Covestro Ag Ord

Welcome to the Covestro earnings call on the second quarter results. The company is represented by Markus Dillemann, CEO, and Christian Weyer, CFO. During the presentation, all participants will be in a listen-only mode. The presentation will be followed by a question and answer session. If you have a question, please use the raise your hand function or post your question into the Q&A tab. You will find the quarterly statement and earnings call presentation on our IR website. I assume you have read the safe-haver statement. With that, I would now like to turn the conference over to Markus.

Thank you, Ronald, and hello and a warm welcome to our second quarter call. The highlights of the second quarter were the continued strong volume increase of 9.3% year-on-year. With this, we are fully on track to our target of a high single-digit percentage volume increase in the full year 2024. Lower prices are still affecting sales, which came in at 3.7 billion euros. We achieved an EBITDA of 320 million, landing on midpoint of our guidance range. Free operating cash flow was minus 147 million in line with our expectations. And we are narrowing our EBITDA guidance to 1 billion to 1.4 billion euros. Let me take the opportunity and give you a brief update on AdMob. As we stated on June 24th, we believe that AdNoc and Covestro can generally reach a common understanding regarding core aspects of a possible transaction. Therefore, we have decided to open our books for a confirmatory due diligence and to start concrete negotiations regarding a potential transaction, including the potential conclusion of an investment agreement. This phase is ongoing in a constructive manner. We pursue the negotiations in accordance with our fiduciary duties, in good faith, open-minded and in the interest of our shareholders, our company, our employees and all other stakeholders. This said, we ask for your understanding that we will not make any further statements at this stage and do not intend to comment further on this issue unless legally required. Let's turn pages to page number 3. Turning back to the business and the volume development in the second quarter of 2024, year on year, the global sales volume continued to increase by 9.3%. This is driven by an improving demand, but also by fixing our reliability issues in Europe. Going through the different industries, construction showed the highest growth rates with a low teens percentage increase. Furniture and electro follow with a high single digit increase. Auto exhibited a flattish development. Looking into the different regions, AMLA continued to benefit significantly from the resolved internal availability issues. Drilling it down into the different industries, we see a mixed picture. Construction and furniture are exhibiting strong growth, mostly associated with better availability of our core products, MDI and TDI. Electro and auto, however, are showing a strong decline. Overall, sales volumes in North America increased slightly driven by strong growth in furniture and a slight increase in the construction industry. Electro developed rather flattish, while auto showed significant decline. Asia-Pacific continues with positive growth across all industries that Covestro is focused on. Furniture, auto and construction exhibited significant growth, while electro showed a slight increase. With this summary of the demand development, I'm now handing over to Christian, who will guide you through the financials.

Thank you, Markus, and a warm welcome also from my side. We are on page four of the presentation. Sales for Q2 2024 are stable at 3.7 billion euros. The strong increase in volume was offset by negative pricing and FX. Prices declined by 9.7%, counterbalancing the volume increase of 9.3%. The negative FX effect of minus 0.4% was neglectable and mainly driven by the weaker Chinese renminbi. With that, let's turn to the next page where we are showing the Q2 2024 EBITDA bridge. Year on year, we have a decrease in EBITDA of 17% to 320 million euros. This is at the midpoint of our Q2 guidance range of 270 to 370 million euros. Selling prices declined stronger than raw material costs due to the ongoing unfavorable industry supply-demand ratio. As a consequence, EBITDA was impacted with minus 186 million euros from a negative pricing delta. The volume increase only partially compensated the negative pricing delta, and the volume leverage was clearly below the long-term average due to the historically low margins. FX and other items also contributed to the negative development to a minor extent. Just to provide full transparency on the EBITDA bridge, Other items were impacted by 23 million euros of restructuring costs in the S&S segment as part of the transformation program STRONG. On slide six, we are breaking down the details for the different segments. and are, as usual, starting with solutions and specialties. In S&S, the year-over-year price decline of 7.7% was leading to a sales decline of 3.3%, despite increasing volumes of 4.8%. FX negative impact was neglectable. Sequentially, sales growth was recorded in APEC and North America, while EMLA was declining. The EBITDA in Q2 2024 was lower year over year, mainly due to a negative pricing delta and the already mentioned restructuring cost. The positive volume development could partly compensate the negative effects from pricing delta and other items. The quarter over quarter EBITDA decrease was driven by a negative pricing delta and the aforementioned restructuring costs being booked in Q2 2024. With that, the EBITDA margin decreased to 9.6%. We are now expecting S&S EBITDA to contribute around the 2023 level. This adjustment compares to the previous guidance of a significant improvement is driven by the assumed mid-double-digit million euro restructuring costs and pressure from higher raw material costs. After solutions and specialties, we are now looking at the segment performance materials. Year-over-year sales increased by 2.5%, driven by 15% from volumes and minus 12% from pricing and minus 1% from FX. Quarter-over-quarter sales increased across all regions. North America and APEC also showed sequential volume growth, whereas EMLA was stable. Q2 24 EBITDA of 196 million euros is 35% below last year. The year-over-year decline is mainly driven by the high comparison base. Please remember that in Q2 2023, we booked an internal insurance reimbursement of 75 million euros, which at the same time burdened the segment others. Nevertheless, also the underlying business was down due to a negative pricing delta, which could not be fully compensated by the volume increase. However, sequentially, the EBITDA in Q2 2024 increased, benefiting from a positive pricing delta and positive volumes. In line with the overall narrowing of our FY24 guidance, we are also narrowing our EBITDA guidance for performance materials to now 400 to 700 million euros instead of 400 to 800 million euros. The next topic is a free operating cash flow development. As you can see from the graph, the free operating cash flow in H1 2024 was negative 276 million euros, with the Q2 FOCF contributing negative 147 million. The free operating cash flow declined year on year, driven by lower EBITDA and the bonus payout for FY 2023 in Q2 2024. Changes in working capital of minus 350 million euros in H1 2024 were mainly resulting from the seasonal buildup of inventories. Given the sharp reduction of inventories at the end of last year, we would not exclude a rebuild in 2024, leading to a negative working capital cash out for the full year 2024. H1 24 capex of 272 million is stable year over year. We increased the CapEx into maintenance to reduce the risk for any major reliability issues like we have seen in 23. The growth CapEx focuses on a few selected expansion projects. Income tax paid of 80 million euros was slightly below previous year. The minus 167 million other effects are mainly comprised of the bonus payoff. All in all, the Q2 24 free operating cash flow is seasonally depressed. Our planning still assumes a negative free op in Q3, but a strongly positive free operating cash flow in Q4 2024. Let's now look at our balance sheet on page nine. Our total net debt slightly increased by 308 million euros compared to end of 2023. The increase was mainly caused by the seasonally negative free operating cash flow of 276 million and negative others. The decrease in the net pension liability of 133 million was driven by an increase of the pension discount rates in the US and Germany. This comprises pension provisions of 265 million euros and the net defined benefit asset of 98 million euros. Summarizing our net debt position, the total net debt to EBITDA ratio is at 3.2 times, based on a four-quarter rolling EBITDA of 1 billion euros. However, based on our mid-cycle EBITDA, the ratio would be only around 1.1 times. Covestro remains committed to a solid BAA2 investment grade rating that was confirmed by Moody's in May 2024. Back over to you, Markus.

Yeah, thanks, Christian. And let's turn to page number 10. And also let's turn now the focus to the future. On June 25th, we launched our new transformation program, Strong. With Strong, we are shaping the sustained competitiveness of Covestro with effective structures and efficient processes and supported by a broad AI implementation. After ramp-up phase beginning 2028, Strong targets to generate annual savings of 400 million euros. This is slightly below 10% of our global fixed cost base. In order to make this happen, we are expecting accumulated 300 million euros restructuring cost. Our updated 2024 EBITDA guidance assumes a mid-double-digit million euro positive impact from Strong, as savings will be partly counterbalanced by restructuring. What are we doing content-wise with Stone? We have an underlying set of measures that leads to these savings one-time cost and potential impairments. For example, we are streamlining our structures and our asset footprint, and we are pushing forward our near and offshoring activities. We also skipped already our 2024 non-tariff selling increases. Further content, we will share with you based on the implementation of further steps and after having informed the respective employees. On the next page, we are now coming to the outlook for Covestro for 2024. We are narrowing our EBITDA guidance for full year 2024. We are now expecting the EBITDA for full year 2024 to come out between 1 billion and 1.4 billion euros. The mark-to-market EBITDA is calculated at around 1.2 billion euros based on June 2024 margins flat forward and our current budget assumptions for 2024. The updated guidance now assumes only limited changes in our product margins per ton. A more pronounced rebound from the historical low levels is getting rather unlikely in the second half of 2024. As there has been no significant change in the global demand picture in the industry outlook, we are skipping the comprehensive discussion and the slide here. Let me just highlight the overall trend. The market outlook on global GDP is now around 2.6% and the outlook for our core industries is mostly unchanged versus the Q1 core. And with this, I quickly hand over to Christian for the full set of KPIs.

Let me now focus on the additional guidance elements for FY2024. In line with EBITDA, also ROSI above WAC has been narrowed to minus 7 to minus 4 percentage points. The free operating cash flow has been adjusted to now come out at minus 100 to plus 100 million euros. The greenhouse gas emissions in scope 1 and 2 are estimated stable between 4.4 and 5.0 million tons. In Q3 2024, we expect an EBITDA between 250 and 350 million euros. We are on track for the forecasted high single-digit volume growth for Q3 and also for fiscal year 2024. However, margins remain on the historically low level, which is expected to lead to a continued negative year-on-year pricing delta in Q3. All other KPIs remain stable. And with that, back to Markus.

Yeah, thanks, Christian, and allow me to quickly summarize. We have seen a rebounding of volumes in a challenging environment in the second quarter, and this continued strong volume growth was driven by globally higher demand and improved internal availability. Sales were stable at 3.7 billion euros, continued strong volumes increase while lower prices and unfavorable currency effects were the main root causes for this development. EBITDA in the second quarter of 2024 came in at 320 million at the midpoint of our guidance range and that was burdened by the already mentioned negative pricing delta. Full year 2024 guidance has been narrowed with now an expected EBITDA of between 1 and 1.4 billion euros. And the transformation program STRONG has been launched with intended savings of annually 400 million euros by 2028. And now Christian and myself are happy to answer any questions that remained open. With that, I hand over to Carsten who will guide us through the Q&A session. Thank you.

Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please use the raise your hand function to ask your question verbally or post your question into the Q&A tab. If you wish to cancel your request, please use the raise your hand function again. When speaking, please ensure that you are unmuted. And the first question comes from Christian Seitz from Kepler-Chevreux. Christian, please unmute your microphone.

I hope you can hear me.

Yes, very well, Christian.

All right. Good afternoon, Markus, Christian, Ronald, and team. Two questions, please. First of all, your cost of consoles for the first time in five quarters are increasing again, year on year, but also sequentially. Can you please explain why? And second question, also a nitty-gritty question, sorry for that. What's the reason for the relatively high tax expense at present and what kind of tax payments should be modeled for the remainder of this year? Thanks very much.

So, Christian, I'm just going to take a volume question and then Christian, so our Christian here is maybe then talking about the tax topics. Cost of goods sold, Christian, is mainly due to higher volumes, but also slightly higher raw materials. And here to mention just as an example, benzene. And that's the simple answer. So higher sales in terms of higher volumes and slightly increasing benzene costs as an expensive and as a large commodity raw material that we buy.

All right. Thanks, Markus.

Yeah, on the tax perspective, yes, in Q2 there has been a bit higher expense, but overall for the full year you should be expecting 250 to 350. We are on track with that for the full year. Q2 is a little bit of an outlier in that respect.

Okay, and why is that outlier? Any particular reason?

There's a bit of more topics with respect to deferred tax assets from that perspective on the German tax group, which is causing a little bit of a higher expense at that stage, non-cash, and therefore relevant is the 250 to 350 for the entire year.

All right. Thanks very much, Christian.

And the next question comes from Sebastian Brey from Berenberg. Sebastian, please unmute your microphone.

Hello, hello. Good afternoon, and thank you for taking my questions. I have two, please. The first is related to the operations in Germany, and I think you touched on it already in response to Christian's questions, but has there been, how close to net income break even are the operations in Germany currently, and has there been a sequential improvement, or was it roughly stable between Q1 and Q2? My second question is on trading by geography. Could you give us a feel for how China is developing, and if you expect any bigger recovery moving into 25? And likewise, any comments on Europe and the US are welcome. Thank you.

Yeah, very happy, Sebastian, to take the first one, and then Markus will go on the second one. With respect to operations in Germany, Between the quarters, it's broadly the same development that we see here. Operationally, we are reasonably close without any special items, if you will, to the zero line. If you take into account the German tax group, it obviously also includes relevant parts of administrative functions which are then trending in that context. So operationally stable, reasonably close to the zero line from the bottom, and then further burden, if you will, from an administrative perspective, which is then driving also the tax losses that we do have sitting in Germany that can be used indefinitely. Markus, please.

Yeah, thanks, Sebastian. Also, welcome from my side. Well, Asia-Pacific, that is mainly China. It continues with positive growth actually across all industries that we are serving. Particularly strong has been auto as well as electro. And currently, let's say we see this trend ongoing for us also in the third quarter. For Europe, the picture is different. We have seen also here good second quarter. But if you now look at the base in Q3 2023, that base was already increasing because we started to fix the reliability issues exactly from the third quarter 2023 onwards gradually, continuing into the fourth quarter then. And that means that also the base... for comparison is therefore increasing, that would then lead to lower, let's say, comparable year-over-year growth rates, which doesn't indicate a weakness in the market, just a different comparison basis, to be clear. And for the US, we see and expect that the third quarter should be relatively stable and steady, with regard to the growth rates. Helpful?

Yes, it's helpful. Thank you. Thank you.

And the next question comes from JD Panya from Onfield Research. JD, please unmute your microphone.

Thanks a lot. The first question is on the different products in the portfolio. of performance materials. Could you give us some color where are we with regards to margin development for MDI, TDI, PC, and polyols? Like what do you see sort of in the market? And sort of a related question, I think your utilization has now jumped to around mid-80s. So maybe you have another 5%, 7% to go, but spreads are really not tightening in the market. I mean, when, you know, could you give us a reference point to last time, you know, when utilization was 85%? What was the sort of mark to market you were looking at, you know, back in the day? Because I'm just trying to understand, you know, what is the leverage Cavastro has internally versus, let's say, improvement in external factors to get out of this 1.2, 1.3 billion EBITDA zip code? And then, sorry, my last question, and apologies, I'll stick to the party line, but just want to understand from the ad hoc situation, you know, is there any sort of scope for the deal to break? Because obviously, you have made considerable progress in terms of even reporting or communication. And I understand there's a three-month window. But is there any reason why we should be worried? or is that completely off the table now? It is really merely a question of a price and a timing point of view. Thanks a lot.

Jaydeep, also welcome from my side. So on the different commodities in our portfolio, let's start with MDI. We perceive the current situation compared to the previous situation that we have talked about to be at a stable margin. situation TDI as well as polyols going slightly down from our expectation and also what we currently see in the first couple of weeks in Q3 and the polycarbonate business is also stable but more importantly in this context is getting by the day basically the respective downstream business because we're selling the minority of polycarbonates in the, let's say, commodity area. This has now only been about one-fifth of the entire polycarbonate we're selling externally, whereas four-fifths is in the more stable downstream business. And that EP part of our solution and specialty business has shown to be, from my perspective at least, very resilient. in the overall context. So, shall I continue then with the second part? Yes, please. Okay, so, well, I could also dwell further, let's say, on MDI, but let's talk about ADNOC. So, from my perspective, the situation and also the information we can provide It has been, from my perspective, as you said, a significant step forward on 24th of June, where we opened the books, where we entered into clear and official negotiations. And I can only reiterate what I have said today numerous times. I think in this phase, the ongoing process is, how shall I put it, going well, to be very clear. And I know that Christian and I have used numerous ways to say it today. But from that perspective, I would take it as we have said it in numerous ways today. not as a let's say indication that something is going right or something is going wrong but rather as the best thing that we can say in terms of how we currently perceive the situation. Because anything we would say in terms of, well, likelihood has increased, likelihood has decreased, would maybe not express where we currently are. I can only say that everything that I have experienced so far personally is that the phase in which we are currently in is going on constructively. And yeah, I could say it in different ways, but that's really what it is. You could now start to speculate and say, well, could this be faster? Could that be slower? Is there anything that we should worry about? But I think given the very confidential environment in which we have worked so far, has served us well, even though I can also fully understand that at times you for sure have more desire to get even closer to the matter and maybe your desire is there to earlier get more information than we're currently providing it. But rest assured, we are continuing to negotiating in good faith, open-minded, and in full alignment with our fiduciary duties. And secondly, I also would like to reiterate once again that we need to balance, on the one hand, time, and on the other hand, quality of the outcome. And really, we balance this each and every day to the best extent possible, also in your interest.

And maybe, Jaydeep, I just also add on top the topic with respect to mark-to-market when we look at the utilization rates. First of all, it's important to see that for us, we have grown in the first half our volumes by broadly 10%. that brings us up on the personal Covestro utilization rate in order to see market development. Certainly that does require also the overall global market utilization rate also seeing further growth. We would expect there is a mid to high single-digit volume growth in the overall market that is required to really get into a balanced supply-demand situation, which then would be leading to pricing power. And from our perspective, this should be happening over time, driven by the demand growth that is continuously although sometimes masked by overarching topics these days, but there is still relevant demand growth that is also expected structurally down the road or helped by unplanned outages as we have also seen historically. But the one piece that we can bank on certainly is the structural demand pattern that needs to grow supply demand into a slightly better shape than where we are right now in order to see pricing power and a higher mark-to-market EBITDA.

If I may just follow up, Markus, with the point about your balance of the outcome versus the time. Yeah, we are closing in on like a year anniversary, I think, in a couple of months' time. So should we, is there any timeframe, i.e., over the next three months where we should see an outcome given now that you are, let's say, yeah, open the books and talk second circuit? Or, again, is there still no timeline to the matter?

JD, it is a very challenging situation, obviously, not in terms of the negotiations, but in terms of, let's say, communicating in the right way in this context. Let me put some flavor on it. As far as we are concerned, we deem a normal DD to run usually for roughly three months, a normal DD. We intend to be faster.

Thank you.

And the next question comes from Chetan Udeshi from JP Morgan. Chetan, please unmute your microphone. Chetan just disappeared. We lost him. So if your question is still valid, Chetan, please raise your hand again. Hello? Ah, now we can hear you.

Yeah, sorry it takes time on the call to allow us to unmute. But thanks for taking my call. I was just curious, is there any short-term disruption that you see in the market for any of your products in terms of supply? I'm not aware if Covestro has any issues, but we've heard about some chlorine outages in Europe, which might be impacting one of your competitors. Is that something you've actually seen in the market? The second question was, just looking at your third quarter guidance, which is it slightly down versus what you delivered in Q2 at the midpoint of the Q3 range? I'm just curious, you know, your Q2 actually included about 25 million of restructuring provisions. So that's implying almost, assuming there are no further restructuring provisions in the numbers, but it feels like your EBITDA is down 40 million or so at the midpoint of the range underlying like-for-like. So, maybe just help us understand how do you see the dynamics from Q2 to Q3, and within that, you know, how does the, you know, at least there is some concern on auto slowdown fit in that respect.

Yeah, Chetan, this is Markus speaking. Also a very warm welcome to you. Let me take the first question. Overall, for us, supply runs steady and that is also the picture that we currently have from an overall industry supply perspective we know that there are some small disruptions but these are not meaningful slash not material enough to really change the supply demand balance so in that context yes few disruptions and not material enough to change the big picture and looking at Christian he is happy to answer your second question

Yeah, exactly. I think if we take the midpoint, we are about 20 million down quarter on quarter. There is volume slightly up in the expectations there. Margins are probably slightly down when we also look at the quarter to quarter sequential basically pricing delta development that we see in others. In EBITDA, we see some slightly negative value, and therefore in some we expect to be slightly down. Your specific one with respect to volume perspectives, yes, on auto, you have also seen in our report, we are slightly softer in the overall growth. EV plays some role in that context. However, if we look at electroelectronics, we see a slightly better development also in our order books, and from that perspective, confidence to have the overall high single-digit volume increase in Q3, but also for the remainder of the year.

Thank you.

And the next question comes from Sebastian Zatz from Citi. Sebastian, please unmute your microphone with star six.

Yeah. Hi, everyone. Thanks for taking my question. I've got a couple as well. First, I want to dive in specialties and solutions where I saw your margins declined quarter-on-quarter and year-on-year, even adjusted for the restructuring charges. I was just wondering what was driving that. Net pricing data turned negative. Could you just let me know what's the reason behind it and how we should think about that for the coming quarters, please? Second question was on autos. You just mentioned a bit of weaker development. Just wondering what you're seeing there. Flat in the second quarter. I assume adjusted for your availability issues. It was probably down. Again, wondering what the outlook in your view is for orders in the second half. And then lastly, I was interested in your free cash flow guidance, the change there that you lowered it. I was wondering again what has changed there. I assume your outlook had always been a little bit back-end loaded anyway. So again, wondering what led you to lower the outlook for free cash flow. Thank you very much.

Yeah, Sebastian, warm welcome from my side. So on the solution specialty margins down, even under adjusted conditions, as you rightfully mentioned, that negative pricing data that remains is driven by the earlier mentioned higher raw material costs, and you might wonder why is that. just go up the value chain so commodity prices were slightly up for standard polycarbonate and that was recalling what I said earlier due to the higher benzene prices so input costs for solution and specialty higher at the same time yes it is a solution and specialty business that's why we need time to pass these higher raw material costs simply on to our customers So therefore Q3 from today's perspective looks slightly stronger quarter and quarter as we were and are able to increase selectively the prices in that segment. And not to forget engineering plastics is amongst the two largest segments in the solution and specialty area, and that's why these developments have significant influence on the overall performance of this segment. Christian, would you like to say something on free operating cash flow?

Happy to take this one. And then there is still that auto question somewhat related. When we look at the free operating cash flow, yes, we have slightly reduced that to minus 100 to plus 100 from zero to 300. I think that's especially driven when we look at the working capital development where we want to absolutely ensure the continuous operational setup that we have at any point of time, the good availability which is in focus as mentioned in the speech and therefore it might be that we basically put the prime on that when we go into the later part of the year given that last year we have basically gone down reasonably strong on the inventory levels and therefore that slight adjustment on the free operating cash flow side and back to Marcus then on the order one.

Yeah, thanks, Christian. So coming back on auto, if you look at the full year, we anyhow expected that we would see a flattish. Sorry, just the technology is dropping down the table here, but we just continue. We have just seen or expect for the full year 2023 that we will see a flat development. So actually no growth. in the overall light vehicle production from a global perspective. As we have seen it in the first quarter year over year, we have grown in auto by roughly 5%. In the second quarter, auto was year on year flat. And from that perspective, this slightly weaker global development, and you might have read the news in particular on electric vehicles that are globally not selling as well as expected. That has an impact, yet at the same time, we still see strong development on EVs as well as still combustions in China, but in Europe and US a weaker trend. So what we try to do to counterbalance that is or what is counterbalancing that is currently developments in other industries, and here particularly to be mentioned the electro-electronic sector. So, yes, auto is a bit weaker than we might have expected it, but there is counterbalance opportunities in other industries.

Great. Thank you very much.

So, there are no further questions at this time. So, with that, handing back to Ronald.

Thank you very much, Carsten. Yeah, thanks for your participation and your interest. I know it was a busy day for you, so I can understand there are less questions, and I know some of the questions we couldn't answer completely, but as time will tell, we're obviously moving on. So let's see. Thank you, and we will see you then on our normal road trip activities coming up mainly for September. Thanks, and bye.