Risks connected with general economic conditions and the medium-term evolution of demand
After a year, 2013, dominated by a high degree of uncertainty, Pirelli expects – consistently with forecasts by leading analysts – that the global economy will gradually accelerate in 2014.
In mature economies, a partial relaxation of austerity measures in the public sector and lower level of indebtedness in the private sector (especially in the United States) should sustain growth on both sides of the Atlantic. Improvement in the economic fundamentals of the United States and, to a lesser extent, in Europe, should also permeate emerging economies in terms of greater exports and further improvement in financial market confidence.
Elements of uncertainty will remain and might derive, inter alia, from the tapering of quantitative easing in the United States, possible political tensions in the more economically fragile emerging countries and, last but not least, geopolitical tensions in the Middle East.
EUROPE: TIMID RECOVERY IN 2014
Although signs of cyclical weakness are still perfectly evident (especially in the labour market), the recent economic recovery could accelerate during 2014, through an easy monetary policy and increased purchasing power (resulting from lower inflationary pressure).
Notwithstanding these encouraging signs, 2014 will continue to be a transition year for the eurozone periphery, especially on account of the labour market remaining depressed and austerity measures that will continue to curtail internal demand. However, the recovery will be stronger elsewhere in the European Union, especially in Germany.
UNITED STATES: ROBUST IMPROVEMENT IN OUTLOOK
After slowing down in 2013, the American economy should undergo a robust acceleration in 2014. With significant improvement in economic fundamentals (especially the real estate market), growing importance of unconventional energy sources (shale gas/fracking oil) combined with a more relaxed political climate in regard to the debt ceiling represent the principal bases for the American recovery.
CHINA: SUBSTANTIALLY STABLE GROWTH
The recent trend data and forecasts issued by leading economic analysts seem to converge on a 2014 GDP forecast that is substantially consistent with the last two years or, in the worst case, in slight deceleration. The structural reforms decided during the third plenum of the Central Committee of the Chinese Communist Party will continue to drive the country towards an economic model based more on consumption and a slow, but steady deregulation of the financial system. While no particular risks are perceived at the cyclical level – partly on account of the ever-increasing attention dedicated by the government to achieving a minimum growth rate – over the medium-long term the country must find a permanent solution to certain endemic problems such as the excessive debt of local governmental entities, a possible bubble on the real estate market and, in regard to society, an ageing population, urbanisation and pollution.o.
SOUTH AMERICA: STABLE OUTLOOK, NOT WITHOUT RISKS
The Brazilian economy should stabilise at its present growth levels. Over the short term, the principal growth driver will continue to be the stimulus generated by the upcoming World Cup soccer championships. The principal risk factors include the impact of changing United States monetary policy on the Brazilian currency and, indirectly, consumer price pressures. The risk of possible devaluations is growing in both Argentina and Venezuela.
RUSSIA: ACCELERATION IN 2014, BUT PRE-CRISIS RATES ARE STILL FAR OFF
After 2013, which was most likely the year with the lowest growth rate in the last five years (around 1.6%), the economy of the Russian Federation should accelerate during 2014 thanks to an increase in internal demand (especially government consumption and families). This acceleration, combined with a substantially stable outlook for energy commodities, might negatively impact its trade balance, and consequently slowing down marginal improvements in GDP during 2014. A return to pre-crisis growth rates is not expected over the short-medium term. The increasing strain between USA and Russia due to the worsening of the political situation in Ukraine and the consequent possible adoption of embargo measures pose a factor of uncertainty in the growth forecast expected in the Region.
The automotive market will continue to be influenced by exogenous factors, such as persistent macroeconomic uncertainty, regulatory obligations, volatile currency markets, and the evolution in demand according to consumer habits and lifestyles. The number of vehicles on the road is forecast to increase at an average annual rate of 3.7% until 2017, with a steady increase in the impact of the premium segment.
In particular, it is forecast that nearly 10% of the total number of vehicles on the road in 2017 will be premium segment vehicles, up from the 9.1% share estimated in 2013. The premium segment will remain concentrated in Europe and the Nafta area, which account for 60% of the total, as compared with 65% in 2013, and in the Apac area, whose weight is expected to grow by 30% from the present 27% level.
Even during economic crisis, the performance of the tyre market confirms the choice made by Pirelli to focus its activities on the premium segment. Even in the face of a situation caused by the difficult international business cycle, the premium segment will continue to grow at a rate three times faster than the non-premium segment, with a forecast annual average global increase of 7.3% between 2013 and 2017, as compared with a 2.4% rate in the non-premium segment (+3.6% overall growth).
In mature economies (Europe and Nafta), the annual growth of the premium segment is forecast to be 5.7%, compared with 0.3% growth in the non-premium segment (+2.2% overall growth). Finally, in rapidly developing economies, the annual growth of the premium segment is forecast to be 11.6%, compared with 3.8% growth in the non-premium segment (+4.8% overall growth).
For 2017, it is forecast that the premium segment will account for 26% of the total global tyre market (38% in mature markets and 15% in rapidly developing economies), up 4 percentage points from the 22% estimated in 2013.
In this context, it may be forecast that:
- the profitability of the premium products made by the automotive and tyre industry will remain structurally higher than the average stability of the respective sectors, partly in consideration of the fact that premium segment tyres are increasingly perceived as products associated with sustainability and safety. These areas are systematically cultivated by Pirelli, using its know-how and cutting-edge technology;
- mature economies will continue to play a preponderant role in the premium segment;
- the tyre segment will continue to be driven by the positive developments of emerging economies, beginning in the Apac area.
In light of these elements, the Group's strategic objectives will aim at balancing the impact of various geographical areas on profitability. In particular:
- the contribution to Ebit made by mature countries, currently 35%, will increase in 2016 (with an average annual growth rate of 12%, tied to the dynamics of the premium segment and greater efficiency, especially in Europe);
- the contribution to Ebit made by rapidly developing economies (excluding Latam), now 20%, is forecast to grow to nearly 30% in 2016 (with an average annual growth rate of 22%, driven by the expected development of the premium segment);
- the contribution to Ebit made by Latam, now 45%, will sink to around 35% (with an average annual growth rate of 3% and a stable “mid-teen” Ebit margin over the three-year period.
Risks connected with the evolution of long-term demand
Social and technological trends have emerged over the last several years that might have a material impact over the medium-long term on the automotive sector and indirectly on the tyre market. On the one hand, these are represented by growing urbanisation (according to United Nations estimates, about 70% of the global population will live in urban areas in 2050) and, on the other hand, by changes in the values and behaviour of younger generations (increase in the average age when a driver's license is obtained, loss of importance of owning a car, increased recourse to various types of car sharing).
These factors will be complemented by the spread of information technologies, with a concurrent expansion of e-commerce and/or telecommuting, and frequent regulatory changes in both mature and emerging economies to limit the presence of polluting vehicles within and near metropolitan areas. These dynamics might be followed by an evolution in automotive sector demand (from changes to vehicle dimensions or type of propulsion system to possible resizing of cars to satisfy the transportation preferences of citizens), with contingent impact on tyre sector dynamics.
Pirelli constantly monitors the evolutionary changes in automotive sector demand by actively participating in international working groups, such as the one engaged in the Sustainable Mobility 2.0 (SMP 2.0) project sponsored by the World Business Council for Sustainable Development (WBCSD). The main objective of SMP 2.0 is to study the possible long-term evolution in urban mobility and promote solutions that might improve the social, environmental and economic well-being of the urban population.
Pirelli implements a “local for local” strategy by setting up production sites in rapidly developing countries to serve local demand at competitive industrial and logistic costs. This strategy improves Group competitiveness in the face of resurgent trading blocs and growing protectionist measures (customs barriers or other measures such as technical prerequisites, product certification, and administrative costs connected with import procedures, etc.).
The Pirelli Group adopts this strategy for its operations in countries (Argentina, Brazil, Mexico, Russia, China, Egypt, Turkey, Venezuela and Indonesia) where the general political and economic context and tax systems might prove unstable in future.
In fact, structural risk factors persist in the Latam area, particularly those involving the political and economic situation in Venezuela and Argentina, and in Egypt, where political and social instability remains dominant and which has altered normal market dynamics over the last three years and, more generally, business operating conditions.
In order to adopt prompt (or even preventive, when possible) measures to mitigate the possible impact stemming from changes in the local context, the Group constantly monitors the evolution of political, earnings, financial and safety risks associated with the countries where it operates. Moreover, in situations where the production capacity of certain factories is underutilised, production can be reassigned to other Group plants.
Competitive risks associated with the markets where the Group operates
Over the last several years, competition has grown in the markets where the Group operates, especially in Latin America, due to the entry of low-cost products from Asian countries and major investments by competitors attracted by the dimensions of the internal market and growth of the middle class (+10 million persons over the next few years).
Pirelli generated about 45% of its Ebit in Central and South America. Consistently with its strategy, it intends to seize the opportunities for value creation deriving from the forecast growth rates in the premium segment of the automotive market by exploiting and preserving its market leadership, both in the replacement and original equipment segments, the broad and consolidated network of single brand retail outlets, both in Brazil and Argentina, and the consolidation of its brand, due partly to its participation in Formula 1 competition.