Covestro Comments from Investors’ Call

Markus Steilemann

Thanks Ronald and very warm welcome also from my side. This is Markus Steilemann speaking, CEO of Covestro. Good afternoon and good morning to our listeners from the United States. Before we go through the details of the second quarter I would like to begin with really exciting and far reaching news. Our new vision, we will be fully circular. Planet change, growing world population, increasing urbanization, global developments like these are enormous challenges. We at Covestro want to help overcome them with our multitude of innovative products and solutions.

We strongly believe that the high quality polymers and their components that Covestro develops and produces are the key to a sustainable future. Our vision clearly states we are doing everything we can to realize the circle [ph] economy, which ultimately is a great social transformation project to make the world climate neutral and to protect its dwindling resources. Guided by this long-term strategic vision, we will anchor the principle of the circular economy within the entire company in order to fully implement it. We are working on a comprehensive set of strategic and operational goals that will lead us toward this long-term vision. We will pursue this path consistently and with commitment in the interest of our customers, suppliers, employees, and the capital markets to name a few of many important stakeholders. While striving to establish circularity in our value chains, we particularly focus on four areas. Firstly, alternative raw materials; secondly, energy efficient, innovative recycling technologies; thirdly, renewable energy; and last cross industry collaboration for joint solutions.

On the next page, we provide examples for each of those four areas. Let’s start with the field of alternative raw materials. Many of you will be familiar with our breakthrough solution in polyurethanes to replace about 20% of fossil feedstock by carbon dioxide in [indiscernible]. Because we have already talked about this innovation I’d like to highlight another marketed product from our coatings, adhesives, and specialty segment. A bio-based hardener for automotive coatings the carbon basis of this product is up to 70% made from renewable raw materials. Through this, we enable manufacturers to optimize the carbon dioxide footprint of their products. Without any compromises with regards to protective functions and appearance, this final top coat for cars requires considerably lower use of fossil raw materials than in conventional systems. We were able to prove this by collaborating with Automotive Group Audi and the coating experts of BASF Coatings.

With the financial highlights on Page 4, I’d like to turn to the results of the second quarter 2020. Current times are marked by the global corona virus pandemic and its consequences in all areas of our life. While we globally continued business operations in the second quarter our daily focus was to take care about the safety of our employees and business partners, to ensure our ability to deliver to customers and to secure a strong liquidity position. As expected, our call volume declined significantly by 22.7%. We achieved an EBITDA of €125 million, which was above market expectation. Despite the massively negative volume impact of the pandemic we achieved a positive free operating cash flow of €24 million in the second quarter of 2020. EPS came in negative at minus €0.28 per share. Despite continued high uncertainties in our economic environment we confirm our full year guidance for this year.

Now let’s move to Page number 5. We introduced the volume chart on this page, a quarter ago to illustrate the weekly regional impact of the corona virus pandemic on our business. The key observation is exceptionally high volatility globally. While overall volumes sold in our core business fell by 22% compared to the second quarter 2019, the monthly break up shows significant dynamics. While we recorded the strongest year-on-year monthly decline in April, with group volumes down by 32%, we observed a sequential improvement since mid of May. June call volumes came in at minus 8% year-on-year. We estimate that the pandemic impacted our global second quarter call volumes was minus 27% year-on-year. In our pre-Corona budget we assumed positive call volumes of around 4% in the second quarter. Looking at the impact by region, the volume numbers reflect the global sequence of the pandemic outbreak. In China we recorded the earliest volume impact, followed by so far a strong recovery. Since May monthly sold call volumes were above the previous year, however, with high weekly volatility. In Europe, we recorded the strongest year-on-year decline in mid-April. During the quarter, various European countries were hit by the pandemic in varying intensities and timings. Since May our call volumes followed a relatively stable, sequential upward trend.

In the U.S. we witnessed the latest volume impact by the pandemic. The recovery path has been lagging the other regions with a volatile upward trend since May. To illustrate what we mean with volatility the depicted volume improvement towards end of June is the result of one weekly data point that includes one big customer order. Looking into July we started the third quarter by continuing the volatile path of sequential recovery. Call volumes in July appear above June, but still somewhat below the previous year. In a nutshell, the recorded pandemic impact and subsequent recoveries followed exceptionally volatile dynamics. Along these lines our visibility was and remains exceptionally low.

Let’s turn to Page number 6. Page number 6 summarizes how we managed the crisis. In response to the unprecedented negative impact on our business we realized substantial cost savings, established a solidarity pact for our global workforce, and secured a strong liquidity position. Let me highlight three points. We entered a far reaching solidarity pact in May. This six month pact includes a temporary salary reduction of 6.7% for a non-managerial workforce. The agreed salary reduction increases throughout the managerial staff to 15% for Board and Supervisory Board members. While this pact was voluntary for all managerial employees, the acceptance was extremely high at close to 100%. The quoted numbers apply for Germany, subsidiaries outside of Germany have implemented comparable country specific measures to reduce cost. I am surely delighted by this level of solidarity through the company among the Covestro workforce.

During the past weeks and months we continuously adjusted the utilization rates of our production efforts according to the development of customer demand. Globally as of July assets utilization rates for MDI and TDI are almost back to normal rates. This is also true for polycarbonates in Asia Pacific. Utilization rates for all other products continue at reduced rates in line with demand. Importantly, our leading production and process technologies have proven their scalability in quickly adjusting operating rates and reliability in safe operations. On the cost side we implemented short-term cost savings in total of more than €300 million. In the second quarter cost saving substantially contributed to earnings. While these cost savings are temporary by definition, we also further executed our structural cost and restructuring program perspective. As announced with full year results in February, we had set a target of reducing global headcount by 400 to 16,800 by year-end. We can now report that we have achieved this global — this goal six months earlier by end of June. We are working on a further reduction of the global headcount by end of 2020.

Now let’s turn to Page number 7. Here I would like to highlight some volume development by region and as a concession to the exceptional time also by industry in detailed numbers. The decline of global call volumes was strongly impacted by a half business with the automotive and transportation industry. Demand in Europe and North America were even worse in terms of year-on-year rates. Demand from auto in China ended the quarter on par with previous year. Demand from the furniture and wood industry in China also finished the quarter with positive double-digit growth rates year-on-year. Yet global volumes in the furniture industries were down approximately 30%. Global volumes to customers from the construction industry declined by approximately 15%. Here volumes for polyurethane based insulation were down by approximately 20%. Polycarbonates realized double-digit volume growth driven by demand for resin used in pandemic related protective gear and face shields. Volumes sold into the electric, electronics and appliance industry partly benefited from extra demand from consumers who established their home offices with new IP equipment. Nonetheless, global volumes decreased also year by approximately 15% while volumes in China were back to single-digit growth.

The positive highlight among the remaining diverse industries were attractive volume growth rates in global medical applications in both the polycarbonates and coatings adhesive specialty segments. Here volumes grew by approximately 25% year-on-year, for example, driven by high demand for housing of respirators. Looking at customer industries by region, we recorded low double-digit declines in auto and electro in Asia Pacific and single-digit declines in furniture and construction. Please note that shown volume growth rates of minus 8.4% in Asia Pacific and at the same time 5.5% in China imply declining volumes of 33.8% in the rest of Asia Pacific. In EMLA volumes declined due to the pronounced weakness in auto and furniture. In electro and construction volumes declined at low double-digit rates. Similarly, in NAFTA, demand was weakest in automotive. All other industries declined low double-digit. With this I will now hand over to Thomas for the full set of financials. Thomas, please.

Thomas Toepfer

Yes, thank you Markus. And also hello to everybody on the call from my side. I’m on Page 8 of the presentation where you have the sales bridge and you see a year-on-year decline of 32.9% for the second quarter of 2020 and the negative volume impact of the corona virus pandemic led to a 22.3% year-on-year sales growth volume decrease and that is the 712 million that you see in the bridge. Moving to pricing the lowest selling prices mainly in PUR and PCS negatively impacted the sales by 9% and that is the 290 million that you are seeing. But it’s important to note that while in 2019 it was mainly increased competitive pressure that resulted in declining selling prices and the movement that you now see in 2020 are rather driven by a lower feedstock price environment. And I would also like to emphasize that sequentially the selling price has only declined by 3%. Moving on to FX rates in the bridge, they were virtually unchanged affecting sales by minus 0.01% year-on-year, driven by the weakness of some emerging market currencies. But on the other hand, sales were helped by a stronger U.S. dollar. And last but not least, portfolio changes reduced our sales by 1.5% or €49 billion in Q2 and you have the details of that in the bullet on the right hand side of the page.

So let’s move to the next one, Page 9. As you can see in Q2, we generated an EBITDA of €125 million, which was above the market expectations. Nonetheless, the decline of 72.8% compared to previous year was obviously very steep. So as a consequence of lower demand from certain custom industries, our product mix was effected unfavorably and this resulted in a relatively high negative volume leverage of 47% and you find this also on the bullets on the upper right hand side of the page. Moving on lower selling prices, as commented before were only partly compensated by a relief of lower fix [ph] prices and as a result, the year-on-year pricing delta was a negative €100 million. FX effects to EBITDA were positive 1.6% year-on-year, despite a slightly negative effect that we just reported in the sales bridge and the difference in absolute numbers is very small and mainly linked to transactional effects. Last but not least, at least the line other items contributed positively with €91 million and the key contributors were short-term cost savings and lower provisions for short-term bonuses. And currently, these bonus provisions for 2020 run at zero. So I would just like to emphasize that excluding a prior year onetime gain of 19 million, which we recorded in our cash segment, the line other items would have even amounted to positive €110 million. And that is obviously a function of the cost saving and efficiency measures that we implemented.

So with that, let’s move into the business units and segments. I’m on Page 10. If you look at our polyurethanes segment on this chart, we faced a core volume decline of 25.9% in Q2 and the polyols recorded the largest negative decline rate, followed by TDI and MDI. And obviously, the key reason for the declines in all key industries was the global impact of the corona virus pandemic. The polyurethanes EBITDA as you can see turned negative in this quarter. But to give you historical reference, this segment had already experienced one quarter of negative earnings in Q1 2009 during the peak of the global economic crisis in that year. Drivers of this year’s earnings were the pronounced volume decline and the negative pricing delta compared to prior year and especially portfolio of earnings were burdened by lower volumes, the take or pay contracts in place with our propylene oxide JV partner, and competitive pressure.

Let’s move to Page 12 where you see the CAS segment. As you can see, the segment posted a year-on-year volume decline of 25.3% affected by the corona virus pandemic and the continued demand weakness from customers for automotive applications. And as the volume leverage of CAS is highest among all three segments, the lower volumes largely contributed to the strong EBITDA decline of 60%. Again, corrected by the onetime gain of 19 million that I was mentioning earlier, which was included in previous EBITDA, the year-on-year decline would have been smaller, but still amount to 49%.

Christian Faitz

Yes, sir. Thank you. I hope you can hear me well. Good afternoon gentlemen. Just two questions if I may please. First of all, can you please share us — share with us the current Q3 trends in the Polyols market as this was the major direct for the polyurethanes business in Q2? And then according to Chart 5, the volume recovery in the U.S. in the last couple of weeks in Q2 seems to have been quite remarkable with or without that one customer you refer to, can you share with us the trend that has continued, if that trend has continued into Q3 or have renewed lockdowns in the U.S. and the entire political situation there, put an end to the volume revival in the meantime? Thank you.

Thomas Toepfer

Well, okay let me take a minute. Can I take the last question? So first of all I think we obviously provided a lot of the details during the month and week of the corona crisis just to give you a little bit transparency. I think it would now be a little too early to say, okay, let’s talk about July on a region by region basis with the month not even having ended. I think our overall message is that the good momentum that we’ve seen in June has continued into July. We think that sequentially we will look at an improvement. Maybe year-on-year is still a slight decline. And I think the general trend is also true for all regions. So it’s not that things have in a certain region completely collapsed after that. So I think let me maybe leave it at this degree of precision because the month is not even over.

Thomas Swoboda

Yes, good afternoon. Good afternoon, everybody. I have two questions, please. Firstly, kind of a follow-up on polycarbonates. I mean, congrats on the performance in Q2. That looks very good. But my worry is a little bit around this capacity overhang, we are still seeing especially in China. And my question is, do you think Q2 could have been already the trough for this business despite the capacities that are coming to the market or is it still relevance here or should we have relevance here that profitability could still deteriorate from the currently very, very good level? The second question is on Polyols and on the EBITDA bridge you have given for Q3. This is very helpful. I was just missing the effect from Polyols, do you expect the headwind from Polyols to start to wane already in Q3 or should we expect this to be a little bit longer lasting, any indication you could give on the phasing of the negative effect from Polyols would be helpful? Thank you.

Markus Steilemann

Yeah Thomas, thanks for the question. [Indiscernible] Markus speaking. Let me let’s say give you some flavor on how we look at polycarbonates. We have a capacity overhang and that was already there in the second quarter. And I have to say that was despite the fact or really under the impression of additional capacity that was coming up. And capacity does not equal capacity. What do I try to indicate? We see still a steep cost curve for the base rates of polycarbonates. That means the highly commoditized grades. And from our assessment, almost all capacity was coming in and you might, let’s say wonder that even though it is new capacity, it comes due to several reasons more on the higher cost side and cost producer side rather than on the lower cost producer side, where we have positioned ourselves very successfully since many years. And that’s why I believe that on the commoditized polycarbonate grade side, we have already seen trough levels and approach trough levels in the second quarter. And at the same time, coming back to what I have said earlier, we have constantly rebuilt the entire product mix over the last decade for polycarbonates, and that gives us now two actually opportunities to play.

On the one hand, to continue to play and shift on the highly specialized rate side and on the other hand, to fully leverage our cost advantage by fully loading wherever possible our low cost base rate polycarbonate plans. So from that perspective, I would not expect despite the fact that there might come additional capacity on stream, that we would let’s say see lower trough levels in that sense. The only large impact that could happen is if we would see a significant drop in volumes in the overall demand in the market that would then in the end also affect us. But I think we have also answered that a little bit earlier on a different context. Currently, we see since mid of May continued trend across the globe and all regions that say of sequentially increasing demand and here, especially in polycarbonates. And I hope that helps you a little bit to see the dynamics here. And for the Polyols question I would like to hand over to Thomas.

Thomas Toepfer

Yes Thomas, I think on the Polyols our assumption would be that the burden will be eased in Q3 simply because it will be only we’re expecting a pickup in volumes relative to the trough that we’ve seen in Q2. And that obviously will lead to at least that the take or pay clause will not be affected or effective. So that will give us a saving here. Plus, I think it could also improve the margins a little bit so that overall and that’s baked into the assumptions that we’ve given you, we would expect a nice rebound if you are in Q3 relative to Q2.

Markus Steilemann

And the third topic is if you look at the current let’s say shutdowns, there is publicly available information that would indicate that we have between 200,000 and 300,000 tons of capacity that is temporarily in a shutdown and has been not taken out of the market, but is not producing. What does that mean? That means between 4% and 5% of nameplate capacity in the market is currently not on stream. And with regard to the last topic on TDI MDI capacity, if I’m not totally mistaken I understand that we have in TDI roughly 200,000 to 300,000 tons of nameplate capacity currently not producing and that represents at current market size, roughly 10% of nameplate capacity being temporarily taken out. And on MDI I just currently do not have any indication due from public sources that really MDI capacity has been taken out even on the temporary note, that’s all we have for the time being.

Markus Steilemann

Markus, this is Markus speaking. So on your first question, the automotive picture for us is that for the entire year we still expect that the automotive segment will be affected, most likely to the largest extent in our entire portfolio. And we see very different pictures developing recently with respect to end consumer demand and also with regards to stock levels. So whereas in China, we see currently that what end consumers are buying and here demand is really picking up quite swiftly and quickly is really also then translated into real production and not served out of stocks. And we have a different picture for Europe and also quite comparable in the United States. We are still a lot of cars are sitting so to say on the inventory that have been brought to the car dealers, that have been produced, and they are sitting still in the inventories. That means whenever consumers are buying there, that does not directly translate into the real demand that would normally under normal, let’s say, inventory levels being created. So what does that mean? Even though we see slight recovery in the automotive industry, demand for our products and here for sure, particularly in the polycarbonates segment, first thing is that demand is maybe not directly related to what the current, let’s say, buying rate of end consumers is.

And secondly, we must also not underestimate that due to the specific situation in particular in Europe and also the U.S. that demand will be highly volatile in our side and continue to be highly volatile in the next couple of weeks and also months to come. So on your second question, given the let’s say the low margins in a market that we have seen high cost producers normally do not react by let’s say continue to be very aggressive on prices, but what they do is they start to shut down temporarily capacities. And I have alluded to that a little bit earlier what currently we see from publicly available sources on polycarbonates as well as on TDI. And so from that perspective, for me, there is a limited risk for further deterioration.

Chetan Udeshi

Yeah, hi. Just a couple of questions. Maybe I missed it but can you inform us or what is the utilization of your assets right now in between businesses? And second question is what is the status of the 200,000 tons MDI expansion that you had landed in Germany this year and with the new CAPEX framework can you remind us of what are the key new capacities that he will have online next year for 2021 in different businesses, thank you?

Markus Steilemann

Okay Chetan, this is Markus speaking. Thanks a lot for the question. So if you would refer to Slide number 6 of our presentation there on the bottom left you would see some indications about where we are in terms of capacity utilization for our plants. In Europe for PUR we are back to high rates and PCS and CAS are still at reduced rates. North America MDI is back to high rates, all other products are running currently at reduced rates. And for Asia Pacific if you are as well as PCS is back to high rates and generally the utilization rates adjusted in line with the respective demand. If you ask about the status of the MDI plant in the Northern part of Germany in Brunsbüttel to be very precise runs at full let’s say nameplate capacity as intended. And the last question is about how much additional capacity would we see for the next year and yeah I will hand over to Thomas.

Thomas Toepfer

Yeah Chetan, maybe let’s put it this way. I mean the 200 KT MDI in Brunsbüttel they are up and running but of course with the market development as markets that we’re not fully utilizing our assets on a full year basis. Therefore I would — what I would say is there is nothing major as the 200 KT coming on stream next year. It’s smaller things like a compounding additions which we have North Rhine-Westphalia and all the other things in the space of CAS but nothing major in terms of MDI or TDI which is not a problem because I think as we just discussed it will take maybe a year or two before the markets comes back to the pre-colonial levels and with the expansion in Brunsbüttel that we have put in place I think we’re absolutely well place to even without big additions next year fully capture the market growth and maybe even more than that. So to your question very precisely, nothing major coming on stream but not a problem, we have enough capacity to grow at least in line with the market.

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