Continental (XTER:CON, Financial), a German-based company that is one of Europe’s largest manufacturers of tires, automotive parts and industrial products, was the largest detractor for the quarter. Investors reacted negatively to the company’s profit warning, which was attributed to three key issues: warranties, revenue shortfall and operational issues. Management decided to take a warranty provision to cover all outstanding product warranty issues in the powertrain division. The majority of the revenue shortfall occurred in the automotive side of the business, where two OEM customers significantly lowered their call-offs for the rest of the year. The operational issues were attributed to plants in NAFTA regions that suffered underutilization. Because management didn’t react accordingly, the company missed its cost targets, but Continental believes restructuring can address this issue by next year. The company also had trouble ramping up production to meet customer demands for 48-volt technology. On top of these company-specific issues, Continental has traded down on the back of industry-wide concerns about auto production volumes and tariffs, but we believe the company has superior end-market exposures and a lower risk profile than many of its peers. Continental’s tire division has an optimized footprint, consisting of large, modern factories in low-cost countries. This benefits the company compared with other global tire manufacturers that are burdened with onerous legacy cost structures in smaller, less-automated plants, which are difficult and costly to shutter. Continental also has leading market share in concentrated segments of the automotive components business. In addition, we expect that the increasing trends of autonomous and connected driving will provide significant, ongoing growth in this part of the company’s business. Finally, we think that the current management team has done a good job improving Continental by taking action to deleverage the business, enhance profitability and drive organic growth.
From David Herro (Trades, Portfolio)'s third quarter 2018 Oakmark International Fund commentary.
