Covestro Earnings Call Highlights

Thomas Toepfer

Now, let’s take a look deeper look at the segments, and I’m on page eight of the presentation. First of all, we observed an increase in core volume in all segments for the full-year, however, that was at a lower pace than in the previous year. So, due to the previously mentioned factors, we did see a decline in profitability in all segments, especially in Q4.

So, let’s start with the Polyurethanes segment on the left hand side. In the polyurethanes industry, MDI faces some short-term volatility due to the recent addition of new capacities. In general, the global demand growth requires one additional world-scale plant per year. However, since Q4 2017, the equivalent volumes of two new plants came on stream, increasing supply pressure in the second half of the year and leading to a sharp fall in prices, especially in Q4. For TDI, the expected deterioration of the industry environment along with the ramp-up of new capacities took place towards the year in 2018. And finally, the margin polyether polyols continued to be slightly below the long-term average. So that the overall, EBITDA margin declined to 7% in that segment in Q4 2018 versus 32.6% in Q4 2017. Although the volume still contributed positively to EBITDA, more intense competition drastically impacted the pricing delta. However, I would like to remind you that, as you can see, for the full year, our Polyurethanes segment still generated a very attractive margin of 23.9%.

Let us now consider on page number 13, the supply-demand driven part of the product portfolio. When looking at future developments, it is key to keep in mind that delays in industry supply are rather the norm than the exception. Therefore, the balances are certainly an indicator for industry utilizations to come but cannot be counted on. In MDI, we continue to expect the structurally sound demand in the short and midterm, despite the global demand slowdown experienced in Q4 last year. MDI remains globally a high-growth industry with growth rates some percentage points above global GDP. As already described, recent supply additions created an oversupply in the short term. For 2019 due to delay of our Brunsbüttel plant coming on stream late this year, this situation is expected to rebalance towards second half of the year. In the mid and long-term, our overall view remains unchanged that the MDI industry will remain balanced and attractive.

In TDI, we expect lower utilization rates in the midterm due to the ongoing ramp-ups of the new plants and the additionally announced new capacities. We see the largest deviations from past forecasts in the polycarbonates industry. Indeed, several new players have announced capacity additions in Asia. We continue to believe in an attractive demand growth and see interesting trends with some potential for upside. However, the supply additions, as announced, could lead to an oversupply situation in the midterm. Therefore, we will closely monitor how the construction of the new sites is progressing and in which product applications the new entrants are able to compete.

The volatile industry conditions require the lowest production cost base on the one hand and speed in decision-making on the other hand. This is what you can observe on page number 14. We are cash cost leader in all our industries and continuously improve our positions with the current CapEx program in place. With the introduction of Perspective in 2018, management has set the foundation to adapt the organizational structures of Covestro to better reflect market needs.

Georgina Iwamoto

I have a question on the guidance in terms of your volume growth assumptions. Can you confirm, like what’s baked in there for your end markets? And I’m particularly interested in how you’re thinking about automotive. So, you grew low to mid single digits in 2018. And in 2019, I mean is that based on automotive production being positive or do you think it will be negative but you can still grow? And then, it would be helpful if you can give us an idea what your regional sales exposure is for automotive. Do you sell more into European and/or Asian or North American markets for automotive? And then, my second question is on the competitive landscape. It looks like you are now including four new capacities versus your previous outlook for polycarbonates one in TDI. How is the landscape evolving so fast, especially since it takes a number of years to build these plants and a number of years for approvals? We’ve always talked about seven years anyway for MDI and TDI? So, if you could just help on understanding this supply outlook?

Markus Steilemann

Yes. Georgina, this is Markus speaking. So, let’s first talk about your question about volume growth and in particular to give you some flavor about the automotive business. We actually estimate also based on external analysis that let’s say after I would say a very challenging year in 2018 where at least according to latest numbers we have seen decline in automotive production of minus 1%, and it was particularly pronounced let’s say in the fourth quarter in terms of negative growth. We expect for the full year 2019 currently as base assumption, 1% growth for the automotive industry in the segments that are relevant to us. What does history now tell us? History told us that we have more or less always out grown automotive passenger vehicle production by 2 percentage points. So, that would indicate if this would continue that we would still see an opportunity to grow low to mid-single-digit numbers on a global scale for the full year in the automotive sector.

Now, translating this into what would that mean for region. Frankly speaking, we are very flexible in terms of our growth. So, it is very difficult for us to say where the real growth will come from because we hear very different signals in terms of what will happen to the European car manufacturers; what will happen to the markets in China; is there a stimulus package; how will that stimulus package really evolve? On the other hand, we see that now some margins that have been out of focus for example India kicking off here and there with some models. And to make it even more complex, we see that in the classical mass markets, our products are not so much pronounced but rather in the fast-growing segments like electro mobility, hybrid propulsion systems, but also zero emission vehicles like fuel cells.

So, to sum it all up, it is very difficult to say where definitely overall the growth will be most pronounced. But, we feel very well equipped to flexibly react and we are very well positioned in a fast-growing segment. That means even there might be let’s say a slow kickoff in Europe in terms of automotive growth after the first quarter, we expect that overall, the market will grow and that we are very well-prepared to support this growth very flexibly on a global basis, regardless of where the growth is finally coming from, that means in terms of regional footprint.

On your second question, if we’re looking into the competitive landscape, yes, we see that there is particularly in polycarbonates, supply additions that have been announced. And if we now see that we’re moving from 2017 to 2022 into 2018 and 2023 the number of announcements have significantly increased, in particular for the year 2023 and some small adjustments for 2018 to 2022. That means the majority of the capacity additions that is currently in the statistics is expected for the outer year for our prognosis, and that might explain the question mark that you had, well, how can it be that so quickly new capacity is coming on stream? It is not coming quickly on stream but particular for the outer years, there’s a huge announcement.

But again, as we explained on the respective slide, it is important to always consider the technical challenges to deliver on time in full such type of capacity. And even once it has been installed, the question is always, what type of quality and to what extent, let’s say, in terms of amount this quality is coming on stream, and that’s what we are closely observing. It is important in this context to mention that cost leadership for the more commoditized part of the portfolio is absolutely essential, and we are absolutely on the top notch left hand side part of the cost curve in a polycarbonates industry. That means even in the highly commoditized arena, we see a huge opportunity to fully play out our cost advantage. I hope that somewhat helps. On TDI, you mentioned, I mean, there’s nothing new, there is no new development. We have those, let’s say, three major plants, which are now ramping up their capacity and bringing fully the capacity into the market. That is not coming as a surprise. It was more surprise that those plants were so much delayed in the past and that they were obviously not running. This is now normalized. That means, all this capacity will now come on stream. To what extent and how technically reliable those plants will be, big question mark for us. We simply can’t judge.

And the second topic is, also the TDI industry has a very steep cost curve. And as we have outlined earlier, there might be an opportunity that there’s still some further price pressure. What I believe that we are approaching, let’s say the rock-bottom of the TDI prices, and we have seen at least first close to this rock-bottom in December and also in January. So, I do not expect that there would be huge further price drop. However, there is still some room. I hope that answers your questions.

Georgina Iwamoto

Yes. That’s very helpful. And if I can just sneak one last one still on TDI. And the demand, outlook seems to be accelerating for the next five years versus the prior five years. Can you maybe explain what would be driving that?

Markus Steilemann

I would currently have some difficulty to understand why you say accelerating. I know that we always have been between 3% and 4%, and I think currently we are at 4%. So, I’m not sure what your, let’s say, analysis or view is based on that you say it is accelerating.

Georgina Iwamoto

So, just looking at slide 13 of your presentation, you show demand growth from 2013 to 2018 was 2.6% for TDI and then forecast for 2018 to 2023 is 4%.

Markus Steilemann

Okay. So, we have here simply a production limitation that it means, it was not that the fundamental demand was let’s say really not there. But, the industry was not able to deliver as much growth as was originally from primary demand perspective there. I hope that explains a little bit why you see this lowering in demand and now the pent-up in demand. It is simply that we could not deliver enough.

Tom Wrigglesworth

Thanks very much. Couple of questions if I may. Brunsbüttel, you’re now saying, as I understand it, you said second half of 2019, you pushed — are you saying that you pushed that out now into 2020? And can we just confirm that that’s effectively a kind of route to market decision rather than a kind of mechanical or operational issue that’s causing delays? Secondly, on utilization rates, could you just tell us where industry utilization rates are across TDI, MDI and polycarbonates today? You said — and just to confirm, you said you’re sold out, right, so you’re at 100%? And then, thirdly, just by way of clarification, you said that a 1% move in price was about a €140 million. So, in essence, to go from where we are in spot today at 1.8 down to the low end of your guidance, you’re saying you just need a 3% move lower in prices. So, we’re only 3% off, a point at which we would be deep into the cost curve, such that the high-cost producer would be leaking cash. Is that the right interpretation of pulling those two comments together? Thank you.

Thomas Toepfer

Okay. Let me maybe start with Brunsbüttel. I think, the way I would look at this is what we have envisioned a mechanical completion at the end of the year. So, that means that essentially the market effect, as you correctly said, will be almost fully in 2020 because also the mechanical startup of such a facility takes several months. So, I think, we’re absolutely in time and at budget with the project. But, the market effect will only come in 2020.

Then, to your question, the percentage points, yes, I think it’s right to say that — as I said, 1 percentage point price movement of €140 million. And therefore, mathematically, your assumption is correct. It takes 3 percentage points to come to the lower end of the guidance range. However, remember that not all of our businesses is price driven. So, this 1% of course would be a mathematical calculation across the board for all our products while what we do see in reality is that a lot of our portfolio is stable in terms of pricing, more than 50%. And it’s the rest of the portfolio that moves the needle and that has to move much more in order to achieve the lower end of the guidance or to bring us to the lower end of the guidance. Then, utilization rate, I would hand it back to Markus.

Markus Steilemann

Yes, Tom. And just on a calculatory basis. If you would take 12% let’s say TDI external revenue and just think about the TDI alone, would be responsible for the price decline, you could easily come to the fact that we would talk about 20% to 25% price decline. Just to put this into perspective, what you really would need to see that TDI alone would lead to the respective achievement or lowering to what’s the bottom of our guidance.

So, now talking about industry utilization from calculation perspective, we would think that MDI next year, given supply-demand balance would be for full-year 2019 at around 85% of industry utilization. It is important to mention in this context again and to really emphasize that we are talking here about an average industry utilization, which is entirely and equally distributed according to our historical experience amongst different layers. And one of the key drivers here is your position on the cost curve. That means while some still as us for example running at full load and full capacity, others have a hard time to find air to breath. That means the average industry utilization is not necessarily indicative for the respective margin levels of individual players.

If we’re now moving towards TDI here, again 86%, at least based on our calculations for 2018 and for full-year 2019, would drop to 77%. But here, it is even more pronounced when we talk about the respective cost curve, how individual players are able to deliver on the even stiffer and more challenging conditions. And, we have a leading position on the cost curve. Do you want to talk about polycarbonate? I don’t know, if you want to talk about polycarbonate…

Sebastian Bray

Hello. Good afternoon and thank you for taking my questions. I would have two, please. The first is on the growth rate for MDI. I think, the CEO of Wanhua was quoted late last year as saying that he expected the Chinese volume growth rates for MDI would come down in the midterm, partly reflecting a decline in the growth rate of the construction industry. Could you comment on how you’ve derived the growth rate that you have shown, the 4 %to 5% volume growth for MDI? That’s my first question. And my second is related to the potential for a buyback. What exactly are you comfortable with the market modeling here? If we put in let’s say an amount that is smaller than the buyback for the last — that you did last time, is that something which you are comfortable with for consensus or is it literally the market should wait until you have actually pulled the trigger and then make the assumption? Thank you.

Thomas Toepfer

On the buyback, I think, the way I would approach this is, we have said, we want to steer the company towards a leverage, which we think is appropriate of 1.5 times, and that is still the case. So, we’re targeting towards that number. And therefore, I think short answer to your question, I would rather than plugging in any number, I think, it would be fair to assume let’s see how the year unfolds and then wait for an announcement that we make. So, I would not say that there is a specific assumption that we already have at this point that would make sense to use for any kind of model.

Markus Steilemann

On your demand development for MDI first, I think it is important to mention that we’re talking about average growth rates, which see some fluctuations year-over-year. That’s I think important to mention. Secondly, if you have only one market to serve, you need to really look at those single markets. We have a couple of markets we are serving. We are present in Europe, we are present in the United States and Mexico, and we’re also present in China. That means we see that in China there is a slowdown happening, and we see this slowdown happening in the construction industry but also in the appliance industry. If you remember the MDI is particularly used for insulation for example in refrigerators, yet on the other hand we see the construction market and the demand for our highly insulating products in the U.S. is increasing. And we also see that demand patterns are shifting, for example, from China into other countries that are producing for the U.S. demand for example, Mexico. And that’s why we come from a global perspective to a slightly different assessment. And we just have lowered a little the global demand for our MDI growth rates, but just rounded them slightly down. So, the 5% is still a 5%, yet say the second digit after the dot has been a little bit lower. But, in principal, we see demand for MDI to be still strong above GDP for the years to come.

Sebastian Bray

Thank you. I don’t want to overstay my welcome, but I appreciate this hasn’t been touched on during the call. Can you put your comment on why the environment for polyols is weak and you expect this to stay the same in 2019 or improve?

Markus Steilemann

Well, if you look at how polyols are used, mainly you use polyols in MDI one-on one-and in TDI, two poloyl parts for one part of TDI. And if look at the pressures that we had in terms of delivering TDI growth, you just see that the ability to sell polyols with TDI and the ability to sell polyols with MDI, simply has been lowered simply due to the fact that there was hardly any TDI available so there was hardly any growth. The topic that we touched early on when I answered the question of Georgina Iwamoto, and that also has driven down slightly the demand for our polyols and that maybe has also led to the pressure on the polyols.

Isha Sharma

Could you please help us with the EBITDA bridge for Q1, because you have given a very precise guidance of 440 million and we’re already at the end of Feb, so hopefully you have some visibility there? Secondly, on TDI prices, given that they are historical lows that we have seen and we have not yet seen the full impact from the new Wanhua and BASF plants, how would you guide the prices and how much lower can they, given that they are already at the historical lows?

Thomas Toepfer

Yes. Let me maybe start with EBITDA bridge for Q1, Isha. And I’m doing a year-on-year comparison. So, the starting point would be the €1.63 [ph] billion that you have seen in 2018. In terms of the pricing delta, we are expecting around 600 million negative pricing delta due to the lower prices, specifically in TDI and MDI but also to some extent in PCS. I think, the FX line, I would classify as neutral. I would say on the volume side, it should be let’s call it mid to — mid double-digit negative. Remember, we do see volume increase relative to Q4, but year-on-year we do see decline because Q1 2018 was very strong. And the others lines should be I would call it low double digit positive, so some relief on the cost side also due to bonus accruals et cetera et cetera. And that brings you then to around 440 that we have guided to.

Markus Steilemann

Isha, maybe some remarks on the TDI prices. If you look at the normal prices, you are right that we are somehow at historically low levels, yet we also must figure — must take into consideration that those price levels were at higher input costs. So, that means we have not yet seen historically lowest margins in the TDI business. That is I think very important to take into consideration. Coming back to what I tried to explain earlier, I have — or currently believe that in December and January we have seen prices in that context that are approaching margin levels that are tending strongly towards historical low levels, but they have not yet reached historical low levels. So, that means in turn, yes, there is still some way towards historically low TDI margin levels, and that still could happen let’s say with the additional capacity now coming on stream. On the other hand, we have just seen in January that prices have not been lower significantly, on the one hand. And secondly, we are also approaching from the cost curve view, levels where the first producers should start to be cash negative that also gives some support. So, from that perspective, I think we are quite close, but we have not yet reached historically low margin levels, just to give you some indication.

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