Covestro Urethane Comments from Investors’ Call

Markus Steilemann

Thanks Ronald. Good afternoon and good morning to our listeners from the United States. Current times are extremely challenging for all of us, both on an individual, as well as on a professional level due to the coronavirus pandemic and its consequences in all areas of our life.

The focus of quarter one 2020 was certainly to first take care about the safety of our employees, and then to find ways to secure our business in the best possible way. Let me start with the financial highlights of the first quarter. As expected, we faced a core volume decline of 4.1%.

However, we reached our EBITDA target of €254 million within the guided range of €200 million to €280 million.

In the first quarter the free operating cash flow was as expected negative. This reflected the usual seasonality. As you know, it was not possible to stick to our initially planned AGM date. We now found a new date and format. It will be held virtually on July the 30th, 2020.

Finally our initial outlook for the year could not be upheld therefore we adjusted the group financial guidance for 2020 already with an ad hoc application on April the 15th.

The chart on Page 3 shows you Covestro’s core volume change year-on-year including the latest available data from April. In the first quarter of 2020 volume sold in the core business fell by 4.1% at group level compared with the same quarter of the previous year. This was due to coronavirus related weaker demand in China in February and March. We estimate the global impact on volumes at minus 8% year-on-year. Under regular conditions the underlying growth in core volumes would have been around 4% positive from the first quarter.

The impact by region gives a better understanding on the global dynamics. Our figures show that mainly China was affected in the first quarter. As it was hit first the impact on our business was highest in February.

In Europe volume impact varied by country, Italy and Spain were impacted first, automotive production stopped were decided late in the quarter. In April we faced the major year-on-year decline with a recent stabilization.

In the United States, we witnessed the latest but hardest hit. The pandemic arrived late and the political actions affecting the economy were implemented one month later than in Europe. In a nutshell, we conclude that quarter two will be affected by many more countries while quarter one was mainly affected by China. Consequently, we expect the impact on core volumes to be significantly more severe in quarter two than in quarter one.

After the regional analysis, let me show you on the next slide, our main customer industries, how they are affected. The chart focuses on automotive, wood and furniture, construction and electronics, all together accounting for around 65% of group sales. The data represents our current internal assumptions for different industries.

For automotive, we observe that a 100% of the production plants reopened in China, on the other hand, all plants are currently closed in NAFTA and some plants reopened in Europe, Middle East Latin America, at reduced capacity. The current lockdown coupled with the lower – with the low consumer confidence is expected to severely hit this industry. Therefore, we assume an industry decline between as minus 15% and minus 27% for 2020.

For the wood and furniture industry, we expect also that the global markets will decline between minus 12% and minus 17% in 2020. Construction seems to be not as bad as automotive or furniture. However, also here we see that the lockdown dampens activity is meaningful. It seems that the impact on this industry will be the highest in NAFTA. Our assumption for the Global yearly development is declined between minus 2% and minus 8%.

For electronics, a major impact is assessed for the region Asia-Pacific. Since we faced a severe decline in this region in quarter one, we might have seen the worst already. We estimate that EE&A were declined by minus 4% to minus 12% this year.

Let me now wrap up this picture on the next slide. In response to the global spread of the coronavirus pandemic, the Board of Management has taken early and decisive actions to adapt the company to the current conditions. In mid-March, we made Home Office mandatory for employees wherever possible. As of today we have thankfully recorded no casualties among our workforce. The second priority was to secure the utilization of our assets and to ensure the ability to deliver to customers.

China was first hit by interruptions in February and reduced production rates. We returned to full production rates in the middle of March. However, as the pandemic spread into other Asian countries our export business from China into Asia Pacific suffered. Therefore we had to again lower rates in April.

In Europe we see rates at around 70% for polyurethane and polycarbonates. Cost has been running at reduced rates as well since April. In the U.S. our beta on site was not hit in Q1 but has now for few weeks also been forced to reduce its output.

In Q1 we recorded a negative impact on EBITDA of around €80 million slightly higher than the guided €60 million. On the back of this, another key priority for us was to review our cost savings and CapEx plans and to secure the strong liquidity position.

Continued on Page 6, we further increased the target for short-term cost savings to now more than €300 million in full year 2020. Previously we planned to achieve €200 million of additional cost savings in 2020. Half of the savings are driven by cost avoidance versus original budget for example lower CapEx related operational expenses. The other half comes from various measures like reduced consultancy cost, travel restrictions and other expense cuts.

In response to the coronavirus effects we identified more than €100 million of additional measures through lower OpEx in line with the reduced CapEx budget, less travel and lower supply chain costs.

This comes in addition to the ongoing perspective restructuring program which is expected to contribute savings of €100 million this year. The savings program includes around 900 planed headcount reductions and a deep streaming across all areas of the group for possible sustainable savings. In total all measures are planned to yield more than €400 million of savings for the full year 2020.

On Page 7, let me now go through our standard chart starting with the regional development. Global core volumes declined by 4.1% year-on-year. We observed the ongoing demand weakness in automotive in EMLA and NAFTA. This translated into a low double digit decline of core volumes in automotive.

Volumes in global electronics also declined by a low double-digit rate entirely driven by Asia-Pacific. Positive volume growth in multiple other industries like medical and chemicals could not compensate the sharp declines.

Asia-Pacific usually our best growth region was severely hit by the coronavirus in the first month of the year and recorded a double-digit volume decline mainly driven by China with volumes down by 29%. All customers industries were affected without exception.

Core volume growth in EMLA was still slightly positive with 1.3%. Growth suffered from the pronounced weakness in automotive. However, strong growth in electronics and multiple smaller industries like packaging, textiles and others could compensate for it. Core volume growth in North America was even strongly positive posting 5.8% growth, drivers with strong growth rates in construction and wooden furniture. These industries counterbalance the ongoing weak automotive demand.

Thomas Toepfer

Thank you, Markus, and also good afternoon and good morning from me as well to everybody on the call.

I’m on Page 8 of the presentation, and the sales bridge that you see shows a year-on-year sales decline of 12.3% for the first quarter 2020, and the main drivers were deteriorating prices in MDI, TDI and PCS which reduced our sales by a total of €219 million as you can see in the bridge.

And on the other hand lower volumes triggered by the coronavirus pandemic reduced our sales by €89 million. FX was positive and added €27 million mainly attributable to the U.S. dollar and finally our portfolio changes reduced our sales by €14 million in Q1 and you have the details of that effect in the bullets on the right hand side of the chart.

So let’s turn the page – on Page 9 you see that in Q1 which generated an EBITDA of €254 million which was in line with our guided range of €200 million to €280 million. The higher competitive pressure in polyurethanes and polycarbonates led to a decline in contribution margin however due to a relief on prices of raw materials the negative pricing delta was slightly less pronounced than we had expected and amounted to €150 million.

The negative volume development translated into an EBITDA impact of €54 million and the line item, other items contributed positively with €12 million. The main contributors being short-term cost savings which were partly counterbalanced by provisions for the restructuring book program which we built and FX had a very small effect as well.

So with that let me turn in to our segments and I’m on Page 10. If you look at our polyurethane segment on chart – on this chart we faced a core volume decline of 3.6% in Q1. Overall the industry utilization stayed at a low level due to additional capacities added during the last 18 months on the supply side, and also due to softer demand triggered by the coronavirus crisis.

Overall our EBITDA margin is at 3.9% in Q1 which was clearly below last year’s level driven by lower volumes and significantly lower MDI and TDI margins. However if you take a quarter-on-quarter perspective, we also see a decline triggered by the missing seasonal volume rebound and by continuing margin pressure.

Charlie Webb

Just a couple for me, so first just kind of following up on that working capital, just trying to understand why we didn’t see a better working capital performance year-on-year I’m surprised given the raw material deflation. The working capital outlays were higher year-on-year especially given the volume environment. So perhaps just first of all on that one and then secondly just around utilization rates, can you help us understand the cross products what the current industry utilization rates are and currently what you’re operating at, just want to try and understand how you are faring relative to your peers?

Markus Steilemann

Yes. Let me maybe take the working capital first, question first. So first of all the raw materials impact first of all is probably less pronounced because our working capital is mainly driven by finished goods and what you saw is the normal seasonal impact after we had admittedly driven down our inventory levels quite low at the end of December. So the pick-up was a little bit more pronounced in Q1 2020 maybe than in 2019 simply because the starting point was more ambitious this year than it was last year. That’s the first one.

Secondly, it’s mainly determined by finished goods not so major – not so much by our raw materials and thirdly the price decline for raw materials that you have seen really only kicks in for us with a delay of at least two months and therefore it had from that perspective no impact on our working capital performance in Q1.

Thomas Toepfer

Yes Charlie, let me take the second question which is a bit difficult because we have as you know extremely extraordinary times here, and that is totally unprecedented and that’s why talking about industry utilization is in this context also is quite difficult as we get very, very mixed messages on let’s say how overall the industry is doing or how individual players might be doing.

So if you look at our full year and just starting with MDI, we assume that as of last year the industry utilization was around 87%, and we did actually not significantly deviated let’s say on a normalized level for the entire year.

For the full year 2020 we are currently calculating again, and that is an estimate on a normalized basis with 80% however that could significantly vary quarter-on-quarter simply due to the fact that some competitors might have shutdown entirely given the cost curves that some of them have, and you know at the end the high cost curve is also steep for the entire industry. But also there were a preponements of turnarounds that were planned maybe later in the year which we also might have seen.

So from that perspective it is very difficult to say, and that is also a picture that we see in our overall setup of assets, we have had assets, and Thomas commented on that a little bit earlier in China that we’re running at reduced rates and very low rates for example in February and March, and I’ll have revamped and then have been slowed down in China but we also have seen similar patterns now in Europe where we have actually brought down production to a much lower level than in previous years in Europe and now we’re seeing actually similar effects in the United States where actually we see positive signs for our potential development of capacity in MDI ramping up again in Europe, so it is a very, very mixed picture.

On TDI, it is actually a similar picture last year the industry based on our – on our insights and market intelligence that was around 80% to 81%, and this year we expect the overall normalized industry utilization to be at around 69% to 71%, just to give you a flavor. But also here we will see asset-by-asset, competitor-by-competitor and entirely different pattern on a quarterly level.

So from that perspective it is very difficult to judge frankly speaking also for us where the overall industry utilization might be at current market demand which is highly volatile and it is, excuse my French very badly here in this context. And therefore it is for me frankly speaking almost impossible to give you a clear number that would be meaningful to be very honest.

Markus Steilemann

So whereas for TDI we have approached trough levels and that is also what our current data indicating that there was continued price pressure on MDI and partially, but only partially also for polycarbonates and less – let’s say less so for TDI. And so, that gives you maybe a flavor why the polyurethane results have further declined.

Thomas Swoboda

I’ve always given us by – I still have two questions if I may and I will try to give them one by one – ask them one-by-one. Firstly on inventory levels, some companies are reporting or saying that there was some degree of panic buying in Q1 which they observed. I know you cannot carry much inventory yourself in polyurethanes but I am just wondering if you have any insight how the inventory situation looks at your customers meaning are the end product base on your stuff, high, low or whatever you might see?

Markus Steilemann

Thomas, this is Markus speaking. We have seen some customers but really, very, very limited amount in the U.S. for example who thought that in case supply chains might be disrupted that there may be – pile a little bit more of materials on stock but that was where they selected, actually for most of the customers we have observed that they are in very tight control actually of their raw material inventories in particular as they were all expecting very, very sharp focus on liquidity and the liquidity situation of corporations plus which I think also gives further evidence to the thesis that inventory levels are rather low.

Currently customers are ordering only what they immediately need which would also indicate and that goes by the way across the Board not only in the specialty grades but also in the commodity area. When they order they want to have delivery on very short notice, and we are also in very close contact with our customers exactly to also make sure that we get access to their cash in terms of that they’re paying, and that’s why we also looking very, very closing about how the ordering pattern looks like, how the demand pattern look like.

So currently I have to say that we have no indication that there’s unusual high stock levels or things like that. So, definitely not for the industries/for the applications that we supported raw materials.

Thomas Swoboda

That’s terrific. And if I may sneak in a third question, a small one, how big is the OpEx for data on – at the current level of investment you have made?

Markus Steilemann

So you probably mean what is the – what is the kind of the sticky cost that we still have in 2020 despite the fact that we cut the MDI-500 project, is that your question?

Thomas Swoboda

Yes, more or less. What would this project cost you on a perpetual basis, if you – would you now stop investing for the time being?

Markus Steilemann

There is no perpetual cost. I mean we will – essentially what we will do is we will, okay, again let’s step back, these projects are executed in stages. The Baytown MDI-500 project was still in the planning phase where the rough engineering was being done, we call the stage-gate 2. Essentially, we must put all our plans we had put them – we can put them into drawers so that at a later stage we can essentially take it up and then continue into our front-end loading phase number three.

So there is no permanent running cost for keeping the option up. There is a certain ramp down cost which we have – which is a mid-double digit million amount this year because we had to ramp down our construction sites, deal with the people, repatriate many people, et cetera, et cetera. But there is no permanent cost for keeping the option up.

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