Urethane Comments from Covestro Investors’ Call

Thomas Toepfer

Yes, thank you Markus, and also a very warm welcome from my side. If you please go to Page 5, you see the sales bridge for the quarter, and as you can see we posted a sales decline of 14.6% in Q3 and the main drivers were deteriorating prices in MDI, TDI and PCS, reducing our sales by a total of EUR686 million. On the other hand, we deliver a positive volume growth contribution of EUR80 million, and also you can see in the bridge that FX effect added EUR70 million, mainly attributable to the US dollar, and also to the Chinese Yuan.

Markus Steilemann

Turning to Page number 8, looking at our polyurethanes segment on Chart number 8. In Q3, we recorded a strong core volume growth driven by all three product groups. Overall, industry utilization stays at a low level due to additional capacities added during the last 15 months. Based on most recent data, industry demand growth remains solid at our predicted long-term trend of around 4% to 5%.

In MDI, the picture remains unchanged for this year; few selected ramp-ups but no new start-up leading to slightly lower average industry utilization estimated at around 87% in full year 2019 versus 88% in 2018. Due to the currently low visibility on-demand we stay cautious about the further development in the short-term; mid-term, we expect that current overcapacities will be absorbed by growing market demand. The recent cancellation of one new 400 kt U.S. project for 221 contributes to this view. For 220, the only announced startup is our MDI facility in Brunsbuettel, Germany with 200 kt nameplate capacity.

In TDI, the latest ramp ups of three wells-scaled plants have increased supply pressure and continue to lower average industry utilization from a tight 85% in 2018 to around 76% in 2019. Of the roundabout one million tons of additional capacity expected between 2018 and 223,800,000 tons have already been started up, and partly our — partly or fully ramped up. From current margin levels, we see limited further downside risk as we believe that high-cost producers are currently operating at/below cash breakeven levels. Potential upside would, for example, come from closure of high cost plants as seen in the past. Finally, margins in Polyurethanes continue to be below the long-term average. Overall the EBITDA margin of 13.3% in PUR in the third quarter 2019 was clearly below last year’s level, primarily driven by significantly lower MDI and TDI margins. Taking a quarter on quarter perspective, the improvement reflects higher volumes and lower internal cost, thanks to undisturbed operations.

Thomas Swoboda

Yes, hi there, thank you for taking my questions. I have three; firstly, on capacity utilization at Covestro, is it fair to assume that your capacity utilization was higher especially in polycarbonates and also in Polyurethanes, then the numbers you have provide us for the market globally. So that was the first question. The second question is on the margin development in polyurethanes compared to polycarbonates. You have said in your prepared remarks, you expect polycarbonates margin to further deteriorate. Historically polycarbonate was less profitable than Polyurethanes. However, it was vice versa the last couple of years, are we going back to the historic ranges where Polyurethanes are more profitable than polycarbonate? And lastly and the third question, on supply demand in polycarbonates, my question is, have you seen your competitors actively reducing capacity canceling a build-out plans or strategically delaying start updates and so on? Thank you.

Markus Steilemann

Thomas, thanks for the question; this is Markus speaking. So on capacity utilization, very short and briefly, I would say we as Covestro should have better capacity utilization, then what you see on average of the industry and the main reason for that is not only, I think our very strong market access and customer centricity but particular the cost leadership in the commodity area and we outlined is earlier in our comments, given during the presentation, that this also enables us to still produce positive margin contribution when some of the high cost producers already getting cash negative when producing. So having said that, we clearly assume that we are having better utilization in the rest of the market, another evidence for that is we are fully loaded. So our capacities are fully loaded. We sell everything that we can sell in polycarbonates and polyurethanes, our assets are fully available. So we do not have any major planned or unplanned shutdowns and that also has helped us to achieve the strong volume growth in polycarbonate and in polyurethanes in the third quarter.

On the second part of the margins with regard to profitability, I would say that the margins for polycarbonate would continue to remain under pressure simply due to the fact that we have had additional entrants and entries in the market in 2019. And we said that earlier between 5% and 6% additional capacity, while at the same time, one major outlet for polycarbonate which is the automotive industry. Let’s say downturn with regard to overall demand and that shifts also volumes into the commodity segment which even further increase the pricing pressure and we do not expect that this pricing pressure in particular commodity segment will end soon simply due to the fact that first, there is no additional demand short term, maybe even midterm from the automotive industry foreseeable.

And secondly, we see additional capacity announced for next year in the range of additional 10%, again announced that does not mean that it comes to fruition. That is what we see. On polyurethane, I think we have tried to explain that a little bit earlier that on TDI, we see limited further opportunities for price to decline and margins to get under even further pressure because some of the high cost producers already most likely cease production and cannot compete anymore. Similar is it with MDI and in this context, you also asked about how do we see the opportunity of polycarbonate profitability, maybe historically go back, let’s say, below polyurethane profitability.

Markus Steilemann

So maybe on your last question, in terms of customer inventories levels in particular I assume or no, I’ve record you, you were very referring to automotive. Destocking, from our perspective might continue into the fourth quarter. However, we expect that it will be a little bit better in Q1, but they’re still very, very high uncertainties, the [indiscernible] inventories. Also given the chemical nature of the respective raw materials in MDI and TDI are normal there might be still slightly higher volumes in polycarbonates but also here, handle it with care, because some of the grades are highly specific particularly also in the automotive industry and you might have some sitting on stocks, but you cannot use them for any other purposes.

So even though there might be inventory system might need to order special grades. Where as in the commodity area, we do not assume that there is high inventory is actually on stock or that for example trade as carry a lot of those inventories that should be through meanwhile. Hope that helps?

Georgina Iwamoto

Hi, good afternoon. And Thomas and Markus, thanks for taking my question. I’ve got two. The first one is on kind of the volume outlook for next year. You’ve got a clear strategy to fully utilize your plan as far as possible. I just wanted and see if you could confirm what kind of capacity you expect to have to grow into for 2020? And then my second question is on polycarbonates you set out some helpful expectations for further weakening of mix over the next few quarters and you previously disclosed about 60% of sales in polycarbonates is resilient. Can you give us an idea of where that figure is today and where you see that heading to in the next few quarters? Thanks.

Markus Steilemann

Hi, Georgina this is Markus speaking. Thanks for your question. So the volume outlook should be around 4%. Also, let’s say, on the average that we plan for and for example 200,000 tons of capacity in MDI coming on stream next year. And so if we also assume for the rest of the portfolio, also due to a different turnaround pattern and things like that because many of the larger turnarounds have happened actually within this year, particularly in the first half and we would think that we have enough for 4% growth. If there will be no outages of our plants. So, considering this 4% is what we would think would be achievable with the next year.

Thomas Wrigglesworth

Thanks very much, Markus and Thomas; two questions from me. Firstly, on Polyurethanes polycarbonates; when we look at that volume, is that all market share or is actually the market share? Taking that you’ve executed larger the map because you’re, these end market has actually declined. So I wanted to get a sense of how much net market share you taken in those three businesses. Second question is, I think we’ve been talking now for two quarters about MDI prices being into the cost curve. It is surprising you how long it’s taking competitors to adjust production. Do you think something has changed in the competitive landscape with — in this cycle versus previous cycles? And any comments on that would be very helpful.

Thomas Toepfer

Maybe start with the second question. So I would say the answer is no, we’re not surprised, I think what we’ve been saying is and we cited some industry journals, which said that in MDI and also TDI we were moving into the unhealthy space so that the high cost producers were probably losing cash with every ton that they produce. We think this is true. And this has led to at least what we see a stabilization in the MDI and TDI prices. So it looks like we have reached more or less the bottom here. But on the other hand, I think what we also said is this does not change the picture of from how long does it take the market to really grow into the capacity before prices start again. And also, we know that it takes a longer time before competitors finally drop out of the market all completely. And therefore I would say the development that we have seen is in line with our expectations, which is a kind of sideways movement in terms of prices for those two products

Markus Steilemann

Yes, Jeff, this is Markus speaking. So, on your second question in terms of market share. If you really look at the numbers for the first nine months and is always very difficult quarter on quarter. You know, inventory levels or turnarounds unplanned shutdowns, whatever. So there is a lot of, let’s say, additional complexity in this while quarter-on-quarter comparisons are really difficult if not misleading. So let’s take the first nine months as an indication, we still see that the Polyurethanes market is growing quite well and that is also reflected in some stabilization in the respective prices and we still again observing additional capacity from last year, which makes progress. So the market is growing at 4% to 5% and I would say, for the first nine months in POR, we even slightly grew below in the market, if you look at the growth rates for polyurethane. And for our polycarbonates there is still 2% to 3% market growth, which means that we are more or less at or slightly above market in terms of polycarbonate. So, this is the picture how we look at it. So again, I would say we are developing within the market range. Right. So, does it help?

Markus Steilemann

So I think your first question with respect to CapEx. Yes, I mean our guidance for 2020 is 1 billion to 1.1 billion. Maintenance CapEx, We always said 300 million to 400 million, the major projects in there is our MDI 500 in the U.S, which is slowly getting costly because we are moving into the planning phase and especially the European activities in terms of our chlorine factory, our Aniline factory in Antwerp. And the related projects to this one. So I think Spain and Antwerp are the major projects that you find in the 2020 number.

Chetan Udeshi

Are you saying 2020 already includes a sizable CapEx from MDI in the U.S?

Markus Steilemann

No, it’s not a sizeable CapEx because most of it, I mean — so I mean, let me just correct myself, 2020 already includes costs for MDI 500, but you will find them in the OpEx line. Mostly, not in the CapEx line because we cannot yet expense it, because we have not yet received the relevant milestone. In terms of the pure CapEx which is capitalized the major numbers in 2020 will come from the European activities that I just made.

Jaideep Pandya

Hi, thank you. Just on the U.S. MDI market, could you just explain me in very simple terms. Why the profitability in the US, remains to be very high compared to the other regions. And what is the sustainability of this when we think of the next two, three, four years when pretty much everyone wants to increase capacity in the U.S. And then the second question really is on China or other, what you’re seeing in China where capacity increases, as you point out of being pushed out into 2021, 2022. So do you think really here that even the big players are suffering and therefore doing this or is it just the balancing act between volumes as you were saying, they need to grow into an utilization? Thank you.

Markus Steilemann

Maybe on the first question you ask, first and foremost days run numbers quoted by some consultants to be very clear because we do currently not see significant capacity additions in particular on the next two to three years. And you might have seen that even one major announcement has been that there is at least a withdrawal of a planned investment and a major investments. So — and in particular the U.S MDI prices here really wrongly quoted by some consultant. So that is very important that there is an indication, maybe on some trends, but the absolute levels are in most cases, simply not correct. So that is I think very important to keep this into consideration.

And then the — there is also some cost issues, if you look for example on tariffs for some of the raw material goods. Take Aniline that you need to import from China into the U.S; there have been additional tariffs on these. So from that perspective, you might also consider that some of the supply chains that have been built and have been calculated into respective investments may simply lead to different calculations after the tariffs have been imposed and may not make the overall investments including other factors that you have to consider as profitable looking at before. But that is speculation, because for sure. We have no idea, let’s say, how the cost calculation look like, but it’s just an assumption that I would make and therefore the cancellation of the respective MDI capacities from our perspective are not demand driven, but more driven by the respective cost developments. Does that help?

Jaideep Pandya

Yes. So in a nutshell, current U.S profitability is better than the other regions, is that right? That’s what I was trying to understand really, to be honest.

Thomas Toepfer

You could say so but — it’s not a major topic, so they are slightly better really slightly better. So to be very clear. For sure, you have an advanced and advantage when you’re sitting in the country because the cost to serve, cost to deliver lower than for local producers. But in general terms, I would say there is still important in the U.S. or however, they have reason to decline, also due to the tariffs that have been imposed. So yes, there is some margins, but again the whole picture is short-term and there is no — short to mid-term there is no significant supply addition in the U.S foreseeable also due to the fact that somebody else was drawn. And again the margins even if you would like to say take the published numbers are only slightly higher than in other regions, also due to the fact that some of the MDI prices are simply misstated.

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