Base-material Boom

Plastics maker Covestro delights investors

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Takes a licking and keeps on ticking over. Source: Covestro

Stock in German plastics maker Covestro, a unit of drugs group Bayer, are powering ahead, reaching €85 ($100) on Monday and up 250 percent from the fall of 2015, when it was spun off as a separate company. Its earnings have risen steadily from quarter to quarter, and the stock has surged more than one third just this year alone.

The company, which makes base materials for products ranging from paints to mattresses and CDs to building facades, has attracted legions of fans. Laurence Alexander, an analyst at US investment bank Jefferies, lists Covestro as one of his favorites. Christian Faitz of investment firm Kepler-Cheuvreux included the company in his most preferred chemical stocks, alongside specialty chemicals firm Lanxess. Predicting that the stock will chalk up new records, both analysts have raised their price targets to €113 and €112 respectively. Around 50 percent of analysts have a buy recommendation on the stock, according to Bloomberg.

The company, listed in Germany’s MDAX index of 50 top non-tech stocks that rank below the DAX of 30 blue-chip stocks, is enjoying a dream pairing of brisk demand and a limited supply from rival companies. As a result, Covestro’s profit margins are on the increase.

Bayer, which has its hands full raising finance to fund its $66 billion takeover of US seeds giant Monsanto, has been cashing in on the gains. It gradually reduced its stake to 24.6 percent in four transactions this year, most recently at the end of September. That’s down from 60 percent in 2015, after it took its former MaterialScience division public under the Covestro name.

A bouncy economy has led to stronger-than-expected demand for Covestro’s products in the auto and electronics industries. This recovery, moreover, has coincided with production difficulties at some of the company’s rivals. Chemicals group BASF, which invested €1 billion in a new Ludwigshafen plant to make its base plastic TDI, suffered a two-year delay in construction and had to settle for a smaller plant. Last summer, the facility then had to be switched off when the company recalled around 5,000 tons of TDI, after finding heightened levels of dichlorobenzene – an organic compound that can cause irritation of the eyes, skin and respiratory tract and is suspected of causing cancer.

Covestro’s competitors in China and Saudi Arabia have experienced similar problems. The TDI market is dominated by five big producers, with BASF and Covestro together accounting for 53 percent. The production outages led to a shortfall that benefited Covestro, which has had virtually no technical problems. “The supply of soft foam base material TDI is limited and demand is high,” said Heiko Feber, an analyst at Bankhaus Lampe. “As a result, Covestro was able to charge a high market price and is profiting from a fat margin.”

The supply bottleneck alone has pushed up prices, widening Covestro’s margin by three percentage points, the company said. TDI prices in Europe were up 42 percent in the third quarter from their already high levels in the year-earlier period, according to data from Citi Research.

“Demand remains very high and will continue to ensure high prices in the market – even if the supply increases.”

Christian Faitz, analyst at investment firm Kepler-Cheuvreux, on Covestro's fortunes

Third-quarter revenue rose 17 percent to €3.5 billion and adjusted earnings before interest and tax (EBIT) soared 74 percent to €705 million. In the first nine months, EBIT almost doubled from the year-earlier period to just under €2.1 billion.

“Investors have gradually recognized the company’s positive performance and bought shares,” said Mr. Faitz of Kepler-Cheuvreux.

But he and other analysts agree that the conditions won’t remain this favorable for Covestro indefinitely. Tim Jones, an analyst at Deutsche Bank, predicted that after a continued “very tight” market in the final quarter, supply will increase in 2018 when BASF’s TDI plant is expected to return to full capacity. Other rivals are also expected to overcome their production difficulties soon.

Mr. Feber of Bankhaus Lampe said Covestro’s 2018 revenue and earnings will likely sink in 2018. He predicted a net profit of around €1.6 billion next year and €1.5 billion in 2019.

But the party is far from over. “Demand remains very high and will continue to ensure high prices in the market – even if the supply increases,” said Mr. Faitz, adding that he was “very optimistic” for the next two years. He said many investors continued to underestimate Covestro. “Covestro is generally still perceived to be a cyclical company. But in fact, that’s not really a risk,” he said.

Hopes among investors that Covestro will make it into the top league of German shares, the DAX index, is a further factor boosting its shares. It’s among the favorites for selection next year. Stock-market operator Deutsche Börse bases its choice on two criteria: the market capitalization of a company’s free floating capital, and its share trading volume. Covestro meets both those criteria thanks in part to Bayer’s equity disposals this year, which increased its free float. So Covestro’s dazzling stock-market rally could have some way to run.

Michael Scheppe reported this story for Handelsblatt from Frankfurt. Jeremy Gray, an editor at Handelsblatt Global, adapted this article into English. To contact the author:

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