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Juicy Urethane Tidbits from Covestro’s Earnings Call

October 26, 2022

Covestro AG (CVVTF) Q3 2022 Earnings Call Transcript

Oct. 25, 2022 3:13 PM ETCovestro AG (CVVTF), COVTY

Covestro AG (OTCPK:CVVTF) Q3 2022 Earnings Conference Call October 25, 2022 9:00 AM ET

Company Participants

Ronald Koehler – Head, IR

Markus Steilemann – CEO

Thomas Toepfer – CFO

Markus Steilemann

Thank you, Ronald, and good afternoon. A warm welcome also from my side. The turmoil of the energy and raw materials market in combination with weakening demand for our products has affected Covestro in the last quarter. Despite this, Covestro sales in the third quarter 2022 continue to be on the high level of €4.6 billion. In this difficult environment, Covestro has reached an EBITDA of €302 million, still in the targeted range of €300 million to €400 million. The free operating cash flow improved to €33 million after 2 negative quarters.

With only one quarter in front of us, we have narrowed our full year guidance range. In parallel to this call, one of the most influential trade fairs in the plastics industry is slowly starting to wind down. We went out there to craft connections with our customers, suppliers and industry partners and to join forces with the challenges of a quickly changing world.

Let’s turn to the next page. Let us now have a look into volume development. The global volume decreased by 5.7%, mainly driven by the demand weakness in the region, Europe, Middle East and Latin America. The region EMLA has seen significant decreases in almost all industries with only automotive breaking the trend but starting from a low base. Only a slightly decline in volume could be observed in the region, North America. Furniture and electro electronics were down, but this was partly compensated by good development in auto and construction. In Asia Pacific, the volume increased on the back of a stimulus program of the Chinese government for automotive and positive trends in construction.

Looking closer into the different industries, the negative trend in furniture/wood and electro is continuing in all regions. Both industries being affected by a post-COVID decline after a hike during the peak of the coronavirus pandemic. Electronics being hit mostly in Asia Pacific.

The picture is, however, mixed for the construction industry. Whilst volume in Asia Pacific and North America are increasing; the situation in EMEA was negatively — the situation in EMEA was negatively affected by the raw material and energy price situation. The globally positive trend is the volume increase in the automotive industry. Here, the weakness of the electro electronics industry might have had a significant impact on the availability of semiconductors which was the main bottleneck in past quarters.

With this overview of our market environment, let us have a look at the global demand situation across all industries on the next page. If we look at the global demand picture, we can see the same trends that we have outlined in our sales volume overview on the previous slide. We the assumptions in the beginning of 2022, the global GDP has suffered from a dampening caused by the corona lockdown in China, the effect of the Russian invasion into Ukraine and the resulting energy crisis in Europe. We now expect the global GDP to be around 3% with the second half of 2022, clearly below this trend. The forecast for 2022 demand growth in global automotive industry is still above 2021, but the anticipated strong recovery has until now not happened. Also, the positive signs from Q3 can improve the overall picture but not compensate first half production losses, mainly caused by a shortage of semiconductors and the lockdown in China.

Our external data provider, LMC, is now expecting a 7% growth in automotive. The subsection on battery electric vehicles and electric vehicles, that is even more relevant for us, however, is still seeing a high growth rate. The outlook on construction is now also less optimistic and is strongly influenced by the European raw material and energy price situation.

Demand growth 2022 has fallen behind 2021 growth and is expected to be a little higher than 2%. As mentioned earlier, the extremely positive trend for furniture and electro in 2021 has now completely reversed and we see both industries significantly falling behind the expected growth rates. Furniture is definitely a low light with a negative growth expectation of around minus 1%. And for electro, we assume now a growth rate in the range of 1.5%.

With this overview of the global demand picture, I’m now handing over to Thomas who will guide you through the financials.

Markus Steilemann

Thanks a lot, Thomas. And we’re now continuing on Page #13. Coming now to a topic that occupies us almost daily: energy prices and the effect on Covestro as an energy-intensive company. The good news is that despite the peak of the energy price in August, and the still very nervous market, our full year energy bill is now expected to be €2.1 billion, even slightly lower than previously assumed. However, this reduction is driven by the assumption of significantly lower production volumes in the fourth quarter and therefore, less kilowatt hours consumed.

In recent weeks, we have seen a downward gas price trend storages were approaching the maximum and temperatures in Germany were seasonally unusually high. So there was an abundance of gas available. Taking the gas price of October 1 to October 18, flat forward, our energy bill would come out in the range of €2.1 billion. Based on the most recent energy prices, we assume an energy bill of around €600 million for the fourth quarter. Please note that the volatility is still extremely high. Having said this, a range of €550 million to €650 million is built into our guidance.

Charles Webb

Maybe first, just on the mark-to-market. I know it’s just an indication of how you’re looking at next year, and it’s just a point-in-time measure. But when you look at, obviously, end of September versus end of October, where we find ourselves now, I guess quite a lot has changed in terms of energy prices, gas prices as well as some of your product prices in NBI and TDI in different regions, things have moved on. Is there any sense you can give us an indication what it is as of end of October just so we understand that? And also within that mark-to-market, just understanding the I guess, bonus provision assumption that we should be kind of thinking within that or not within that would be super helpful. So just some clarity there.

And then just one on CapEx looking into next year. Can you just help us understand the various building blocks, maintenance as well as some of the bigger growth projects within your kind of €1 billion to €1.1 billion that you have set out for next year in CapEx. Just wondering if there’s any flexibility there given where we find ourselves in the cycle to perhaps reduce spend looking through next year as well.

Thomas Toepfer

Yes. Sorry, this is Thomas. Yes, I mean, let me try to help you a little bit. So I would agree that the September mark-to-market probably is the low point. I would say if you were to push it into October, that number would go slightly up. It would only go slightly up because there is a 4-week delay before the reduced energy prices really hit our P&L. And therefore, I think the energy prices that you see today of whatever below €100 per megawatt hour they will also only come in with some delays.

So I would definitely say that the September number is as far as we can see from today, a low point and things are moving up since then. And in addition to that, it does increase. It does include, as you pointed out, also a bonus provision. So we’ve not assumed bonus to be [indiscernible] of around €100 million to €150 million. You can always ask the question whether it would be paid out or not because you may know our bonus regime, if we don’t earn the cost of capital, there is quite some flexibility to further reduce the bonus and at , I think there’s no discussion that cost of capital would not be earned. So I think those 2 data points may help you to go out where that stands. And as I said, in my view, it’s a low point.

CapEx, you know that we have this maintenance CapEx of roughly €400 million to €450 million. And that means, of course, there is some other projects which are in the middle of the execution, and they are very difficult to stop. For example, the aniline plant in Antwerp and there are some other major CapEx plans where I think stopping or delaying them would cause significant friction costs. But of course, there is some other things which would only be started or could be delayed. So I would definitely say that in the order of magnitude of a couple of hundred million, we do have some flexibility to manage CapEx and we are, of course, currently looking into that number as we prepare for 2023.

Charles Webb

That’s really helpful. That’s really helpful. I’ll squeeze one more in. Could you share what could be in terms of the MDI landscape in terms of supply and demand, a lot of your competitors talking about restructuring European MDI businesses and capacity. I presume chlorine and the energy price has been a bit of an issue there. But just understanding what you’re seeing on the supply/demand side for MDI in Europe today.

Markus Steilemann

Charlie, this is Markus speaking. Maybe from my side, we have learned at least from, let’s say, publicly available sources that, for example, Huntsman is discussing it. We also see that there is at current point in time, plenty of supply in Europe available. And we, in this context, try to raise prices, but there is some if not some difficulty to put it mildly out there. So long story short, it remains to be seen where midterm, the energy prices are going because we have witnessed that in other industries for numerous reasons, take the polycarbonates, I mean the base polycarbonate industry a couple of years ago, where, let’s say, on very short notice, many competitors were out there and saying, I’m shutting down here, I’m shutting down there. And now we have similar, let’s say, quite short term, let’s say, drastic reactions with one or the other public statements.

And over time, when things are panning out, you saw that many of those announcement to shut down plants have either never been executed or have been executed at a significant delay. And when we thought where the plants will remain on stream, all of a sudden, they were closed. Just to name one example, the Singapore [indiscernible] operations of polycarbonate. So long story short, the normalized view, let’s say, when we are through this turmoil, it is pretty clear that the capacity of European production assets is needed and that there is also plenty of demand that will be also in the future being sourced from Europe. And one key reason for that is the, let’s say, disrupted supply chains which in the last 1.5 to 2 years have taught many market players a significant lesson.

So if we just oversimplify it and say, well, because of, for example, landed cost from Asia Pacific or the United States or European assets will be in competitive. I do not believe that this is, let’s say, the main reason. There’s other reasons, for example, the geopolitical turmoil, the overall development that we currently see with regard to, may I call it, new world order developing that might also bring back a lot of assets into competitiveness again.

And let’s not forget, we have a lot of, let’s say, regional nature of those supply chains. So long story short, no matter what you currently read and no matter, let’s say, how short term the reactions are, I tempt to say that some of those reactions are a little bit of an overreaction. And under normalized conditions, we will also see that European assets and particularly, MDI assets will be back on track and will be also sought after by European customers of MDI.

Christian Faitz

A couple of questions, please. First of all, speaking of MDI, Markus, would there any update on the decision for your MDI project in Texas or China? Because I believe you wanted to communicate that during Q4?

Second question, I understand the mark-to-market on the cost side. But would you mind sharing your volume assumptions [indiscernible] potential recession assumptions for your mark-to-market €900 million EBITDA for 2023.

Markus Steilemann

Yes, Christian, good to hear again. And still remember, let’s say your visit on last week, much appreciated. Christian, on MDI, the short answer would be no update these days because as we announced already in earlier, let’s say, interaction opportunities. We are still thoroughly investigating, let’s say, that investment, and we will come up with a decision in the fourth quarter, but not today, not now.

So please bear with me that here, we still take some time to really take a detailed, thorough assessment of the overall situation of the overall, let’s say, investment and also of the overall, let’s say, framework conditions.

On the mark-to-market, the assumptions we have taken, and Thomas alluded to that, the September margins flat forward the planned volumes flat forward as an assumption for 2023 and also then the planned costs that we take into consideration in the first attempt for 2023. So this is how we came to the mark-to-market based on September margins. So with particular regard to your volume assumptions, we assume that volumes will be relatively flat compared to the 2022 expected volumes.

Thomas Toepfer

This is Thomas. Just if you want to play around with that assumption be aware that the volume sensitivity, of course, is much lower in 2023 than in a normal year. The numbers we usually state that there is some €60 million to €70 million. I think for next year, I would rather expect a volume sensitivity between €20 million to €30 million per 1 percentage point of growth. And therefore, I think that’s also important to keep in mind if you want to play around with that assumption.

aideep Pandya

Yes. The first question is really around your energy and gas bill. So you’ve given us the volume number for usage of last year because you’re running such lower utilization in MDI, and TDI has been off-line. What is the actual energy usage for 2022? And then if you were to just use spot prices for 2022, current prices are the — what sort of would be the energy bill for next year? That’s my first question.

The second question is really around what you see with regards to the Polyurethanes landscape in Europe. I mean, at what point do you think that the customers are going to panic because in TDI, we have seen a very sharp reaction with [indiscernible] surprises in China, but we haven’t seen that with MDI. So what explains in your opinion, this difference in reaction?

And then the final question really is just around polycarbonate. Do you see energy prices as well as raw material unavailability or availability, having an impact on polycarbonate supply chain also in Europe because there have been a couple of announcements here and there? So what do you see with regards to polycarbonate spreads and profitability?

Markus Steilemann

Okay. Jaideep, this is Markus speaking. So let me just start with the last question maybe on the European polycarbonate situation. And let me also put it into context about, let’s say, some of the other questions that you have asked.

If you compare our 3 large volume products in the portfolio, TDI, MDI as well as polycarbonates. And if you put the overall energy demand of the products for TDI at 100 so to say. Polycarbonate only consumes about, let’s say, 1/3 because the energy intensity is much lower compared to TDI. And MDI is somewhere in the middle.

Just to give you an idea which product group is hit the most by the current overall, let’s say, energy bill increases and gas price increases. What does that mean? We have seen still some temporary closures of some European assets in polycarbonates. The main reason is that there’s numerous technologies out there and some technologies are simply no longer cost competitive despite the fact that there are not so much energy like, for example, TDI. We feel in this context, very well positioned with our polycarbonate plants given size, economy of scale as well as the opportunity, therefore, to, let’s say, continue to produce also in a very challenging conditions.

So that’s why — we also did not face any, let’s say, raw material availability issues with regards to what we need to produce polycarbonate, but also as we produce quite a bit for captive use in our own, let’s say further compounding, let’s say, planned for our engineered plastics businesses. We also did not face any raw material shortages in that regard. There have been smaller, let’s say, shortages with regard to some additives that we could so far always find second or third supplier options and did not, let’s say, have significant, let’s say, loss of business due to some of those smaller additives. So that is hopefully quite comprehensive picture about how we look at the polycarbonate situation.

Let’s talk a little bit on question number 2. And here is a significant difference in terms of asset size and individual plant size compared to total market size. So TDI in Europe is down. In that sense, 2 major production sites are down with 600,000 tons. And those 600,000 tons is just represented by 2 major world-scale plants, one in Ludwigshafen, 1, let’s say, in Dormagen, that is our plant. And this is 600,000 tons out of 700,000 that means, like-for-like, you have taken out more than 80% of European production capacity.

Having this in mind, even demand was significantly down for TDI, 85% of, let’s say, supply shortage after a couple of weeks has led to the situation that you can currently observe that customers simply saying, wait a moment, I need TDI. I have out of my inventories and looked through my inventories. And now I need to buy [indiscernible] sudden recognizing that 85% of capacity is out in Europe. And at the same time, you see that there have been lots of export from Asia Pacific arrive in Europe, but also here, there is due to logistics reasons and other reasons, and also capacity restraints in — constraints in Asia Pacific and the U.S. because we’re talking about global capacity in total, simply not sufficient TDI. And that all of a sudden then as usual with such a, let’s say, highly volatile product has led to this significant reaction of our customers.

For MDI and now comparing to TDI, the situation is different because we maybe see around 5% to 10% of curtailments only. That is given the market size compared to total plant size, plus a little bit more flexibility on how you steer an MDI plant. That means you could much more adjust in more, let’s say, smaller doses to the market demand as well as to potential supply issues. And that is why you have not yet seen similar strong reactions of TDI compared to MDI. So that’s, let’s say, from polycarbonate, MDI, TDI and for the energy topic.

If you don’t mind, I would like to hand back to Thomas.

Thomas Toepfer

Jaideep, this is Thomas. So I hope that I got your question correctly because there was a little bit of a background noise in the line. So I would say, if you assume volumes going up or down, you can essentially assume that our energy consumption goes up and down with the same percentage unless you would assume that the product mix changes, Markus has just alluded that TDI has a much higher energy intensity. But if you were to take the same mix, essentially is very proportionate. And second, your question was what would be the energy cost with the prices as of today? I can only give you a rough indication, if you look at Page 13 of the presentation, we will be somewhere between the €623 million per quarter that we had in Q3 and the €450 million that we had in Q2. So let’s give or take, it will be a €300 million saving per year relative to where we stand in 2022 with the same amount of volume. So I think as a rough indication, this would be the number that I can give you.

Chetan Udeshi

Yes. Thanks. I was just coming back to the mark-to-market number, and thanks for providing it. I’m just curious, why did you decide to give us like 2023 mark-to-market, so early in the — let’s say, so far before we actually talk about 2023 outlook, which will be more in February. Are you trying to sort of steer off to that sort of numbers, closer to €1 billion rather than €1.6 billion? I think I’m just curious why talk about 2023 so far ahead of time, let’s put it this way.

And second question, Markus, it’s more related to your point on TDI, big capacity curtailment. What’s stopping that on the MDI side you think? Is it more the fact that there are more players? So maybe the market is not as, let’s say, consolidated in nature, and hence, you don’t see the same sort of response so far on the MDI side because though MDI might be steering better than TDI, it doesn’t feel like any of the European MDI producers are really earning cost of capital at least not in Q3 based on the high energy costs.

And last question is, can you confirm between Europe as a whole, did Covestro had breakeven EBITDA in Q3? Or was this below breakeven?

Thomas Toepfer

So Chetan, let me start with your first question, the mark-to-market. You know what, there was no particular thought behind it or any guidance or anything if we wanted to scare somebody away, it’s just that I think it’s a good tradition that we have that in Q3 as a technical indication, we give you the mark-to-market for the following year because mark-to-market for the current year for the last, let’s say, 2.5 months would not make a lot of sense. And therefore, I think there was no particular thought behind it other than we’ve always done it and people gave us the feedback that they find it helpful.

Of course, it does show that the consensus for 2023 still has I mean, I would say some ambition, which we think can be achieved if the economy is turning. But of course, that the assumption must be that you cannot put for quarters in a row and then achieve the current consensus. So I think it just gives you a little bit of guide rail to judge what has to happen in order to make — to give you the 2023 result. I think that’s all.

And then, okay, maybe actually we have an EBITDA question. Q3 EBITDA for Europe, I think not surprisingly, was not breakeven. We were loss-making with respect to our EBITDA numbers in Europe.

Markus Steilemann

Chetan, this is Markus. Thanks for your question. And as you [indiscernible] addressed it as a kind of a follow-up to my previous statement. The numerous factors for TDI being different. We have a similar, let’s say, consolidated market structure in terms of the suppliers. That’s not too much different from MDI, but what is particularly different is 2 reasons. Number 1 is TDI, I have alluded to is much higher energy intensive than MDI. And number 2 is the respective TDI players have much fewer plants in total, and each plant is representing a much higher share of the total market.

And those 2 factors together, that means the high energy consumption as well as the even higher concentration within an anyhow consolidated market has a much stronger impact with 1 plant, so to say, it’s not an operation between 8% and 10%, assuming a world-scale plant between 8% and 10% of the global market is out. So — and that’s why those 2 plants that were out in Europe represented 80% to 85% of the European market and almost 20% of the global market. And you cannot just easily it because it needs to run at around 50% plus output rate.

So you don’t have the decision like an MDI more or less with the overall, let’s say, a number of plants being out there that an individual competitor can say, okay, we run on 1 line, 2 lines or 3 lines. And in that particular context, therefore, not so many plants have been taken out or capacity. And at the same time, you have much higher flexibility to steer, let’s say, and being therefore also a little bit closer to market demand. So it’s not a jumping of capacity in or out, but no more gradual adjustment.

And last but not least, I think what is important, the TDI plant of us in Denmark and in Germany was out not due to, let’s say, cost reasons in the first place, but due to force majeure in the upstream value chain for chlorine production because the chlorine production was out due to a technical issue. And that technical issue has led to a TDI plant shutdown. So that’s the situation.

Geoffrey Haire

I just wanted to ask a question around impairments of assets. I’m not in the . So this may be a fairly simplistic question. I just wonder at what point, given the closures you’ve got in TDI and obviously running MDI at lower capacity utilization, will you have to consider empowering some of the assets.

Thomas Toepfer

I think, Geoff, I mean, very simple. We follow the rules of IFRS here. Clearly, the current economic environment is a triggering event to have a look at our values in terms of goodwill, but also in terms of asset values. I think it’s — it shouldn’t be a surprise or you know that some of our are at the brink of such a test. We have also, in the last annual report noted that [indiscernible] with a 10% sensitivity would run into a need for impairment. And therefore, I think with that indication, will be running into that test. And I would clearly not exclude that it will lead to an impairment need, which I think in a crisis is, in general, not a surprise.

Thomas Swoboda

Yes. Sorry for the technical issue. I will still try 2 quick questions. Benzene costs were very high in Q3. I remember we discussed that broadly in the call. My question is, was that a bigger headwind in Q3? And is this already digested or is it going to bug you in Q4?

And very quickly on TDI. I mean we have been recurrently hearing from you and from your peers that MDI and TDI do not travel that well. Apparently, you are serving your clients from other plants importing into Europe. I mean how long are you comfortable doing that? Is this just a short-term fix? Or is it something that could last for longer?

Markus Steilemann

Yes. Thomas, [indiscernible] benzene has seen quite some peaks. You’re absolutely right. Currently, we are talking about benzene prices of about €900 per ton. The peak, just in comparison, has been at €1,700 plus. And we believe that we could mainly digested this in the third quarter, but it will also last a little bit into the fourth quarter because we’re still selling off inventories that have been produced, let’s say, with those higher costs. So long story short, it takes due to the slightly subdued demand, in particular in Europe some time to adjust those costs.

And on the second question. Yes, once again, these are the most complex questions. You’re right, on the one hand, MDI and TDI are not traveling very well. That’s true. And that’s why, in particular, on MDI, you see only a part of the market segments being supplied with imported MDI simply where activity after long transportation is still acceptable for the particular application of the customer. So that means serving an MDI market from outside Europe, given all the complexities, import, cooling and so on and so forth. As I said earlier, it will be difficult in the mid to long run. That’s number one. And even in the short term to further increase MDI import into Europe is a challenge because as we see with TDI, there’s simply not sufficient capacity available to cover up for the entire European overall production capacity. So that’s number one.

TDI, same topic. We’re just currently seeing from recent price developments, in particular in China going through the roof. That also this, let’s say, rather — that this is a rather short-term solution because once TDI prices are back to a level where it pays off to restart European TDI plants, they will be restarted. And so — and that’s why I do not think that there will be let’s say, a mid to long-term opportunity to really continue to supply from the outside world.

And once again, let me reiterate one other topic. This is a market where you supply in the region for the region. We have seen no geopolitical disruptions currently going on and manifesting itself. And we have seen over the last 2.5 to 3 years, significant supply chain disruptions. So many customers are concerned about being able to only bank on long-distance imported goods and that’s why I believe next to all, let’s say, the spreadsheet calculations that might lead to different assumptions, I truly believe that there will be demand for European-based TDI production, there will be demand for European-based MDI production as well as respective consumptions.


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