Covestro AG

XETRA:1COV

Q2-2025 Earnings Call

[Ronald Kohler, executive]

Welcome to the Covestro Earnings Call on the second quarter results. The company is represented by Markus Steilemann, CEO; and Christian Baier, CFO. [Operator Instructions] You will find the quarterly statement and earnings call presentation on our IR website. I assume you have read the safe harbor statement.

With that, I would like now to turn the conference over to Markus.

[Markus Steilemann, executive]

Thank you, Ronald, and good afternoon to everybody, and a warm welcome to our second quarter call. With the end of today, Covestro's Chief Commercial Officer, Sucheta Govil, will go into her well-deserved retirement after 2 consecutive terms on the Board of Covestro. I would like to express my sincere gratitude to Sucheta for her exceptional contributions and her dedication to shaping our company.

On behalf of the entire Board of Management, I now have the great pleasure to introduce the new Chief Commercial Officer of Covestro, Monique Buch, to the investor community. Monique is an esteemed top manager with an impressive track record and a long-standing experience in the materials business. In her last position, she served as Executive Vice President, Nonwoven at Lenzing AG Austria. This position had been preceded by various leading positions at Freudenberg and Dow Corning. She obtained a master in Industrial Engineering & Management from the University of Twente.

The other members of the Board of Management of Covestro and I are delighted that Monique will take an active role in improving our business performance while transforming Covestro to the circular economy and execute our sustainability -- sustainable future strategy. Turning to the next page. Positive news are coming from our M&A team. We always said that we are looking for bolt-on acquisitions for our Solutions and Specialty business. Now with the acquisition of Pontacol, a Swiss manufacturer of multilayer adhesive films, we have done another step in this direction. This move expands our specialty films product and technology portfolio, enhancing our European market presence.

The acquisition offers attractive value creation through portfolio, organizational and procurement synergies. The addition of production sites in Switzerland and Germany strengthens our global manufacturing network and improves regional availability of adhesives films. This expansion enables us to deliver more powerful customer solutions, increase competitiveness and grow sustainably. We expect sales growth in the low double-digit euro million range by accessing growing applications, including security glazing, flexible printed electronics and wind blade leading edge protection.

The EBITDA contribution of these attractive applications is expected in the mid-single-digit million euro range. The closing is expected in the second half of this year. After these encouraging news, let us now turn to the key effects of the last quarter. Turning to next page. The key effects of the second quarter were sales volumes remained stable. We had lower sales of EUR 3.4 billion, and they were caused by lower prices and unfavorable currency. We achieved an EBITDA of EUR 270 million, which is in the upper half of our guidance range. The free operating cash flow came in negative at EUR 228 million. Following our July 11 announcement, we adjusted our guidance for EBITDA, free operating cash flow and return on capital employed above WACC. We were the first of several chemical companies that have since revised their guidance in response to adverse market conditions.

Turning over to the next page. We are looking at the business and the volume development in the second quarter of 2025. Year-over-year, global sales volume remained flat, almost balancing negative developments in Europe, Latin America and Asia Pacific with positive volume trends in North America. Across different industries, construction showed the highest growth with a mid-single-digit percentage increase, mainly driven by regional supply and demand patterns without major import-export trade flows. All industries depend on imports/exports declined. Automotive saw a low single-digit decline. Furniture followed with a mid-single-digit decline and Electronics was most affected with a high single-digit decline.

Regional performance varied significantly. Europe and Latin America presented a mixed picture. Furniture/wood showed a slight increase. Automotive remained flat, while construction declined slightly and electronics dropped significantly. North America sales volumes, especially in Performance Materials, increased significantly, driven by strong growth in construction due to gaining market share from competitors relying on imports. Furniture/wood increased slightly. Electronics developed flattish, while automotive showed significant decline. Asia Pacific maintained a slight sales volume increase due to significant growth in construction, automotive with slight growth, but strong negative trends persisted in electronics and furniture.

With this summary of the demand development, I'm now handing over to Christian, who will guide you through the financials.

[Christian Baier, executive]

Thank you, Markus, and also a warm welcome from my side. We are on Page 6 of the presentation and are coming to the year-over-year sales bridge. Sales for Q2 2025 declined by 8.4% to EUR 3.4 billion. This decrease was mainly caused by negative pricing and FX effects. Prices declined by 4.8%, affecting both segments, while the negative FX effect of minus 3.2% was primarily driven by the weaker U.S. dollar, Chinese renminbi and Mexican peso.

As mentioned earlier, overall volumes remained nearly flat at minus 0.4%. However, there was a divergence between the 2 segments with Performance Materials experiencing a slight decline, while Solutions and Specialties achieving a slight volume growth. With that, let's turn to the next page, where we are showing the Q2 2025 EBITDA bridge. Year-over-year, EBITDA decreased by 15.6% to EUR 270 million, which falls in the upper half of our Q2 guidance range of EUR 200 million to EUR 300. The performance above midpoint and consensus was driven by the release of EUR 44 million short-term bonus provisions following the adjusted guidance for FY 2025.

Selling prices once again declined more sharply than raw material costs due to the ongoing unfavorable industry supply-demand ratio. The price decline was most pronounced in APAC and EMLA after the tariff announcements of the U.S. government. As a consequence, EBITDA was impacted by minus EUR 100 million from a negative pricing delta and additionally adverse FX effects. The small volume increase shows the ongoing shift to reduce low-margin business with strong market products. Other items were largely positive due to the aforementioned release of the bonus provision and included restructuring costs for STRONG of EUR 37 million.

On Slide 8, we break down the details for the different segments, starting as usual with Solutions and Specialties. In S&S, the combination of 3.4% negative FX effects and the year-over-year price decline of 3% led to a sales decline of 5.4% despite increasing volumes by 1%. Sequentially, sales declined globally with growth recorded only in APAC, while EMLA and North America declined. The EBITDA in Q2 2025 remained stable year-over-year as the negative pricing delta and FX effects were offset by positive volume development and others, mainly from bonus provision release and cost contingency.

The quarter-over-quarter EBITDA decline was caused by a negative pricing delta, while volumes and others contributed positively. The EBITDA margin remained stable. In line with the adjustment of our FY guidance, we now expect S&S to contribute between EUR 650 million to EUR 850 million to our FY 2025 EBITDA. After Solutions and Specialties, we now turn to the Performance Materials segment. Year-over-year sales declined by 11.8%, driven by negative contributions of minus 6.6% from pricing, minus 3.0% from FX and minus 2.2% from volumes.

Quarter-over-quarter, sales increased in APAC and North America, while EMLA declined. The Q2 '25 EBITDA of EUR 149 million is lower year-over-year, mainly due to a negative pricing delta, while positive volume effects from reducing low-margin or loss-making business. Sequentially, the EBITDA in Q2 '25 rebounded after the Q1 impact from onetime costs related to the closure of our PO JV with Lyondell. It increased due to positive effects from others, mainly from bonus provision release and cost contingency, positive volumes and pricing delta following the high energy costs during the winter period. We are also reducing the EBITDA guidance from EUR 400 million to EUR 700 million and now expect PM to contribute between EUR 200 million to EUR 500 million. This adjustment is based on the low probability of a margin recovery for H2 2025.

The next topic is the free operating cash flow development. As you can see from the graph, the free operating cash flow in H1 '25 was negative with EUR 481 million, with Q2 FOCF contributing negative EUR 228 million. The free operating cash flow declined in H1 year-on-year, driven by lower EBITDA and higher CapEx. Changes in working capital of minus EUR 314 million in H1 '25 were mainly due to the seasonal buildup of inventories, however, less pronounced than in 2024. H1 '25 CapEx of EUR 365 million was higher year-on-year due to phasing. We reiterate our CapEx guidance of EUR 700 million to EUR 800 million for the full year '25.

Income tax paid of EUR 85 million was similar to the previous year. The minus EUR 127 million in other effects mainly comprises the bonus payout, which was slightly reduced compared to 2024. Overall, the Q2 '25 free operating cash flow is seasonally depressed. Our planning assumes an improved but still negative free operating cash flow in Q3, but a strongly positive free operating cash flow in Q4 2025.

Let's now look at our balance sheet on Page 11. Our total net debt increased by EUR 492 million compared to the end of 2024. The increase was caused by the seasonally negative free operating cash flow of minus EUR 481 million and the decrease in the net pension liability to EUR 215 million was driven by an increase in pension discount rates, mainly in Germany. This comprises pension provisions of EUR 285 million and a net defined benefit asset of EUR 70 million.

Summarizing our net debt situation, the total net debt-to-EBITDA ratio is at 3.8x based on a 4-quarter rolling EBITDA of EUR 0.9 billion. Without the significant strong expenses of around EUR 140 million in H1 2025, the increase would have been limited to a ratio of 3.3x, which would have been an increase year-on-year of only 0.1x. Covestro remains committed to a solid investment-grade rating, which was just confirmed in April by Moody's, including a stable outlook.

That concludes the overview of the Q2 financials, and I'm handing it back over to Markus.

[Markus Steilemann, executive]

Thanks a lot, Christian. We are continuing with the outlook for Covestro's core industries on Page 12 of the presentation. Global GDP forecast has decreased to 2.5% from February's 2.8% outlook. This reduced global outlook also affects most of Covestro's core industries. Automotive growth forecast decreased to 0.6% from 2.7%, primarily due to U.S. tariff policies disrupting global supply chains and demanding weakness in Europe and North America.

EV and battery electric vehicles outlook remains strong at 24% growth. Construction industry growth forecast increased to 0.6%, partly due to stabilization in the Chinese housing market, though ongoing conflicts and political uncertainty limit further growth. Furniture industry growth forecast decreased to 0.5%, which is 1 percentage point below earlier forecast, mainly due to weaker production in APAC and North America regions. Electronics industry growth forecast is now at 3.7% with persistent uncertainty regarding U.S. trade policy and potential tariffs affecting investments. Household appliances showed slightly higher expected growth at 2.4%.

Let's turn to the next page. As already mentioned, we have adjusted our guidance as published on July 11 due to downgraded industry growth expectations following U.S. tariff announcements and the lack of substantial margin recovery prospects. The EBITDA guidance is now between EUR 700 million and EUR 1.1 billion, down from EUR 1.0 billion to EUR 1.4 billion after the first quarter. The free operating cash flow guidance has been adjusted in line with EBITDA and is now expected between minus EUR 400 million and plus EUR 100 million.

Accordingly, return on capital employed over weighted average cost of capital is now projected at minus 9 to minus 5 percentage points instead of minus 6 to minus 3 percentage points. The current mark-to-market estimate is approximately at EUR 900 million based on July forecast assumptions flat forward, so on midpoint of our current guidance. Greenhouse gas emissions forecast remains stable at 4.2 million to 4.8 million tonnes. Unfortunately, the day after our ad hoc release, we were impacted by a fire in the transformer station in Dormagen owned by the chemical site operator, Currenta. The sudden lack of electricity led to a shutdown of our polyol plants, but mainly damaged our chlorine production, which subsequently impacts our TDI as well as several solutions and specialty value chains.

We are still uncertain about the full financial impact. However, first preliminary evaluations revealed a possible high double-digit to low triple-digit million euro EBITDA burden for the full year 2025. We are still trying to mitigate the effects of the incident as much as possible. Beyond that, additional financial expectations are Covestro sales are estimated between EUR 13 billion and EUR 14 billion. Our Q3 EBITDA is expected in a range between EUR 150 million and EUR 250 million, including our preliminary assessment of the Dorman impact of a mid-double-digit euro burden. The financial results range was adjusted to minus EUR 140 million to minus EUR 180 million. All other financial expectations remain unchanged. As the guidance adjustment has been significant, I would like to quickly hand over to Christian for a detailed view on the external market headwinds leading to the revision.

[Christian Baier, executive]

Thanks, Markus. And let me just provide transparency on the key factors that led to the adjustment of our EBITDA guidance. The midpoint of our initial February guidance was EUR 1.3 billion, which we now have revised to EUR 900 million. The primary driver is the absence of the margin recovery perspective, which we anticipated for 2025, resulting in a negative pricing delta of approximately EUR 550 million. We also expect a low triple-digit million euro volume decline and unfavorable exchange rates for U.S. dollar and Chinese renminbi with a mid-double-digit euro million impact.

Combined, these external market developments total around EUR 700 million in negative impact. To counter this, we have launched short-term cost contingency measures expected to deliver up to EUR 275 million in savings. Positive effects from our strong transformation program were already included in the initial guidance. Other savings of around EUR 100 million include reducing short-term bonus provisions for FY 2025. Our internal measures can offset approximately EUR 300 million of the roughly EUR 700 million negative impact.

Despite these comprehensive efforts, the remaining EUR 400 million difference explains the EBITDA guidance adjustments announced between February and July. We remain committed to driving our transformation and we'll continue to pursue every opportunity to improve our performance throughout the remainder of 2025.

Back over to you, Markus.

[Markus Steilemann, executive]

Yes. Thanks, Christian. And before summarizing the second quarter, I would like to give you an update on the XRG transaction. Regarding the European foreign subsidy regulation, we have been informed about the conclusion of the Phase 1 review and our entry into a Phase 2 investigation. This Phase 2 referral was expected given the size of the deal and its significance as it is the first FSR review involving a national oil company as well as the first complete takeover of a German blue-chip company by a Middle Eastern company.

This in-depth Phase 2 investigation can last up to 90 working days. On merger control approvals, we have now advanced to a 90% approval rate with only Vietnam remaining prior to closing. We reiterate our confidence to close within the second half of 2025, most likely in Q4 with the subsequent payout of EUR 62 per share to Covestro's shareholders. Let's turn to the next page and allow me to quickly summarize. We have seen in the second quarter flat volume development that was burdened by economic and geopolitical uncertainties. Sales came in lower at EUR 3.4 billion, mainly caused by lower prices and unfavorable currency effects. The EBITDA for the second quarter of 2025 of EUR 270 million was above the midpoint of the guidance range and was helped by internal measures.

The full year guidance for the year 2025 has been adjusted with an expected EBITDA now of between EUR 700 million and EUR 1.1 billion. And the XRG transaction is on track with expected closing in the second half of 2025. And now Christian and myself are happy to answer any questions that remain open.

And with that, I hand over to Carsten, who will guide us through the Q&A session.

[Carsten Intveen, executive]

Thank you, Markus. Ladies and gentlemen, we will now begin the question-and-answer session.

[Operator Instructions] And the first question comes from Christian Faitz from Kepler Cheuvreux.

[Christian Faitz, analyst]

Two questions, please. First of all, at the low end of your EBITDA guidance for the Materials segment, you're not expecting much of a positive contribution in H2. So just about EUR 40 million at best, I guess, kind of H2 '22 situation. What are the assumptions for this lower end? And I take it this includes the force majeure effects, correct?

And the second question would be, are there any signs of a demand revival into Q3 from any key customer industries, furniture, electro/electronics, automotive?

[Markus Steilemann, executive]

Yes. Thanks, Christian. This is Markus speaking for your questions. Let me start with the second part or second question, the revival signs of any industries going into the third quarter. I hope we could provide you with an overview about where the different industries in terms of overall industry outlook look like. And I'm here specifically referring to one of the slides that we have in our presentation that supports the respective call.

And there you see that many of the industries that we are serving mainly take automotive, construction, furniture, electro -- and electronics, there is a positive growth outlook for the full year 2025. However, in general terms, we have to say that this industry growth outlook has been revised downwards for some major industries. And that downward revision having now Q1 and Q2 behind us, for sure, would impact the second half of this year stronger. So if you do the math, you would figure out that currently, there is limited to no signs of a significant uplift. It might be regionally slightly different here and there. But in general terms, we have to say that the world is still challenged. And one of the major reasons is the ongoing uncertainty due to ongoing negotiations of U.S. tariffs.

So that is the underlying thing. And that all comes on top of the uncertainties that we have seen so far and the prolonged crisis, and I don't want to reiterate it since when we already have consecutive crisis going on 2021 with Corona, energy peak and so on and so forth. So long story short, the market currently is in a very challenged overall situation. So that means for second half, I personally would not see a significant broad-based across the board uplift in demand. And once again, there might be here and there some regional differences by industry or in general. But I do not think that this is sufficient to provide a broad positive overall uplift of the markets for our industries and for our main customers, yes.

So it's a very broad answer. But before we now go into details, and then it's maybe seen as, oh, there's a positive sign here, positive sign there. Broad basis from today's perspective, the markets will remain very challenging. So...

[Christian Faitz, analyst]

So to summarize it, front-end loaded here with the front end being behind us.

[Markus Steilemann, executive]

Well, let's not forget, Covestro is doing a lot on self-help. We have just -- and I have been mentioned today is this program is strong. We also have made it very clear where we stand in terms of the rest of the year outlook with our updated guidance. And now coming back, let's say, to your first question, the costs that we had to digest this year for example, restructuring costs for PO11 are nonrecurring then, let's say, for the next year, most likely.

And the Dormagen case that I just mentioned has not been included in the midpoint, but should be covered at the low point. So there will be ongoing margin pressure also for our materials like polycarbonate and polyols. So it will remain a challenging year. And at the same time, we have to also make clear that we do everything that is in our own power to make sure that we deal with the current situation. So the underlying is relatively stable, yet at, for us, also low levels. And therefore, we would expect that Q3 is therefore similar to the second quarter, but excluding the Dormagen incident. So I hope that gives you somewhat a picture and a flavor.

[Carsten Intveen, executive]

And the next question comes from Geoff Haire from UBS.

[Geoffery Haire, analyst]

I was wondering if I could ask Markus, if you had any comments on this policy in China, this anti-involution policy and what impact and the timing of it might have on the chemical industry as a whole. But -- and also -- and I'm aware of, obviously, your other hat that you were with the VCI, but also what you make of the action plan from the EU that has been announced.

[Markus Steilemann, executive]

Okay. Sorry, Geoff, I have to repeat it because I forgot now to unmute myself. So after 40 quarters of reporting here, so finally, that also happens to me. So wonderful. No.

So the anti-involution policy, we currently do not see any direct effects on our businesses for the time being to be very clear. And with regard to the current conversations on European level, I -- is it on countermeasure? Or is it more the general, let's say, because you talked about VCI. I'm not sure, Geoff. Can you just clarify? Because I understood you that you say, how do you look at the energy on the European, let's say, overall policies, but not as potential countermeasure, is it?

[Geoffery Haire, analyst]

No, I was just wondering, obviously, the action plan that the EU announced. And all I meant was I was aware that you obviously have other responsibilities. But I was wondering what impact do you think that could have on the chemical industry in Europe? And also, do you think that the anti-involution policy may result in old capacity being taken out, not for Covestro, but for the industry more as a whole?

[Markus Steilemann, executive]

As I said, with regard to evolution policy, let's see. Once again, we currently do not see any impacts, at least not in short term. And I also have not seen, let's say, any announcement that would support, let's say, that thesis that old capacity would be taken out. On Europe, the European Chemical Action Plan, first and foremost, what I am positive about also in my role as a VCI President is that finally, that new economic reality has obviously arrived in the Brussels offices and therefore, also has now led to action that seems to me a more balanced approach towards economy and the ecology.

So whereas climate was on top of the list, let's say, and maybe only on top of the list for the last administration, I now see that it is a more balanced approach being taken. And that in itself, I see as a very positive sign, yet the effects, whether it has really positive effects, whether it makes the EU and its industries more competitive, that remains to be seen. And therefore, more actions and more swift actions have to be taken. And without repeating myself, that is, let's say, lowering bureaucracy, doing something on tax, tackling the high energy prices in Europe and so on and so forth. So a good start, but way too little to really turn now the tides.

[Carsten Intveen, executive]

And the next question comes from Chris Counihan from Jefferies.

[Chris Counihan, analyst]

I just wanted to ask about Dormagen and specifically how long you expect the plant to be out for, firstly? Obviously, you've given a financial impact, but just I wasn't sure if I heard how long you expect it to be on force majeure for as of today.

And then secondly, obviously, that's about 1/3 of your TDI capacity. If I look at my supply demand. Is there the potential for the other 2/3 to benefit from the market being a bit tighter?

[Markus Steilemann, executive]

Yes, Chris, thanks for your question. Very roughly speaking, we expect Dormagen to be out for several months. And now comes the big but. What is mainly affected for the several months is the chlorine supply. The chlorine supply is absolutely essential to run the TDI plant. However, there's other chlorine customers internally as well as externally, and that's why we also issued that force majeure because there is onward opportunity to gradually at least bring back some of the other internal value chains, for example, in the Solutions and Specialty area, but that will also be a matter of weeks, so not days, but really weeks.

So gradually, we expect that more and more plants will come up on stream, but the big volume and also a margin contributor, TDI that is definitely out from today's perspective for several months. With regard to your second part, we have just observed that Asia prices have rebounded based on the prices that were quoted by traders. First, we have to take a look at it, is it sustainable? And in the U.S., we have, let's say, in the entire industry, not so fast-moving prices due to contractual basis, and I'm talking more about what I perceive as a general industry pattern rather than our own situation. And therefore, we have not seen any reaction so far. And also, please bear with me, we're not going into any further details because the TDI market is a very, let's say, narrow market. And therefore, anything I say could be one word too much around this. And from that perspective, please allow me that I leave it with that.

[Carsten Intveen, executive]

Geoff, there seems to be a follow-up question. No.

Okay. Then there are no further questions at this time. So handing back to Ronald.

[Ronald Kohler, executive]

Okay. Thanks for your question. I know it's a busy day for you today with a lot of reporting. So if you have any follow-up questions, don't hesitate to contact the IR department. And with that, I would thank you for your interest, and see you next time. Bye-bye.