Schaeffler AG (OTC:SFFLY) Q2 2022 Results Conference Call August 4, 2022 4:00 AM ET
Company Participants
Klaus Rosenfeld – Chief Executive Officer
Claus Bauer – Chief Financial Officer
Renata Casaro – Head of Investor Relations
Conference Call Participants
Akshat Kacker – JPMorgan
Richard Carlson – Credit Suisse
Alexander Wahl – Stifel
Edoardo Spina – HSBC
Sanjay Bhagwani – Citi
Oleksiy Soroka – ING Bank
Renata Casaro
Dear investors, dear analysts, good morning. Welcome to this earnings call. Mr. Rosenfeld, Group CEO; and Mr. Bauer, Group CFO, will take you through the presentation slides prepared by us in the IR team. May I remind you to limit the number of your questions, follow-up questions to one, so that everyone has the chance to participate in this call. As usual, the call will be conducted under the disclaimer.
Without further ado, I leave the floor to Mr. Rosenfeld. Klaus, the floor is yours.
Klaus Rosenfeld
Thank you very much, Renata. Ladies and gentlemen, good morning. Thank you for joining our Q2 conference call. We will immediately go into the presentation as usual and leave as much room for your questions as possible.
Let me start on Page 4 of the agenda where you have the overview with the usual key messages. I think you will all concur that the Q2 2022 quarter was unprecedented in terms of the mix of headwinds, uncertainties and constraints and in light of that environment, I think we have posted a solid and encouraging Q2.
Encouraging, why? Because I can proudly say that the management team here has been successful and very much aligned in fighting this environment and doing the right things for the company, not only in terms of performance, but also in terms of transformation. Q2 sales 4.4% up. That includes a sales contraction in China of 12.5%. We have never seen something like this. And if you look into detail, Claus will explain this later on. You saw a really bad April with nearly 50% loss of revenues, but also a speedy recovery after the lockdown was lifted. And that comes together with good growth in the other regions.
So if we take the 4.4% and consider the China impact, we are definitely okay on the top line and think that, that will further continue in the positive also in the second half. In terms of business development, the key number you look at is order intake in Automotive, €6.6 billion for the whole division, strong book-to-bill ratio with 1.6x clearly indicating further growth in the future. And we’re particularly proud of the E-Mobility order intake. €3.2 billion is already in the first half above the full year target. We will not share with you any new target, but I can share with you that the trend is continuing and we’re seeing further interesting orders coming in.
As you know, we have always been selective and we will remain selective, but I think we have reached the point where the E-Mobility division has clearly earned its right to grow, has the license to operate and will now manage in the next year’s the ramp-up phase to make sure that the division will then ultimately become profitable and earn money. Q2 margin 5.3%. We have also here several factors that impacted this margin level. We are seeing progressing price realization from our sales recovery activities also here. Claus will give more detail. They — and that’s what we always said. They can only partially compensate cost inflation. The biggest impact in the margin clearly came from the setback in China.
If I would just take that out and say what would have been if April would be at the same level like June and the margin would clearly have been above 6%. And that clearly indicates that we are in the midpoint of our guidance range for the first half 2022. Free cash flow minus €219 million in the quarter. I think it’s more prudent to look at the half year minus €204 million. The minus €204 million is exactly the number we paid out for restructuring, driven by the realization of the Space One program. So we can more or less say the cash flow before M&A and without these one-off restructuring costs is still positive in such a quarter with that impact from China that is, I think, acceptable result.
Also here, I can already say we are clearly focused on making the guidance on cash flow. And Claus will explain how that can be calculated. But I can say upfront, I’m very confident that we will make our above €200 million or even the number that you have in mind when you look at consensus figures. We have always been able to demonstrate cash flow strengths in the second half and we will clearly build on this with a focus on working capital, as Claus will explain.
Guidance or metrics confirmed. The only area where we fail to meet the guidance floors was a margin for Automotive, 2.5%. We made 2% in the first half. And also here, the impact was China and we think that this is something that we will be able to mitigate in the second half.
So we are confident on all components and all metrics that the guidance will be met based on the understanding that Automotive top line will sequentially improve in the second half, driven by the regional mix, pricing and still being based on a conservative outlook in terms of volume. You saw this in the back end of the slide deck that we are still projecting 77 million cars or around this. So a slight gross market volume in the second half and then clearly improved outperformance going forward.
Let me finish this first page by the macroeconomic picture. There are clearly uncertainties that will determine also the second half. The intensity in this — in the mix of uncertainties and the headwinds will remain from our point of view. So it will be very important to manage through this in a careful, but also straightforward manner.
Let me finalize the page here. In this environment, also in Q2, we have been clearly focused on continuing, if not even accelerating our transformation. And you will see some later examples where we have been successful. We are clearly determined not to just manage the environment, but also continue to manage our transformation.
That leads me to Page 5 with the highlights and the lowlights. I think you could read all of this. I’m not going to do every sentence here. But we are positive on the Automotive Technology division. If you look a little bit into detail, you’ll see outperformance in Q2 of 130 basis points, slightly below the range we have for the full year.
Don’t forget we never guided for a quarter. We always guided for a year. Strong growth in America. European growth despite the challenges and the strong order intake continues in Q2, what gives us confidence going forward. Aftermarket, a continued positive market supporting sales development, in particular, in Americas, but also in Asia-Pacific shows how important that division is and how it also contributes to our top line growth. Industrial is clearly the outperformer here. We have exceeded another quarter with more than €1 billion, 14% growth, continued positive momentum. I’m really happy to see what Stefan is achieving here. And it’s good to know that this comes across the sectors and across the various divisions and subdivisions.
So we are clearly demonstrating here that the Industrial division, despite a difficult environment, can outperform the market and is on a continued positive growth trend. That leads then to the last point. I think you will also see this on the next page. Being an automotive and industrial supplier, we have said it on and on and on with a diversified regional setup helps to cushion headwinds and we will continue to — we will continue on that path to go for more diversification as you also saw from the latest acquisition we announced.
On the negative side, geopolitical situation, macroeconomic, I think you all know this. It is unprecedented what we’re seeing and it requires a lot of caution and also foresight to get this right. The supply chain headwinds are still there. Here and there, we see some positive developments. COVID restrictions, hopefully we’re not seeing any further lockdown in China. You just saw what the German government recommended for the fall. We clearly have cases in the company here also in Germany that don’t really help us to get the maximum performance out of the plants. Trade, logistics constraints, you all know this, difficult, but so far we can say we have not been in a situation where we have interrupted a supply chain or negatively impacted a customer.
Input costs, yes, in particular, on energy and some of the freight and logistics side, still increasing numbers on the other side. Raw material, if you look at the price for hot rolled coils and this is clearly pointing in the right direction. How this unfolds in the rest of the year we need to see, but we feel with what we have in our forecast, we are on the more conservative side. And again, I said that the second half is clearly determined by uncertainties. So let’s stay calm and confident, but clearly also focused on the most important levers to manage our performance.
6 now gives you for the second time this mix in terms of top line, goes from a divisional point of view, but also from a regional point of view. I think the numbers speak for themselves. I don’t have to comment more. If you just look at the darker blue boxes, minus 12.5% in China, a new experience for us. On the other side, 16% growth in Americas and good growth in Europe and in Asia-Pacific tells you how important it is not only to be multi-divisional, but also multi-regional. If you then look at the share of sales by the divisions, the share of Industrial in the second quarter has further increased, 28% now. You see the growth rates here and you see how much it makes sense to do — to be an integrated automotive and industrial supplier.
In terms of the business highlights, I will go through the pages with the key figures quickly because most of what I’ve written down here I’ve already said and Claus will explain it in more detail. You see the 2% EBIT for the first half. Clearly disappointing when we think about H1 2021, but okay if we consider the environment. Positive, as I said, the strong development of order intake, in particular, in E-Mobility. And here, let me immediately go to the next page, you have it in more detail. They are — what drives all of this is the focus of Schaeffler on its solutions and product offerings. We are very happy with our 4-in-1 e-axle that comes with up to 15% more range.
And it’s a very balanced and interesting offering including the Thermal Management Module and also the best Thermal Management Module as such, is a strong achievement. It received nominations for highly integrated systems with a new heat pump technology, also something where we think in future CO2 emission reduction and green product will play a much more important role.
In terms of Automotive Technologies, apart from the product development and the new technologies, I also would like to say a word on the portfolio management. Please go to Page 10 and you see here that we are actively shaping our portfolio and further building the ecosystems in which we’re operating.
This is an interesting example because you all know as part of space we announced to sell our global chain drive business that was already agreed with a PE fund in August ’21. And we successfully closed this now in the first days of July. 9 locations have been carved out, R&D input and production in Europe, more or less seamlessly without any hiccup with customers, a complex transaction, but very well executed, 560 employees will leave the P&L and we are clearly happy that this smaller divestment has happened now. It reduces risk, it reduces capital employed, and it will help us to reshape the portfolio.
On the positive side on growth and building the future, you all know about the joint venture Innoplate that we announced end of June together with Symbio. It’s clearly something where we see increasing interest in fuel cell systems. The idea to focus on what we do best with fuel cell bipolar plates has clearly been the driving force here. And we are very happy with this joint venture, is progressing well, has gained a lot of interest from customers and we will exactly demonstrate here our top experience and excellence in precise forming and stamping.
So 2 examples, not the biggest examples, but examples that show that we are driving the transition, that we are clearly rigorous in terms of executing what we promised and that gives me a lot of confidence that also further steps will bring this company forward.
Automotive Aftermarket, I think I already said it all. In this environment where we may even see a situation where people will rethink the buying cars, but rather repair, it is exactly right position for future growth. 13% margin in H2 — in H1, excuse me, is a strong margin. Don’t forget the 14.9% in H1 2021 had a significant positive one-off that should be deducted. So the margin is more — more or less in line with H1 ’21. Let me show one example here what is important, we all said that Aftermarket is a division that has its own challenges and clearly digitalization, a more focused customer relationship management, is of the essence.
And here, I can say we’re very happy that we have now our new cloud-based integrated customer relationship management tool live. It shows a lot of activity, makes the life of our sales teams much easier and Jens is very much focused here on more customer-centric, data-driven, marketing-driven actions, and that will continue — will help us to continue to grow that business. Jens is now in his new role for some months and I can say I’m really happy to see how he manages the division and how he continues to show excellence in its operations. Industrial, I think, the — a little bit the star in the second quarter, strong growth across all regions except China. Clearly strong volume growth in the Industrial division distribution area, but also in areas like industrial automation that we see as key growth going forward.
Regional, a good mix that we observed and I think all of that tells you that we are clearly focused on driving this division forward. We are executing our strategy. You saw Ewellix with the excellent strategic fit, a pretty tough auction, but an acceptable price that will help us to close certain strategic gaps and build, in particular, our linear business. 11.7% margin. If you just see and look back, it’s now at a continuous level of solidly above 10%, even 11%. We are clearly committed to deliver the 12% to 14%. And I think the next page, Page 14 shows you that even in this environment with an order book that indicates further growth, we are positive also on the second half of 2021.
The key here is the customer relationship. I can say we have great examples here from the aerospace, from the robotics side and I could go on and share more of this but the positive attitude towards Schaeffler, the competitiveness of our products and our solutions is really making great inroads also in terms of our market share.
Let me quickly just remind you and those of you that were not part of the little call that we did some weeks ago, the portfolio addition we did here, Ewellix was announced end of July. As I said, it is, from our point of view, a compelling add-on to our portfolio mix, significant growth and significant synergy potential. We acquired, in particular, a strong team. I’ve been in touch with them now after the acquisition, and I’m impressed by the straightforward, no-nonsense.
We want to create value mentality of the Swedish colleagues. They will clearly deliver on what they promised, and we are very optimistic that the acquisition based on the excellent strategic fit will further enhance the value that our Industrial business will bring to the table. Let me also add here. We clearly know that this was a number that was bigger than the previous smaller acquisitions. We are clearly aware that our financial resources in this environment are limited. So there are no bigger other similar acquisitions in the pipeline, but we are clearly looking as we did in the past for a smaller additive technological-driven acquisitions where it makes sense, but nothing to be expected soon.
For the first priority, we now need to digest and finalize the acquisition and then integrate it properly into our Schaeffler Group. Capital allocation is my last page, 16. I think we can say that CapEx spend was still prioritized and will continue to be prioritized along the capital allocation logic that we have introduced. The idea of the reinvestment rate clearly pays off. Those that grow get more than 1, those that don’t grow or will not grow the future get less than 1. That’s a pretty easy scheme.
The €303 million you see is slightly less than what we wanted. It has to do with the fact that some of the projects cannot be realized in this environment as quick as we wanted. The plan is still to continue maybe with some shifts of CapEx spend also into the new year, but we see that the execution of our plans is done properly. And we have, as you saw, updated our CapEx indication for the rest of the year from around €800 million to around €750 million. Let’s see how that goes. In any case, we will not stop reasonable investment for customers and for growth. But we will continue to be very disciplined in overspending and spending in the wrong areas.
With that, Claus, I would hand it over to you. Thank you very much.
Claus Bauer
Thank you, Klaus. The second quarter was certainly extraordinary. We go to the next page already. As you might remember, we reported already in our Q1 call that the second quarter was anticipated to be our most challenging due to the COVID-induced lockdowns in China that Klaus already mentioned. It is maybe worth to go a little bit into more detail. We talked to you about our campus in Taicang and maybe different than other players in the market besides the indirect supply chain implications, we really were impacted with the shutdown of our biggest campus in China.
Therefore, we lost around 60% of our production volume and 50% of our sales in China for the month of April. You see that also reflected obviously in the pie chart on the lower right side, but we see China with minus 12.5%, definitely a number that we not have been used to in the past. Nonetheless, as Klaus already mentioned, we achieved also for the quarter against a pretty good prior year, still a slight sales increase of foreign exchange adjusted of 4.4%, which — and we will go into a little bit more detail also. It’s mainly driven by our pricing actions to recover the input cost inflation.
From a gross profit standpoint, the China lockdown, as you can imagine, since we were impacted with our most significant campus there added to the production cost. You see that in the bridge in the middle, that’s not just the material price inflation that is also a significant fixed cost under absorption contribution from our China lockdown. And obviously, then as we already explained to you in the Q1 call, we then had to ramp up this campus in a so-called closed-loop production that caused additional costs and inefficiencies. What you also see, obviously, here is the plus €78 million in price action. And that I will break down a little bit more in the divisions.
Automotive Aftermarket and Industrial are close to a full recovery of the input cost inflation. In Automotive Technologies, we are technically done with our negotiations with our customers. We have reached acceptable recovery ranges. The execution comes with a little bit of a time delay. So you don’t see that necessary fully in Q2, but there will be a catch-up impact then in Q3 and even Q4 due to this retroactive lump sum catch-up for the first half of the year. Other impacts on the production cost, you see also mentioned here in the key aspects, obviously, due to the very complicated supply chain circumstances, not just with the China lockdown but also volatile customer call-offs and other supply chain interruptions, semiconductors to name only the most prominent one.
And the induced stop-and-go in our factories, obviously also caused some inefficiencies from a production cost standpoint. If you go into the overhead costs, then you see an increase year-over-year. And if you look into the details, you see that, that increase is mainly driven by selling expenses. There, you see reflected not surprisingly, 2 things. First, our very significantly higher volume in Industrial. Industrial sales come other than — or differently than automotive OEM sales come with outgoing freight and logistics expenses, and therefore, with the increased volume, the selling expenses also increased. And secondly, you would see the significantly higher cost for freight and logistics reflected here.
The one other very obvious number on that slide, you’ll find on the lower right, with the Automotive Aftermarket having a 3.6 percentage point higher overhead cost ratio and I think Klaus mentioned that already in his highlights, but that is mainly due to the positive onetime impact that we benefited from in Q2 of last year, where we got a cost reimbursement from a service provider in a significant amount. The EBIT pretty much follows what we discussed in gross profit and overhead expenses, obviously. What you will see and Klaus mentioned the 5.3% EBIT would have been more in the range of 6.1%, 6.2% if we didn’t have the China impact in April, mainly. So we would be for the first half of the year in the range, let’s say, of 6.5%.
But also interesting is, of course, Q2 with €200 million, you see a significant drop. But if you add back the China impact, then from an absolute standpoint, you see both Q1 and Q2 we are nominally in euros at the same level as we have achieved in the second half of last year. And with the 6.1%, so despite China and other challenges here, we are obviously in the middle of our guidance of 5% to 7%. I will not talk about the details in the division because I will talk to that on the next slide. Automotive Technologies, again, it became clear already in Klaus’ section that most of the China impact and then also other difficulties hit mainly Automotive in the second quarter. Automotive therefore had, for sure, a very challenging quarter.
And nevertheless, you see on the top left that we grew significantly in our new business areas, E-Mobility and Chassis Systems. But as you see in engine and transmission and bearings, and if you remember, our Q1 calls, there was a significant negative number in these 2 mature business areas, but you see there almost a breakeven with last year, adding to a beneficial mix here. The EBIT bridge on the right side, obviously, what jumps into the eye immediately is the gross profit deterioration of 5.2 percentage points. Of this 5.2% deviation to the prior year Q2, around 50% would be a recovery gap that is still existent in the second quarter between input cost inflation and our recovery.
The recovery so far has mainly been achieved in avoidance of price — contractual price reductions. All the negotiations for positive price on top of it will mainly hit even with retroactive adjustments and lump sums in the second half of the year. Around 30% of that gross profit impact is related to the volume and fixed cost and the absorption impacts of the Chinese lockdowns and around 20%, so 1 percentage points is attributable to the — yes, the actions on the shop floor to adapt to the volatile environment. I mean I almost don’t want to call it inefficiencies because it’s obviously very efficient to adjust very flexibly to these situations. But nevertheless, you can also imagine that if you have to react ad hoc to a new situation, that is not — is jeopardizing your optimal cost structure in the production.
If you look at the 0.5% EBIT for the second quarter and Klaus already said it, definitely not what we aspire to. But if I now would add back the China impact and also a price recovery that is already negotiated but will only hit in the next half year, we would have been in the range of 3%, which then obviously would also be safely above our guidance for this year. And that supports our view for a recovery also from a margin standpoint in the second half of the year, and therefore, also maintaining our guidance in every aspect.
The outperformance on the left side, if you read the outperformance for the entire quarter, the entire world with 130 basis points, clearly below our guidance that starts at the low end at 200 basis points, but we also indicated that for the total year, we will be rather at the upper end of our guided overperformance, so more in the 400 basis point to 500 basis point range. But if you look at the detail, you see a little bit why, and you see a healthy outperformance in Europe and Americas. Asia Pacific, it’s a breakeven, but from a volume standpoint, not so significant for us. And then you see the big underperformance in China. We will then see, I think, reflected a little bit maybe our special situation in China where we also have been really not indirectly, but massively directly impacted by the lockdown in our Taicang campus.
Klaus said it also we never wanted to take too much attention to this metric on a single quarter basis but rather on longer term. And with the recovery in China and we see healthy volumes there and therefore, still think that we will outperform the general market at the upper end of our guidance. Automotive Aftermarket, on the next slide, you see a moderate growth, highly also driven by the price recovery in the top line. China impacted also here, not as prominently as in Automotive Technologies, but also a significant warehousing location was impacted by lockdowns. And then you also have obviously, the supply chain impact that all of us experienced and thus we’re experiencing with the situation in China.
But nevertheless, you see China also significantly down for that reason. But the other regions in breakeven or a significant growth, as Klaus already said, in the headlines, Americas and Asia Pacific with very significant growth. And on the EBIT bridge, you see here the minus €21 million in SG&A expenses there. That is the significant onetime impact from prior year that we didn’t have this quarter. It’s about half of that and the rest then is the increased logistic costs mainly due to price and rates in freight and other logistics services. For the Industrial division, you see China impact here as well. I don’t — almost tiresome to always mention China. But I mean it is an impact that we have more logistically driven also here, similar than Automotive Aftermarket, not so much production-driven.
Our Taicang campus is highly related to automotive production. But you see then the very healthy growth in all other regions. If you go down, then you see that also our market clusters all reflect a good growth rates, except renewables, which then again is mainly China and mainly a winter impact here. If you look at the EBIT bridge on the right side, then you see here a significantly positive contribution in the gross profit — or from gross profit that reflects, first of all, of course, significant volume increases, but then also a satisfactory price recovery approaching almost a full recovery of the input cost here.
And then if you go to the right, you see then SG&A expenses, that is the volume impact, higher outgoing freight, but also the price impact for logistics that I already talked about. If we then come back to more — the entire group. Net income, nothing much to say here that clearly follows everything that I talked already about and mainly the EBIT. The ROCE and Schaeffler value-add is mathematically logically reduced as prior year strong quarters roll off and are replaced especially with this challenging Q2. And I think that we can leave to that and spend a little bit of time for cash flow. In regard to cash flow, and you see it minus €219 million for the first half of the year, minus €204 million. It’s clearly driven by a softer result, but then mainly also by increase of working capital, and here, in that regard, mainly an increase of inventory.
We increased inventory in the first half of the year in the range of €500 million. Around half of that would be price, so value and FX impacts, but the other half is really increased volumes in inventory. That is due to the fact that we wanted to be flexible and not cause further interruptions in our production due to missing inventory. So there’s some technical safety net in that inventory. I have to say all of that is technically a safety net. We think that we are at the end of the first half of the year at an inflection point and will from now on be able to really comfortably exploit all the opportunities that will come up in the second half. And if anything, then we will reduce inventory throughout the second half of the year.
Right now maybe also is already — if you followed my numbers, they are not explicitly written here, but if you follow them mathematically, that also explains to you how with a negative cash flow of minus €204 million, we still are confident to meet and beat our guidance of greater €250 million. We increased, as I said, inventory €500 million in the first half of the year. That increase will not happen in the second half of the year. It will rather be reduced, let’s say, for example, €100 million, maybe €150 million, then you already have a swing of plus €600 million to €650 million.
We have lower restructuring payout in the second half of the year than we had in the first half of the year of around €100 million. Then if you read all our documents here, we also think that there was slightly higher CapEx. So deduct another €100 million, just roughly speaking. But if you add all that together, you are easily in the range of €600 million to €700 million swing without any further actions of cash flow. We had minus €200 million in the first half of the year. If you’re now at €400 million or €500 million, then you’re between plus €200 million and €300 million for the total year and add a little bit of improved operational performance, no further China lockdown. And I think all our peers and we also are rather optimistic that the second half of the year, at least doesn’t get worse. And then you are in the range of our guidance greater than €250 million.
Maybe one last comment on this slide. On the lower right, you see what Klaus already alluded to, the restructuring payout was exactly the coincidence, €204 million. So if you now take that out, then you can, for the sake of, yes, defining the cash flow, you can say the underlying cash generation is still close to breakeven, maybe even positive even under the very challenging circumstances that we face, especially in the second quarter. Let’s come to net debt. Net debt is — the leverage ratio is at 1.3x. That is a function of the softer EBITDA. And then obviously, also the dividend payout of €328 million that happened in April.
So clearly, as I also said with in regard to where we see the second half of the year from a cash generation, but also profitability, clearly, a high point, if you will, and approaching the 1.0 again towards the end of the year, excluding, of course, the acquisition of Ewellix. Ewellix has an impact, as we also said, clearly of around 0.4x on our leverage ratio. There’s no maturities until March 2024. And our available liquidity with 16% of last 12 months net sales is still comfortable and allowed us to be opportunistic about the acquisition of Ewellix.
With that, I’m at the end of my section, and I would hand over to you, Klaus.
Klaus Rosenfeld
Yes. Thank you, Claus. Let me — before we come to the final page, quickly talk about the outlook and the guidance that we confirmed. As you know, a guidance is only as good as its assumptions. You have the assumptions on 29. And there are 2 main things that I would like to comment on. The one is Automotive Tech. You know that in July, IHS figures rather point to 81 million. Our guidance is still more conservative on that than that. We think that it’s rather in the 77.5 million range. If you take that number and look at the chart, the blue number, the H2 number is the IHS assumption. Our assumption would implicitly clearly be lower, but still point to some market growth in H2.
The number is in the range of 38.7 million, and that’s slightly above the 37.8 million in H2 ’21. So a little bit of growth, but not a market assumption that we think is maybe too optimistic given the environment. I think that’s the one thing I would like to mention. As I said, we all believe the challenges will continue, and it’s rather prudent to be on the conservative side.
The second thing is Automotive Aftermarket. You know that when we talked about our midterm targets, we rather use a global GDP growth figure. And Jens, I think, had a very convincing case here to say that’s not really a good indication for where my growth is coming from. So we had introduced now what he calls the global LV parc — car parc growth. That’s what we introduced here.
It is also an IHS market figure, and that will be used going forward to indicate where he stands in there. You see that at the moment, this figure on a global basis is somewhere around 2%. Also here, we are confident that this is prudently conservative, and we have a chance to outperform that number. And on Industrial, the logic and the metric has been unchanged. Here, you can clearly see that we are outperforming being global industrial growth — production growth figure. On that basis, again, as I said before, the guide then for 2022 is confirmed on all metrics. I think we have explained it now during the previous pages, both from my side and also from Claus’ side.
The focus is on the 2.5% floor for Automotive. We are confident that, that is achievable. It’s clearly a function of profitable growth. And I can say that the first figures that are coming in for July clearly indicate that we are on the right track when it comes to further growth in the second half. The second focus is then on free cash flow. And while the gap seems to be a little bit bigger than in the past, with the situation, working capital, as Claus defined, I am very confident that by the end of the year, we will definitely be above the €250 million.
Let me also say here, also it’s early days. Don’t forget, our logic is we want to pay dividend out of free cash flow. And therefore, we clearly see that as something that needs to be taken into the equation when we manage towards the end of the year that there is a decent dividend possible. This gives me the opportunity to sum it all up. Page 31 is the conclusion page. I’m not going to read all of this to you. You have it here. We have also put in the back up another slide that explains a little bit, the qualifications. For sure, we are not assuming a situation where all of a sudden, there is a major setback in terms of energy availability.
We are prepared for a situation where gas would be not ultimately available at the same levels. But even this guidance is not based on a complete shutdown of the economy. You see the description of the external headwinds in Page 34. On Page 2, let me say, we are tackling these headwinds. We are, for sure, as usual, managing with our eyes on the road and the hands upon the wheels. We are proactive in terms of mitigating and adapting what is possible in our production facilities. Claus talked about this. This is the core and one of the key strengths of Schaeffler to manage its plans properly.
Industrial gives us also an excellent outlook going forward on a midterm basis. We will stay the course. The secular growth drivers are intact. The transformation in automotive is happening as we speak. We’re focusing on our strategy and the Roadmap ’25 priorities. Clearly, sustainability is one of the key drivers. We will not cut back on that, but rather accelerate. And we have always shown that cost discipline without any radical programs is always possible. And therefore, I can say again, while there will be uncertainty while it will continue to be tough probably also in 2023, we are confident that we can cope with these headwinds well, and we’ll demonstrate to you that we will make the guidance, we will generate strong cash flow in the second half and deliver what we promise.
You have the outlook also for the Capital Market activities. Tough days, certainly, we’ll be available for road shows in the next days, Monday, Tuesday as well and then have also some interesting fair events in front of us. We look forward to talking to you again then on November 8 for the 9 months release. With that, we’re at the end and are now happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question comes from the line of Akshat from JPMorgan.
Akshat Kacker
Akshat from JPMorgan. 3 from my side, please. The first one on cost inflation. You mentioned that inflationary pressures continued to rise through the P&L in the second quarter. Can you just remind us on your expectation for gross headwinds in 2022? And also how do you expect this to evolve going into 2023 based on the situation today because you’re seeing raw material prices come down, but you do have sustained energy, labor and other kinds of inflation? That’s the first question, please.
The second one on OEM cost recoveries. Is it possible to quantify the euro amount recovered from the OEMs in the first half of the year? And do you expect the net balance between inflation and OEM cost recoveries to turn positive from the third quarter onwards? Just some quantification around that would be super helpful.
The third one on the €3.2 billion order intake in E-Mobility. You have previously mentioned that a large chunk of it is linked to battery electric vehicles, pure BEVs. Can you share more details on what components or systems dominate this order intake in the first half of the year, specifically linked to BEV, please?
Klaus Rosenfeld
Okay. Akshat, let me start with the last one. We all know that you are very interested to know more about order intake, and we appreciate this. But we have so far decided not to go into customer names. Other companies are doing that more. I’m more outspoken on this, but we will stay our course here. I can tell you a significant share of the intake that came in the second quarter is BEV related. But let me also reiterate the black and white BEV or nothing is, from our point of view, not the way forward.
We still see, in particular, in China, that there is still significant demand for hybrid solutions. We can debate for long how long this will last, but we also would take a profitable half project if it makes sense for us. I can also say that what’s coming in is very much driven by our Schaeffler USPs and by our technology. And therefore, I’m very happy about the quality of the order intake that we acquired. In terms of OEM cost recovery, also here, you will understand that in a call like this that is transcripted and where all our customers will look at what we say, we’re not going to quantify numbers.
What we can say, Claus, and I think you alluded to this already, we are very happy with what we have achieved in the first half in terms of contractual arrangements with our customers without some very smaller exceptions we have done with our negotiations. You know what we indicated and also by divisions, it’s clearly inconceivable to assume that there is 100% cost — sales recovery on the Automotive Tech side, where we are at the moment and how this is flowing in, clearly indicates to us that we are able to recover what we put in our forecast.
And on the Industrial and Automotive Aftermarket side, it’s clearly more geared towards 100%. So we are happy what we are seeing in these 2 divisions. There is a time lag in this and whether it will lead to a net positive is something where I would say we would — should rather wait for Q3 until we indicate here a direction. But let me stress again, the work that has been done by our sales team in Automotive is really outstanding in managing this new phenomenon of sales recovery without any hiccups, without anything that is overdone. That’s a great achievement by Matthias and his team.
In terms of cost inflation, again, also not black and white mix. We don’t have one steel category. We have numerous steel categories. If you think about the different needs for the future, then E-Steel, for example, is something that has a different price development than the normal hot rolled coil. The hot rolled coil is definitely going down the price, how this will continue remains to be seen. Production is up, in particular in China. So from the steel side, we see a relaxed situation.
On the other hand, energy is still high. What happens with labor is still not really clear. As long as inflation stays high, as long as unemployment is low, and we need people, and that’s clearly something that is different than in other years. We need to see how we tackle this. But that’s more a topic for 2023 than for ’22, Claus. But maybe that’s the directional statement we can give you. I’m not sure whether you want to add something for the rest of the year, I can only say again, we are confident that with what we are doing a decent result inside the — or in line with the guidance is definitely possible.
Claus Bauer
Maybe one addition here. We were very transparent in telling you in past calls that our sourcing strategy and price lock-in strategy for steel was a little bit different than in the past. Some of our steel contracts we didn’t lock in for the entire year, but only for half a year. And I think I reported in Q1 that, that might be a risk for the second half of the year. Now that risk, as you said correctly, that has pretty much gone away because we see the relaxation in the steel price or industry markets.
The — however, I would also not see a lot of tailwind in that regard because prices peaked after we locked in for the first half of the year and are now coming and are close to the levels that we really have been locked in. So I would say it’s neutral for the second half of the year. But definitely, the risk that we still have seen in Q1 for the second half of the year definitely went away. And now the biggest risk also then into — and you asked about 2023, the biggest risk that we are seeing right now for 2023 is gas and electricity.
I mean, you are following the price peaks and spikes as we are. And we are not talking about plus/minus 20%. We are talking about tripling one day, then going down by 30% the next day. Then so the volatility in that market is unprecedented. And despite the very small portion, and I did some math also in the last quarterly call, I think, based on our bill of material, if 2% of your cost structure triples in price, you still have a 4 percentage point impact on your cost. So it has unprecedented levels that we are talking about. We are not seeing this impacting us in 2022 because we locked in early, a very significant portion of our gas supply.
But obviously, that is only locked in for the calendar year, and therefore, is a risk if markets will not calm down is a risk for 2023. But that’s — we obviously are monitoring the situation and are tactically reacting to that — all that. What I said also for 2022, obviously, is under the condition that gas contracts and electricity contracts stay firm and are not opened up by an emergency 3 gas situation in Germany, for example, when we would have to free float and buy on the spot market again.
Operator
The next question comes from the line of Richard Carlson from Credit Suisse.
Richard Carlson
So I want to actually just start off from where you left off on the gas question because I think that’s a question a lot of investors have in mind right now and are worried that you guys might be in a bad position in the future. So can you talk about your overall level of dependence to gas? Is there a way to minimize that? And then also within your own supply base, is there suppliers that you are worried about because of their gas situations?
And then the second question for me, just back on the price recoveries from the OEMs. Is this good news to your guidance that was not previously there that gives maybe a little bit of a cushion? Or was this something that’s kind of been expected all year long and it’s just probably finally getting to hit the numbers?
Klaus Rosenfeld
Let me start with the last one. I would say, yes, there is a little bit of a tailwind in terms of the second half because we are well expected — because we have achieved what we wanted but where we were a little bit more cautious in the first half. So I would say it’s delivered as promised, but with some headwinds for — with some tailwind — excuse me, some tailwind for the second half. It’s a function of how this comes in on the timing side. In terms of gas, again, a situation where there is some dependency.
The dependency is focused on Europe and on Germany. There’s no real problem in China. There’s no problem in Asia Pacific, and there’s no problem in the U.S., but in Germany and in Europe, we have dependency on gas. I can tell you that, a, fully understood. That’s always the first point that you need to make sure and we have our own contingencies plans planned by planned, location by location in place. The strategy that we have articulated internally is a strategy that goes around reduce and safe.
It goes about substitute and replace and also about prioritize. So we think we can sustain a significant reduction of gas when it comes accidentally. I think we are not going to give you a number, but I give you an example. We have, in particular, in Germany, what is called blockheizkraftwerk, that’s where gas is turned into electricity. If gas would be going to a shortage, we would simply go back to the authorities here and say, we’re not going to burn gas to produce electricity.
We want the electricity from the local providers that can help us to save a significant portion of the gas that we are today using in Germany. On top of this, we have in every plant short-term measures, but also midterm measures. And gas dependency is typically associated with heating in winter. Some of that can be replaced by other energy sources. Some of this we will need. And that’s, Richard, in particular, when it comes to our heat treatment, their gas is not only used to create heat, but also as a part of the process. It’s a fraction of this.
And again, if it’s — as long as it is not completely stopped and black and white, we think that we are on the safe side to continue production in more or less all our plants. Our contingent plans go as far that we can say if there would be shortage that is bigger than we expected, how would we then support within this plant network with our more than 40 plants among each other. Because for us, the continuous or the continuity of production is important. If the German authorities would cut gas by the day and say, you get 5 days out of 7, that would be for the whole industrial core of Germany, a problem that’s fully understood.
We are part of the working teams with the Ministry of Economics in Berlin to explain that. As long as we can rely on a continuous gas supply day by day, even if it’s on a reduced basis, we are on the safe side. On top of this, we will clearly see what we can do midterm technology-wise to substitute gas by other sources. Oil could be a source. Let me say this, you’re loud and clear. We think that this is, to some extent, although it’s clearly bad for the overall situation, also a proof point how can we go about our sustainability targets.
This is exactly also a mindset problem where people can learn to say how can we be creative in using other sources and not just go back to oil, saving, replacing, substituting, reprioritizing, that’s the nature of the game. And I will help another call just after this to push our key leaders to make sure that they follow that plan. And with this having said, I am confident that we can sustain a situation where there’s a shortage of gas. What would be difficult to say this also and what is not part of the guidance, if all of a sudden, there’s no gas available at all or all of a sudden, the whole supply chain stops because others can’t supply their products to us anymore, that could become a problem.
Do I expect this? No. Have we alerted all our suppliers with letters, with calls by a priority list of ABC how important it is that they are still continuing to supply us with material, with some rings whatsoever? That has happened. And with the breadth of suppliers we have, with the understanding of our supply chains, I also feel comfortable that there is no immediate risk to be expected where there will be a complete disruption of a supply chain or a complete standstill in Germany of the production. So we’re working through this.
As I said, with as a task force that is not led by one of the board members for Europe. And I feel I have to say much more confident in the middle of July than I felt in April or in May how we are dealing with that situation. A long answer to a short question, but I think you can’t — this is not black and white. And it is a risk situation that we first need to understand and then learn to mitigate.
Operator
The next question comes from the line of Alexander Wahl from Stifel.
Alexander Wahl
My first one is a follow-up on this part with the gases. First of all, can you just confirm minus that roughly 90% of your gas supply for 2022 as locked in, in terms of prices? And then related to this, on your substitute and replace part of your contingency plan, I guess there’s probably a little you can do at this stage. But in general, if you were to switch from gas to electricity, this will basically mean you need to buy electricity at the spot market price at this point in time? Or is there any, yes, contracts you can already agree to get a better grip on potential cost developments here?
And then the second question is a follow-up on the recovery rates. I understand that you don’t want to provide anything in terms of potential price tailwinds in the second half of the year. But could you elaborate a little bit on how we should think about general price tailwinds in Q3 and Q4, given that there will probably also be some components from retroactive price adjustments?
Klaus Rosenfeld
Alexander, let me do the first one and then Claus can take the second one. If I understood you correctly, you asked whether how much of the gas supply is locked in and you mentioned 90%. That number is a good number. And it also tells us that we need to — clearly, when we go forward now for planning and budgeting purposes, see how — what that means for ’23. And the second one was a little bit difficult to understand. If I got it right, you said how do you go about substitution?
And what can you already lock in electricity on a forward-looking basis? Without going into all details here, that’s more than a fair question. But we — what we would do is here, we would not think about forward contracts like in a stock market, but you would — and that’s — there, we have buying power. If you think about the locations where we are here in Herzogenaurach. It’s an easy one to go to the Stadtwerke and tell them we are about to change direction and we need this from you.
Can you commit to this? So it’s more a purchasing thing that happens on a gradual case-by-case basis than a forward buying electricity in the stock market strategy. But I can assure you, we have, in particular, in the rural areas where we are, here in Herzogenaurach, we employ 8,500 people, the mayor of this town and the ones — the people that run the electricity supply companies here would — there would be very wrong advice to not support us in our ability to manage the situation. Claus?
Claus Bauer
Yes, yes. I think you said I’m taking the second one. I think I have to admit I was — were all your questions answered? Or is there anything open, please? Could you please repeat?
Alexander Wahl
Yes. Now my second question was related to pricing tailwind in the second half. So I understood that you don’t really want to share with us any concrete figures in terms of how much tailwind you get. But in terms of modeling Q3 and Q4, could you shed some light on the retroactive price adjustments. I mean, there’s probably a component that is not sustainable, not reflective of the, yes, sort of sustainable pricing tailwind. So could you just elaborate on how we should think about Q3 and Q4?
Claus Bauer
Yes. So I think if we look at the divisions, I think we were clear that for Automotive Aftermarket and for Industrial, we are there. So I think it’s safe to assume that there’s similar price recoveries as in Q2 for Automotive Technology. That’s obviously a little bit more difficult. And as Klaus said before, especially in a public call like this, we have to be a little bit more cloudy due to not give away any leverage that we would have. But I would say that there is, on average, a 1% point margin improvement due to higher price recovery in the second half of the year versus the first.
Alexander Wahl
Okay. That’s very helpful.
Klaus Rosenfeld
Yes. And then let me add here something on this topic. You saw from other competitors the very positive remarks and now we are the best in terms of sales recovery. This is also a question of long-term customer relationship. And clearly, of buying power and negotiation power, but we have always said we want to be fair. We have a new world with some inflation that we never had for the last 10 years. We want to work with our customers not only for 1 year, but for many years.
And it’s important to find the right balance here. We are not going to overdo certain things if it’s not in the long-term interest of the company by squeezing and outsmarting customers because we may know better or we have an opportunity here that may be short-term and shortsighted. So think about this more than like a new world where you have to be able to convince customers that this is a long-term relationship where the pain that comes in somehow needs to be shared. But where at the end of the day, the joint value creation story is the overarching principle.
This is how we’re approaching it. You will see and maybe in the next quarter, it will be interesting to look at this in more detail, but I can tell you, ’23 will be probably the most decisive year, whether the customers come back and say, and now we want the opposite direction again or where they say, no, that was a fair deal in 2022 and will be supportive again on further price increases or more gradual developments, if necessary. It’s wrong to be too short-term on this. It’s important to see the whole holistic thing and be balanced.
I’m not saying that we have not been aggressive. We have been exactly on the spot what we wanted to achieve. It’s done for the 2 smaller divisions. And in automotive, we will see how it comes in. I can only reiterate there is a little bit of tailwind here as we feel for the guidance, but let’s wait and see what the third quarter is going to bring. Hopefully, that’s a little bit more color for all of you.
Operator
The next question comes from the line of Edoardo Spina from HSBC.
Edoardo Spina
The first one is on the tax rate. I calculate about 20% for the second quarter. The first quarter was much higher. I was wondering if this is due to the account mix or if there’s any other impact there, and if you can give us an indication for the full year tax maybe next year as well.
Also second question is on the financial cost. There was a big decline in 2021 compared to 2020. Can you highlight the guidance and indication for 2022 and also if there is any strong sensitivity to the interest rates. And the final question is more on order intake for the E-Mobility, if you can give us an indication if the number of customers you are selling to now or ordering from now is higher or lower than in the past? Do you see like an expansion of the customer base? Or do you see the OEMs more concentrating the number of suppliers or in your case, the number of customers than before?
Klaus Rosenfeld
Let me do the last one. And I can say the customer spectrum is broad. We have since many, many years, more or less every carmaker in our portfolio. And here, I can say in the intake in the second quarter, there are some very interesting customers in — that we had as customers on the combustion engine side, but that have now become new customers on the E-Mobility side.
So it’s not broadening the spectrum from a company perspective, but from an E-Mobility perspective, we have always said we don’t want to be a company that only serves combustion engine components for one customer. We are — and that’s what Matthias is doing. He’s always trying for those customers that are long-term to say we want to have in both areas in the mature and in the new a fair share, and that’s happening at the moment. Claus?
Claus Bauer
Yes. So in regard to the tax rate, the tax rate is always a little bit front-loaded in our circumstances because we receive a higher portion of dividends into our parent company in the first quarter. And this dividend then causes withholding taxes that are not deductible from our taxation or tax base here in Germany. So therefore — and you — I think you’re aware about our normal expected tax corridor is between 28% and 32%. That is over the entire year. Right now we are at the low end, 28-point-something for the total half year.
And again, that is almost exactly in line with our expectations. Although if you look at it quarter-by-quarter, there is some distortion due to — mainly due to the effect that I just described. From a interest rate or interest result — financial result, of course, there is some dependency on the general interest in the market. We have defined our spreads and therefore are dependent on the base rate. But at this point, a lot of this, as you know, is financed in Europe with not as much dynamic in the base rate as we would see in the U.S. market. So there will be an impact. But I mean, it’s definitely watched by us and managed accordingly.
Operator
The next question comes from the line of Sanjay Bhagwani from Citi.
Sanjay Bhagwani
I have just 2 questions left. My first one is on China sale. So Auto Tech was 15% down versus light vehicle production in China around 5% to 10% for Q2. So I think you briefly touched upon the reason for this underperformance of 10%. That was a specific campus lockdown. So could you maybe elaborate a bit more on that? And can we expect this — so H2 to be significantly high outperformance in China because you also recovered a large part of this 10% underperformance. That’s my first question.
And my second question is going back to energy costs, I think, maybe could you just remind us what percentage of your sales or cost is energy costs. I think in your example scenario when you are mentioning you touched upon somewhere around 2%. Is that a fair number to go with? That would be very helpful.
Claus Bauer
Yes, I’ll start with the last portion. The 2% is indeed a fair number as it relates to our bill of material. So — and I think I mentioned that already in past calls also. The — I’m not so sure that I understood all your components of your prior questions. I think one was about the outperformance in China. And again, I think we always were clear that an outperformance is really a measurement over a longer period of time, sometimes even longer than a calendar year, but definitely longer than 1 quarter.
I think we were heavily impacted with our impaired situation on our main automotive production hub in Taicang in that specific quarter. And I would assume that, that normalizes itself over time, whether it will be now in the next quarter for the rest of the calendar year, or including the next year, but we will definitely not. An underperformance of 10 percentage points in China is definitely not what is the long-term situation.
Klaus Rosenfeld
Let me add to this. I mean, you all saw that the lockdown was not a complete lockdown of the country. It was a lockdown in particular in the Shanghai area. China is a large country and there are other factories that could run as normal. We had this with our industrial plants. They were running as normal. And therefore, the automotive part was definitely over-proportionately hit by — also by the location.
And then if you think about Shanghai port, you’ve all seen these pictures that was also one of the reasons where the supply chain was really squeezed. And therefore, again, don’t look at this as a quarter and try to draw conclusions from this for the overall Chinese business. This was, to some extent, a reflection of what Claus said. We were hit in our main production hub differently than others that were producing closer to Beijing or somewhere in the West of China.
Claus Bauer
Okay. One more.
Operator
Our last question comes from the line of Oleksiy Soroka from ING Bank.
Oleksiy Soroka
It’s Oleksiy Soroka, ING. Most of my questions have been answered. But can you elaborate a little bit on your M&A strategy, obviously make some acquisitions. What do you have in mind within that?
Klaus Rosenfeld
Thanks for that last question. Clearly, the M&A strategy that we followed in the last years is intact. We have always said we look at smaller additive — additions to the portfolio that must be technological-driven that must show a strong strategic logic. What is smaller? We always said in the past somewhere around up to €500 million. Now Ewellix was in total financing terms a little bit above this, but it clearly ticks all the boxes when it comes to strategic logic, when it comes to synergies, when it comes to integration risk, when it comes to addition to the portfolio and so on.
So that’s another proof point that what we have done in the past is clearly along the lines of what I just explained, and this will also guide us going forward. We don’t see any major transformational acquisitions at the moment in this environment possible. Also, as Claus said, we have, to some extent, used our financial firepower. We are, in this environment, clearly very much focused on balance sheet strength. Equity is going up. Leverage ratio is definitely okay. And we don’t want to overdo anything. So we will be careful now with further acquisitions.
But the general logic, this M&A radar with the different segments, with the different areas of the business is — will be continued. We will continue to be disciplined. And I am also proud to say we have always said we want to strengthen our industrial business and with Ewellix that hasn’t happened. It doesn’t mean that we will exclude anything on the other 2 divisions. There are opportunities here and there, but we will be selective and disciplined and clearly value-oriented when it comes to also the financials of a potential acquisition.
Oleksiy Soroka
Actually, if I may have a follow-up. Do you have any outlook on your rating? Private rating?
Klaus Rosenfeld
Can you say it again? You have —
Oleksiy Soroka
Do you have any views and outlook on your rating agency ratings?
Klaus Rosenfeld
Well, we are in constant conversations with the rating agencies. We updated them on Ewellix. I think Claus has just spoken to them yesterday. We think our rating is firm. And again, we can’t speak for them, but I can tell you that both of us have a strong financial background, and we’re happy with what we have. We know their parameters, and I don’t see any need for a rating reaction.
Oleksiy Soroka
Okay. No, that’s not how I meant. I meant that maybe with a positive angle, but maybe in the current environment —
Klaus Rosenfeld
Why don’t you wait and see? I think it will be a function of the delivery in the second half, but the rating is firm when it comes to the downside and that there’s upside, it remains to be seen. But that’s a function of how we manage through these complex environment.
Operator
There are no more question at this time. I hand back to Mr. Rosenfeld for closing remarks.
Klaus Rosenfeld
Yes. I think we have said it all. Thanks a lot for joining us. We know it’s a hectic day for most of you because there are so many companies reporting. And we thank you for the participation. We look forward to our further interaction, and thank you for your interest in the Schaeffler company. All the best. Enjoy the rest of the week and stay cool. Bye-bye.
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