Compagnie Générale des Établissements Michelin Société en commandite par actions (OTCPK:MGDDF) Q4 2022 Results Conference Call February 13, 2023 12:30 PM ET
Company Participants
Florent Menegaux – CEO
Yves Chapot – General Manager, CFO
Conference Call Participants
Thomas Besson – Kepler Cheuvreux
Philip Koenig – Goldman Sachs
Michael Jacks – Bank of America
Giulio Pescatore – BNP Paribas Exane
Martino de Ambroggi – Equita
Jose Asumendi – JPMorgan
Sanjay Bhagwani – Citibank
Christoph Laskawi – Deutsche Bank
Ross McDonald – Morgan Stanley
Pierre-Yves Quemener – Stifel
Florent Menegaux
Good evening to everyone, or good afternoon. Thank you for joining us for our annual results presentation. I’m with Yves Chapot the Co-Partner and we’ll spend an hour with you. Let me start first with our sales that were up 20.2% in 2022 and which are in a very, I would say, hectic environment has delivered an operating income of €3.4 billion, which is inline with our guidance. So amid market turbulence and the highly inflationary context, Michelin sales increased to €28.6 billion and the segment operating income, as I just said, has reached €3.4 billion. The free cash flow was punctually impacted by inflation and the year end trade timing, and we will have ample explanation later on. Over 2019 to 2022 period, the Group has demonstrated the resilience of its business model. Coming back to last year events, the sales were up 20.2%, lifted by the firm pricing discipline and the fast growing non-tire sales. The tire markets were up slightly in 2022 supported mainly by OE from a low comparison basis and sustained demand in truck and mining markets. The tire sales volume were down mainly impacted by the conflict in Ukraine, the COVID consequences in China and reflecting as well the Group priority to maintain the margin per unit. The price mix effect came to 13.7%, demonstrating the Group’s determination to offset all cost inflators. Non-tire sales grew by 22% at constant exchange rate, confirming their strong momentum. And finally, we had a 6.2% positive currency effect, led mainly by the US dollar.
Our segment operating income totaled €3.4 billion or 11.9% of our sales, driven by the dynamic pricing management and mix effect. The pricing maintained unit margin integrity offsetting a record €2.7 billion in higher costs, which is really an unprecedented rise in 2022. Operating margin reflected a 1.2 dilutive effect from price increases and each reporting segment contributed to improved segment operating income with specialties, RS3, our segment three margin, reaching 16.2% in H2 2022. The reported free cash flow before acquisitions was minus €104 million. The structural free cash flow was at €378 million, down from the revised guidance we gave a few months ago. With the one off impact of inflation on working capital, the reducing structural free cash flow was down €500 million and the Q4 has been penalized by two events, one purchasing cuts and the stronger December sales and that equal to €300 million down on our free cash flow. All of that will be offset by timing effect in the Q1 2023, that’s why we say it was punctual. But Yves will come back in more details on this. The overall Group performance improved in line with Michelin Motion 2030 strategy plan and which sits on three main pillars; People, Profit and Planet, and managing the best equilibrium of those three pillars at the same time.
Our net income reached €2 billion. The dividend has been set and will be proposed at the AGM at €1.25 per share. And looking at the projected environment in 2023, we have taken a conservative stance at the year that’s just started. That’s why we have a conservative guidance of €3.2 billion in the segment operating income at constant exchange rates and in excess of €1.6 billion in the reported free cash flow before acquisitions. Once again, this is a conservative stance. If we rewind a little bit over the period, what has happened between the results 2019 up to the results in 2022. In the first three columns, you see the effect of volume, price mix and basically cost of inflation. You’ve seen the unprecedented swing in the price mix effect with the cost inflation. And that was offset by volume down mainly due to Ukraine, China and the determination to make sure that we offset every cost through to protect our margin per unit. And then of course, we have improved our performance and that’s what explains the major increase we had in our full year results. Industrial performance, SG&A performance and all performances in every type of businesses that were driven even through this unprecedented crisis period we went through over the past three years. So I just want to take the opportunity to congratulate all our teams that really did fantastic job during this period.
Now I leave the floor to Yves who will give you greater details on our results.
Yves Chapot
Thank you, Florent. Good evening, everyone. To rebound on floor introduction, I will start to share with you am holistic view of the Group achievements in 2022. I will later zoom on the profit KPIs that I will cover in detail in my presentation. But looking at the people and the planet KPIs, you can see that we have reached all our targets in 2022. On the people side, the percentage of women in management improved by 5.5 points to reach 29.4%. Our associate engagement improved by 3 points versus 2021 to reach 83%, and we have seen the number of labor related accidents decreasing in ratio from 1.29 to 1.07. On the planet side, our Scope 1 and 2 CO2 emission to basically the energy we produce or the energy we purchase have been decreasing by 17%, thanks to partially production reduction but also efficiency improvement and our ability to source renewable electricity in several countries in 2022. 52% of the electricity we purchase is from a renewable origin, and it’s an increase of 10 points versus ‘21. And you can see that both the i-MEP or the environmental impact of our factories and the share — the sustainable material rate has also improved versus 2021.
So moving to the activity, I will start by sharing with you the situation of tire market around the world. In Europe, that has been heavily perturbated by both the conflict in Ukraine and also the outbreaks and the lockdown due to the COIVD-19. Passenger car and electric tire markets landed 1 point above 2021 but still below 2019, thanks to a dynamic OE market. The OE market grew by 7% but is 8% below 2019, and the sluggish replacement market, which decreased slightly by 1%. The seasonality by market has been very contrasted. OE market was below 2019 during the first half, minus 1, and has seen a sharp rebound in the second half plus 15. On the other side, the replacement market, which is overall back to 2019 level, has seen a sharp drop in the Q4 minus 11%. This phenomenon is both due to poor winter season, particularly in Europe and also in North America, but mostly to the destocking in distribution, distributors have received important quantities of budget tire brands during Q3. Truck & Bus’s market tires is down by 4%. If we exclude China, the market is up 7% versus 2021. This is mostly due to the original equipment market, which is down 19% but up 12% if we exclude the Chinese market. I remind you that in 2021, the China 6 norms have led to massive new vehicle purchase from fleets when 2022 have been penalized by COVID lockdowns and outbreaks. Europe and North American markets are well oriented as lack of drivers and strong demand in freights constitute to strong incentive for fleets to renew their vehicles.
The replacement market is up 1% globally and 6% outside China, led by strong freight demand all along the year. In Specialties, market has been overall well oriented, pulled by the demand in mining, the recovery of commercial aviation in Europe and North America and a strong demand in material handling and conveyor belts. Construction and Agriculture [indiscernible] a more contrasted picture according to the different segments and geographies. So in this market, our sales reached a new record at €28.6 billion, volumes were down by 2% for the full year with a better Q4 than expected, minus 0.9%, thanks to SR2 and SR3, when our SR1 sales have been down by 4.1% in Q4. And also, we have seen a better sell-out and sell-in in our distribution entities. We benefited from a scope effect, mostly driven by Allopneus integration. Price/mix reached €3.25 billion, of which €3 billion is coming from price effect of 12.8% when mix contributed to the eightth of nearly €200 million. The price effect was 11.4% during the last quarter with the lag effect of raw material adjustments on our long term contract businesses. Non-tire businesses overall grew by 22% and contributed to by 1.1 points to our overall turnover improvement. Lastly, we benefited from a strong tailwind from ForEx, including 5.5% effect in the last quarter.
In this context, our segment operating income increased by €430 million, of which €184 million is due to ForEx effect and nearly €250 million is coming from the progress of the company. Volumes effect was negatively high due to a sharp slowdown of our activity in the last quarter. If our overall sales were down by 2%, our selling tire volumes were down by 3% and our tire production was down by 5.8%, with a sharp reduction in the last quarter in order to manage our inventory level. Price and mix have more than offset all our inflators. In these inflators, you can see that raw materials accounted by nearly €1.2 billion, logistics €600 million; energy nearly €0.5 billion and labor cost €200 million. The non-tire activities, high tech materials, mobility experience and fleet managements, contributed to 26% of our segment operating income improvement, although, they account only for around 5% of our sales. Other effect are some of different amounts of which the most important is the reduction in the variable pay as we have not reached our free cash flow targets. Looking at the performance by segment, I think there is three key takeaways. The first one is you can see that all segments contributed to our segment operating income improvement. Second one is that the dilutive effect due to the price increase represents nearly 120 basis points when the overall group operating margin has only reduced by 60 basis points between 2021 and 2022. And the third message is that SR3 is nearly reaching 50% in SOI at the end of the year and was at 16.2% in the second half of the year.
Our free cash flow is landing at minus €104 million before M&A and after the financing of our joint venture, and has been heavily impacted by the inflation and the seasonality of our transactions. Most of the increase in inventory, more than €1 billion, is due to inflation. We landed with the same level of inventory in finished product than in 2021, but with slightly higher raw material and semi-finished inventory to compensate for the disruptions in procurement all along the year. Inflation impacted our accounts receivable as well and better sales than expected in the last months have contributed also to an increase in accounts receivable. As we sharply reduced production and raw material purchasing during Q4, our account payable landed despite inflation at a level which is slightly ahead of 2021, but lower than what we were expecting initially. The last effect — these last two effects are temporary and we are already seeing an improvement in free cash flow versus standard years in the first months of 2023. And as mentioned in our previous call, CapEx are catching up after the decision to reduce them in 2020. And the challenge we encounter in order to restart the CapEx in 2021. The other element contributing to the free cash flow, interest cost, taxes are in line with our forecast. Looking now at the evolution of our net financial debt. You see that the net financial debt increased and it’s mostly pulled by the payment of dividend, share buyback, we buy €120 million of our shares during 2022, but stay at a very healthy level with a gearing at 25%. At the same time, all our credit ratings, short term and long term, has been renewed by the rating agencies.
Looking now at the return on capital employed, which is one of our strategic KPIs You can notice that despite inflation, which heavily impacted our capital employed, the ROCE return on capital employed, improved by 50 basis points over 2022, thanks to a better asset turnover ratio and a slight reduction of our NOPAT due to the price increase. 10.8% is above the target we have set for the group within our Michelin in Motion strategy, and is above both our weighted average cost of capital, which has been constantly the case since 2019, except of course in 2020. It shows the ability of the group to create value even in this highly inflationary environment. Our net results has progressed by €164 million. Also interest rates increase weighed down on our financial results. And we must remind that in 2022, we have recorded more than €160 million of provision due to the stop of our operation in Russia. When at the same time, in 2021, we have recorded a strong positive result for the sales of 51% of Solesis, our medical subsidiary. Therefore, earnings per share increased by 9% in 2022 and we are proposing a dividend increase by 11%, inline with our target to gradually reach 50% payout ratio. It represents a yield of 4.8% for shareholders who have acquired Michelin share in the last day of 2022 or 4.38% for shareholders who invested at the average 2022 share price. We’ll pursue our share buyback programs aiming to neutralize the effect of employee shareholderships program.
Moving now to the guidance. We first built our ’23 guidance with the assumption that market will be stable or, let’s say, slightly around zero. Some markets will be slightly positive. But we’ll have fundamentally a very different seasonality, a different market mix and a different geographical mix than 2022. I’ll remind you that 2022 has been marked by an unprecedented volatility. We expect a strong decrease in the first quarter, looking at the market, followed by a rebound in the second quarter. We are also expecting more dynamic OE markets versus replacement and probably a rebound in China from the second quarter. So with these market assumptions, we have built our budget with conservative sales volumes due to all the uncertainties around us and with an inflation in between €600 million to €1.2 billion. This funnel may appear wide. I just remind you that last year, at the same period, we were betting on an inflation of €1.2 billion and we land at €2.7 billion at the end of the year. We are looking to compensate this inflation with our pricing and retain the mix effect for the company. Our CapEx should reach between €2.2 billion to €2.4 billion to continue the catch-up of 2020 and 2021. Integrating also some inflation in CapEx, such — with some components such as semiconductors and also the necessity to accelerate our energy transition, particularly in Europe and our digital manufacturing effort. You will see in the appendix that if we calculate the average CapEx between 2020 and 2022, you will find €1.8 billion which is the exact similar figure of our capital expenditure in average between 2016 and 2019. But of course, the distribution between the different years is pretty different.
In conclusion, we are aiming to generate segment operating income above €3.2 billion at constant exchange rate and a free cash flow above €1.6 billion. We have decided to abandon the notion of structural free cash flow, which was relevant when we were coping only with raw material prices increase and to guide on free cash flow before M&A and after financing our joint venture that you can directly read in our financial statement. I thank you for your attention. And I think that now it’s time to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question is from Thomas Besson with Kepler Cheuvreux.
Thomas Besson
I have three questions, please. First, on the guidance. I understand, I think you’ve most repeated that twice, but this is not only cautious guidance today in the context of limited visibility, or do you think it’s really the best view you would have? And can you confirm as well that the €1.6 billion free cash flow guide refers to the reported free cash flow pre acquisition. So if we use the former structural free cash flow and the reversal you’re expecting, the reported free cash flow should be more in excess of €2 billion? That’s the first question. The second, could you talk about the pricing environment by region? I think you and a few competitors on enterprise hikes in December, January, North America, Europe, Japan, others have not followed. Could you comment on that, are they sticking? And did you see as well distribution more positioned for price cuts than price hikes, no ordering again. And last question, could you talk about the SR3 margin trends in ’23 and the lag effect from indexation. Is it fair to think that we get further support from that indexation in H1 before it wins in H2? And therefore, should we maybe expect SR3 margins to eventually progress further from ’22 levels?
Florent Menegaux
So I will answer — we’ll alternate. So it’s more likely. And so on the first one, I think we’ve answered that already, but I will repeat. We’ve taken a conscious decision to be cautious for the year 2023, because there are many still many uncertainties. So Yves explained in details, a cautious stance on volume. We are still in a very volatile environment and we still operate under the crisis condition in many domains. So that’s why we’ve taken this. On the question number two…
Yves Chapot
So on the free cash flow, the guidance is on the reported free cash flow pre-acquisition but after financing of our joint ventures. And in an inflationary environment, the gap between this reported free cash flow and structural free cash flow we use to report on is in the opposite way. Inflation tend to inflate particularly the working capital even if you stay with exactly the same level of activity, the same level of inventory. So generally, in the past, structural free cash flow was above the reported free cash flow. But we will guide you all along the year and we’ll give you — it will oblige us to better communicate, particularly on the impact of inflation on the working capital, inflation, both from raw material that will capture pretty well in the past with the structural free cash flow, but also other inflation factors, such energy cost, for example.
Florent Menegaux
So on question number three, on the price hikes, let me rewind a little bit. We were entering in 2022 thinking that we would not have to raise the prices, and we ended up by raising the prices 3 times. So for the year 2023 now, we still have the follow-up of this coming. We still have some inflationary that will also — a lagging effect of inflation in many domains that will hit 2023. As far as we are concerned, we are not really looking at whether the prices are sticking or not. We are — so far, we are constantly monitoring our relative share versus our prices. And so far, I would say it’s okay. What we’ve seen — and let me take an example. If we look at the US market, what we have seen is the Tier 1 players have been exactly following the market in terms of volume, while the only — the segment — the Tier 2, the Tier 3, have decreased more heavily for the benefit of the Tier 4. So really the very cheap prices. So I would say that if I look at the US market, the Tier 1, the premium brands are still holding their share because they are addressing a market that is less sensitive to prices than others, and it’s exactly the case for Michelin. Now the anticipation from the distribution, what I can talk about is the level of inventories at the Michelin brand in every market on a worldwide basis. We are well positioned everywhere. There is still high inventory in winter in Europe. But apart from that, level of inventory are adequate. So I don’t see any really attempt from the distribution to anticipate price decrease. We will see, because as we have said constantly, in this environment, we are looking at — we have a three month horizon. So we’re looking ahead three months and we are then deciding on what we should do in terms of pricing. But so far, I would say we have zero reason to change our policy.
Yves Chapot
And for the last question about SR3. The SR3 margin improvement in the second half was due to two elements. The price and the lag effect from indexation that you captured very well, but also the fact that we were able to debottleneck our operations, particularly in the mining business where we were able to debottleneck both production but also expeditions and logistics issues that has been indicating us all along the first half of 2022. Of course, we will have, let’s say, a favorable comparative for — during H1 2023 and less favorable, less effect in the second half, as you mentioned.
Florent Menegaux
And the demand on SR3 is holding — especially on mining, is holding very well.
Operator
The next question is from Philip Koenig with Goldman Sachs.
Philip Koenig
My first question is just on the fixed cost absorption, which obviously weighed on your earnings in the second half of the year. Can you just describe the drivers, was that mainly driven by the production in Europe where you maybe scale back to destock some of your inventory? And is that something that you continue to expect in 2023, or should we sort of assume a more normal drop through on the volumes? My second question is just on the cost drivers. I know you gave quite a wide range, but maybe you can maybe give a bit more of a breakdown of the different items between raw materials and other inflation. Some of the raw materials obviously came down quite a bit in the second half of the year. So could we maybe expect potentially a bit of a tailwind actually from raw materials in the second half of the year? And then my last question is just generally on the volumes. I know you’re being conservative but obviously, you are guiding for markets rather flat, and for Michelin’s volumes to be down at the midpoint. You made very clear that you will hold very firm on your pricing policy. But just how long would you be willing to sort of grow below the markets in order to hold your price? Maybe very keen to your thoughts there.
Florent Menegaux
I will start and then Yves will complete. So as far as the fixed cost absorption, we had a change in the market during the summer, which led for us to have more inventory than what we wanted to have. So therefore, in Q4, we had to sharply cut the production down. But again, this was to adjust the inventory in the second half, which we have done. And therefore, we expect to have less impact of fixed cost absorption in the year 2023 that what we had in the year 2022. As far as the the volume and pricing element, it’s like fine cooking, it’s always a question of proportion. So so far, we are, okay with the way volumes are — and margin per unit are evolving. Again, we have accepted the fact that we wanted to protect the margin per unit first In a very hectic environment, there is no point of trying to chase market share, especially in this oversupplied market. We have to focus ourselves into extracting the value, demonstrating the value to our customers and insisting on the quality of our product. And so far, it’s proven to be right. And maybe Yves you want to…
Yves Chapot
What I can — maybe on the inflation breakdown. I mentioned quite a wide funnel in between €600 million to €1.2 billion, but because there is a lot of uncertainty who knows what will be the cost of energy during the summer and the next fall. That’s true that there was a slight relief in the past weeks versus the cost of energy in the month of October, for example. We have, let’s say, in accordance to our policy, we hedge part of our energy for 2023, but generally, we hedge half so that we still have uncertainties about the other half of the energy. We also expect some inflation in labor costs. And regarding raw material, that’s true that some raw materials such natural rubber prices are going down, but versus the average acquisition price of 2022, some raw materials such as silica or all the raw material that they serve a lot of energy that are energy intensive to produce will be probably at a higher price in average in 2023 than 2022. So that’s a lot of elements on which there is plenty of uncertainties. And what we are aiming for is to hedge this inflation with our price and retain the mix effect for the company.
Florent Menegaux
And if I — just the last complement is you mentioned energy, raw materials, labor and the fourth element is logistics. On Maritime, it’s true that it is better. The environment is easing. However, on [terrestrium] transportation, it is still high and there is — the lack of drivers does not lead to excess capacity in that transportation. Therefore, we don’t foresee a massive decrease in the transport prices on the ground.
Operator
Next question is from Michael Jacks with Bank of America.
Michael Jacks
The first one is, could you please comment on the velocity or run rate of Asian tire imports into the US and Europe. Have you witnessed any moderation there or are they still continuing at a similar pace? My second question is on pricing dynamics between Tier 1, Tier 2 and 3 brands. I know you mentioned that there is an art to pricing. But do you perhaps have a sense for the magnitude of pricing divergence between Tier 1 prices, which have been going up and Tier 2 prices, which could have been going down due to channel destocking in the past quarter? And at what sort0 of level do you start becoming concerned that a further widening in this [gap] could drive a larger trade down effect potentially? And then my last question is on share buybacks. Your presentation suggests that additional opportunistic buybacks will be considerable or a program will be considered. Is there any time line on this in terms of when a decision might be taken and are there any value parameters that you can comment on initially?
Florent Menegaux
So on buybacks, I will leave Yves to answer. On the pricing dynamics and the question of the Asian imports, so it is true that we have seen the Asian imports catching up heavily, especially in the second semester everywhere around the world. Now do we see anything easing there? The level of inventory in the dealership are high with the Asian tire imports. So now I think they have taken the inventory they could take. So I don’t foresee another — still such a big influx of these Asian tire imports happening in 2023, but they would remain at a high level. Now in terms of the pricing dynamic, as I was explaining. So we mainly sell Michelin brand, more than 83% of our tire business is on the Michelin brand. So overall, on every segment, everything. And what I was explaining that the price war that exists on Tier 2, Tier 3, Tier 4 is for Tier 2, Tier 3, Tier 4, not for Tier 1 at this stage. So we don’t see, at this stage, any concern for us, even though there is a slight trading down, but it’s mainly happening between Tier 2, Tier 3 — Tier 2 to Tier 3, Tier 3 to Tier 4 rather than Tier 1 to Tier 2, Tier 3, Tier 4. But we have seen it is true, also that we have seen a slight volume down. But for me, it’s more inventory adjustment effect than anything else. And back to inventory, for us, we see adequate inventory level everywhere in North America, Europe in summer tires. The only excess inventory that exists overall is for winter tire in Europe. I think it will, over time, fade away. Now as I was mentioning, the dealers are heavily loaded with Asian tire at this point. On buybacks?
Yves Chapot
On the buybacks, in fact, the strategy has not changed. It consists in neutralizing the effect of the shares that we are issuing for employee shareholdership program or for the share that are given according to our long term incentive program. Last year, we bought 120 million of shares and we give a mandate to a bank for a given period. The decisions for this year program will be made in the coming probably two months. [Jerry] will give to a bank a mandate for a period of four to six months to achieve this buyback.
Florent Menegaux
And we have risen the dividend, we will propose an enhanced dividend per share.
Operator
The next question is from Giulio Pescatore with BNP Paribas Exane.
Giulio Pescatore
The first one on pricing. I think there is a price difference at which brand almost doesn’t matter anymore in tire. So I understand that so far trade down has only been in the Tier 2 and Tier 3 segment, but understanding there is a price difference at which brands cannot be kind of justify the gap. I mean we’re talking about tires, it’s not really a luxury product in my view, but I could be wrong, so please if you can elaborate on that. And the second one on volumes. Volumes were really good in Q4, I was pleasantly surprised to see that and especially given how much the market was down, at the same time you managed to achieve a destocking. So can you maybe help us reconcile the things? So you outperformed the market and you also achieved the destocking. What led to the demand being so strong in Q4? And then the last point, a bit more technical on the other line. What should we expect in 2023 from the other line, which was quite significant?
Florent Menegaux
I missed the last portion — what can we expect from?
Giulio Pescatore
The other line in the SOI, in the segment operating income bridge, was a very significant portion of your FY in 2022. Just wondering how should we think about this line in 2023?
Florent Menegaux
So to the first element of your question on pricing, at which point do we become a luxury product, I don’t know. So far, tires are still cheap in relative terms compared to what they do and they are still indispensable. And the quality product, especially in a time where you have a high inflation, is a much better investment than having a cheap performance — a poor performing product at a relatively high price. So when we look at that, at this stage, we have not seen, especially in the premium and luxury segment, we have not seen trade downs. The tire is a very highly technical component in the vehicle, it’s indispensable to your pleasure of riding to your safety, to the performance of the vehicle. So therefore — and it is still relatively cheap. So I think we are far from having reached a level where it becomes a so-called luxury product. And then for you…
Yves Chapot
For the volumes, the outperformance in the second half was due to first, the SR3 because our mining sales have been growing and we know that in mining we gained market share in the second half and in both in Q3 and Q4. And also the fact that our distribution companies, particularly in Europe, had a better sell-out than the sell-in. So they grew in terms of volume versus selling what they purchased from tire manufacturers, of course, including Machine. And that was a good surprise of the last months of the year. Regarding the segment operating income bridge, generally, we set the other element at zero because we build on our budget based, for example, on the assumption that bonuses will be reached because by definition, if we achieve our budget, the managers and people will get their bonus. And of course, all along the year, depending on the expectation, we can see for the lending, we might adjust this line mostly in the second half till the end of the summer, it’s very difficult to guess precisely where we are going precisely to land. But that’s — and there can be also other elements in 2020 and 2021. For example, we recorded there all the COVID-19, let’s say, extra cost or specific costs such a mask, all the devices that we bought to protect our employees. So it’s a line where you will find also, let’s say, other activities, but that, let’s say, is a nonrecurring or that we cannot include in the SG&A or the cost of goods sold.
Operator
The next question is from Martino de Ambroggi, Equita.
Martino de Ambroggi
The first question is on the free cash flow. Just to understand what’s your expectation to recover what you lost and you consider one off in ’22. So what is expected in ’23? The second one and sorry I’m asking you again on volumes. But if I take the midpoint of your guidance, in terms of your guidance, you have minus 2%. While if you look at your market projections, the midpoint is basically flat. So I was wondering if you can discuss where you are losing the volumes by division, by regions, as you prefer? And the last question is on the car business, return on sales. So I suppose the negative mix in terms of channel will put under pressure your margin in the car business, considering the equation that specialty is recovering and maybe also trucks.
Florent Menegaux
So on the mix, OE/RT. Yes, it is true that we will have, as OE will catch up, we will have a negative OE/RT mix. However, the mix are very complex in our business. So you have to consider that OE is also under indexed contracts. So as we go and as the inflators somewhat stabilize, we will have the backlog effect of all the index contracts that will come into fluctuation. So that will offset somewhat the negative OE/RT mix. But as you said as well, there is a segment mix amongst SR1, SR2, SR3, which will have a positive effect because SR3 right now is under very strong dynamics. So overall, that’s — and it’s very difficult to predict exactly what will happen in terms of mix. So that’s why we’ve taken a conservative stance. As far as the volumes are concerned, we have taken, as I said, a conservative stance. So we have said, we just want to make sure that we over deliver versus over forecasting. Yves and I have had a long discussion on this and we said, okay, let’s make sure that we forecast low and we will see. Now we don’t have enough time to describe what will happen in every market around the world. But basically, that’s the look we’ve taken on this, we’ve said let’s be conservative on our volume forecast. And overall, we should deliver. Now the last point is we are prepared to lose some market share to make sure that we maintain our margin per unit because, again, in this environment, there is no point trying to chase market share at the expense of profitability.
Yves Chapot
Yes, maybe to complete on the volume, we also know that the first quarter will be lower than last year because 2020 — I’ll remind you that 2022 has been, let’s say, impacted by both the start of the conflict in Ukraine at the end of February, the first two months was basically without this event. And then there was a very strong effect of the lockdown in the second quarter in China, then another lockdown in the fall and then with the opening of China, the outbreak of the COVID-19 in November, December. So that’s also the reason why we have built our guidance on the, let’s say, conservative volume assumptions. Regarding free cash flow, I’ll remind you, last year, we were betting on to reach free cash flow above €1.2 billion. Basically, our free cash flow has been impacted by €1 billion of inflation in the working capital that we can, let’s say, spread in half between raw material and other element of inflation. If you look just our inventory, they are hurt by €1 billion and finished product inventory are exactly in tonnage at the same level than they were at the end of 2021. So inflation has heavily weighed on the working capital. And on the other hand, there is the calendar of our transaction at the end of the year that has also an impact. The fact that we reduced purchasing in the last 12 months, which has led to have less accounts payable than we were expecting. And a better performance in terms of sales in the last month that has also led to have higher account receivable than expected. And this €300 million should, let’s say, mechanically be translated or transfer to the first quarter of 2023. As far as inflation is concerned, of course, we might have to bear some inflation in 2023. But we have decided to take aggressive stance to control our level of inventory, better manage our payables and receivables in order to generate free cash flow above €1.6 billion in 2023.
Operator
Next question is from Jose Asumendi with JPMorgan.
Jose Asumendi
Just a couple of questions, please, maybe three of them, please. Can you comment a little bit around the dynamics, volume dynamics in SR3 within agriculture, infrastructure, mining, how do you see that evolving? Second, can you comment on the revenue contribution from scope in ’23? And then I’d love to hear a little bit around — we have this debate on Asian tire imports taking market share in China, and you’ve been excellent at passing on price increases offset raw materials and also adjusting capacity in Europe. I’d love to listen a little bit more around your view as to how can you basically take the opportunity to market share in China. And although you might lose some market share in Europe, how China is longer term, structurally an opportunity for you to grow the business and offset some of this loss in market share in Europe?
Florent Menegaux
I will start with the last portion of your question on China. There is still a lot of uncertainty about when China will recover from where they are today. Again, as Yves I mentioned, we went through zero COVID policy to easing policy, which led to major disruption in the Chinese market and in the overall supply chain on a worldwide basis. Now when will that be over? That’s the uncertainty in 2023. The fundamentals of the Chinese economy are strong. The number of people accessing to market and eager to access to mobility are still very high. So there, it is the big unknown for 2023 when China will be on a more stable basis. Again, if you look at — if you compare China right now versus Europe or North America, the immunity, the collective immunity in the country is not yet known. So that’s the big uncertainty. So on the positive side, we can — it could offset some of the drawbacks in Europe. Yes, at this stage, we said to ensure to bet on it right now. So that’s what we have said. And maybe Yves, you want to take SR3?
Yves Chapot
Yes, on the SR3 volume dynamics. So for 2023 — and we are expecting a bit, the continuity of what we have seen in the second half of — in 2022 and particularly in the second half. We should see mining continuously growing and particularly in the first half. We should also see the aircraft division growing, particularly if China is opening up, I mean, 2022, the commercial airlines have grown sharply in Europe, in North America. With the opening up of China, we can maybe come back not too far from, let’s say, pre-COVID level. And for the other segments, such as construction, agriculture, material handling, we are a little bit more prudent as this segment are also impacted by inventories building and which linked to the evolution of GDP, particularly the material handling. But mostly, we bet on strong growth in mining, commercial aircraft and, let’s say, stable activities overall in the other segments.
Jose Asumendi
And scope should be 2% or so on revenues in ’23?
Florent Menegaux
Scope, you mean change of perimeter, change in scope. We did not perform a huge acquisition in 2022. So therefore, the scope effect should be minor. In 2021, just the last day of 2021, we acquired 100% of Allopneus. In 2022, we did a couple of acquisitions. We have [indiscernible] the transition in Indonesia, we had an operation in Australia for our conveyor belt division. But it will not — let’s say, it will not have a huge effect on the scope line.
Operator
The next question is from Sanjay Bhagwani with Citibank.
Sanjay Bhagwani
My first one is on the pricing. So I understand that you increased the prices earlier in January. Could you maybe remind what was the magnitude of these price increases, and how much of that is basically covering the backlog inflation of ’22? That is the inventory that is sitting at a higher raw material cost. So my question is basically, let’s say, this year, we end up with inflation at the upper end of the guidance range, then how much of more price increases would you require? So that is my first question, and maybe I’ll just follow up with the next one after this.
Florent Menegaux
So in some regions around the world, we’ve done already in 2023, a price increase where we needed to adjust. So that’s, again, to cover the three months horizon we have in front of us, and then we’ll see. That covers the lag effect plus what we foresee — what we see in the inventory and the time it reaches the market three months basically. So that’s — we’ve done what we needed to do. What else — we’ll see how the inflation goes and it covers all the inflators. Now I want to remind you as well that we have the index contract that are still lagging between three months and sometimes nine months behind, and all those price hikes in the contract will come into [fruition] during 2023. So now if we look at the magnitude of what we have done already, basically, it comes back. If we look at from 2019, the price/mix effect has been €4.6 billion, of which we had a nice mix effect, but the bulk is pricing, and we have offset 100% of the inflation. So if you look at the inflation column, we had €3.9 billion, if you divide by our revenue and you have the magnitude of the price increase. So it has varied from 15% in some segments up to 45% or 50% in other segments.
Sanjay Bhagwani
And then my next question is on inflation. So maybe just to understand a bit more color on that. So let’s say, if raw material stays where it is and the transportation goes down and LNG goes down. So how should we think of, let’s say, the sensitivity? Is it likely that you end up more towards the lower end of the guidance range? And then what should basically be your higher end of the inflation range is incorporating? Maybe just a little bit more color on that.
Yves Chapot
So part of 2022, 2023 inflation is embarked in the [viriation] of our inventory at the end of the 2022. But what will lead to a lower end of the range might be if energy prices were staying at their current level, not fluctuating back to the level we have seen during the summer and the fall of 2022. Mostly that — the rest of course, if raw material prices were going down, but it’s where also there is a lot of uncertainty. And back to Florent’s comment about uncertainties about the way China will will rebound. We know also that China rebound will have a favorable effect on our volume and our — because we have strong market share particularly in the SR1 there but also, we might have also effect on the cost side, because it will lead to increasing energy prices. So that’s where we have plenty of uncertainty in the equation.
Florent Menegaux
And inflation, it’s roadmap, logistics, energy and now labor because after three years of high inflation, of course, labor is increasing and so we have to factor this as well.
Yves Chapot
And maybe a last comment, inflation has a different nature, for example, in Europe or in North America. In North America, we have higher labor components. In Europe, part of inflation — strong part of the inflation is imported through energy and raw materials. So we have also to look at that with different geographical lens.
Sanjay Bhagwani
And my last question is on the volumes. So Q4 volumes came in better than expected. I think you mentioned it is it largely just because of the SR3 or partially because of SR1 and SR2 as well? And then I think you mentioned that Q1 volumes are likely to be lower than the than the full year. Did I catch it correctly?
Florent Menegaux
So yes, Q1 is not over 2023. So we just had one month of three months. And what we have seen in the last quarter of 2022 is it was mainly SR3. And within aircraft was high, mining was high, Beyond Road was slightly down and SR1 was down replacement on the rise in OE and SR2 was better than expected. So again, we have 20 different business lines. So it’s always difficult to agglomerate this. But are we seeing similar trend in Q1 2023. So far, it’s inline with what we were anticipating.
Operator
The next question is from Christoph Laskawi with Deutsche Bank.
Christoph Laskawi
Quick ones, I would say. The first one, you stressed plenty of times now that the guidance in itself is a bit cautious. So I’d like to understand if we take the low end of both volumes and the higher raw material headwind. Is that still covered in the above €3.2 billion, or is it more working with the midpoint? And then the second question would be, you’ve cut production a bit in late ’22. Are you still running on lower production rates right now and would you keep that’s ongoing into the next couple of months, assuming that the market is not changing much from where it currently is? And then lastly, more or less on the logistics, we are hearing plenty of other companies complaining about, especially truck deliveries not being on time, creating a lot of hiccups in the supply chain. Do you see the same and is this, to some degree, impacting your production run rate and what you are delivering to the dealers right now, or is it basically smoothing out, as you said, for SR3, which had the hiccups before?
Florent Menegaux
In terms of reliability or logistics, it’s very simple. It is still problematic. On Maritime, it is improving. But on broad transportation, it is still very hectic. For the main reason, which is there is a lack of truck drivers in most of the countries around the world. And that is for us — we anticipate that to be structural, so it will not ease quickly this. So now we constantly have small perturbation in our plants due to this. However, the big slowdown we had to do in the Q4 is behind us and now we are coming back to a more normal level, inadequation with the level of the sales, which are, as Yves mentioned, in the first quarter 2023, forecasted to be low because the market has to absorb the inventories and the mileage, we have to wait to see what will be the real mileage driven, et cetera. So at this stage, it’s too early in the year to prognose anything. So the utilization rate of our plants, it varies. We are still not where we would like to be either because of logistic reliability issues or because of hiring or training. We still have, for example, in North America, very high turnover. But in China, we still have a lot of COVID cases. So one third of our staffing in China right now is with COVID. So therefore, we have plenty of reasons why the production is not yet back to a more routine setup and for the working — the midpoint on inflation.
Yves Chapot
Yes, for the guidance. So of course, you can try to find the point where we set up our guidance. As I mentioned, the guidance is a floor that we are aiming to reach, both in segment operating income and on free cash flow. And we work also with — we work with a range because at the beginning of the year, there is such level of uncertainties that it’s extremely difficult to communicate only on a single point.
Operator
The next question is from Ross McDonald from Morgan Stanley.
Ross McDonald
I have three questions. Firstly, on free cash flow. I think you suggested that free cash flow is already improving in January. So I’m just curious to what extent we can expect free cash flow to be much less negative in the first half of this year, given the offsets from free cash flow seasonality? Secondly, on mix, I think you showed on the slides that 56% of SR1 sales are 18-inch and above, up 500 basis points from ’21. How quickly do you think you can pivot on the mix side into larger room size tires from here? Should we be expecting another such move in 2023? And then lastly, you show very strong original equipment share for electric vehicles. I’m just curious if you can share any observations around the length of the replacement cycle for electric vehicles or maybe the loyalty or pull through demand that EV drivers are showing towards Michelin?
Florent Menegaux
So on free cash flow, I will leave Yves answer.
Yves Chapot
So for the free cash flow, we are not disclosing figure by months. We are already quarterly reporting. When I’m telling you that we have seen already this transfer from Q4 to the first quarter, that’s true that we have already seen part of this effect. And overall, we built our free cash flow guidance with the assumption that this one off effect on the working capital that we have in the last quarter and then the last two months of 2022 will not be reproduced in 2023. Don’t forget that we have a huge seasonality. In a normal year, so normal year is probably a year before 2019, between the highest and the lowest point of our working capital, you can have a fluctuation of €1 billion. In 2022, this fluctuation was €2.7 billion, and it’s partially due to inflation due to also the disruptions we have in the supply chain. We have with, for example, with the war starting in Ukraine, we have accumulated inventories of some raw material that we were sharing missing in the second half of the year. So all that has contributed to the disruptions that we described. And that’s why we are — if 2023, let’s say, will not be a normal year but a year less — a little bit less volatile and with the fact that we want also to better manage our inventory, that’s why we are also conservative on the sales side. We should be able to generate more than €1.6 billion of free cash flow.
Florent Menegaux
So as far as the 18-inch is concerned, and I’m glad you’ve noticed that. Yes, they are still progressing in the share of everything we sell. We anticipate that we will have progression as well in 2023. However, as Yves mentioned, we are increasing our level of capital expenditure to — but we’ve been surprised by the speed at which we’ve been catching market share in 18-inch plus. So therefore, we are here and there a max start in terms of capacity. So we are continuing our investment there. So we still have dynamic mix in the segment one. But to what level, it’s too early to say at this stage.
Yves Chapot
But what we can say is maybe 5 points is rather on the higher gain over the year. If you look the average of the past three to five years, we generally gain 3 to 4 points per year or per semester. 5 points is rather on the higher side of the range.
Florent Menegaux
And on replacement cycle for electric vehicles. In terms of loyalty, at this stage, we have not seen any meaningful differences from what we have experienced on other type of vehicles. However, this is a very new market. So it’s probably too soon to understand really what will be the replacement law. Our share shows that it is still very interesting.
Yves Chapot
And also, we can add that we are relatively over-indexed in premium electric vehicles where we can expect to have as in the premium IC vehicle where you’ve seen a higher royalty to original equipment brands.
Florent Menegaux
So this would be the last question.
Operator
The last question is from Pierre-Yves Quemener with Stifel.
Pierre-Yves Quemener
I guess the first one would be to Yves, sorry, to come back to the breach of the segment operating income. I’m afraid I did not understand what was in that 354 positive impact of other in the bridge on the Slide 7. The second question, if I shoot the three questions I have in a row, is related to net debt change. What’s in the €471 million that has inflated the debt on Slide 10, and how should we think of that into 2023? And my last question would be rather simple. In your free cash flow guide of €1.6 billion, at least, how much of working cap reversal is baked in?
Yves Chapot
So on the SOI bridge, I mentioned in the €354 million, you have a lot of different effects, some, let’s say, we’ll say, nonrecurrent or extra expenses. For example, in the past, we used to have the COVID-19 costs that were recorded there. Of course, in 2022 this amount has dropped. So it has contributed positively to the effect. The other — the main effect is coming from the variable pay provision that we are recording at the end of the year, which is based on the performance of the current year. As you have noticed, in 2022, we have reached our target related to segment operating income, but not to the free cash flow. So therefore, the variable pay for all employees is lower than it was in 2021. Regarding the change in net debt in the €471 million, you have the new lease, it’s a mechanical effect that you have every year and the reimbursement of the leasing, in fact in the EBITDA, but the new lease according to the IFRS standard is recording in the net debt change. You have also the share buyback effect of €120 million. And you have also the debt from the company that we acquired in the M&A, you have purely disposal and acquisitions, which was €76 million, if I remember well. But when you acquire a company, you also acquire some debt and it’s in this amount. And the last question regarding free cash flow reversal, I’m sorry, I did not retain the…
Pierre-Yves Quemener
That’s very simple, Yves. How much is working cap reversal, the positive inflow you expect from working cap reversal in 2022? How much is baked in at €1.6 million, how much that represents?
Yves Chapot
It’s mostly, the €300 million that we commented that impacted negatively versus our guidance, the free cash flow of 2022 in the last quarter…
Florent Menegaux
Very good. So thank you very much, Stifel, for your last question. And thank you all for your interest in Michelin. And we will see you very soon and at least in July…
Yves Chapot
And at the Capital Markets Day.
Florent Menegaux
Yes, you’re right. We have a Capital Markets Day in March…
Yves Chapot
13th of March.
Florent Menegaux
It’s 13th of March. So we expect a lot of you to be with us. Thank you.
Yves Chapot
Thank you very much. Bye-bye.
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