Covestro AG (CVVTF) CEO Markus Steilemann on Q2 2022 Results – Earnings Call Transcript

Aug. 02, 2022 11:35 PM ETCovestro AG (CVVTF), COVTY

Covestro AG (OTCPK:CVVTF) Q2 2022 Earnings Conference Call August 2, 2022 9:30 AM ET

Company Participants

Ronald Koehler – Investor Relations

Markus Steilemann – Chief Executive Officer

Thomas Toepfer – Chief Financial Officer

Markus Steilemann

Yes. Thanks a lot, Thomas. So now we come into maybe a more complicated part of the presentation, talking about energy. But we deem it to be very helpful for you to understand how the overall energy market is developing and how Covestro is also positioned in that market with regard to purchasing but also with regard to locations that we have, particularly in Europe and Germany.

As you all know, the situation of energy supply has become a major issue that requires our continuous full attention. The price increases for natural gas and electricity keep us busy in trying to pass them on to the market. To be very clear, up to now, all Covestro sites in Europe, and especially in Germany, are fully supplied with natural gas to run our plants flat out. We are [indiscernible] with the federal government and the network agency responsible for the supply coordination on a frequent basis.

Throughout 2021, we have seen quarter-by-quarter an increase in our energy spend compared to 2020, finally leading to energy cost that almost doubled from 2020. The increase of quarter four 2021 of €260 million has since then continued to be the magnitude of the quarterly increases in Q1 and Q2 of 2022 on top of the energy costs of 2020 and 2021. Our initial evaluation of the energy spend for 2021 was €1.5 billion. With the revision of our guidance in May, we incorporated an increase of up to €2 billion. Given the current extremely volatile situation, we expect quarter three to show another sequential increase of €350 million to €400 million on top of the cost of 2020 and 2021. We are now assuming our total energy bill around €2.2 billion for the full year 2022, which reflects the prices of last week of July flat forward.

As you can see, on the three pie charts on the lower part of the slide, the major driver for the cost increases, are the European energy prices, which represent also the major share of our global energy purchases. Our energy mix comprises roughly 50% electricity and roughly 50% energy from other sources, including gas and other fossil fuels. Our sourcing activities are focused on the spot market. Covestro does not engage in any hedging activities for its energy purchases.

Let’s turn to the next page. If we now come to the specific situation of Covestro in Europe, you can see that Covestro entertains a large production base in Europe, and especially in Germany, with 25% of our global capacity for core products being located here. The shortfalls of current gas deliveries from Russia are posing a threat to the energy supplies to Germany and by that also to Covestro. We believe that our other European sites are not impacted at all or to much smaller extent.

In Germany, the Federal Network Agency which is the response – which is responsible for gas supply coordination and allocation, has declared gas warning level 2 on June 23 this year. But basically, nothing has changed fundamentally. The lacking gas volumes could so far be sourced from other sources, and no gas restriction has been imposed. To minimize possible risk scenarios, these risk scenarios of 10% to 40% gas curtailment have been evaluated in Covestro and detailed plans to reduce or stop production to align with the potential reduced gas supply have been developed.

For example, we have simulated a scenario with 25% curtailment of gas supply to Covestro in Germany, and the impact would be a low to mid-double-digit million euro impact on EBITDA per month. However, we are fully cooperating with the authorities and Federal Network Agency and are evaluating all measures to reduce our gas consumption by working with our suppliers and the chemical park operators providing us with raw materials and theme.

Please follow me to the next page. If we are now looking a little bit deeper in how the German natural gas network is structured. In the past, 55% of the German gas supply came from Russia through the different pipelines, Nord Stream 1, Yamal, [indiscernible]. The transfer points for Russian gas through these pipelines are concentrated in the eastern part of Germany. Accordingly, the German gas grid has been built for the flow direction east to west. As you can see, the lack in gas volumes from Russia have partly been replaced by supplies from Norway and the Benelux countries, starting from the first quarter 2021 – 2022, excuse me, with handover points mainly on the Western German border. This is where the plant of Covestro in North and Westphalia are located. The Covestro plant in Brunsbüttel in northern part is close to the majority of the new LNG floating storage and regasification units FSRUs. So these terminals are planned to be erected and brought online by the fourth quarter of 2022 or early 2023.

The grid appears for major flow direction east to west, but now more imports and LNG volumes come in through the western side. So it is not sure that the grid can transport as much volumes west to east. This needs to be simulated, tested and might even require additional infrastructure measures. In the case of curtailment, there is a possibility that some regions in Germany, especially in the eastern part, will have stricter rationing than some regions in the western part. What I want to say to sum it up, plants of Covestro are favorably located and might be even part of a critical infrastructure that could result in a reduced curtailment of gas in case such a curtailment is seen as a necessary step by the Federal Network Agency.

With that, I would like to quickly summarize. So please follow me on the next page. The record sales of €4.7 billion in the second quarter 2022 driven by significant price increases mitigating the extraordinary inflationary pressure. We also delivered an EBITDA above the guidance range in the second quarter 2022 due to faster-than-expected normalization of COVID situation in China.

The guidance revision reflects the challenges ahead in the second half of 2022. Therefore, we reduced the EBITDA guidance from €2 billion to €2.5 billion to now €1.7 billion to €2.2 billion. We also had seen a record dividend payout of €3.40 per share, and that represents a payout ratio of 40%. And the 2-year share buyback program of €500 million has been started. And now we have €150 million bought back during the first 4 months. So overall, we had a solid second quarter in a challenging environment.

Christian Faitz

Yes. Good afternoon, everyone. I have two questions, if I may. First of all, related to your updated outlook, you mentioned broad-based demand weakness across key customer industries. Can you please elucidate this a bit more? What are you seeing in your order books? What are your salespeople reporting back? And then second question, can you please comment on your view how the low Rhine water levels, which is now going actually into the dry season, could cause supply issues, for example, in [indiscernible] as we saw for, I believe, in 2018? Thank you very much.

Markus Steilemann

Yes. Christian, thanks a lot for your question. This is Markus speaking. So if you look at the current overall environment for our end market, you could say that the so-called stay-at-home categories are across the board affected. And notwithstanding the specific situation that we have alluded to in our presentation in China due to the lockdown that has amplified some of these effects quite significantly, you can say that those so-called home categories are very broad-based across the regions. And that includes furniture, mattresses, electro-electronics. And on top of that, we also have seen impact on the automotive industry, for example, but not only limited here to China and also to Europe. And that has numerous reasons. One reason for that, for example, is that we have had since months a so-called microchip crisis. But on top of that, we also have seen the effect, particularly in China, also because of the headquarters of our engineering plastics business being in China. And that engineering plastics business has above-average exposure in the Covestro portfolio to the automotive industry. So long story short, I would say those three categories, so Asia Pacific, on the one hand, the automotive industry as well as the so-called stay-at-home categories have seen a downturn. And also to be clear here, that downturn, particularly on stay-at-home categories, has accelerated in July.

On the Rhine level, maybe here, what we have seen so far, and we monitor the situation by the day that we currently can handle the situation, and we are, I would say, much better prepared than we have been about 4 years ago when it happened first time in October, November 2018. So that is maybe not, let’s say, a news that would totally please you. However, as I said, we are much better prepared. Currently, we have no, let’s say, issues to supply our plants in Europe, next to all other, let’s say, supply chain issues that we have in the overall scheme with regard to specifically issues with regard to the Rhine level and water levels. So from that perspective, I would say that currently, the situation is under control. And that, let’s say, even if things would, let’s say, deteriorate from here a little bit, we still think that we can keep up supply to our North Westphalia plants, let’s say, intact. And from there, we don’t see currently increased risks.

Georgina Fraser

Hi, and good afternoon. Thanks for taking my questions. The first one I wanted to ask is you provided in the slides mark-to-market for July. I imagine that includes an average of prices across the months. So, maybe if you could let us know where the mark-to-market is today and if you’d be willing to give us a sense of the EBITDA contribution by each major region? And my second question on the same vein is – TDI in Europe, I think, is probably loss-making today. Could you possibly talk us through any reasons for or arguments against scaling back production? Thank you.

Thomas Toepfer

Yes. Georgina, this is Thomas speaking. Let me maybe start with the mark-to-market question. So yes, I mean, first of all, I mean, we – even ourselves, we do not have daily margins or anything, but we have monthly margins. So therefore, I would struggle to give you any specific development over the course of July. However, currently, what we would see in August is probably a further margin decline relative to what we had in July, simply because we’re seeing that the energy costs are higher and they affect us negatively and we do see the price level that we have. On the other hand, what we also see is that going forward, raw material prices are decreasing. That should then be a positive with a certain delay of, whatever, 60 days or so. So I think there are some negatives and some positives that we already see. Therefore, we do think that the mark-to-market is fully intact. And it’s still a good guidance. So I think that will be my statement on this one. Markus, do you want to take the TDI question?

Markus Steilemann

Yes, Georgina. This is Markus speaking. Thanks for your question. So looking at TDI, and in all fairness, I mean, we can’t, as you might understand, let’s say, go into too many details here. But TDI in Europe, given, let’s say, current peaking levels of raw materials on the one hand, but still, on the other hand, also energy prices, might be loss-making at an EBITDA perspective, but still has a positive, let’s say, contribution in terms of fixed costs, so from that perspective – or diluting the fixed costs. So in that perspective, I don’t want to go, let’s say, into too many details because I think this is not appropriate on such a call. Nonetheless, we are closely observing and monitoring the situation with regard to how the cash costs and how the overall, let’s say, profitability levels are developing from a global perspective and also on a respective site level. But just as a reminder, and that has not changed, given the fact that we have a proprietary technology, the so-called gas phase or [indiscernible] gas phase technology for TDI in place – in a world scale plant in Dormagen, we are still convinced that we are the cost leader in TDI in Europe. So regardless, let’s say, of a global picture within our own cooperation when it comes down to European assets, we believe that we have a very competitive cost position with regard to TDI in the European asset landscape. I hope that gives you some flavor.

Markus Mayer

Good afternoon, gentlemen. Two questions more on a potential change in trade flows given the higher cost curve in Europe. Can you give us some flavor how your European-based Performance Materials business, how much of this is really for the regional market and how much for the export market? Or is it only for regional market? And if you also expect any kind of change in trade flows for your business globally.

Markus Steilemann

Yes. Markus, thanks a lot for your question. And let me take this one up. This is Markus speaking. In general, we produce in the region for the region. So we try wherever we can to avoid transporting, in particular, highly reactive products like TDI and MDI simply for the reason, let’s say, of serving out of one region permanently other regions. For sure, we have respected trade flows, but this is mainly driven by other reasons. For example, if we have planned or, in some cases, unplanned shutdowns, we need to make sure that we, based on these facts, deliver and supply respective markets, then we put, for example, highly reactive goods and transport them across regions or yes, in case there is short-term arbitrage opportunities, then we might also consider to transport goods. In that context, however, in general, we serve the respective markets from the region in the region. Have we seen trade flow activities now from one region going into other regions increasing? Yes, we have. So there is clear evidence based on import/export data that there is material flow, particularly from Asia Pacific, arriving in Europe and here, particularly in Southern Europe. And there is also a slightly increased level from North America also coming into Europe. Not all of that, but at least, I would say, a significant part can be attributed to material trying to find its way from the currently lower cost production areas in Asia Pacific into high cost and, therefore, low-margin production areas in Europe. And that is very easily explained because, particularly in Asia Pacific, if you look at the energy costs that have hardly moved during the crisis as well as raw materials, which have not, let’s say, moved that significantly, but they also have moved and now even slightly coming down, we clearly have to say that it obviously makes sense for one or the other producer to import from Asia Pacific into some regions of Europe.

There is a couple of things that were listed on the long run currently, not on, let’s say, short-term, against that, say, significantly increased levels of imports. Number one, it’s logistic capacity. And number two is you have to build also the respective infrastructure. So it’s a limit at least short to mid-term to how much you could actually import. And the second bit is for TDI and also some MDI applications, the reactivity of the material, because the quality of material, given the higher activity, deteriorates the quality. And we’ve seen it in the past already numerous times that then only some applications can be served. I do not want to include that this might have structural effects in many years to come. But for now, the short-term effects are as I have described them. I hope that helps a little bit.

Thomas Toepfer

I think – I mean Charlie, I would say is that Wanhua, I mean I jokingly tend to say they are our favorite competitor because they do behave in a very rational way, and that’s also what we are seeing here. So, I think they are not the problem. What we are seeing is that, of course, the industry utilization in polycarbonate is very low and that there are many players that are newcomers to the market or not in a market – in a strong market position. So, therefore, here the situation is slightly different. This is also why we do differentiate more and more into engineering plastics where we compound the material to decouple ourselves from the website pricing. But on the Wanhua side, we do really observe that they behave in a very rational manner, which is absolutely helpful for the market.

Charlie Webb

And are you seeing them curtail supply of MDI as in like do extended shutdowns or whatever? Is that starting to become more of a feature? I mean MDI spreads – I mean of course, pending prices have been part of it, but still look pretty pressured.

Thomas Toepfer

Yes. I think that specific question, it would be great if you could direct that – direct it to Wanhua. I don’t feel we are positioned to give that answer on their behalf.

Charlie Webb

Okay. So, you don’t see anything in the market at this stage per se?

Markus Steilemann

Once again, I think – it is Markus speaking. I would love you to turn to Wanhua and ask that question. One thing that is in that context sometimes really maybe forgotten is that – the overall situation is, let’s say, the most impactful for the market leader. And we have seen, let’s say, Wanhua being a very rational player in the past.

Geoff Haire

Yes. Good afternoon and thank you very much for the opportunity to ask. Two questions. First question is a little bit detailed. But I think if my math is right, your working capital chance in Q2 was about €68 million. I just wonder – it seems low given energy cost prices and raw material cost increases as well. I just wonder if you could maybe give some details on that. And then the second question, and I apologize for this, but going back to the new MDI plant decision, given that BASF has announced a doubling of that capacity in North America, does this make you sort of more favorable to moving – considering building the plant in Asia now?

Thomas Toepfer

So, let me start with the first question. So, first of all, your math is right. I have the same number in my mind. The reason, of course, is that the price increases already happened, to a large extent, in the first quarter of this year, and we are continuing on that very high level. Plus there is a little bit of different working capital buildup in Q2 – Q1, Q2 last year versus Q1, Q2 this year. But your math is absolutely right. And you can also see that overall, the working capital buildup this year relative to last year, if you look at the free cash flow statement, is only a little bit more than €100 million more. So, I think that those numbers do square for me. It’s really the price level that was already pretty elevated at the end of March.

Geoff Haire

Thanks.

Markus Steilemann

Geoff, and then your second question, if you look at the overall MDI capacity development globally and look also what has been announced by when the BASF plant decision, as you call it, and as announced, is exactly in line with what has been announced a couple of years ago. So, that was part of our long-term supply-demand assumptions and is now just, if you want to say so, materializing as planned with that is, as usual, an exception because most of the announcements either come too late or come never or do not come to the announced extent. So, this is, let’s say, an example of the 40% to 50% of announcements that obviously come on-time and in full, and with that, do not have, let’s say, a new facet to the already known information that we will make the basis for our MDI decision.

Matthew Yates

Hi. Good afternoon. A couple of questions around your capital allocation and balance sheet headroom. Thomas, I didn’t really understand your comment on the buyback in terms of saying it’s in keeping with the existing timeframe. If you have done the €150 million already, that looks to me like you are trying to complete the program over 1 year rather than 2 years. And given the whole buyback was intended to be opportunistic and countercyclical, wouldn’t it makes sense to accelerate the buyback at this point. And then maybe the second question, just following up on what Geoff asked about, the CapEx. Is there any update on the bottom line of new investment decision there? And any debate about pushing that out given the weaker demand backdrop?

Thomas Toepfer

So, yes, let me – on those two questions. So, I mean, the CapEx decision you are referring to the MDI decision and the question, where to build it, I mean we always said a decision would be taken after the summer break. I would feel this is still valid if you define it as a long summer. So, don’t – please don’t nail us down at the 1st of September, but we will come to a decision then in Q, I mean I would say, second half of the year, but not in December, rather September, October, we will come up with something that is then also discussed by the various committees that we have to go through. Of course, it needs Board approval. It needs Supervisory Board presentation, etcetera, etcetera. So, I think September, October is a realistic timeframe here. On the share buyback, what I wanted to say is, I mean we have the 2 years. We have the €500 million. We are not saying because we were already executing €150 million, there is necessarily an acceleration. Our goal is to execute it, as I said, over the 2 years with the amount – there can be some periods that are a little faster and some other periods that are a little slower. There is no indication of what we did so far that we always must accelerate it and be done within the year. I think that would be not exactly our target. And sorry, I should also say – sorry, I think you asked whether share buyback was independent of MDI, yes. I think those two things, we don’t see them as intellectually connected.

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