THIS WAS 2011

FY 2011 has been a noteworthy one for Continental. Operational improvements, driven by a rebound in auto markets, in conjunction with several key developments like the successful refinancing of its banking facility and the stake sale by Schaeffler bolstered its credit profile. The performance so far has been solid with its top-line growth figures outpacing the growth numbers in each of its markets by a significant margin. It reported a double digit top-line growth as well as EBIT growth in the first three quarters of 2011. Notably, the performance in Q3 remained robust, defying fears of the economic slowdown gripping the European auto-industry during the second-half of the year. The YTD revenue growth stood at 18% Y-OY, along with an EBIT growth of 39% Y-O-Y. The margins also improved on a Y-O-Y basis, in spite of the heavy headwinds in raw material procurement for its rubber division that caused deviations to the tune of USD 766 million. Also, the company did rather well to offset the impact of the wide gap between projected and actual price-rise figures for the raw material through effective price increases. The actual raw material price increases were far higher than those expected by the management at the start of 2011 (EUR 900 million for 2011 vs. earlier guidance of EUR 700 million). Nevertheless, the incorporated price increases were in line with the overall industry trend of passing on the higher raw material costs forward. The major credit positive developments so far in 2011 have been (a) the successful refinancing of its VDO facility with additional EUR 6 billion. This reinforced the companys maturity profile and decreased its financing costs (b) the stake sell-off by major stake holder Schaeffler from a previous c.75% to c.60%, which makes a Continental-Schaeffler merger less likely. For Schaeffler, this move helps it reduce its debt burden. For Q4 FY 2011, we expect another quarter of stellar performance. With the pressure on raw material front, which was guided for in its Q3 conference call and which had led to a considerable margin dilution in Q3, finally easing out. A further improvement in its Net Leverage is expected, as prompted by the positive FCF generation and working capital release in the quarter.

OUR EXPECTATIONS FOR 2012

Continental would continue to improve its credit profile through 2012 with a goal of reaching a standalone investment grade profile by the end of the year. While this target appears achievable on the back of the cyclical improvement that Continental has showcased in the last few years. The risk posing the biggest threat to Continental s plan is more-thananticipated decline in its main auto and tire replacement markets (Europe and NAFTA) in 2012 which could potentially derail its plans. For 2012, we expect moderation in its operating performance relative to the strong performance it displayed in the previous years in view of the challenging market scenario in Europe. Having said that, we believe that Continental will continue to outshine the overall

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growth in all its markets on the back of new innovative products. The raw material pressure is expected to subside in 2012, which would offer some comfort in a softening demand scenario. With its plans to increase the current tire capacity by 22 million tires within 2015-16 timeframe, we expect a higher capital expenditure in 2012 and in the following years. We also expect supplementary bolt on acquisitions in India and China to boost its Asian presence. Although, an improvement in its Net Leverage is expected in 2012, we believe it will be considerably limited on account of the high intended capital expenditure, potential due dividend payments for 2012 and the testing market conditions. The present liquidity remains strong with upcoming maturities covered until 2013, which does not warrant any need to access to capital markets in the near term. One thing to observe closely through 2012 would be Schaefflers strategy with respect to its stake in Continental, when the existing investment agreement expires in August 2012.

OUR PROJECTIONS

An underlying assumption is that Continental would continue to outperform the growth in each of its markets. We anticipate a double digit growth of around 15% in its revenues for 2011 which would surpass the managements guidance of EUR 29.5 billion for the year. For 2012, we expect a slowdown in growth rates owing to the vulnerability of its end markets owing to the economic slowdown. Further, it is assumed that continental will successfully offset the additional raw material headwinds in the rubber as well as for rare earth metals in 2011 through improved operational efficiencies and higher pricing; although, we expect that pressure on raw material front to slightly ease in 2012. We have also taken the capital expenditure to be at EUR 1.7 million, lower than the guidance of EUR 1.8 billion for 2011 (current run rate as of 9M EUR 1 billion) and EUR 2.2 billion for 2012. Additionally, we have assumed dividends payment of EUR 1.5 per share for 2012, in line with Continentals intention of resuming dividends.
RISK/OPPORTUNITIES

The primary risk associated with Continental is an economic slowdown particularly in Europe. Although, the company is doing well to enhance its geographical footprint, it still remains highly reliant on Europe. At the same time, expansion in Asia holds a vast opportunity for growth and might turn out to be a big upside. Furthermore, continued raw material pressure with softening outlook might exert pressure on its financial profile. There remains a certain degree of risk with regard to its major shareholder Schaeffler, although the current investment agreement limits the control which Schaeffler can wield on Continentals strategy and decision making until August of 2012. Given that merger of continental and Schaeffler is not improbable, it will dilute continentals current credit profile. However likelihood of the merger remains slim in the short term as the priority for both the

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entities is to improve their respective standalone credit profiles. The recent reduction of stake by Schaeffler has further lowered this possibility.

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