Materials IPO Makes Strides Despite Headwinds

Covestro, the business spun out of Germany’s Bayer, has outperformed its parent despite anxieties about Chinese demand

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The logo of plastics company Covestro is pictured outside the company’s headquarters in Leverkusen, Germany, on Sept. 1, 2015. Photo: European Pressphoto Agency

Dec. 29, 2015 7:30 a.m. ET

This child has happily toddled free of its parent. Shares in Covestro, the materials business spun out of Germany’s Bayer, have risen nearly 30% since its October listing while its erstwhile parent’s stock is about flat.

There is an element of good timing here. Covestro had to cut the number and price of shares sold in its listing amid investor concerns about Chinese demand. Shares in chemical sector peers like BASF had fallen, spooked partly by heightened volatility in China’s stock market this summer.  As it became clearer that was a market dislocation, the shares rallied—and took Covestro with them.

The next test will be February’s results and guidance for 2016. That isn’t straightforward: The outlooks for its three businesses are very different.

In polyurethanes, the rigid and flexible foams used in everything from furniture to cars and Covestro’s largest business by sales, overcapacity is a problem, particularly in Asia. While lower oil prices helped profitability this year, those benefits are quickly passed onto customers.

The fundamentals are better in polycarbonates, the strong plastics used in the automotive and electronics industries. Demand is helped by substitution designed to produce lighter products, even if the drag from falling use of CDs and DVDs continues.

Covestro has other advantages. Its capital expenditure is falling, boosting cash flows. And its specialty coating and ingredients business, its smallest by sales but a third of earnings before interest, tax, depreciation and amortization, is a stable, high-margin unit. Covestro doesn’t look expensive against bigger commodity-chemicals peers and its coatings business deserves a premium.

That could help Covestro keep its feet next year.

http://www.wsj.com/articles/materials-ipo-makes-strides-despite-headwinds-1451392203