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Urethane Comments from Covestro Investors’ Call

Covestro AG (CVVTF) CEO Markus Steilemann on Q4 2019 Results – Earnings Call Transcript

Markus Steilemann

NAFTA, and the U.S. in particular, also suffered from a weak automotive industry, as well as a sluggish demand in electronics in 2019. Unfortunately, an unplanned outage at our Baytown plant affecting TDI and polycarbonates further effective growth in Q4. Strong growth rates in construction, combined with positive growth in furniture and diverse other industries were almost able to counterbalance the weak spots.

Thanks, Thomas. Looking at our polyurethanes segment on chart number 7. Over the course of 2019, we recorded a solid core volume growth of 2.3%. Overall, industry utilization stays at a low level due to additional capacities added during the last 18 months. Industry demand growth is expected to remain solid at our predicted long-term trend of around 4% to 5%. In MDI, 2019, was characterized by few ramp ups but no new start-up, leading to a slightly lower average industry utilization.

Due to the currently low visibility on demand, we stay cautious about the further development in the short-term. Midterm, we expect that current over capacities will be absorbed by growing market demand. For 2020, the only new MDI facility being added to the industry seems to be ours in Brunsbüttel, Germany. We are glad to confirm, that we started the plant in December, and that the ramp up of the 200,000 tons nameplate capacity has been going smoothly since January.

In TDI, the simultaneous ramp ups of three world scale plants have increased supply pressure and continue to lower average industry utilization in 2019. From current margin levels, which are at historical trough, we see rather limited further downside risk as we believe, that high cost producers are currently operating at, or below cash breakeven levels. Potential upside would, for example, come from closures of high cost plants. Recently, we have already seen the temporary closure of some smaller plants in Asia with around 200,000 tons nameplate capacity. As announced and awaited for some time, one midscale plant is announced to close down in Eastern Germany, beginning of the second quarter 2020.

Finally, margin in Polyurethanes continue to be below the long-term average. Overall, the EBITDA margin of 11.2% in PUR in full year 2019, was clearly, below last year’s level, primarily driven by significantly lower MDI and TDI margins.

Christian Faitz

Yes, thank you. Good afternoon gentlemen. Christian here, Kepler Cheuvreux. Couple of questions please. First of all, thanks for giving us a number for the coronavirus impact for Q1, it’s very helpful. Could you qualitatively describe the situation in China that’s, what I mean is, how impacted is the logistics chain at present for the precursor material that you need? And how impacted do you see current end demand in China, and potentially, also affecting customer productions for China produced products geared to international markets? And then the second question, your reported tax rate has arisen two years in a row now. What would be a good tax rate assumption for 2020? That’s it for now.

Markus Steilemann

Christian, good speaking to you again. This is Marcus speaking. I cannot give you the complete picture that you are asking for. I have the slight suspicion that you asked me to explain the overall situation for all industries in this context. But I tried to do, let’s say. my best to provide you with anecdotal evidence for the situation that we have. So, first and foremost, as usual over the Chinese New Year, we’ve had normal shifts in place, which were let’s say, running our continuous processes in the major sites, that is not only at Caojing, but also sites for smaller production in South China. And some of them in the Eastern part of China, a little bit more North of Shanghai. And we were able to continue running almost all plants at reduced rates, for the entire time.

And now we see, that some of the plants are going back to let’s say, full operation in recent days. And that applies for our continuous process plants, but also for smaller system houses/compounding plants and film plants that we have. So overall, we are trying to get back as quickly as possible to normal operations, and we currently seem to be successful in that from all we hear from our Chinese colleagues. The logistics situation remains a true challenge. And that is sometimes very small items, like packaging, for example, barrels that we need to have, but also pellets that we need to have.

And then another challenge is the drivers, actually the truck drivers. So, even if you’re able to produce, even if you’re able to package, then you need to have truck drivers, which are shipping stuff to the customer. And then some of the customers actually do not have resumed operation, that means, it’s difficult to ship the material to them, because nobody is at the receiving end.

So, there’s lots of bits and pieces. So the overall supply situation will remain, at least, from our perspective, for some time quite fragile. And that describes a little bit the overall situation in China, and I do not assume that this situation is different in most of the industries that we are currently delivering to. And that’s why I also – and we have done that, confident that the current estimate for the first quarter and the current guidance is reflecting the picture pretty well. However, to look beyond what will happen then, beginning of April for us today is simply impossible. And that’s why this is also not included, by any means in the full year guidance, everything that goes beyond end of March.

And that’s from my perspective, the current situation, as good as I can describe it, but please feel free to ask any additional question.

With that, I would like to hand over to Thomas to deal with the tax rate.

Thomas Toepfer

Yes, on taxes. I mean, we had a P&L tax rate of 26.8% in 2019. Our guidance for 2020, would be that, our ETR, so our P&L tax rate should be in the range between 24% and 26%. However, be aware, that our cash tax rate will be roughly 15 percentage points higher than that. But that is in line also roughly with the guidance that we had given for 2019 before, because the cash tax rate is expected to be above the ETR is simply because of phasing effects.

So I think, fundamentally, no changes to what the ranges that we had given out for 2019, going forward.

Isha Sharma

Hi, thank you for taking my questions. First one would be, what is the magnitude of price increases from the current levels that you would need to achieve the midpoint of your guidance? And then related to that, how likely is it that high cost producers who burn cash in the situation and are doing shutdowns because of which the prices should improve, would start producing again, once the prices are, again, at an attractive level?

This would be the first one. And the second one would be, if we assume that there’s a little bit of recovery in prices during the year and a pickup in business activity, would you still prioritize the short-term savings of €200 million? Thanks.

Markus Steilemann

Isha, this is Markus speaking. We’re just debating here in the background, a little bit to be a little bit more transparent about what we are doing by being so quiet here on the other end of the line. Because, I think we’ve been quite clear about how we see the current mark-to-market situation. And Thomas alluded on that quite nicely, that he said, this is about €1.1 billion. If you would translate that now in terms of sales, and would say that everything comes through which we sell more in terms of pricing, and about 1% to 2% of additional sales would maybe lead to about €120 million additional EBITDA.

And you can now choose to what extent you would like to distribute that to which product portfolio, because I think we also made it very clear, that in the polycarbonates, as well as TDI business, we would not see quick recovery in prices. So, the only remaining larger commodity segment would be MDI, and then you would need to just make your own math about how much additional price increase you would need on MDI.

Let’s say, in terms of generating additional €120 million EBITDA, if you would increase our sales by 1% to 2% just to keep in mind, MDI is 20% of our portfolio. It would maybe lead to a 10% price increase on a year-on-year basis, I mean, full year-on-year basis. And that gives you some indication, so, where you would need to end up.

Is this unusual? Have we seen that historically? Yes, we have. So it is not unusual. Would we see it for the full year? Would we see it from which point in time? Very difficult to say frankly speaking. So, that also leads me to the second part of the question, where you said, well, when will those high cost producers enter. We have to take into consideration that some of the high cost producers have small plants. And it is very difficult to say when they will restart and what will be the effect.

Just to keep in mind, there is significant capacity currently not producing. That also means that if the market prices would recover, there will definitely be a few producers lining up to immediately restart and resume production again. And that will also subdue price movements in TDI but also polycarbonate only on a commodity segment for polycarbonate for quite some time. And that’s why it’s very difficult to say where exactly would be the price from which high cost producers will immediately end up.

On TDI, if you just take the cash cost curve is very steep. So, low cost producer to high cost producer 50% difference. On MDI, we assume it’s 30% difference. So I would assume whenever, let’s say, the prices will increase by 1%, 2% there will be a first one in line who would immediately produce but then it would be a staggered approach. It is very difficult to judge frankly speaking.