Continental's Warning on Car Slump Shows Reality Is Hitting Home

(Bloomberg) -- Continental AG investors breathed a sigh of relief on Tuesday after a long-expected warning about full-year earnings suggested the German car-parts maker is finally facing up to the deepening slump in global vehicle production.

The shares rose as much as 5.4% after the Hanover-based manufacturer said its profit margin would be narrower than previously forecast and the outlook for the overall market is far gloomier. Automakers and their suppliers are reeling from a significant slowdown in China that kicked in last year and has spilled over into 2019, while demand for cars also appears to be peaking in North America and Europe.

The new outlook “does not really come as a surprise” because the company’s previous expectations were seen as unrealistic, Mainfirst analysts wrote in a note. “Resetting expectations could provide some relief.”

Continental joined French car-parts supplier Faurecia SA -- which is sticking with its full-year financial guidance -- in predicting a significant slowdown in worldwide vehicle output. Daimler AG, BASF SE and Lear Corp. have in recent weeks also lowered targets for the year. On Monday, Continental’s smaller German peer Duerr AG and steelmaker Kloeckner AG also took similar steps.

The Stoxx Europe 600 Automobiles & Parts Index jumped 3.4% while Faurecia shares rose as much as 9.6% in Paris trading, the most in more than six months.

Continental is now targeting a full-year profit margin of between 7% and 7.5%, adjusted for some items and before interest and taxes, according to a statement late Monday. The company had forecast a margin of at least 8%.

What Bloomberg’s analysts say

“Continental’s original 2019 margin guidance appeared optimistic and suggested a 2H recovery, which we always considered unlikely, as recent Chinese and EU weakness shows no sign of easing. Continued global-trade tensions have overshadowed what’s probably a cyclical peak in global-auto demand with added emission compliance, electric-vehicle and tech headwinds.”
-- Michael Dean and Gillian Davis

Faurecia, whose largest shareholder is PSA Group, on Tuesday significantly lowered its market outlook, saying car production would be down 4% compared with 2018 and its previous forecast for a 1% decline.

Continental’s previous outlook was based on expectations that global car production would be flat this year. The manufacturer now expects a decline of about 5%, which means its profit target “will no longer be achievable,” it said.

The company is targeting between 44 billion euros ($49.3 billion) and 45 billion euros in revenue, down from a previous range of between 45 billion euros and 47 billion euros. It also warned profit at its automotive division could be hit by potential warranty claims in the second half of this year, but declined to specify the warranty issue or estimate its possible financial impact.

“Investors will be focused on how much of that reduction is related to the warranty claims and Continental-specific issues and whether those factors are recurring or one-time in nature,” Tom Narayan, analyst at RBC Capital Markets, wrote in a note.

Potential Listing

Preliminary figures indicate Continental’s second-quarter adjusted Ebit margin was around 7.8% and revenue was approximately 11.2 billion euros, according to the statement. The company is scheduled to release final earnings for the first half of the year on Aug. 7.

As part of a broader overhaul to brace for the industry’s shift to self-driving and electric cars, Continental plans to complete preparations near the end of this year to potentially carve out its powertrain division. That unit makes components for combustion and electric-powered vehicles and is valued at as much as 5 billion euros.

But that project has taken longer than expected. Continental sees a potential listing for the division -- dubbed Vitesco Technologies -- in 2020, depending on market conditions, after initially targeting a possible IPO in the second half of this year. It expects the carve-out to cost 350 million euros and trigger a negative tax hit of another 100 million euros.

Chief Executive Officer Elmar Degenhart stressed the strategic importance of the company’s reorganization into three divisions at Continental’s annual general meeting in April. The manufacturer must become more agile to navigate a fundamental transformation in automotive technology, he said. A separate listing would allow the powertrain unit to raise fresh funds on its own if needed.

Continental plans to keep a majority stake in the unit in the mid to long term. It’s considering selling a stake of up to 25%.

--With assistance from Ania Nussbaum and Jan-Patrick Barnert.

To contact the reporters on this story: Christoph Rauwald in Frankfurt at crauwald@bloomberg.net;Tara Patel in Paris at tpatel2@bloomberg.net

To contact the editors responsible for this story: Anthony Palazzo at apalazzo@bloomberg.net, Iain Rogers, Chris Reiter

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