2. Economic Value Added management

The ThyssenKrupp Group is managed and controlled on the basis of an Economic Value Added ("EVA") management system. The key goal of this system is to maintain continuous increases in corporate value by focusing on business segments which - with respect to their performance - are among the best worldwide. To achieve this objective, an integrated controlling concept is applied. It allows for goal-driven controlling and coordination of activities of all segments, supports decentralized responsibility and promotes overall transparency.

By taking timely appropriate actions, the integrated controlling concept realizes the increase of corporate value by bridging operating and strategic gaps between the actual and target situation. The prerequisite for this concept is the existence of high-quality operational and strategic reporting systems for the accounting of actual and budgeted results as well as internal and external reporting. The values determined under US GAAP for each and every reporting unit form the basis for our reporting system.

In the ThyssenKrupp controlling concept, strategic and operational elements are linked to timely reporting which is accompanied by regular pro-active communication. The concrete elements of this strategy are: economic value added performance measures and active portfolio management.

The central performance measures are return on capital employed (ROCE) and Economic Value Added (EVA). These two ratios reflect the earning power of capital employed in the form of a relative quantity (ROCE) and an absolute value (EVA).

ROCE is calculated as follows:

 

income before income taxes, minority interest and interest

ROCE=
 

capital employed

The numerator is composed of income before income taxes, minority interest, net interest income or expense, and an internally allocated interest expense associated with accrued pension liabilities. Management's performance as well as the Capital Employed included in the denominator of the profitability ratio include the activities of both continuing and discountinued operations. The capital employed denominator can be computed on the basis of either asset or liability items. For the calculation based on asset items, net fixed assets are added to working capital. Deferred taxes are not included in the computation because the standard figures are determined on a pre-tax basis. Capital employed calculated based on the following liability items including discontinued operations and the breakdown of the disposal group as disclosed in Note 3 of the consolidated financial statements:

Group million €
*) adjusted due to the change of inventory method (see Note 4)

 

 

  

Oct. 01, 2002*

  

Sept. 30, 2003*

  

Oct. 01, 2003

  

Sept. 30, 2004

Total Stockholders' Equity

 

  

8,287

  

7,671

  

7,671

  

8,327

+ Minority interest

 

  

298

  

320

  

320

  

410

+ Pensions and similar obligations

 

  

7,065

  

7,401

  

7,401

  

7,221

+ Financial payables

 

  

5,683

  

4,948

  

4,948

  

4,270

./. Marketable securities/cash and cash equivalents

 

  

941

  

713

  

713

  

1,437

+ Deferred tax liabilities

 

  

551

  

771

  

771

  

984

./. Deferred tax assets

 

  

998

  

1,283

  

1,283

  

1,15

Total as of measurement date

 

  

19,945

  

19,115

  

19,115

  

18,625
           
 

 

        

Average

 

  

19,530

  

18,870

The ROCE is compared to the weighted average costs (WACC) of capital employed. The cost of capital is determined on a pre-tax basis, as is the standard result used. On this basis, the weighted interest for the Group from equity (14.0%), financial payables (6.5%) and pension accruals (6.0%) amounts to 9.0%. This weighted cost of capital is maintained at a constant level in the medium term, in order to guarantee a relatively high degree of continuity over the periods. Therefore the interest rate is only adjusted if changes are material.

The segments' cost of capital are derived from the Group's cost of capital for equity, financial payables and pension accruals based on the relevant segments' capital structure. In addition segments' specific business risks were taken into account. Therefore, weighted and risk-adjusted segments' cost of capital amount to: Steel 10.0%, Automotive 9.5%, Elevator 9.0%, Technologies 10.0%, Services 9.0% and Real Estate 7.5% .

EVA is computed as the difference between ROCE and the cost of capital, multiplied by the capital employed. Additional value is created only if the ROCE exceeds the weighted cost of capital. Accordingly, cost of capital reflects the minimum acceptable rate of return. In addition, individual target profitability is agreed for individual activities, which are based either on the best competitor or on an inter-industry benchmark. This management and controlling system is linked to the bonus system in such a way that the amount of the performance-related remuneration is determined by the achieved EVA.

The following tables illustrate the development of the performance measures in the previous two fiscal years.

Year ending Sept. 2003 * ' **
* unaudited
** adjusted due to the change of inventory method (see Note 4)
*** income incl. discontinued operatiions before income taxes, minority interest and interest (net interest income or expense incl. interest expense associated with accrued pension liabilities)
 

 

  

Income before interest ***
(million €)

  

Capital employed
(million €)

  

ROCE
(%)

  

WACC
(%)

  

Spread
(%-points)

  

EVA
(million €)

Group

 

  

1,407

  

19,530

  

7.2

  

9.0

  

(1.8)

  

(352)

thereof:

 

  

 

  

 

  

 

  

 

  

 

  

 

Steel

 

  

627

  

8,777

  

7.1

  

10.0

  

(2.9)

  

(255)

Automotive

 

  

282

  

2,940

  

9.6

  

9.5

  

0.1

  

3

Elevator

 

  

389

  

1,647

  

23.7

  

9.0

  

14.6

  

241

Technologies

 

  

49

  

1,166

  

4.2

  

10.0

  

(5.8)

  

(68)

Services

 

  

120

  

3,191

  

3.8

  

9.0

  

(5.2)

  

(166)

Real Estate

 

  

70

  

1,782

  

4.0

  

7.5

  

(3.5)

  

(63)
Year ending Sept. 2004 *
* unaudited
** Income incl. discontinued operations before income taxes, minority interest and interest (net interest income or expense incl. interest expense associated with accrued pension liabilities)

 

 

  

Income before interest **
(million €)

  

Capital employed
(million €)

  

ROCE
(%)

  

WACC
(%)

  

Spread
(%-points)

  

EVA
(million €)

  

Change in EVA
(million €)

Group

 

  

2,271

  

18,870

  

12.0

  

9.0

  

3.0

  

572

  

924

thereof:

 

  

 

  

 

  

 

  

 

  

 

  

 

  

 

Steel

 

  

1,076

  

8,633

  

12.5

  

10.0

  

2.5

  

212

  

467

Automotive

 

  

397

  

3,043

  

13.1

  

9.5

  

3.6

  

108

  

105

Elevator

 

  

404

  

1,709

  

23.7

  

9.0

  

14.7

  

250

  

9

Technologies

 

  

90

  

687

  

13.0

  

10.0

  

3.0

  

21

  

89

Services

 

  

369

  

2,769

  

13.3

  

9.0

  

4.3

  

120

  

286

Real Estate

 

  

86

  

1,752

  

4.9

  

7.5

  

(2.6)

  

(46)

  

17

Income before interest of the ThyssenKrupp Group in 2003/2004 increases by €864 million to €2,271 million. This improvement was slightly increased by the reduction of capital employed within the measurement of return on capital. Capital employed fell by €660 million to €18,870 million. The ROCE in 2003/2004 was 12.0%, compared to 7.2% in the previous year. Hence, the cost of capital relevant to the Group of 9.0% was exceeded, the Economic Value Added increased by €924 million to €572 million.

In the Steel segment, income before interest increased by €449 million to €1,076 million. With a slight decrease in Capital Employed, the 2003/2004 ROCE increased from 7.1% to 12.5% which exceeded the cost of capital of 10.0%. After achieving a negative EVA in the prior year, a positive EVA of €212 million, an improvement of €467 million, was achieved in 2003/2004.

In the Automotive segment, the 2003/2004 income before interest increased to €397 million which is €115 million more than the prior year. With a slight increase in Capital Employed, the ROCE increased from 9.6% to 13.1% which is significantly higher than the cost of capital of 9.5%. After recognizing a very low EVA in the prior year, the EVA increased by €105 million to €108 million in 2003/2004.

In the Elevator segment the ROCE remained at the high prior year level of 23.7%. With a slight increase in Capital Employed, the EVA rose by €9 million to €250 million.

Technologies' income before interest increased by €41 million to €90 million in 2003/2004 as a result of the current favorable order and workload situation as well as the absense of restructuring charges. Capital Employed decreased significantly by €479 million to €687 million due to disposals. As a result of these items, ROCE increased significantly from 4.2% in the prior year to 13.0% in 2003/2004. With a cost of capital of 10.0%, a positive EVA in the amount of €21 million was achieved. This corresponds to an increase of €89 million compared to the previous year.

In the Services segment, income before interest increased by €249 million to €369 million in 2003/2004. This increase was due to the better economic situation in the international materials and raw materials markets, the implementation of efficiency and cost reduction programs and new marketing activities. Due to disposals, Capital Employed decreased by €422 million to €2,769 million. The effect of both items resulted in a significant increase of the ROCE from 3.8% in the prior year to 13.3% in 2003/2004, which exceeded the cost of capital by 4.3%-points. After recognizing a negative EVA in the previous year, a positive EVA of €120 million was computed in 2003/2004. This is an improvement of €286 million.

Within Real Estate, income before interest increased from €70 million to €86 million. With an almost constant Capital Employed, the ROCE increased from 4.0% in the prior year to 4.9% in 2003/2004. The EVA improved by €17 million and was calculated at €(46) million.

ThyssenKrupp's active portfolio management directly follows the result of the analysis of the performance measures. It involves structural measures which are principally of a strategic nature, including the selection and expansion of business units with which the targeted increases in EVA or value are to be realized, as well as the timely and profitable withdrawal from activities which do not achieve adequate increases in EVA. These measures further aim at creating new operating activities through a favorable entry in evolving markets. For the Group as a whole these measures are of particular importance when it comes to establishing a balance between value generators and cash providers. This is a basic prerequisite for dividend continuity and sustained growth in core activities.