how we operationally steer the company and that's also not how we would now engage with customers.

As I said, we are settling 100 -- close to 100% of all these forwards at the hedge price and not settle them financially. And therefore, what we would enter into very transparently with our customers is indeed the hedged price and not some artificial market price.

Michael Punzet

You think you are able to pass through the hedge prices to your customers?

Claus Bauer

Yes. Okay. Yes. I mean, that comes back to the question, what costs are customers willing even to engage in negotiation. In the past, it was clearly the hidden assumption that labor and nonproduction material operating supplies is the problem of the supplier or producer of parts and has to be offset with productivity. Last year has shown that clearly with gas and energy prices, tripling and quadrupling and also wage inflation, clearly above a normal productivity level that these need to be included in the negotiation. And I can report that we already included nonproduction material in our last year's negotiation. So, we prepared the ground and I'm very confident that we will get to the same recovery ratios with, as I said, different underlying cost drivers but the result will be the same.

Michael Punzet

Okay. Maybe a follow-up. You mentioned that some of the contracts running up to 3 years. Can you give us any idea which part of the contracts will not through this year?

Claus Bauer

It's about 55%.

Klaus Rosenfeld

Well, then, ladies and gentlemen, if there are no further questions, then we would stop here. Thanks for listening. The colleagues are then available for further explanations if necessary. Thanks for your support and we see you soon again. Thank you. Bye-bye.

Operator

Ladies and gentlemen, the conference has now concluded and you may disconnect. Thank you very much for joining and have a pleasant day. Goodbye.

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Schaeffler AG (SFFLY) Q1 2023 Earnings Call Transcript