Covestro AG (CVVTF) Q1 2023 Earnings Call Transcript

Apr. 28, 2023 4:02 PM ETCovestro AG (CVVTF), COVTY

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Covestro AG (OTCPK:CVVTF) Q1 2023 Earnings Conference Call April 28, 2023 10:00 AM ET

Company Participants

Ronald Koehler – Head, Investor Relations

Markus Steilemann – Chief Executive Officer

Thomas Toepfer – Chief Financial Officer

Carsten Intveen – Investor Relations, Director

Markus Steilemann

Thank you, Ronald, and hello and warm welcome also from my side to the results of our first quarter. Today we published our Q1 details after we had pre-released the headline figures two weeks ago.

Sales were down by 20% compared to last year to EUR3.7 billion, clearly indicating the global demand crisis we are currently facing. Against this trend, we achieved the first quarter EBITDA of EUR286 million, clearly beating the guidance of EUR100 million to EUR150 million given in early March. Free operating cash flow was also better than expected by us, despite the usual seasonal working capital buildup.

After positive trend in EBITDA during the first quarter and improved visibility going forward, we are now returning to a quantitative guidance for full year 2023 with a refined range for our financial KPIs.

Finally, as you recall, in the first quarter 2022, we initiated a EUR500 million share buyback program. The program was paused mid 2022 due to the recessionary environment. With more clarity on the outlook, we are now restarting the program in May.

Markus Steilemann

Thanks a lot, Thomas. And I would now like to come to a specific topic, as we are not only quantifying our full year guidance, but we are also resuming our share buyback program. Let me quickly remind you, we started the EUR500 million share buyback program end of February, 2022, and the reason for the buyback program was that major M&A acquisitions were out of scope. We fed our share to be undervalued, and as such a good investment in two sub tranches of each EUR75 million, we purchased around 3.5 million shares in the first half year of 2022. Yet, due to the recessionary environment with the start of the second half of 2022, we had then temporarily suspended the share buyback to protect our balance sheet and retained cash within the company until an economic rebound becomes foreseeable. However, it was always our strategic intention to execute the share buyback in an anti-cyclical manner.

Now, our raised EBITDA and free operating cash flow guidance and the improved visibility that the second quarter 2023 will sequentially result in higher volumes and a further raised EBITDA. We consider this to be the right point in time to reinitiate the buyback. We are still firm in our opinion that our share is currently undervalued and deemed the investment into our own shares as best investment for our shareholders. Consequently, the third sub charge of up to EUR75 million will be launched in May.

Let’s turn pages now to page number 19. A very busy chart. So let me guide you through it. As you know very well from the past and the current situation, Covestro’s business is a cyclical business. In times of an economic downturn or our core products, MDI, TDI and polycarbonate are usually strongly affected. Our products are an early indicator of a crisis as we are at the very beginning of the value chain and have strong exposure to multiple consumer industries. There are steps in the value chain between us and the consumer market. But in time of crisis, the stop of stock replenishments is regular in immediate action and progressing very fast throughout the different value chains. So our products are an early indicator to an economic downturn.

During a recession, the value chain empties through destocking. Upon the start of an economic recovery, a fast and efficient replenishment of the value chain is also required again. Rebounds often create a strong demand to quickly refill the supply chain. These high growth rates usually lead to supply shortages, allowing Covestro to execute the pricing power to again realize financially attractive margins.

So despite the cyclical behavior, the long-term growth drivers for our products remain intact or even improve. The current energy crisis will have a positive impact on the growth of MDI and polycarbonate. The trend for effective insulation to save energy can add one to two percentage point to the growth rate of MDI in the future as MDI is the best insulating materials for buildings and appliances. And MDI is so versatile, it can also be used in the manufacturing of wind turbine blades giving additional benefits of longer lifetimes and reduced maintenance rates. Our polycarbonates are an essential part of the battery pack in most electric vehicles as well as a contributor to lightweight and technically advanced electrical features. This results in a two to five times higher use of polycarbonates in modern EVs compared to a regular combustion car. With that, we believe that once the crisis is over, we will see again a strong rebound of demand for our products.

Let’s turn pages to page number 20 to another topic of special attention. In the past year, the competitiveness of European TDI production compared to competitor imports from Asia-Pacific was always a point of discussion. And yes, there were times like in the third quarter of 2022 when gas prices peaked so that the import of TDI was cost-wise a better solution than local production in Europe. Consequently, and supported by a temporarily significant gap of toluene prices between Europe and China, the imports were peaking at this point in time, taking into account the shipment delay of about six week. Also, we were importing TDI from our plant in China.

You can clearly see an above chart that the landed cost advantage of imports from China in the third quarter peaked even considering logistics and import duties of EUR350 to EUR600 per ton. But as soon as the gas prices were coming down, this advantage quickly disappeared. And with the continuous gas prices declined since the January, 2023 disadvantage has now reversed. So Europe, as a TDI production location, is definitely competitive and has its place to cover the market demand.

If we take a look at the imports that have been coming in from Asia-Pacific in 2022 around 100 kilotons TDI have been imported, and market prices have nevertheless peaked during the time of high gas prices. This clearly indicates that the market needs the European asset base for reliable supply. And with the announcement of a 300 kiloton of European production disappearing towards third quarter of 2023, Europe will even require more imports to cover again rising demand. Demand as of 2024 will exceed the local European production. And customers are hesitant to rely on import, given the supply chain interruption seen in the past two years. We believe that we have a clear technological and cost advantage with our gas phase TDI technology, and additionally, an advantage of having a production in the heart of Europe being able to supply TDI competitively to our customers.

So now let’s turn to the last page of today’s presentation. Let me quickly summarize on page number 21. Volume decline is resulting in lower sales or has resulted in lower sales of EUR3.7 billion in the first quarter, and that was caused by weak demand and ongoing destocking across many industries. Our EBITDA came in with EUR286 million above guidance range of EUR100 million to EUR150 million, and that was driven by cost efficiency and improved pricing data across both segments. This negative free operating cash flow of minus EUR139 million still came better — came in better than expected, and it was held by ongoing strict working capital measures.

We also now quantified the guidance for full year 2023 with an expected EBITDA between EUR1.1 billion to EUR1.6 billion, and we resumed our — will resume our EUR500 million share buyback program with a third tranche up to EUR75 million starting in May.

Markus Mayer

And then the last question is on TDI, is that last year, roughly 100,000 tons have been imported to Europe, is this is net zero [ph]? Also the maximum of imports which can be imported to Europe given its chemical activity, or what would be theoretical maximum number which could be imported to Europe? That’s all for my side.

Thomas Toepfer

Markus Steilemann

Yeah. Absolutely. So, Markus, if you look at the TDI import capacity, what we are basically talking about is not only shipping capacity, but we — what we need, we need storage capacity and unloading capacity in respective harbors, which is a key challenge as we’re talking here about hazardous and very reactive chemicals. So having said that, it is not easy to build those capacity up. But even if it is built up, let me quickly recap on what I tried to explain a little bit earlier in one of the slides. It is absolutely necessary that we get this additional capacity imported into Europe as one of the largest sites in Europe, which represents roughly 40% of European based capacity is about to be shut down by third quarter of 2023. That means we have name played out 300,000 tons. How much real available capacity is represented by this? The jury is out. Nonetheless, we and our customers strongly believe in the growth opportunities and their demand for TDI, and therefore, we need import capacities. Otherwise we will have at least for some time temporarily maybe a shortage of TDI in Europe.

So we need this capacity, and therefore you can assume that there might be an upscaling within this year of another 50,000 tons of import capacity on top of the 100,000 tons that we have seen being imported last year. So, yeah, once again, it’s difficult to judge talking about, let’s say, the chemistry we are handling here. We need that import capacity and we feel in this overall situation as the — yeah, let’s say, one of the last two standing TDI suppliers with the IP protected leading cost position, let’s say, very well-positioned in that market.

Charlie Webb

Brilliant. It worked. Maybe just two questions from me. So first, just thinking about the spreads, maybe you can just walk us around a little bit obviously you kind of alluded to a slightly better kind of volume indication seasonally and sequentially, looking through the year. So just how do you see spreads shaping up in terms of that balance of supply/demand across some of your key commodities? Just a sense on that regionally, and by you those — kind of key commodities, NDI, TDI, polycarbonate would be really useful.

And then just second question, on TDI itself. Obviously, some talk around some of the limitations MOFCOM has put on TDI prices for one of your competitors to close the deal that they are currently undertaking. How do you think about that in terms of what it — has or what implications it has for the China TDI market? And how would you calibrate that into your kind of mid-cycle thinking in its current form? Does it reduce kind of your mid-cycle as it relates to TDI earnings in in China? Does that have a small impact or not? Just trying to understand that, would be great.

Thomas Toepfer

Yeah. Charlie, let me maybe start with the — with a spread question. So I think from an overall picture, you’ve seen that our mark-to-market stands at 1.4, our midpoint of the EBITDA guidance is at 1.35. So essentially what we’ve done, take the number and maybe reduce it slightly. I’m not going to call it a haircut, but it’s a slight reduction that we’ve made.

If you look into the immediate future, that’s also true for the second quarter. So we’re essentially assuming that the uplift that we’re expecting for Q2 in terms of EBITDA is purely coming from better sales volumes, which are seasonally driven. And as I said, the fact that China has no Chinese New Year, and that the construction season is kicking in, but we’re essentially assuming that the margins stay flat also in the second quarter of the year.

The upper end of the guidance 1.6 would require some meaningful upside of the margin to happen the second half of the year. I think this is in the cards if demand picks up, but of course, we’re not planning with it. As I said, our base assumption is still flat volumes and also, margins essentially flat forward. So — yeah, so I think that would be it from my side on the spread.

Maybe Markus you want to talk about TDI.

Markus Steilemann

Yeah. Thanks Charlie for your question and thanks also for once again hinting on TDI. So what’s the situation? One, the largest, let’s say, local producer of TDI in China has bought a smaller competitor. And one of the first measures is that they will shut down a smaller capacity in the order of magnitude, I think a 30 or 40,000 tons of TDI capacity. So a kind of a small consolidation is going on there. However, given the size of those players, that has called the anti-trust authorities on stage and they have gone through a rather, let’s say, sophisticated paper that kind of limits the opportunity of setting the price for TDI in China. However, that goes back, I think for, looking three to four years backwards on the pricing. And we must not forget that, for example, one of those years was 2021, where we have seen rather high prices.

So long story short, I would not expect that this overall regulation, including, let’s say, this potential price cap, if I may call it that way, will have any significant impact on our ability with regard to earn money with TDI. And secondly, also on our ability with regards to our mid-cycle earnings not only because of that very specifics that I just described, but it is just one country and it’s just one product which is not representing the major share of our entire product portfolio.

Let’s not forget about the wonderful products like MDI, polycarbonate and the Solutions & Specialty segment. I hope that answers your question.

Jaideep Pandya

And then the third question really is on MDI. If I just use furniture as a reference industry, do you expect growth to rebound to the sort of five-year historical average for all this MDI capacity that is coming? Or do you think that even if we under undergo maybe for the next 12 months, because it is coming from essentially one player and that player is expected to be disciplined, we won’t have overcapacity issue in MDI? Thanks a lot.

Thomas Toepfer

Markus Steilemann

Yeah. Maybe then, on — Jaideep, on the last topic with regards to MDI. So we believe that structurally MDI growth is fully intact. We also believe that — and you said, well, just let’s take the furniture example as one example, but to really look into the MDI growth, there’s two things that need to be considered. Number one is, we’re not only talking about newly constructed private and commercial buildings, but also about a significant market for refurbishment of buildings. And not to forget that about 25% to 40% of global energy demand is driven by cooling and heating of buildings. So there’s a huge need for more, let’s say, energy efficient buildings. And that is the key driver for retrofitting of homes and new built homes for insulation materials where MDI plays a major role. And that’s why looking at that demand pattern, first and foremost coming out of a crisis, there is a high chance that the market would show a very strong rebound pattern, which would then very fast lead into balanced markets.

And looking a little bit further out, there is, from today’s perspective, an announcement, limited capacity built up to 2025 and 2026, and following years, in 2026 and following years, there is currently even no announcement about additional capacity being built or edited. So the market might even get short or very short in the midterm, and you cannot just turn on the tap and say, okay, let’s produce some more MDI, no matter how you do it, it takes a couple of years from the first planning/announcement to really get quality MDI out of the pipes. And that’s why from today’s perspective, you might come to a gloomy outlook. I would say with a quick rebound, limited announcements and also the need for structural need for MDI given, let’s say, the sustainable development and energy, let’s say, reduction targets, the MDI market is still intact.

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