Covestro: Comment After Q4 Release

Summary

• Strong pricing power to offset European energy cost pressure.
• Record dividend per share supported by strong fundamentals.
• After the sell-off, we see a record valuation discount compared to peers.

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We previously covered Covestro (OTCPK:CVVTF, OTCPK:COVTY), and today we are looking once again at the German player, going into more in-depth analysis following today's results on its Q4 and FY publication. We recently published a follow-up article on BASF, and we can clearly state that Covestro has performed better this year. In our previous analysis, we emphasised the following:

1. The new divisional structure was a positive sign for investor confidence and better margin visibility over the long term
2. Pricing power over cost inflation pressure
3. Asset replacement cost is higher than the current market cap
4. A valuation more discounted than ever compared to its peers

So, how is our thesis playing out?

Q4 & FY Results

Looking at the recent results, the German group - as expected - has shown strong growth compared to the previous year's results that were still impacted by the COVID-19 pandemic. Compared to the same period in 2020, Covestro saw revenue increase by +48.5% to €15.9 billion, both on higher volumes (+10%), but above all, thanks to the increase of average selling prices (+34.7%), we note that FX was almost irrelevant with a total loss at €91 million during the full year. The significant pricing power positively influenced the company margins, thus EBITDA grew two times to €3.08 billion.

Covestro EBITDA evolution

Source: Covestro Q4 and FY Results

Cross-checking the natural gas impact with BASF, we note that Covestro is better positioned as a percentage of cost going on 2022 guidance.

Nat Gas BASF impact

Source: BASF Q4 and FY Results

Nat Gas Covestro impact

Source: Covestro Q4 and FY Results

Despite the strong recovery in global demand, growth was limited by product availability. Raw material supply constraints and weather conditions further deteriorated margins. Regarding the various segments, the Solutions & Specialties segment saw sales growth of +50% to €7.5 billion and EBITDA to €751 million. The growth in Performance Materials was at 48.9%, reaching €8.1 billion, while EBITDA tripled, from €896 million to €2.5 billion. Despite the positive results and Covestro's ability to increase prices over cost, our internal team thinks that the Solutions & Specialties division EBITDA will suffer for longer duration contracts versus the Performance Materials segment.

Conclusion & Valuation

Last February, the German group presented the new Sustainable Future strategy and announced a reorganization of its activities, starting from 1 July 2021, with the creation of seven new business units divided into two large areas: Performance Materials and Solutions and Specialties. Looking at the recent disclosure, the company has already announced synergy effects for €26 million and the aim to permanently reduce costs by €120 million by 2025.

Given its strong performance, the German chemical player is proposing to its Board the biggest dividend per share in history set at €3.40, in line with Covestro payout ratio set between 35% and 55% of net income. We would like to remind our readers that the company set a new dividend policy last year. Moreover, we note that during the call, management was not too enthusiastic about future major acquisitions, and for the above reason, and in light of the recent business performance, Covestro's CEO has also proposed a new share repurchase program for total consideration of €500 million (almost 5% of its market cap). We based our valuation on a forward EBITDA set at €2.5 billion and it is currently very cheap compared to its peers and versus its own historical average. The Company is trading at a multiple lower than 5x EV/EBITDA and our internal team believes that this valuation does not reflect the solid company fundamentals. With a dividend now yielding 7% and with a P/E of 6x based on a multiple (mid-cycle) of 5.5x EV/EBITDA, our base case scenario sees a 20% upside from the current level. Trading at €46 per share at the time of writing, we rate the company with a buy and add a target price of €55 per share.

2021 Covestro main ratio

Source: Covestro Q4 and FY Results

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.