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Urethane Highlights from Covestro Investors’ Call

Covestro AG (CVVTF) CEO Markus Steilemann on Q2 2019 Results – Earnings Call Transcript

Markus Steilemann

Good afternoon, everybody. The second quarter developed in line with our expectations. The year-on-year comparison continues to look weak. However, we see a stabilization of margins since Q4 2018 based on sequentially flat prices for the group overall. A strong achievement this quarter is certainly the positive core volume growth of 1.1%. It demonstrate our capability to compensate a very weak development of the automotive industry and even withstand weaker demand across industries overall.

Our EBITDA decreased significantly in a year-on-year comparison but stabilized nicely quarter-on-quarter. On the cash side, we took countermeasures to limit the seasonally higher working capital, thus, we could achieve a solid operating cash flow under the given circumstances. Based on this set of results and despite continuously challenging economic conditions, we confirm our full year 2019 guidance.

Now moving to page number 3, let me provide some more insight into our core volumes development by regions and industries in the second quarter of 2019. NAFTA was the best growth region this quarter. We achieved a strong core volume growth of 6%, despite declining auto production in the United States. Double-digit growth in construction, wood and furniture, medical and other smaller customer industries was able to more than compensate the weak development in automotive and electronics. Asia Pacific suffered from the economic slowdown.

The weak demand led to negative core volume in automotive and construction. Still strong volume growth rates in electronics and wood and furniture compensated the development and enabled us to post positive growth of 2%. Europe, Middle East and Latin America suffered the most from the weak automotive industry. Additionally, a weaker industrial production in Germany led to volume declines across several industries.

This negative volume development could not be compensated by volume growth in construction and wood and furniture. Overall, we are satisfied to see that our diversification across industries and regions helps us to counteract the current weakness in the automotive industry and allows us to manage a challenging demand, a challenging demand environment.

I now hand over to Thomas for the full set of financials.

Thomas Toepfer

Thank you, Markus, and good afternoon also from my side. I’m on page 4 of the presentation where you have the sales bridge and you see that we have posted a year-on-year decline of 16.9% in terms of sales. However, I think it’s worth noting that sequentially the sales increased by 1.1% relative to Q1 2019. If you look at the chart, you see that the main driver was the price effect was declining and deteriorating prices in MDI, TDI and also PCS, reducing our sales by a total of €724 million.

Markus Steilemann

Thank you, Thomas. We are now going to chart number 7 and talking first about polyurethanes. In the second quarter, we recorded slightly increasing core volumes. Strong core volume growth in TDI compensated for a weaker MDI performance, while polyols remained on prior year’s level. The lower MDI volumes were driven by our limited availability due to a scheduled maintenance shutdown in China.

In our view, the MDI market growth remained healthy. Overall, industry utilization state at low level driven by the additional capacities adding during the last 12 months. For MDI, prices were moving up and down in the last months, reacting to short-term effects like for example, several maintenance shutdowns in China end of April, or destocking and restocking measures by customers. Due to the current volatility in the industry and the low visibility on demand development, we stay cautious about the further development during the course of the year.

Mid-term, we expect that the current overcapacities will be absorbed by growing market demand. For TDI, the industry environment remains under pressure, also in the second quarter, margins did not move away from their low point as a consequence of significant capacity additions in the industry. On the positive side, we see limited further downside risk as we believe that high-cost producers are currently operating at cash breakeven levels.

Finally, margin polyether polyols continues to be below the long-term average mainly driven by weak U.S. market. Overall, the EBITDA margin of 11.6% in PUR in the second quarter was clearly below last year’s level, primarily driven by significantly lower MDI and TDI margins. Taking a quarter-on-quarter perspective, we see a slight improvement driven by a higher MDI margins and higher TDI volumes.

Thomas Swoboda

I have 2 questions, if I may, please. Firstly, on the potential drought in Europe this year, again, do you see a risk there to face the low Rhine water levels this year, again and if so is anything you can do to prepare? And the second question is on CapEx. I mean you have quite a sizable CapEx program going forward. It does not seem that the economy is bouncing back, again, very soon. My question is, what would make you reconsider the speed and the amount of the CapEx you want to spend over the next 3 years?

Markus Steilemann

Thomas, this is Markus speaking. On your first question and also growth patterns in Europe and here particularly, Rhine river levels, if you look at our growth rates in Europe, in the first half of the year, we still think that this overall situation will not significantly change in the second half. But that is also included in our guidance that we have given. If you now particularly look at Rhine river levels as of last year, in Q4 you could say that in 2018 we had an effect in terms of EBITDA of roughly €50 million plus/minus and for sure, we have taken the experience of last year into consideration.

What does that mean? You have 4 major modes of transportation, one is pipeline and we’re talking about railway, we’re talking about trucks and we’re talking about ships. And the Rhine river level, for sure, affected the ship transportation. So for this year, we prepare ourselves as good as we can to compensate as much as we can potential impacts of lower Rhine River levels. However, we could never ever fully compensate if all ships would not be able to ship the Rhine River.

And if this would take on for longer, however, we have opportunities here in pipeline, in trucks and also, in railway cars, to partially compensate it, in particular, if it’s just the short-term topic and also on very short term, we could also do something on, let’s say, inventory levels on the raw material side and also on the finished goods side. But that is also limited in terms of how long we can do that and that is actually what we are preparing for. We currently do not have as anyone, any idea how the Rhine River levels will develop. However, if it gets as worse as last year, we, I think will be better prepared.

With that, I would like to hand over to Thomas for your second question.

Thomas Toepfer

Yes, Thomas, with respect to CapEx, I mean, let me say a little bit bluntly. Of course, we’re not stubborn and just stick to our CapEx numbers without looking left and right what is happening in the economy. We monitor this very closely and therefore, we have a very, I would say, clear review of all the CapEx projects and check whether they make sense strategically and whether they add value. And we do this review in autumn in connection also with the business planning. However, on the other hand, I think, it’s fair to say we do have 7-year CapEx cycle, so it’s, we cannot steer the business on a short-term notice for those kind of projects. And therefore, in terms of flexibility, I will say, the €900 million that we’ve indicated for this year, are pretty much fixed.

In the outer years, of course, we do have flexibility and I think, we’ve proven this in the past that if really we should face a prolonged and deep recession, we can, of course, stretch projects or take products out, especially in the outer years. But again, the, I think we have to balance the strategic ambition because the CapEx is the foundation for future growth and in the long term, we do see that the markets that we serve, especially with MDI, but also with the other product have a solid and secular growth rate above GDP and therefore, that justifies also a CapEx program.

Chetan Udeshi

Just couple of questions. Just on Q3 guidance, can you maybe give some color by the 3 key product segments or maybe even CAS if you want, so TDI, MDI, polycarbonates and CAS, how do you see the development there for each of those businesses? And then I had a question on the comment made previously during the opening remarks that the climate is challenging and you guys will take whatever it needs to improve the business? And frankly, when I look at the pricing development, only been weak across the board, or it’s been incrementally weakening since the end of last year and now you’re talking about volume growth slowing down. So I’m just wondering what is sort of internal strategy to cope with this current environment because you also said at the same time that you don’t want to change something on CapEx in the short run as well.

Thomas Toepfer

Yes, let me maybe take your first question, Chetan. So I mean, just roughly speaking, I would say, if you go through the segments, in CAS, obviously, you have to strip out the €19 million revaluation effect, which will not repeat itself. And if you project CAS into Q3, otherwise, I think it’s a pretty stable development in terms of EBITDA. And then I would say, our PUR segment also we expected to be broadly stable and maybe a slight decline in PCS due to ongoing pricing pressure that we see, especially in Asia. This is broadly speaking the development that leads you from the result in Q2 to the, around €410 million that we indicated for Q3.

Markus Steilemann

Yes. And Chetan may be on your second part, I hope that I hit the nail here on the head because I was not absolutely clear what you’re referring to, short- or mid-term topics on let’s say, climate challenging. I think what we have observed and what we’re currently striving for is in the third quarter, we are able to deliver more, particularly because we have more volume available. Secondly, you could say that we somehow see first signs of things bottoming out as we also stated earlier in our presentation. Some of the high cost producers are now really reaching the point where they would burn cash if they would continue.

So that is also helping a little bit and that is slightly differently pronounced in the different product groups. So let me also give you here some ideas. On MDI, I think we could observe that we are kind of bottoming out in terms of pricing. On TDI, yes, there’s still some room that prices might be lowered a little bit, but here what again, reiterate that we have a leading cost position and many producers are really hitting now the point of where they would be cash negative. And on polycarbonate, we see still that prices might further decline, but also, here some producers are hitting already cash costs.

Sebastian Bray

I just have a quick factual one. Could you please give us a reminder of the relative auto exposure across CAS polycarbonates and polyurethanes?

Thomas Toepfer

Well, I mean, just briefly, the auto exposure for the entire group is just below 20% of our sales and for PCS, it’s 1/3 of their sales and I think the others and CAS’s I would say within group average. So that PUR is a little less.

Isha Sharma

Quickly, please correct me if I’m wrong, but you said that you have seen higher margins in MDI quarter-over-quarter, I’m guessing and could you please put some color as to why that is? Is it because of the shutdowns that you have seen and therefore, limited availability for just the quarter, or is it something that you see as a trend going forward? Also, if you could please talk about the end market trends a bit region wise, especially for North America, if you see any weakness there, or are the prices still sticking?

Markus Steilemann

Isha, maybe on your first question, so the, if you took the full quarter view, we had higher MDI prices in April and here, in particular, in China and that was also is somehow coming together with what we would call the peak of the maintenance shutdown and therefore, also some restocking. Now prices came down, again. So that was just a short peak and that was predominantly what has driven the quarterly, let’s say, margins higher than we have seen them in the first quarter. So from that perspective, we would not see this as a long-term trend now already, but rather a peak in the second quarter and now let’s say, we are back to the levels that we more or less have seen beginning. So having said that, I would like to turn to the second question.

So what was very strong actually in the quarter-to-date, we have seen strong construction in North America, the development. We have seen strong wood and furniture, whereas, automotive as globally, you have seen the picture was a negative. Just to give you an indication, in construction double-digit growth, and for wood and furniture double-digit growth, and in automotive and transportation from our perspective, a higher single-digit negative growth, just to put some flavor on that. And we do currently not see to those numbers a significant change moving forward into the third quarter.