Urethane Comments from Covestro Investors’ Call
Covestro AG (OTCPK:CVVTF) Q3 2018 Earnings Conference Call October 25, 2018 9:00 AM ET
Ronald Koehler – Head of Investor Relations
Markus Steilemann – Chief Executive Officer
Thomas Toepfer – Chief Financial Officer
Thomas Swoboda – Societe Generale
Christian Faitz – Kepler Cheuvreux
Neil Tyler – Redburn Europe Limited
Sebastian Bray – Berenberg
Geoff Haire – from UBS
Markus Mayer – Baader Bank
Paul Walsh – Morgan Stanley
Chetan Udeshi – JP Morgan
Laurence Alexander – Jefferies LLC
Georgina Iwamoto – Goldman Sachs
Thomas Wrigglesworth – Citi
Good afternoon, everybody. This quarter, we delivered solid results despite several headwinds from internal as well as from external factors. Thus, core volume growth was broadly flat with 0.2% in Q3. Thanks to a strong volume leverage and despite a negative pricing delta, we defended the high EBITDA level of the previous year’s quarter. Additionally, helped by our ongoing share buyback program, we achieved a 7% year-on-year earnings per share increase.
Based on the solid results achieved during the first 9 months and despite the increasingly challenging economic conditions, we confirm our full year 2018 guidance. In addition, I would like to highlight 2 major projects that support our long-term profitable growth. Firstly, we decided to invest into new world-scale MDI plant. We announced this investment 2 weeks ago. Secondly, we are today announcing a new efficiency program called Perspective. Combined with the carryover savings from the existing performance enhancement program, we now target cost savings of €350 million by the year 2021.
During Q3, we faced 3 unexpected headwinds. Firstly, we suffered from an unplanned shutdown of our MDI site in Caojing, China. Secondly, we were affected by the force majeure declaration of our supplier for a key precursor in polyols, which significantly limited our product availability in Europe. Both incidents reduced our growth rate by about 3 to 4 percentage points during Q3. As both plants are now back on stream, we do not expect any spillover effects into Q4. However, as we remain sold-out for these products, we will be unable to catch up during Q4. Thirdly, we noticed a summer weakness in Europe, especially pronounced in automotive and construction. This reduced our core volume growth by an additional 1 percentage point during Q3.
Although it is part of a regular seasonality in our businesses, it was stronger than expected. In addition, this year compared against 2 past years without the typical summer dip. In Europe and Latin America, volumes declined for the given reasons driven by our automotive, construction and wooden furniture businesses. Volumes in North America slightly progressed based on a positive growth in automotive and electronics. Asia-Pacific and especially China remained the region with the highest growth rates, despite the constrained availability on MDI. We achieved high single digit growth rates in automotive and transport as well as double-digit growth rates in many other smaller customer industries like sports and leisure, medical, engineering and packaging. Globally, we once again achieved a solid growth rate of above 2% in automotive. Therefore, we continue to outgrow global OEM production by around 4 percentage points.
Thanks, Thomas. And we are continuing on Page number 7. Looking at our Polyurethanes segment. In Q3, global demand was strong for the polyurethanes industry. Based on our insights, we expect a PU industry growth of 4% to 5% in 2018. MDI remains globally a high-growth area with an expected full year growth of above 5%. We did not notice any structural changes in global demand drivers.
As explained, we faced limited product availability for MDI in Asia and for polyols in Europe and Latin America due to unplanned shutdowns. These were the main drivers for the decrease of core volumes this quarter. The MDI industry currently faces some short-term volatility due to the recent startups of two new plants. Generally, global demand growth requires one additional world-scale plant per year. This year, two new plants came on stream, increasing supply pressure. Next year, we expect significantly less capacity additions. Hence, our overall view is unchanged that the MDI industry will remain balanced in the mid and long-term.
For TDI, we again realized the contribution from fly-up margins of around €130 million in Q3 due to the continuous tight industry last quarter. With that, the total TDI fly-up added up to around €0.5 billion already in the first nine months of 2018. With the new capacities finally being on stream, we observed the industry rebalancing, as expected. TDI prices are currently normalizing quickly, thus we assume no fly-up contributions during Q4. Finally, the margin polyether polyols remains resilient, but slightly below the long-term average as higher raw material prices were not fully compensated by price increases.
Let’s move towards Page number 8. In polycarbonates, we delivered a solid core volume growth of 2.6% in Q3. The ongoing product mix improvement and the deemphasis of low-margin businesses are well reflected in the Q3 figures. We continue to outgrow significantly the global auto market. In Q3, we achieved a mid-single digit core volume increase compared to a 2% decreasing global auto production. In the first nine months, our high single digit growth compares to a flat global auto production. Electronics also contributed nicely with an above-average growth. As we continue to focus on less volatile and high margin business, we accept a double-digit decrease in volumes in the construction businesses.
The EBITDA margin progressed from 22.6% in Q3 2017 to 30.3% in Q3 2018. Excluding the one-time benefit of €36 million from the disposal of the sheets businesses, the EBITDA margin reached around 27%. The margin increase was mainly driven by a strong pricing delta, supported by a positive volume leverage and the ongoing product mix improvement. In Q3, higher raw material prices could again be more than compensated by increased selling prices.
Nevertheless, prices came under pressure during the quarter on more commoditized grades in Asia-Pacific due to the ramp-up of new capacities in China. Despite some fading short-term tailwinds, the industry outlook for polycarbonates remains attractive. We consider the industry supply and demand to remain balanced mid-term.
Now let’s move on to Page number 10. Let me take the opportunity today to provide more details on two long-term initiatives we kicked off during Q3. Firstly, our investments for securing long-term growth opportunities. On October 9, we announced the long-term MDI CapEx program until the mid of the next decade. In case you have not seen the detailed investor presentation on this subject, it is posted on our IR website. For now, I describe the highlights. Besides the already public capacity extensions in Caojing, Brunsbüttel and Tarragona, we have announced our plan to build a new highly efficient, world-scale MDI plant on our existing site in Baytown, U.S.A., as well as a new aniline plant in Antwerp, Belgium.
Focusing on the new MDI plant, the total amount of €1.5 billion includes investments into the complete chemical backbone. This will extend our leadership position in a number of areas. By 2024, it will boost our nameplate capacity in the U.S. from 330,000 tons to 740,000 tons per annum, after closing a less efficient MDI unit of 90,000 tons. With that, we will become the number one player in terms of capacity in the region and the number two player globally. Equally important, we will be able to extend our long-term competitiveness by further improving our cash cost position. Overall, the long-term MDI CapEx program will allow us to satisfy increasing demand and accompany growth in a highly attractive industry.
On Page number 11, you will see that we plan to significantly increase our capital expenditure over the next years. Despite these major new projects, however, we are sticking to our previously indicated upper end of annual CapEx of €1.2 billion. In MDI, we now have a comprehensive program that allows us to grow long term in line with the industry. The expansion of our 200,000 tons MDI plant in Brunsbüttel is slightly delayed. This said, we expect to ramp-up the plant in the second half of 2019. With the startup of Brunsbüttel, we will become short of in-house aniline supply. In order to achieve once again the best possible cash cost position, we decided to build a new aniline plant in Antwerp. The construction of the new chlorine plant in Tarragona is on track for a startup in 2020. This will also significantly enhance our cash cost position. In addition, we are now starting the engineering work for our new U.S. MDI plant. Construction is expected to start in 2022.
We are convinced that the MDI industry remains highly attractive in the long term, given solid structural demand growth and distinct entry requirements, such as access to technology. As a consequence, we expect to generate a decent return on capital employed on our CapEx, well above our cost of capital. This assessment is based on conservative assumptions, such as a payback time of less than 10 years, while our plants can operate for around 50 years. The long lifetime of our assets is well demonstrated by 90,000 tons line in the U.S., which started up in 1974 and is going to be closed in 2024. Back to Thomas.
Now if you look at Q4, usually, we’d like to provide you with the main EBITDA year-on-year bridge items for the upcoming Q4 quarter. So given the current trend of decreasing prices for TDI, MDI and also polycarbonate, we assume a negative pricing delta of more than 300 million for the quarter. On the other hand, the expected solid volume growth should allow for an EBITDA benefit in the high double-digit millions. And in terms of the other items, please remember that we have booked a provision relief for our Tarragona plant of 63 million in the fourth quarter of last year, which obviously will not repeat itself. And this is why we expect a high double-digit million burden in the other items bucket for Q4. And last but not least, the FX effect is expected to be neutral.
So just one last point in terms of current news, as you might have noticed, we might face a specific risk for our German production sites due to the historic low levels of the Rhine River. The messages at this point in time, we expect no material negative financial impact, but of course, every day that passes along without relief makes our guidance more challenging. So far, we’re confident with respect to the specific Rhine issue.
I have two questions. I think we have all being waiting for TDI to be really in trouble. Now it looks like MDI is under pressure stronger than TDI. I’m just wondering, if you could give us a little bit more insight why do you think TDI is holding up better versus MDI. And the second question on your expansion project in MDI, I’m sure you have done it but still the question, would you need the MDI greenfield expansion in case we should see a global recession in the next two to three years? So would you still need the capacity by 2024 as you plan?
So as we have lined out, we have already seen in the first nine months an effect of roughly, let’s say, 0.5 billion in terms of TDI fly-up. And given that fact, as we said previously, we do not expect any further, let’s say, effects coming from the TDI and there’s numerous, let’s say, reasoning for that. One of the reason could also be that despite the fact that now all capacities are on stream, that obviously the market is in demand for TDI and needs the TDI that is currently being produced from the assets that are up and running in the way how they’re up and running.
On MDI, we must not forget that we are entering into a kind of low season, and that we have seen two major capacity additions, which do not change the long-term picture and the mid, let’s say, term picture how we look at the MDI development. MDI is still in high demand. MDI is still the key material for many applications and cannot be replaced in those applications. So despite the fact that we had a long term historical growth of 6% to 7% in MDI, we only plan the, let’s say, MDI long-term growth with around 5% and that also leads me now to answering the second question that you have raised in this context.
We have made rather conservative assumptions about the capacity additions in MDI as well as on, let’s say, historically speaking, demand development in MDI. And that’s why we believe that mid to long-term, this respective MDI investment is absolutely necessary to fuel the market. Still considering that any announcement that has been made publicly is coming in full on time. And as we know, and we have pointed out this previously numerous times, the respective MDI investments in many cases come either delayed or when they come on time, they’re not coming in full. So putting all this into context, we still believe that we have based the investment case on very conservative assumptions and the 6% to 7% historical growth by the way, have also included recession periods in the last 20 years.
The next question comes from Christian Faitz who’s calling from Kepler Cheuvreux.
I typically like the sentence but given the condition financial markets are in, congrats on the results. First question, can you give us an indication of how your price and mix in your MDI creates move in Q3? And then second question, can you please share your thoughts on key demand trends at this point in time for polyurethanes as well as polycarbonate products in terms of global customer demand trends?
To be honest on your first question on monomeric MDI and polymeric MDI, we would prefer not to give a specific answer here. That leads me immediately to your second question. If you look at the overall demand trends and I’m seeing customers normally on at least almost weekly basis, and if I’m traveling around the world and see where customers are, there’s one fundamental trend that I specifically see for the customers in our industries. What they’re doing, they have, for sure, high uncertainty and there’s also a lot of psychological momentum going on, yet what we also see that they’re starting to getting their feet on the ground to adjust to the changed global supply situation and the new, let’s say, let’s call it, world order in terms of tariffs, in terms of Brexit, in terms of Turkey, in terms of Iran.
So what they’re doing is, they’re just adjusting their respective supply chains. And this transition and this adjustment leads to not only short-term, let’s say, insecurity, but in particular it also leads to the fact that we have seen some dips here and there in demand. But overall, we just have to say and also our strong October indicates that also in terms of our order books that they’re just adjusting. To give you an example, Chinese appliance manufacturers, they have a very clear strategy to globalize their business and also internationalize their production. And now, they’re just speeding up this process because the overall economic situation and geopolitical situation forces them to be quicker.
On the other hand, visiting Mexican customers, for example, in this industry but also in the automotive industry, clearly indicate that they are now benefiting from some of the imposed tariffs that they’re seeing, for example, from Asia Pacific, from the U.S., and we also see now some of the Chinese customers moving, for example, into markets like Mexico, to making sure that they still can continue to supply the U.S. market. So what we see is less overall of a end consumer driven demand dip more than a structural change and also high uncertainty level in the industries that we are serving. And that’s why also, as I’ve said, indicating what we’re seeing in our order books does not really point towards a global recession rather towards general adjustment that is going on.
The next question comes from Mr. Neil Tyler calling from Redburn Europe Limited.
Moving to your new cost reduction program, can I just ask for a couple of points of clarification, please? Firstly, the net increase in fixed cost that you anticipate for this year of approximately 250 million, how much of that has already occurred in the first 9 months of the year? And then within that the same topic, can I just make sure that I understand this correctly that the 150 million net cost increase that you anticipate for next year, is that the total amount by which you expect fixed costs to inflate, or is that an additional amount over and above underlying fixed cost inflation? And then final question, the 300 million or so price decline that you — I think you said for Q4 that you anticipate, is that a net price raw material effect or just a former? And if just a former, could you please give us any indication of what you’ll anticipate the raw material effect to be?
Yes. So let me start with the last question. So if we talk about the bridging items for Q4, and we say we’re expecting more than EUR 300 million negative effect, this comes from pricing and raw materials so it’s the net effect that we’re talking about. It corresponds to the 27 million that you have seen in the bridge for Q3. Then in terms of the cost, as you’ve seen, we’ve indicated for 250 million cost increase for 2018. This is a relatively evenly distributed number so you should not expect any specific spike in the fourth quarter to come. And then for 2019, we’re expecting an additional 150 million of fixed costs in terms of energy, wage increases, wage inflation, et cetera, et cetera, which will come on top to the 250 million roughly that we were indicating for this year.
The next question comes from Mr. Sebastian Bray calling from Berenberg. Please go ahead.
I would have two, please. The first is on definition. What is the difference between core volume growth and total reported volume growth in the Polyurethanes segment, please? I think the volumes were stable as a whole, but there were 2% decline in core. What explains the difference? The second is a question about a statement that was made earlier on the growth trajectory of MDI. Am I right in saying that the percentage figure of, let’s say, about 6%, 7% historical demand growth is purely an average and the demand did actually contract in 2008, 2009? The data around that, which is publicly available, is sometimes a bit sketchy.
If we are looking into the definition of core volumes, we intend to produce product like TDI, MDI and polycarbonates. But given, let’s say, the chemical nature of our production, we also have quite a large amount of products, which we not, let’s say, as a primary purpose producing, for example, caustic soda; for example, hydrochloric acid and also styrene. And we have to also sell those products in the respective markets and with that also generating quite — let’s say, generating also external sales. So if you’re looking at the polyurethane business, it is very clear that we have here definitely sold some of those side products, which then contribute also to their respective volume growth.
But if you just look at the core product MDI, TDI as well as polyether polyols, we just exactly have the negative core volume growth in Q3 that we have lined out. Now talking about your second question, 2008 as part of the, let’s say, general economic meltdown that we have experienced in those 2 years 2008 and 2009, yes, we have seen a minus 2% volume dip. That is what we have seen in 2008. Yet to be also very clear, that was historically, absolutely exceptional year, which we have not seen in that order of magnitude before. And still despite this claim, this very one year, we still have seen an historical average growth of 6% to 7%. And that’s why I think, the planning ahead with 5% is pretty solid and pretty conservative.
Just two questions from me. I wondered on the 300 million that you’re talking about for the fourth quarter, if you could give us a notional split between the polyurethanes and polycarbonates. My sense is, it’s mostly polyurethanes, but maybe you could steer me better on that. And the second question I had, as a sold out on a number of these products, you’re still talking, Markus, very positively about volumes. And yet maybe I’m looking at the wrong data, I’ve seen TDI, MDI, certainly polymeric MDI and polycarbonate spreads collapsing in spot markets back to levels that we saw in 2016 and ’17. So what I’m really asking is what am I missing in terms of what’s changed apart from a bit of capacity coming on stream. It seems like the spread reset is a little bit stronger than perhaps the strength in the markets that you’re communicating from a demand side. I’m trying to reconcile those two things.
Let me take the first question with the pricing delta. So I think it’s a fair question. If we talk about more than 300 million negative pricing delta, I would say you will find negative pricing delta for both, our polyurethane and also the polycarbonate business. However, polyurethane is anything between 80% to 90% of the total, just to give you the order of magnitude. So the polycarbonates, it’s much less pronounced.
As you direly addressed this also to me, if you look at the overall situation, we think that the entire situation currently is much more supply driven than demand driven. Yes, we’re entering into, let’s say, the fourth quarter, which is traditionally weaker quarter of all four quarters in the year. Yet, currently, all MDI plants are running flat out. We have no outage or planned shutdowns currently. So having said that, that explains a little bit in which direction currently short term the market is heading.
It does not change, let’s say, that we have seen those two major capacity additions coming on stream. But yet on the other hand, we still see MDI being overall in strong demand. And we also have to consider, let’s say, in terms of pricing. What you see in pricing charts is normally spot markets and only a particular group of MDI grades, which does not reflect the entire product that we’re having in MDI grades. So from that perspective, the picture that you have based on, let’s say, this very much reduced data might look different from what we are seeing currently in the business.
I’ve just got one question, if that’s okay. You were mentioning that you made some very conservative assumptions on the market outlook before taking the decision to announce your MDI facility in the U.S. I was just wondering if you could confirm whether your supply outlook included the full 1.5 million additional capacity from Wanhua in your supply forecast. And if not, can you indicate what level you anticipate from the Company?
Short answer would be yes to your second part of the question.
Okay. So includes the full 1.5 million?
As I’ve said earlier, Georgina, we have included all announced investments as they were announced. That means that they come on stream in full at their respective announced dates. And we have not taken into consideration, let’s say, further insight that may indicate a delay in startup or even if the plant would come up on time but not in full. That is also one part of the some — why we said we took a more conservative approach by having, from a historical perspective, a lower than witnessed demand growth rate; yet on the other hand, we took the maximum. That means fastest addition of supply into consideration before we’re doing the math.
We have a follow-up question from Neil Tyler. Please go ahead.
I wanted to ask you whether you’re able to share any information you have on the ongoing DOJ investigation that was launched in July around polyurethane pricing. Is there anything you can tell us with regards to that investigation whether you know what’s being looked into, and over what time frame when we might find out whether there’s a conclusion to that?
Well, I mean, what I can tell you is, I can confirm that we have been contacted by the U.S. Department of Justice regarding an investigation with the polyurethane industry, and I can also tell you that we are fully cooperating with the authorities throughout the investigation. But what is also clear is that we strongly deny all allegations that have been made and that we are clearly defending ourselves. You know that there is also 12 civil lawsuits that have been filed in addition to that. We think they are completely unbased and as I said, we will vigorously defend ourselves in these lawsuits.
So when you refer to allegations, are you referring to the lawsuits or has the DOJ made an allegation or are they just carrying out an investigation?
Well, I mean, they’re carrying out an investigation with respect to antitrust behavior in the polyurethane industry and that is at the core of the allegations that the DOJ has made. And as I said, we think there’s not a basis for any of the points that they are claiming.
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