Ladies and gentlemen, welcome to the Pirelli conference call, in which Pirelli's top management will present the company's first half 2020 financial results. A live webcast of the event and the presentation slides are available in the investor relations section of the Pirelli webcast. I remind you that a Q&A session will follow the presentation. I would now like to introduce you to Mr. Marco Tronchetti Provera. Please go ahead, sir.
Good evening, ladies and gentlemen, and welcome to our conference call. This afternoon, I shall address the outlook for the industry and the company for the second half of the year, as well as the progress of our strategic evolution. Mr. Andrea Casaluci, our General Manager, Operations, will elaborate on Pirelli's first half operating results, while Mrs. Valeria Leone, our Head of Strategic Planning and Controlling, and Investor Relations, will discuss our financial results. Before getting into the core of our discussion, I wish to welcome Mr. Angelos Papadimitriou, General Manager, Co-CEO, who has just joined our management team. You already know the hardships we are all going through. The second quarter of 2020 has put our business to the test more than ever. We took extraordinary steps to cope with the general crisis triggered by COVID-19, never compromising on the health and safety of our people.
We trusted our company to the High Value segment, which proved once again its resilience. We kept working on our competitiveness and COVID action programs, which are well on track, and we are accelerating our transformation program towards a leaner, faster, and more profitable company. A more volatile environment on Forex and Raw Mat led us to review our guidance for the full year, while confirming all the internal levers, namely volume, price mix, efficiencies, and cost reduction. A solid cash flow generation is still expected. Pirelli was the only one tire company to provide a full year outlook in the middle of the COVID-19 crisis. Despite the high volatility of the external scenario, we confirm that we foresaw in earlier April. Car production to decrease by around 22% compared with last year.
Premium prestige car manufacturers to overperform the synergic segment by almost 10 percentage points. This, coupled with the 18 inches and above tire market, now expected at -13% year-over-year, is proving again that High Value, our main target, is more resilient. Pirelli volume guidance is also confirmed. With around 52 million car tires, a reduction of -19% versus 2019-2020, 2019 levels, which with 18 inches and above performance expected above market trend. Going to the next slide, High Value resilience is expected to become even more established in the second half of the year, sustained by Replacement recovery in Europe and APAC and OE rebound in the U.S.
In this context, we expect to overperform the market, benefiting from a strengthened leadership in 18 inches and above in China, where we expect to grow double-digit and accelerate a new product pipeline to catch new consumer trends and SUVs growth. In Europe, targeting the growing all-season segment and the new high-value push demand coming mostly from synergic SUVs. In US, leveraging on our third generation of high-mileage products for SUVs. In China, developing new dedicated lines for the highly growing e-commerce channel. We'll be launching 6 new product lines in next 12 months, 3 for Europe, 2 for US, 1 for China. First-half performance in high-value discounted our policy to support third partners in keeping low stock levels and our exposure to areas most impacted by mobility restrictions, as Mr. Casaluci will better detail.
Moving to our cost reduction plan, progress in line with our expectation, pursuing a flexible cost structure and limiting the effect of the production lockdown and fall in demand. The combined growth benefit for the Cost Competitiveness Plan and COVID Action Plan for the full year are confirmed at about EUR 280 million, approximately 6% of 2019 cost base, or EUR 140 million net of inflation and slowdown. In particular, as per main indications, the cost competitiveness plan will contribute for approximately EUR 160 million or EUR 110 million net of inflation, while the COVID action plan is expected to generate approximately a further EUR 120 million, EUR 30 million net of production slowdown worth EUR 90 million.
During the first half of 2020, consistent with our forecast, gross benefits from the two plans amounted to 45% of full year target. Net of inflation and slowdown, efficiencies were equal to around EUR 32 million, since the slowdown was felt more in the second quarter. For the second half, we expect approximately EUR 150 millions of gross efficiencies, with a major contribution from SG&A, product range optimization, and footprint rationalization. Net of inflation and slowdown, benefits are expected to amount to EUR 110 million. Next slide, improving the 2020 cost competitiveness is obviously not our only objective. As I said in May, we are changing the way we work to achieve three major objectives: a leaner company, a faster company, and economic benefits. We are also integrating digital technologies across the company for a more effective execution.
More specifically, the design effort is led by multidisciplinary teams, integrating business and staff, as well as people, management, and technology. The three vital ingredients for a change of mindset, which are the three vital ingredients for a change of mindset. The target working model is much more horizontal, linking all actors of the value chain, from consumers owning cars, fitting high-value tires, right through all the suppliers. The operating model is built around 14 journeys, under which 80 processes are being redesigned. These processes and workflows are run digitally on four integrated cloud-based platforms, like Salesforce. Artificial intelligence models are integrated in the workflows, since they help improve the decision making and act as early warning systems. The transformation program is broken down in waves.
In the first wave, we are working on application to improve our relationship with consumers and customers and get as close to them as possible. Their needs will guide the performance of our value chain. Progress is underway. First key milestones have been achieved, and with positive feedback from our organization, where a new digital way of working has been adopted with enthusiasm and effectiveness. To mention just a few examples, in the pilot countries where we have released our new sales processes, Italy and Germany, we have already reached over 90% adoption rate from our workforce. More than 300 products have already been developed with the support of virtualization. Our transformation program is a major undertaking and will take around 2 years to reach a higher ground, from which further opportunity will be captured.
To accelerate this undertaking, and in parallel, broaden the management team, in consideration of my future succession, my proposal to the board to nominate Angelos Papadimitriou as a new General Manager and Co-CEO has been accepted. Mr. Papadimitriou has held leadership positions in important multinational companies and has proved his skills in profitable growth, both organically and with M&A. He has formally joined Pirelli four days ago, on August first. Our respective roles and key missions are summarized as follows: I will be responsible for strategy setting, orchestrating the plan, and controlling strategy implementation. I will also approve major corporate policies, initiatives, and projects. Finally, together with Chairman Ng, I will represent management and the board to all our key stakeholders, the general public, institutions, shareholders, and investors.
The General Manager and Co-CEO will start off by focusing on the acceleration of our wide-ranging transformation program, and with the achievement of its targets. The General Manager Operations focuses on day-to-day operations, integrating all new improvements in our line functions, R&D, manufacturing, supply chain, sales, marketing, and so on, in all regions. Let's now move to 2020 targets. With the first quarter release, we confirmed our April guidance, being more confident in its lower range. Revenue, approximately EUR 4.3 billion, adjusted EBIT margin, approximately 14%, implying an absolute value of EUR 590 million, and net cash flow of about EUR 230 million. We confirm the impact of all internal levers, namely volumes, price mix, and actions on cost. However, we now face a more volatile external scenario on both forex and raw materials, as Mr. Casaluci will better detail.
We now forecast revenues between -20% and -22% year-over-year, an adjusted EBIT margin between 12% and 13%, implying an absolute adjusted EBIT of EUR 530 million in the midpoint of the range, EUR 60 million less versus the previous indication, due to the above-mentioned external headwinds and an increase on the other costs. This increase is related to non-cash items. A net cash flow between under EUR 90 million and EUR 220 million, leading to a net debt of about EUR 3.3 billion. Mrs. Leone will give you more color on second half trend. Now, I leave the floor to Mr. Casaluci, please.
Thank you, Mr. Tronchetti, and good evening, ladies and gentlemen. Let me start with the second quarter tough market dynamics and how Pirelli weathered the storm. COVID-19 outbreak heavily impacted car tire demand in second quarter, with a 36 drop in volume, affecting both the original equipment and replacement channels. In the original equipment, -47%, several production facilities around the world were kept locked, especially in April and May. Replacement demand, -32%, also suffered from mobility restrictions that kept consumers at home for several weeks. High Value, -26% in replacement, showed again its better solidity versus the Standard segment, -33%. Overall, Pirelli 18 inches and above performance in second quarter was aligned with the market, -35%, with different trends among channels.
Overperformance in original equipment, -43% versus -47%, still benefiting from the customer base widening in North America and Asia Pacific, already underway since the second half of 2019. Slight underperformance in the replacement channel, -29% versus -26%. To support our main distributors, we took the stocking actions until April in Europe, and for the whole quarter in the US. In the US, we were more affected by lockdowns, since stricter measures have been taken where the concentration of premium and prestige cars is high. Example, California, Florida, and the Upper East Coast, and some consumers trading down towards lower brands, given their economic hardship. In general, performance in Europe was solid and very strong in Asia Pacific, where we gained market share.
For the Standard car, our drop was more pronounced, -50% for the second quarter compared to the market, -36% for the second quarter, due to our high exposure to Latin America, where we keep reducing less profitable, lower rim diameter products, and we are gradually exiting from the less profitable mass market segments. Looking ahead, visibility is still very low. We can confirm our market view at around -19% year-over-year for the full year. This figure does not assume, so far, a severe second wave of COVID-19, with new mobility restrictions. In the second half of the year, the market trend is expected to be approximately -10%. All regions are still expected to record a double-digit drop, apart from APAC. China is absolutely driving the market recovery, especially in High Value .
The 18 inches and above replacement market in the region is expected to be already growing in the third quarter. In Europe, the market is rebounding, but there are some concerns over the upcoming winter season because of reduced new car registrations, low consumption of winter tires during the lockdown, trade stocks likely to be realigned to the new demand scenario. In North America, there are good signs coming from the original equipment, but it is still very difficult to assess replacement trends due to very heterogeneous situations in stock levels and supply chains, coastal areas more damaged by lockdown restrictions, some consumers trading down towards lower brands due to the economic crisis, a still rather high number of coronavirus cases. In Standard regions, Latam and Russia and Middle East and Africa, a gradual recovery is expected.
Yet, the presence of scattered COVID outbreaks, coupled with the difficulties of the real economy, will extend the challenging market situation. As already said by Mr. Tronchetti, our efficiency efforts over the entire Pirelli value chain and across all regions are confirmed and in line with forecast. We are optimizing our cost baseline and facing the short-term impact of COVID-19 with an overall program of approximately EUR 280 million, out of which around 45%, or EUR 126 million, already saved in the first half. Let me, let me give you an update on the major activities within each stream.
On product cost, with a full year target of EUR 60 million and 50% of the target already achieved during the first half, we are on track with expectations, continuing to streamline the entire product range toward a value-based portfolio, working on tire structure simplification, weight reduction, and material portfolio decomplexity, and exploiting virtual design process, reducing need for physical prototypes. After freezing about EUR 20 million worth of benefits last quarter, manufacturing initiatives are now in line with forecast, having reached about 50% of the EUR 60 million full year target. In this stream, we leverage on both structural and short-term actions, in particular. We continue to rationalize our footprint, especially in Latin America, and constantly exploit benefits from lowered waste, increased flexibility, and plant digitalization.
We focus on quick efficiencies from factory flows optimization and strict control over fixed and variable costs, mainly consumables, ancillaries, indirect materials, and energy consumption. Regarding SG&A, in the first half, we recorded almost 40% of the full year target, since we expect a major contribution from belt-tightening of G&A and marketing during the second part of the year. In particular, this stream, we continue applying a strict control over professional services and overheads, deeply reviewing marketing, communication, and motorsport events, supporting more digital activities, taking advantage of procurement renegotiations, optimizing distribution flows, and exploiting warehousing efficiencies from stock reduction. Finally, we confirm our efforts toward a leaner organization that will bring us a full year cost saving of around EUR 50 million, out of which 50% already saved in the first half.
In terms of activities, we are leveraging on footprint rationalization in Latin America, development of our existing shared service centers in Latin America and Europe, process reengineering, also thanks to digital transformation, and forthcoming introduction of structural remote working. Pirelli took a number of measures to address the harsh demand scenario, which led to low utilization rates in second quarter. On the manufacturing side, the production slowdown has allowed a significant reduction in inventory levels in second quarter by over 2 million pieces in car, -15% compared to March 31st, which partially anticipated the reduction expected for the third quarter. Added to this decrease was a reduction in inventories of finished motorcycle products, -7% compared to March. In parallel, we increased mix rotation to provide optimal customer service level.
Complexity is coming down, thanks to the already mentioned improvements in the component design modularity and range optimization activities. On the commercial side, actions are balanced with the need of our partners to keep low stock levels, so as to safeguard their financial health. Strong investments in the online business, in particular in China, this channel is growing fast, and we are consolidating there our leadership in 18 inches and above with ambitious growth targets. Trade innovation aimed to bring new traffic to the point of sales of our partners, where, together with them, we have successfully designed a contactless customer experience. Turning to innovation, COVID-19 crisis is not impacting the pace of our new product pipeline. Indeed, we are accelerating in the areas where we see opportunities, and we will launch six new lines in the next nine, 12 months. Key boost, a strong post-COVID-19 recovery.
The new product pipeline will catch new consumer trends and SUVs growth. We have just launched in the global market, the new Cinturato P7 flagship product, designed for the premium segment with many innovative features. A distinctive design to optimize safety braking distance, as proven by the Eco Label A on wet braking across the entire present range. Flat profile, aimed for rolling resistance reduction and mileage to allow consistent CO2 savings. Optimized footprint, structure, and aerodynamics to limit noise, allowing to reach the perfect fit with electric cars, as proven by Pirelli own Elect marking. New level of performance, reached in cooperation with OE partners, such as BMW, Audi, Mercedes, Jaguar, Volvo, Alfa Romeo, and many others, that allowed us to be leaders in homologations already at product launch. Let's finally move to the operational drivers of our guidance.
All internal levels are confirmed with volume between -18% and -20%, of which High Value at around -14% and Standard around -26%. Price Mix at about +2%, driven by the improvement in both channel and regional mix, as already shown in the second quarter. Net efficiencies worth EUR 110 million, and cost cutting COVID worth EUR 13 million, net of slowdown. However, we now face a more volatile external scenario on both Forex and raw materials. Forex outlook worsened in second quarter, and we now foresee that the volatility of emerging currencies, especially in Latam, will continue for the rest of the year, coupled with a weaker U.S. dollar. We now expect Forex to impact negatively the group revenues by 4%.
The shift of raw materials from a EUR 15 million tailwind to a -EUR 10 million headwind is due to higher volatility of the oil, which is trimming down the overall commodities tailwind from +EUR 105 million to +EUR 95 million, and the different exchange rates outlook. We remind you that 78% of our production is located in low-cost countries, whose currencies are expected to devaluate against the U.S. dollar, making the raw material bill more expensive, FX impact from -EUR 19 million to -EUR 105 million. For our assumptions on raw materials and Forex, please refer to slides number 26 and 27. The EUR 70 million of other costs include EUR 35 million of non-cash items, provisions on bad debt accrued in the second quarter, other provisions, and some costs related to the reduction of inventories.
20 million related to transformation programs, and EUR 15 millions of lower earnings. The difference versus the May guidance is only related to the increase of non-monetary costs, EUR 20 million more related to fix from stock and bad debt, and other provisions. As a reminder, we confirm the usual drop through 42% on volumes, around 50% on price mix, and 15% on Forex. As already pointed out by Mr. Tronchetti, we are putting all the efforts needed to protect our cash generation, also from an operational point of view. I now leave the floor to Valeria for the review of the financial results.
Thank you, Andrea. Good evening, ladies and gentlemen. I'm glad to participate in our conference call in my capacity as the Head of Strategic Planning and Controlling. On slide 18, let's analyze the net sales bridge. In the first half, our performance showed the impact of the actions taken against the COVID crisis. A sound price mix rebounded in the second quarter, mainly supported by a strengthening of our positioning in China. Efficiencies and cost-cutting measures, which produced savings for EUR 126 million, more than offsetting inflation and the impact of the slowdown. Strong inventories reduction, allowing us to bring cash absorption almost to zero in the second quarter. Let's go through our financial results, starting from our top line. We ended the first half of 2020 with net sales of about EUR 1.8 billion, -31.6% year-over-year. Mis- as Mr.
Casaluci told you previously, the global demand slowdown affected our volume trend, -29.5%, especially in the Standard segment, -35.4%, where we kept following a selective strategy. Our High Value performance proved to be resilient, with a less pronounced decrease in line with the market, -23%. Price mix was +1% in the first half and discounts a different trend between quarters. -1.3% in the first quarter, with a negative channel mix, steeper decline for the replacement sales, and a temporary drop in the regional mix. In the second quarter, we were back to a sound +3.3%, supported by the rebound of both the channel and regional mix recovery of sales in China, with the continuous contribution from product mix.
This trend is expected to continue in the second part of the year. Finally, Forex was negative by -3.1% in the first half, with a downward acceleration in the second quarter, -4.7%, due to the increased volatility of emerging market currencies, the Brazilian reais, the Argentine pesos, the Russian ruble, the Mexican pesos. This trend is expected to continue in the second half, with pressure also on the U.S. dollar. Moving to profitability on slide 19, we used our internal levers to minimize the impact of the external scenario. The cost competitiveness program produced structural efficiencies worth 3.5% of our sales, covering inflation, -EUR 23 million, Forex -EUR 17 million, and raw mat headwind, -EUR 15 million. The latter impacted by the depreciation of main currencies, -EUR 37 million of countries where the group's production is located.
For example, Latin America, Romania, and Russia. COVID emergencies cost-cutting measures, EUR 62 million or 3.5% of sales, basically offset the impact of the slowdown, -EUR 71 million. As mentioned in slide 26, the slowdown was mainly felt in the second quarter, reaching in the first half, about 80% of its expected annual impact, worth EUR 90 million. Price mix was positive, EUR 7 million in the first half, thanks to the solid performance in the second quarter, that is EUR 22 million. The decline of volumes was -EUR 332 million, reflecting the usual 42 drop through...
Finally, D&A and other costs, with the latter amounting to EUR -35 million, and mainly related to non-cash items, that's minus EUR -28 million, such as provision on credits, approximately EUR -10 million, due to a more conservative stance in the current scenario. No monetary costs relating to the strong stock reduction in the second quarter, minus EUR -15 million, and other provisions worth EUR 3 million for LTI. The remaining EUR 7 million was the balance among costs related to transformation programs, approximately EUR 10 million, and lower earnings related to Prometeon royalties, and the positive impacts of approximately EUR 13 million of the standing costs included in the first quarter 2020, due to postponement of some activities to the second half due to COVID. For example, F1, motorsport racing, events, and sponsorships.
For the second half of the year, the impact of the other costs is expected to be more or less minus EUR 35 million, of which 7 non-cash and EUR 70 million on full year. On slide 20, about our cash flow and net financial position, we closed the first six months with a net debt of about EUR 4.3 billion, almost flat versus the first quarter. Cash absorption in the second quarter was basically zero or minus EUR 4 million, mainly supported by the sharp reduction inventories, EUR 175 million, or 2.1 million car tires, and 200,000 motorbike pieces, with an increase of 285,000 car pieces and 230,000 motorbike pieces in the first quarter, due to the lockdown measures.
In the first half of the year, inventories went down by a net 1.8 million pieces in the car, and 400,000 pieces in the motorbike. At the end of June, inventories accounted for 21.4% sales, about 1 percentage point less than last year and in the first quarter. Inventories are expected to be further reduced in the second half by around 200,000 car pieces, reaching 20% on normalized sales. In the second half of the year, we expect to generate a net cash flow closer to the second half of last year, that is EUR 963 million, versus EUR 985 million in the second half 2019, thus reaching approximately EUR 190 million-EUR 220 million of full year target.
For the second half of 2020, operating cash flow is expected to be almost in line with the second half 2019. That is, EUR 1,160 million, versus EUR 1,182 million in second half 2019, supported by an EBITDA, basically at the second half of 2019 level, EUR 658 million, versus EUR 674 million in the second half 2019. It contained CapEx, EUR 49 million, versus EUR 223 million in the second half 2019. A more contained positive net working capital, EUR 576 million, versus EUR 765 million in the second half 2019, consistent with the lower level of activities compared with 2019, with lower receivables and payables. Lower interest and lower taxes are almost offsetting the cash out for restructuring.
Now, finally, just a few words on the comparison between the new and the previous guidance. The midpoint on new guidance on the Adjusted EBIT is equal to EUR 530 million, EUR 60 million less versus the 590 million indicated as a floor last May. The midpoint of the new target for cash flow is EUR 205 million, EUR 25 million less, versus the floor of the previous guidance, worth EUR 230 million. In terms of cash flow, the EUR 60 million reduction in EBITDA translates into just EUR 25 million cash absorption. Part of this is due to the additional non-cash items versus the previous guidance, amounting to EUR 20 million, including in the other costs, in particular, higher provisions and stock accounting treatment linked to 300,000 pieces additional inventory reduction versus previous guidance.
The rest comes from the higher target for year-end inventory reduction, which should bring an additional benefit of at least EUR 10 million. Finally, on slide 21, our capital structure. As of June 2020, our gross debt stands at EUR 6.2 billion. When compared to the first quarter, this increase is due to the drawdown occurred on April 2 on our EUR 800 million, five-year ESG bank line, subscribed on March 31. Net financial position and liquidity margin remained stable versus the end of March at EUR 4.3 billion and EUR 2.2 billion respectively, thanks to the action taken to preserve liquidity imbalance. As quick reminder, during the first half, we have managed to subscribe at a very favorable terms, the previously mentioned EUR 800 million loan, which made our debut in the sustainable finance space.
Extend the maturity of a EUR 200 million bilateral financing, originally due in June 2020, and now postponed to September 2021. Exercise the sole borrower discretionary option we had on the tranche of our main bank line coming due in June 2020. That is EUR 253 million, therefore now postponed to June 2021. During our first quarter call, we anticipated we had proactively approached our lenders to gain flexibility on those financial covenants, which at a certain point in the future, and with an extended slowdown, could go under pressure. We can confirm that we have successfully addressed our needs for the next 18 months and have received support by all lenders. Finally, during the first six months of 2020, our cost of debt went down to 2.22%, from 2.83% in December 2019.
Mainly thanks to a lower exposure of high yield currencies, generalized interest rate reduction, a lower margin applied to our bank financial debt due to our financial performance. I thank you very much for your attention. Now I leave back the floor to Mr. Tronchetti.
Thank you. So this ends our presentation. We may now open the Q&A session.
As a reminder, please press star and one for questions, and please remove the speakerphone option when asking questions. The first question is from Monica Bosio of Intesa Sanpaolo. Please go ahead, madam.
Good evening, everyone, and thanks for taking my questions. I have three. The first one is on the inventories. I understood that the group reduced materially the inventories, and I'm just wondering if you can give us more color on the dealers' inventories level. Do you see the dealers' inventories in a healthy position now to face the demand trend ahead? Or are there any areas where we can see some tensions in terms of dealers' inventories? And the second question is on the expected slowdown of the replacement in the third quarter, due to a likely weak winter season. I know it's maybe difficult, but could you please quantify what kind of slowdown do you expect in the replacement for the third quarter? And the very last is on the footprint rationalization in Latam.
Do you expect any asset writedown ahead, or can you quantify the restructuring costs for 2020? Thank you very much.
Thank you. I answer to the last question, and then I give the floor to Mr. Casaluci. No, we already put in our accounts the effects of the restructuring in Brazil, so nothing is expected this year on this area. But in general, we don't see major restructuring of assets around the world. We have done what should have been done last year. Mr. Casaluci?
Thank you, Mr. Tronchetti. As far as stock in the dealers is concerned, we see, let me say, mostly recovered picture in Europe on summer. So, the level of stock we see in the trade in summer in Europe is in line with the needs of the market. While in winter is still too high compared to the expected reduced demand in the last quarter of the year. China, we don't see major, major risk on the stock level. Overall, the situation is back to the normal, to the normal environment.
While in the US, there are different, different pictures compared to if we look at the, let me say, most affected areas of the United States, as I said in the presentation, California, Florida, and the Upper East Coast, the supply chain overall is not yet stabilized, and there are still risk in the stock level of, the dealers. While in the rest of the US, is more, more, back to a normal, to a normal environment. As far as the expectation of the winter season, as I said before, the pre-booking, started in line with our expectations, so we don't expect negative surprise in the third quarter.
While for the normal season, that normally start end of October in Europe, there are some risk related to the lower car registration in the first half of the year, and to the high stock level in the trade. So our estimation is a one-digit negative demand on winter in the last quarter.
Thank you very much. Very clear.
... is from Akshat Kacker of J.P. Morgan. Please go ahead.
Thank you. Akshat from J.P. Morgan. Three from my side. The first one on your full year EBIT guidance. When I look at the implication for the second half, a large part of it depends on the pickup in the cost savings to EUR 17 million from EUR 14 million in the first half. Could you just summarize what parts of those cost saving measures are really accelerating in the second half, and if there are any risks to achieving those cost savings? That's the first one. The second one is on your market underperformance in the High Value Replacement market. I can understand dealers restocking and really trying to maintain pricing power. Can you just give us a picture, if you have, of how market shares have evolved on a sell-out level in the first half for High Value Replacement please?
The third one is on raw materials. I can see that your core underlying assumptions on raw materials are more bearish than peers, especially on synthetic rubber and Brent crude oil. Can you comment on that, please? The second element of raw materials effects, has this effect impact factored in the sharp depreciation of the dollar? Because even against emerging market currencies like the Turkish lira and the Chinese renminbi, the dollar has depreciated. So just trying to understand what drives that weaker effect impact on raw materials then. Thank you.
One general answer on exchange rate, we consider the trend of devaluation in Turkey, Brazil to continue. There is a weakening also of the dollar that we don't see any major changes. And so our forecast for the full year includes this trend. We do not expect any change in the trend. I leave the floor to Mr. Casaluci to answer to the business questions, and for the cost, Mrs. Leone will give you the answers.
Thank you. As far as the expectation on the High Value , performance in the second half, considering that we have finalized our destocking process in Europe early-
I meant the, sorry, I meant the sellout share in the first half on High Value, please, replacement.
Yes. In the second half of the year, we project to gain market share, and we project in the High Value to overperform the market all in all, at least 0.3 in terms of share. Drivers: enlargement of the customer base, introduction of new products, mainly US and Europe, and completed the stocking phase in the trade.
So for what-
For what regards the profitability of the second half, I'll try to give you more color. Consider that in the second half, we will expect a stronger contribution from internal levers. First of all, lower volume decline. We should have more or less 9-10% minus versus 29.5% in the first half. The price mix should be around 3% with a higher drop through, so means approximately 50% second half versus 26% in first half. And that's what's very important is the contribution that will come from efficiencies recorded net of inflation slowdown. That should stand more around more or less more than EUR 100 million versus net effect in first half around EUR 32 million.
Okay. Thank you. Over back in the queue.
One point I just want to add a point. We have you have to take into account that first half in Europe of our results was affected also by the bankruptcy of Fintyre in Germany and also the negative effect in Italy. And so now we are recovering volumes lost because of it through our other clients. So, I think that this is over, and so the second half should profit of it. Thank you.
Thank you.
The next question is from Kai Mueller of Bank of America. Please go ahead.
Hi, thank you very much for taking my question. The first one sort of follows up a little bit, with regards to the markets. Obviously, you know, a lot of people are talking about somewhat more driving that's happening in the summer and back end of the year, when people travel. Have you seen some more promising trends on your sellout from your customers, that demand is coming through, that the sellout is accelerating, but you obviously are still worried about the sell-in given where the dealerships stand right now with the inventory level? The first one. And then what I found is quite interesting is your comments,
With regards to down trading in the U.S. in terms of brands or price points, does that mean customers are no longer purchasing, let's say, a Pirelli tire, or they go—do they go for a lower cost version?
First, I leave to Mr. Casaluci the other answers. For the down trading, we have to consider this as something that is not affecting Pirelli in a consistent manner. It happened in United States, only United States. And is something we see we can cope with, thanks to the new lines that we are launching in United States that will be much more performing in terms of mileage, and that will satisfy the demand of people asking price per kilometer. That's the answer we are giving to this down trading that can be offset, thanks to the brand, but brand related also to a mileage effect. Casaluci?
Yes. I confirm there is a recovery in the demand, and if we look on the trend of April, May and June during the second quarter, this is clearly visible in all the major high-value markets. For example, the market in June, in the 18 inches and above, was basically flat in Europe, and was -14% in North America versus the -35% of May, and was flat to slightly positive in China already in the month of May.
Perfect. That's very clear. Thank you.
The next question is from Gabriel Adler of Citi. Please go ahead.
Hi, Gabriel from Citi. Thanks for my questions. My first questions on price mix. So, your full year guidance suggests the price mix will remain around 3% in the second half. Given the positive channel mix, would have helped in Q2, and this channel mix is likely to slow in the second half if replacements and OE growth converge, what's going to offset this, that means the price mix will stay at around 3% in the second half, similar to what was achieved in Q2? My second question is on the other costs that you're guiding to. Can you just give a little bit more detail, please, on what gives you confidence that this is going to be limited to EUR 35 million additional other costs in the second half?
Could you talk through your assumptions on other costs and specifically around provisions, what you're expecting in the second half? And then my third and final question is on CapEx, because you've reaffirmed your CapEx guidance for 2020, but could you give us a sense of how much this relates to delays, and how much will come back in 2021? Given that we're clearly seeing overcapacity in the industry and in High Value , is it fair to assume that CapEx will remain significantly below 2019 levels in the coming years? Thank you.
I answer the last question, and then I leave the floor for the other answers. CapEx, obviously, will be an increase compared to 2020. We don't see a reason to go back to the level of 2019 because we are introducing a number of changes that are increasing our productivity in the factory. So, we believe that this time, these three months of lockdown and smart working helped us in finding ways to be more efficient, and so an increase compared to 2019, 2020, but not at the level of 2019. That is the trend we see today. Mr. Casaluci?
Yes, price mix expected to be +3% in the second half. This +3% is basically done by -1% on price, which confirms the performance of the first half, mainly related to original equipment and a +4% on mix. The +4% on mix in the second half is expected to be driven by a +1% on region mix because of the overweight of China in the performance of the market and in our sales, and the 3%, which is the usual product mix performance, that is the combination of the growth, the High Value , and the decrease of the Standard, and the micro mix inside our product offer.
As for us, the additional other costs, as you asked before, we will rise up from EUR 35 million up to EUR 70 million. The additional 35 to first half are related to EUR 7 million on non-cash items related to additional reduction of finished product stock, and EUR 13 million of cash items linked to transformation. Now, to which 10 million, more or less, will be related to R&D, cyber activities, and digital, and to lower earnings from Prometeon, that will be working in second half by around EUR 5 million, and motorsport sponsorships due to the concentration Formula One and other sporting events in the second half.
The difference versus the May guidance is only related to the increase on non-monetary costs, as we said, during the speech, and they will be equal to EUR 20 million related to fixed from stock, plus EUR 3 million euros, the debt plus EUR 10 million euros, and other provision, plus EUR 7 million euro.
Okay. If I could just quickly follow up on price mix. Is this 3% product mix you mentioned, an acceleration compared to first half? What was product mix contribution in the first half?
So the different speed compared to the first half and the second half is related to the bad performance of the first quarter, that was affected negatively by the region mix and the channel mix. As you remember, the region mix in the first quarter was affected by the slowdown of China. And the slowdown of China is affecting negatively our performance because our average selling price in China is roughly 20% higher to the average of our replacement sales, because of the mix, mainly. And so this is affecting was the main reason of the negative performance of the first quarter, that was, what, -1.3.
Now, in the second quarter, we are back to a normal performance with a positive impact of the region mix, is a plus 3.3%, and as I mentioned before, we do expect a stable performance from now on, on a 3% on the entire half, second half.
Okay, understood. Thank you.
The next question is from Henning Cosman of HSBC. Please go ahead.
Yes, good afternoon. Thank you for taking my question. I understand the guidance cut is due more to the external factor, so I just wanted to make sure on the internal factors, you're now giving yourself enough cushion for the second half, so that you don't have to cut again, and specifically, or maybe on the COVID actions. You're obviously looking to generate the same amount of growth savings again, while the net impact is much higher because the slowdown is allegedly much lower. So, if you could just remind us of the dynamic there, how do you sustain the growth savings, while the negative offsetting element of slowdown comes down?
Then the second question, also maybe to take the opportunity of the FX cut again, to discuss this a little bit more. If I accumulate the FX components on EBITDA, just within the raw material, I think over the last four years, it's accumulated to something like EUR 330 million, and it appears that there's also a structural component to this. Maybe we could just talk again about if it's just the volatility that makes this structurally very difficult to contain, or is it really just the continuous depreciation of the emerging market currencies? I perfectly understand you have the 78% in low-cost countries, but it just seems there's no real offsetting element because you sell, of course, mostly into hard currency-denominated countries. Thank you.
First of all, we suffer on for the Latin American devaluation was much, let's say, deeper than expected, and that affected obviously the impact on our exchange rate. Cost of raw material increase also was the second element that affected and is affecting our cost in the future. In the second half, the effect will be lower in the original equipment, because in the original equipment, we had the cost matrix that was creating an advantage for our customers, and for us, was a minus. In the second half, this effect will be offset, so the big numbers will be more balanced in the second half. But I leave to Mrs. Leone the answer on details.
So for what regards the Forex, in order to recap the number, on the full year, the Forex will account, we expect to have EUR 200 million in terms of revenues, and will be driven by the weakness of Latam currencies that will account for 82% of the total effect, plus 7% will come from Russian ruble. On EBIT adjustment, the impact of this Forex is twofold for us. First, because we have the negative consolidation effects from the translation of the local statutory PBT in euro. And the second effect will then emerge from raw mat purchase price in local currencies, more than offsetting the reduction of commodity prices in euro, in dollar-euro.
I remind you that, the Pirelli production is located in low-cost countries for 78%, so means in high volatile currencies, while 60% of Pirelli raw mats are denominated in dollar and 35% in euro. Plus, the effect in full year 2020 is stronger than usual, since the current COVID crisis has severely impacted the export volumes versus United States and Europe, thus reducing the natural currency hedge on our accounts from more competitive sourcing. So, this is in order to recap all the Forex effect. For what regards your previous demand on second half competitiveness and COVID, the details, for the second half of the year, we expect approximately EUR 150 millions of gross efficiencies with a major contribution of, as, Mr. Casaluci said before, during his speech from SG&A, product range optimization and footprint rationalization.
Net of inflation and slowdown benefit, we expect more or less EUR 110 million coming from the four main projects included in competitiveness.
Okay, thank you. I'll get back into the queue.
The next question is from Martino De Ambrogi of Equita. Please go ahead.
Thank you. Good evening, everybody. Two more questions on the full year guidance. If I take the midpoint of your Adjusted EBIT guidance, it implies the second half is not far from last year, roughly -4%. High end would be even higher. So, my question is, what's your level of confidence, low end, high end of this range, considering the remarks you made at the beginning, saying that the visibility at market level remains low?
Yes. Mmm, we base our expectation in second half on a better performance on the 18 inches and above. We expect to have something close to 0.6% reduction compared to last year versus a -3% of the market. In any Standard segment, we continue the pruning of our portfolio. So, the reason why we are confident on second half EBIT is based on this, on the mix that Mr. Casaluci elaborated before. So that's why we consider that the replacement market as a whole in our segment will be close to what was last year.
Considering that we expect to have between 10%-15% reduction in winter due to the lower number of kilometers made by winter tires last year, and because in Europe there was 38% less sales of new cars in the first half, which means that for Germany and Italy, mainly, the season, the winter season for new cars, it's really very poor.
Okay, the second question on the guidance relates to the COVID costs, EUR 26 million, which are not in the guidance, or below the guidance. What's the rough figure for this line for the full year?
Anyhow, they are below the guidance.
Yeah, yeah, below the guidance, the 26 in the first half, and what should we expect for the full year?
For the full year, we expect more or less EUR 34 million-EUR 35 million.
Okay, not a big change.
No.
The last question is still on CapEx, because none, none of your competitors cut CapEx by 60% as you did immediately when the emergency started. Is there any risk of losing any opportunity in some markets or segments because of this? I understand that your indication of a higher CapEx for next year, if I assume something in the region of EUR 300 million is a reasonable assumption?
Yes, Mr. Casaluci speaking. Yes, it's reasonable. It's too early to have a clear number and clear picture, but it's reasonable to go back to a more normal level of CapEx. And no, there are no risk because we have decreased everything which is related to capacity increase, and we are protecting all the necessary investment for the technology upgrade... and to assure the business continuity. So, no risk so far.
Okay, thank you.
The next question is from Thomas Besson of Kepler Cheuvreux. Please go ahead.
Thank you. I have two very quick questions, please. The first is the one on the EUR 25 billion incremental raw materials you're reporting. I was wondering why you're not trying to pass part of that to end customers, as you seem to anticipate a better mix in H2 with replacement stronger than OE. That's the first question. And the second, when I look at your slide 11, and you outperformed a lot in OE, you underperformed a lot in replacements in H1. So, two small questions. First, are we still in the pull-through phase, or is it just the fact that some of the models you are exposed to are working well, while your whole replacement market was soft? That's it. Thank you.
First of all, the raw materials, you have to take into account that the view we have today, being in August, goes up to November. So, our figures, considering the input cost of the raw materials are quite certain. So, there could be something happening, but it will affect only the very last part of the year. So, we expect this number being consistent with what is going to happen. Mr. Casaluci?
Yes. Yes. We are overperforming the market in Latin America in the 17 inches and above segment. That is what we define premium segment in South America, because the 17 inches itself is still a high-value segment for these regions. And we are overperforming both in original equipment and in replacement in the first half, and we do project a growth in the market share also in the second half. And this is, as you mentioned, at leveraging mainly on the pull-through rate of the original equipment that are fitting Pirelli tires in the last two years.
Thank you.
The next question is from Gianluca Bertuzzo of Intermonte. Please go ahead.
Good evening to everybody and thank you for taking my question. I have three questions, actually. The first one is: how would you describe your first half and second quarter performance, compared to your peers, mainly in terms of profitability? Second one is on 2021. I know it may be too early to comment, but do you see any structural reason preventing you in 2021 to go back to the same level of profitability of 2019? I mean, if we look at some of the drivers that have led you to revise downward this year guidance, such as Forex in low-cost countries, it seems this kind of pressure might not easily go away.
Last question, more a housekeeping question, is on the level of total restructuring we can assume for this year. Thank you very much.
I start with, general, question you, you raised about 2021. It's very, very early to say. What, what we, we, we can see is that on replacement market, 18 inches and above, we, we, we don't see, major risks not to recover in 2021. That, that is a, a general statement we can make, unless there are other waves of, COVID, that until now are unexpected. But for the rest, I leave the floor to Mr. Casaluci.
Yes, I confirm what Mr. Tronchetti mentioned before. So, the risk related to Forex is not so it is not something we can completely offset. It's too early to say if we will be back to the profitability of 2019 in 2021. We have still a high level of uncertainty from now till the end of the year, so it is extremely difficult to forecast 2021. But our target segment, the High Value, in 2021, is expected to be back to the normal level of 2019. While the other segments of the market most probably will require at least another couple of years.
So we do expect to be back to the normal level of the market of 2019, not before second half of 2022, with the exception of High Value . So, we are confident with our business model to protect the profitability.
The next question is from Jose Asumendi of J.P. Morgan. Please go ahead.
Thanks very much, Jose at J.P. Morgan. I want to follow up on Akshat's question and maybe ask a little bit more sort of, you know, longer term for the coming two years. Coming back to, you know, to the discussion we had during the IPO, product mix has always been, you know, an important opportunity for Pirelli.
... how do you think about product mix improvement over the coming, not, not, not six months, but, you know, one, two years, which could actually allow us to understand, you know, how margins can actually normalize on a one and two-year view and see the value within Pirelli equity case? Thank you.
But what we are working on is to reduce the breakeven point. So, what you see, the actions we have taken already in our three years plan and the additional actions taken for COVID-19 are having an impact on our cost basis that is quite consistent. 6% on the base load, gross is something that will change the profile of risks on cost side, looking forward. On product mix, on product in general, the new ways of evolving, making the new sets of tires in a faster shape and with better performance is related to all what has been done in the last few years. So, we have invested heavily in R&D.
We have invested in technology in R&D, simulation, mathematical model, standardization inside the factories. All this will provide us a number of new lines that will reduce drastically the cost. This is an additional value that we can exploit in 2021, 2022, and should support our business model that I can call a High Value , low cost in a sense that we are trying to be as effective as possible, and COVID helps in a way to make additional action in place. That's why we feel comfortable that our performance is will be much more performing in the next couple of years that one can expect today.
Thank you very much. Thank you, Davide.
Thank you.
The next question is from Andrea Balloni of Mediobanca. Please go ahead.
Yes, good day, and thanks for taking my question. My first one is about interest cost. You did a good reduction in the first half. I would like to know, what are you projecting over the second part of the year? Can you expect a similar trend also in the second half? My second question, I'm sorry for that, is about free cash flow. I lost your comment about the full year 2020 guidance. If you can give us the main driver of a reduction in the guidance. I guess it, this is basically maybe about the lower profitability, but could be probably something which could be offset also by net working capital, if you can repeat it, please.
My very last question is again about COVID-19 cost. I lost your answer to my colleague about the full year '20 amount. Just to understand, it was EUR 26 million in the first half, and I lost the amount for the full year. Thank you.
Mrs. Leone?
Yeah, no problem at all. For what regards the cash flow guidance, what we told before, that the midpoint on your target is equal to EUR 205 million. That means EUR 25 million less versus the guidance we gave in last May, that was equal to EUR 230 million. And, what's the difference? In terms of cash flow, we have EUR 60 million reduction in EBIT, that translates just into, twenty-five million euro cash absorption. Part of this is due to the additional non-cash items versus the previous guidance, that's equal to EUR 20 million, included in the other costs, in particular, higher provisions, and, stock accounting treatment that are linked to 300,000 pieces, additional inventory reduction versus previous guidance.
The rest comes from the higher target for the year-end inventory reduction, which should bring an additional benefit of at least EUR 10 million. For what regards the COVID cost, what we told before, that we recorded in the first half EUR 26 million of direct COVID cost, and our estimate for the full year is equal to EUR 35 million, so only EUR 8-9 million plus in the second half.
Okay, and about interest cost in full year?
I give the floor to Francesco Tanzi for-
Thank you.
- the analysis.
It's Francesco Tanzi speaking. For what is concerning the interest charges, we see a stable trend, and assuming, interest rate curves and spread does not change, we will probably keep, our cost of funds, in line with the first quarter, with the first half.
Thank you.
That was the last question. I'll turn the conference back over to management for any closing remarks.
So this conclude today our today program. Thank you for the attendance and have a good evening.