Covestro AG

XETRA:1COV

Earnings Call Transcript 2023-Q1

[Ronald Koehler, Head, Investor Relations]

Welcome to the Covestro Earnings Call on Q1 2023 Results. The company is represented by Markus Steilemann, CEO; and Thomas Toepfer, CFO. During the presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. [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 now like to turn the conference over to Markus.

[Markus Steilemann, Chief Executive Officer]

Thank you, Ronald, and hello and warm welcome also from my side to the results of our first quarter. Today we published our Q1 details after we had pre-released the headline figures two weeks ago.

Sales were down by 20% compared to last year to EUR3.7 billion, clearly indicating the global demand crisis we are currently facing. Against this trend, we achieved the first quarter EBITDA of EUR286 million, clearly beating the guidance of EUR100 million to EUR150 million given in early March. Free operating cash flow was also better than expected by us, despite the usual seasonal working capital buildup.

After positive trend in EBITDA during the first quarter and improved visibility going forward, we are now returning to a quantitative guidance for full year 2023 with a refined range for our financial KPIs.

Finally, as you recall, in the first quarter 2022, we initiated a EUR500 million share buyback program. The program was paused mid 2022 due to the recessionary environment. With more clarity on the outlook, we are now restarting the program in May.

Let's turn to page number three. In line with our vision to become fully circular and to achieve climate neutrality, we successfully completed two milestones and initiated a new project towards simplified recycling. A major circularity milestone has been achieved with Baytown, our US site receiving its ISCC plus certification. We are the first manufacturer of polyurethane and polycarbonate raw materials in the United States achieving this.

Now the Covestro network of ISCC plus certified plants reaches across nine major sites spanning across all regions. This network allows us to regionally produce and offer a broad variety of our circular intelligence materials to our customers. These products contain a minimum of 25% sustainable content and are marketed under the CQ brand.

The second breakthrough is related to the EU funded PUReSmart project for chemical recycling of polyurethane mattresses. This project has been completed successfully with closing the loop from polyurethane foam to a chemical recovery of raw materials in a high level of quality and purity. Now, for the first time, a flexible foam sample has been produced from the fully recycled polyol and TDI. Both raw materials were obtained in Covestro pilot plant in Leverkusen, which were inaugurated in 2021.

A new governmentally funded project has been initiated by a consortium of industry and science to design future automotive headlamps from a polycarbonate mono material. The project's target is to design lighting systems in such a way that they can be recycled at the highest possible value-added level. Covestro is the partner of choice for this project as we do not only have extensive expertise in this area, but we also already showcased a visionary headlamp concept a few years ago. During the three-year project, the transfer of the results to other applications like the appliance industry will be also examined. We will keep you posted on the outcome of this exciting new endeavor.

Let's turn the page -- to page number four. Despite a reduced CapEx plan for 2023, we nevertheless planned to spend almost EUR400 million for growth projects with a focus on solutions and specialties. During the first quarter, we announced two important projects. Firstly, our business entity thermoplastic polyurethane will be built its largest site in Zhuhai, China with an overall capacity of 120,000 tons. It will be constructed in three phases until 2032. The mechanical completion of the first phase with the capacity of 30,000 tons is estimated for the end of 2025. The total investment lies in the low three digital million euro range. This will also be the company's largest investment in the TPU business. The site will furthermore utilize the most advanced production technologies and will be run on 100% green power. We expect the EBITDA contribution to be in the range of a low to mid double-digit million Euro.

TBUs are a highly versatile plastic material offering a broad range of properties for diverse set of applications. Most prominent applications are the IT, consumer electronics, footwear and automotive industry. The second example comes from our business entity specialty firms. The high double-digit million euro investment into new extrusion lines at the Map Ta Phut site in Thailand will be completed by 2025. The added polycarbonate firms production is an answer to the increasing demand and supporting our expansion of future technologies and industries.

Our Makrofol and Bayfo product range is used primarily in the identity documents, medical and electronic industries. The EBITDA contribution we are expecting lies in the low to mid double-digit million euro range. Both investments have in common that we are also expanding our sustainable CQ product range with at least 25% alternative non-facile raw materials.

Now let's turn to slide number five. We are now coming to the volume development in the first quarter 2023. Year-on-year, the global sales volume decreased by 17% caused by significantly weaker demand across all regions and limitations in our internal availability. The region Europe, Middle East, Latin America has seen significant decreases in almost all industries important to Covestro and was again, clearly the weakest region. Part of the volume weakness was caused by our production limitations in Germany. We plan a gradual ramp up of the production during the second quarter and third quarter, and the return to a normal output in the fourth quarter of this year.

Asia-Pacific is also showing a clearly negative volume development across all industries with a modest pickup after Chinese New Year. Electro, automotive and construction decline significantly and furniture lightly. Sales volumes in North America were also declining, but with a more mixed picture. Construction is showing a considerable decline, electro is still with a slight decline, but we observed in end of destocking in furniture wood with slight increases and also slight increase in auto and transport.

That concludes the overview on the demand development, and I'm now handing over to Thomas, who will guide you through the financials.

[Thomas Toepfer, Chief Financial Officer]

Yes. Thank you very much Markus, and also from my side, a very warm welcome to everybody on the call. I'm on page six of the presentation. So let's start with the sales bridge.

As you can see, our sales declined 20.1% to EUR3.7 billion, and Markus already mentioned the negative volume growth of 16.8%. That is almost equally spread across both segments, PM and also Solutions & Specialties. You can also see that our sales were affected by 3.9% lower prices. That, however, was mainly coming from performance materials with negative 7.1% and only negative 0.5% decline from Solutions & Specialties. And you also see there's a small FX effect of 0.6% year-on-year driven by the stronger US dollar and stronger Chinese RMB.

So let's go to page seven and you have the EBITDA bridge. Also here, of course, volumes in Q1 significantly affected our EBITDA and that shows that we are still in a very weak demand environment. You can also see the negative pricing delta with price decreases as an effect of the low demand and the ongoing destocking. And in Q1 raw material energy price increases contributed to the negative pricing delta. However, as of Q2, we do assume a year-on-year tailwind from lower variable cost.

You see also a positive development from other items. And behind us is significant cost savings, which we realized especially in the Performance Material segment. So that overall, EBITDA came in at EUR286 million, clearly above the guidance of EUR100 million to EUR150 million, which we had given and the better than expected results are driven by, as I said, strict control of fixed cost and the lower than expected burden from the pricing delta.

So let's look at the sequential development on page eight. As you can see on the upper side of the page, sequentially, we see a slightly negative sales development, which is due to minor reductions in price and also currency. But I would like to highlight that we are looking at stable volumes sequentially. And if you look at the lower part of the page, you can see that our EBITDA is coming back into positive territory from the historical low point which we had in Q4 last year. And also with that, of course, we have finished the negative trend in terms of our EBITDA margin and we're returning to a positive 7.6%. And therefore, I think with this we do see that Q4 actually represents the trough of the cycle.

So let's look into the segments and go to page nine where you have Performance Materials. Overall, sales declined sequentially. This is driven by a strong sales decline in APAC because of the Chinese New Year, followed by a slight decline of sales in North America. However, we've seen slight sales increases quarter-over-quarter in Europe, Middle East, and America.

And in Q1 2023, if you look at the lower part of the page, EBITDA of EUR173 million is significantly below last year, but however, it is significantly better than expected and also increasing sequentially. So the year-over-year decline is driven by the volume decline, the negative pricing delta, which was counterbalanced partly by positive fixed cost development. If you look at the EBITDA sequentially, we are returning to positive numbers driven by the fixed cost savings, the positive pricing delta quarter-over-quarter, and additionally, of course, the usual seasonal inventory up.

So let's now go to our segment Solutions & Specialties on page 10. The year-over-year demand weakness also here is a major factor for the sales decline. If you look at the upper side of the page, you see sequential sales growth in EMEA benefiting from positive volumes, but slightly negative pricing. And the regions APAC and also North America are still declining.

If you look at the lower part of the page, you see that our EBITDA for Q1 2023 is below our Q1 2022, and the positive pricing delta -- and we have a positive pricing delta, which I would like to emphasize both year-over-year and also quarter-over-quarter. And the EBITDA margin of 8.8% is still depressed by destocking. So we do continue to see significant margin upside going forward.

Let's go to the next page 11 and talk about the free operating cash flow. So, first of all, if you look at the graph, you see we came in at EUR139 million in negative, which is below previous year, and of course, mainly attributable to the lower EBITDA year-over-year. What I would like to emphasize is there was, of course, a negative cash contribution from trade working capital built up of EUR257 million. But as you can see in the highlighted line item in the table, this is a purely seasonal effect. So I can reassure you that we run a very stringent working capital management, and we will limit this clearly to the seasonal rebound so that overall, and you've seen our guidance, we are targeting a positive free operating cash flow for the full year.

Also, if you look at the table, our CapEx is absolutely in line with our budget and the full year guidance, and you do see a negative income tax payment of EUR22 million, mainly driven by payments in China. So I would like to remind you that for the full year, we're expecting cash tax payments of between EUR200 million to EUR300 million for the full year.

On page 12, I would just like to explain two one-time effects which are affecting our P&L and therefore also on net income. So, first of all -- and you see it highlighted, we had D&A impairments in Q1 2023 at minus EUR33 million. EUR30 million of this relate to the discontinuation of our non-strategic and loss making Maezio product line and the closure of the site in Markt Bibart, it's non-cash item, but as I said, of course, it affects our P&L.

And secondly, I would like to talk about the DTA adjustments. So last year we adjusted our deferred tax assets in Germany, and as a consequence, based on the IFRS rules, we are no longer allowed to activate our tax loss carryforward in Germany as the accounting projections expect further losses in Germany in the full year 2023. So the tax rate will continue to be affected by the regional profit mix, and currently we assume a P&L income tax of between EUR150 million and EUR250 million for the full year.

What I would like to emphasize though, is that in contrast to the IFRS rules based on German tax rules, the tax laws carryforward can be used indefinitely. So this means we're confident that in the future we're able to use the tax laws carryforward in order to lower our tax rate and we're economically not making any losses by the IFRS rules. And as you can see, the impairments and the income tax together then cost the net income to be negative, which came in at minus EUR26 million.

So let's go to page 13 and look at our balance sheet. And let me start by saying our balance sheet remains very solid. The total net debt increased by EUR215 million versus the end of 2022. You see a decrease in net pension liabilities of EUR26 million driven by the increase in pension -- by the increase of the pension discount rate in Germany and in the United States resulting in a EUR404 million net pension liability, and that consists of pension provisions of EUR462 million, which to a smaller extent are offset by a net benefit from pension assets of EUR58 million.

Now, the total net debt to EBITDA ratio stands at 2.8 times based on a four quarter rolling EBITDA of EUR1.1 million. And quite obviously, based on our mid-cycle EBITDA, the ratio would look totally different rather in the region of 1.1 times.

So let me just close this chart by reiterating the key statement that Covestro remains committed to a solid investment grade rating.

With that, I would like to turn to page 14, and talk about our measures to improve the financial performance. And compared to our initial financial planning for 2023, we have identified several levers for cost savings and improvement of our financial performance during the course of this year. So already in 2022, a differentiated hiring approach was initiated, and that means we're only rehiring positions that are absolutely crucial for the company's performance or indispensable for the reliability and safety of the operations. And therefore, since the start of the program, the number of FTEs has been reduced by around 250. And we've also, on top of that, implemented a freeze for the contracting of temporary workforce.

Now, if you look at the other items on the chart in terms of operational savings, they are essentially based on lower maintenance costs, and that means our thumb costs. So savings from our LEAP transformation program and the additional long-term savings are supporting our cost ambition in this category. And then under the headline portfolio streamlining, we are eliminating non-strategic and loss making businesses like, for example, the Maezio product line and its production site in Germany. But I would also mention here the successful sale of our 3D printing business, which was also actually loss making. And in addition to that, we reduced various negative one-time items. In addition -- and that is the last bucket, we strongly reduce our underutilization costs and various small scale contingencies are, of course, also contributing to further savings over the course of the year.

So with that, let me come to the outlook for Covestro core industries on page 15. Compared to our last assumption, the outlook for the global GDP has slightly improved from 1.5% to now 1.9%, which is, of course, a step into the right direction, but far from normal growth rates with that we have observed in the past. This positive development, however, does not hold true. If we look at our core customer industries, the automotive growth expectation has been corrected downwards to 4.2%. However, within this, the electric vehicle outlook remains unchanged and strong with positive 43%. And this gives us confidence because our engineering plastics business and the polycarbonates exhibit a much stronger -- exhibition to EVs compared to classical combustion engine driven cars.

A very similar picture can be drawn for the construction industry. The further reduction to only 0.5% growth for 2023 is strongly influenced by the globally increasing interest rates. The higher construction costs and ongoing destocking and the outlook for the furniture industry remains also on a low level for the year 2023.

If you look at the electro industry, the demand expectations have been also corrected downwards to 1.7%, and against this negative development in electro within this the appliance industry is seeing stronger signs of recovery and is actually expected to grow at 4.4% after being negative throughout the year 2022.

So with this rather mixed picture from our customer industries, let's now come to our own outlook for 2023 on page 16. What I can say is that as the year progresses, our visibility clearly has improved and therefore, we decided to reinstate our quantitative guidance ranges for our core KPIs. And we're now expecting an EBITDA off between EUR1.1 billion and EUR1.6 billion for the full year 2023. And compared to our initial guidance, the increase is driven by successful internal cost measures and a positive development of the pricing delta.

We expect unchanged flat volumes year-on-year for the full year 2023 and sequentially, we expect a slight volume increase in the second quarter driven by seasonal effects and also better product availability in Germany.

Now, the seasonal effects are very much driven by Asia as the second quarter will not be impacted by the Chinese New Year, and also the usual improvement in the construction industry after the end of the winter period in the Northern Hemisphere. And in the second half of 2023, we assume further sequential improvement in the volumes mainly driven by resolving our own production limitations. So this should allow us to return to a year-on-year growth in the second half of 2023, given the low comparison basis.

As you can also see in the chart, the current mark-to-market calculation comes out at about EUR1.4 billion based on the March margins flat forward, and this is slightly above the midpoint of our new quantified guidance range. Our assumptions for the revised mark-to-market were lower fixed cost and the improved margins as of March with unchanged flat volumes for the full year.

And on this chart you can also see that we confirm our mid-cycle EBITDA level of EUR2.8 billion in 2024, driven by underlying capacity growth and of course, the realization of the RFM synergies.

So that leads us to page 17 for the overview of the remaining KPIs. As I said with the quantified EBITDA guidance, as I explained on the previous slide, is now EUR1.1 billion to EUR1.6 billion. We keep the EBITDA guidance range for our Solutions & Specialty segment to be around previous year. As you can see in the second line item, the free operating cash flows also upgraded, and we're now expecting a positive number within the range of zero to EUR500 million in 2023. This is mainly driven by the improved outlook for the EBITDA and the Solutions & Specialty segments delivering a positive free operating cash flow significantly above previous year.

Now, in line with the EBITDA adjustment, we guide for a ROCE above WACC between minus six and minus two percentage points. And the ESG KPI related to our net zero target comprises our greenhouse gas emissions, which we now guide to be between 4.2 million and 4.8 million tons. For the second quarter, we expect a sequential improvement in volumes and flattish margins, which should then lead to an EBITDA of between EUR330 million and EUR430 million.

For the other KPIs, I can tell you the financial result was slightly adjusted to be between minus EUR130 million and minus EUR170 million. And the closure of the non-strategic, and as I said, loss making Maezio product line and the related production site in Germany led to an impairment of EUR30 million. Therefore, we have increased our full year D&A guidance to EUR900 million versus the guidance which we have given in March.

Our ambitions for a strict CapEx regime remain fully in place, and we're guiding for EUR800 million, that has not changed. However, as I have alluded to in the beginning of the presentation, we continue our investments in the profitable growth of the company.

So with that, I would like to hand it back to Markus.

[Markus Steilemann, Chief Executive Officer]

Thanks a lot, Thomas. And I would now like to come to a specific topic, as we are not only quantifying our full year guidance, but we are also resuming our share buyback program. Let me quickly remind you, we started the EUR500 million share buyback program end of February, 2022, and the reason for the buyback program was that major M&A acquisitions were out of scope. We fed our share to be undervalued, and as such a good investment in two sub tranches of each EUR75 million, we purchased around 3.5 million shares in the first half year of 2022. Yet, due to the recessionary environment with the start of the second half of 2022, we had then temporarily suspended the share buyback to protect our balance sheet and retained cash within the company until an economic rebound becomes foreseeable. However, it was always our strategic intention to execute the share buyback in an anti-cyclical manner.

Now, our raised EBITDA and free operating cash flow guidance and the improved visibility that the second quarter 2023 will sequentially result in higher volumes and a further raised EBITDA. We consider this to be the right point in time to reinitiate the buyback. We are still firm in our opinion that our share is currently undervalued and deemed the investment into our own shares as best investment for our shareholders. Consequently, the third sub charge of up to EUR75 million will be launched in May.

Let's turn pages now to page number 19. A very busy chart. So let me guide you through it. As you know very well from the past and the current situation, Covestro's business is a cyclical business. In times of an economic downturn or our core products, MDI, TDI and polycarbonate are usually strongly affected. Our products are an early indicator of a crisis as we are at the very beginning of the value chain and have strong exposure to multiple consumer industries. There are steps in the value chain between us and the consumer market. But in time of crisis, the stop of stock replenishments is regular in immediate action and progressing very fast throughout the different value chains. So our products are an early indicator to an economic downturn.

During a recession, the value chain empties through destocking. Upon the start of an economic recovery, a fast and efficient replenishment of the value chain is also required again. Rebounds often create a strong demand to quickly refill the supply chain. These high growth rates usually lead to supply shortages, allowing Covestro to execute the pricing power to again realize financially attractive margins.

So despite the cyclical behavior, the long-term growth drivers for our products remain intact or even improve. The current energy crisis will have a positive impact on the growth of MDI and polycarbonate. The trend for effective insulation to save energy can add one to two percentage point to the growth rate of MDI in the future as MDI is the best insulating materials for buildings and appliances. And MDI is so versatile, it can also be used in the manufacturing of wind turbine blades giving additional benefits of longer lifetimes and reduced maintenance rates. Our polycarbonates are an essential part of the battery pack in most electric vehicles as well as a contributor to lightweight and technically advanced electrical features. This results in a two to five times higher use of polycarbonates in modern EVs compared to a regular combustion car. With that, we believe that once the crisis is over, we will see again a strong rebound of demand for our products.

Let's turn pages to page number 20 to another topic of special attention. In the past year, the competitiveness of European TDI production compared to competitor imports from Asia-Pacific was always a point of discussion. And yes, there were times like in the third quarter of 2022 when gas prices peaked so that the import of TDI was cost-wise a better solution than local production in Europe. Consequently, and supported by a temporarily significant gap of toluene prices between Europe and China, the imports were peaking at this point in time, taking into account the shipment delay of about six week. Also, we were importing TDI from our plant in China.

You can clearly see an above chart that the landed cost advantage of imports from China in the third quarter peaked even considering logistics and import duties of EUR350 to EUR600 per ton. But as soon as the gas prices were coming down, this advantage quickly disappeared. And with the continuous gas prices declined since the January, 2023 disadvantage has now reversed. So Europe, as a TDI production location, is definitely competitive and has its place to cover the market demand.

If we take a look at the imports that have been coming in from Asia-Pacific in 2022 around 100 kilotons TDI have been imported, and market prices have nevertheless peaked during the time of high gas prices. This clearly indicates that the market needs the European asset base for reliable supply. And with the announcement of a 300 kiloton of European production disappearing towards third quarter of 2023, Europe will even require more imports to cover again rising demand. Demand as of 2024 will exceed the local European production. And customers are hesitant to rely on import, given the supply chain interruption seen in the past two years. We believe that we have a clear technological and cost advantage with our gas phase TDI technology, and additionally, an advantage of having a production in the heart of Europe being able to supply TDI competitively to our customers.

So now let's turn to the last page of today's presentation. Let me quickly summarize on page number 21. Volume decline is resulting in lower sales or has resulted in lower sales of EUR3.7 billion in the first quarter, and that was caused by weak demand and ongoing destocking across many industries. Our EBITDA came in with EUR286 million above guidance range of EUR100 million to EUR150 million, and that was driven by cost efficiency and improved pricing data across both segments. This negative free operating cash flow of minus EUR139 million still came better -- came in better than expected, and it was held by ongoing strict working capital measures.

We also now quantified the guidance for full year 2023 with an expected EBITDA between EUR1.1 billion to EUR1.6 billion, and we resumed our -- will resume our EUR500 million share buyback program with a third tranche up to EUR75 million starting in May.

So -- and for questions that remain open, Thomas and myself are now here to answer them. With that, I hand over to Carsten who will guide us through the Q&A session. Carsten?

[Carsten Intveen, Investor Relations, Director]

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. Please unmute your microphone. Christian, could you please unmute your microphone? So far we have not been able to hear you.

[Christian Faitz, Kepler Cheuvreux]

Alright, sorry. Yeah. Can you hear me now?

[Carsten Intveen, Investor Relations, Director]

Yes. Very well. Thanks Christian.

[Christian Faitz, Kepler Cheuvreux]

Yes. Alright. After three years of teams, I still can't handle it. Anyway, good afternoon, Carsten, and team and obviously Markus and Thomas. Two questions please. First one, and very straight one. What is your order book visibility at present?

And the second one, I mean, I don't need to need to be nagging, but any particular reason why your R&D expenses in Q1 are up quite considerably in relation to the past, and should we count on a three digit quarterly figure going forward? Thank you very much.

[Markus Steilemann, Chief Executive Officer]

So, Christian, this is Markus speaking. Thanks for your question. Looking at the order book, for sure, for April, as we are, let's say, almost 100% because it's basically the last day of the months. For May, we see currently about 40% of the usual order intake, and that's not unusual. And for June, 20% roughly. And that, let's say, is not an unusual pattern, so to say, which gives us, let's say, quite some good insights about the month to come. So from that order, so to say, of order intakes and order book view, we definitely see that what we have baked in into our full year guidance and also Q2 guidance is obviously coming in.

Positive news is maybe if you look into some more specifics, there is, as you know, some talks about the general situation in North America in terms of, let's say, some economic macro indicators. What we see -- we have seen a slight dip in April, but it looks as if in May things are not only back to normal, but even slightly positive, a bit more positive than we expected it.

So maybe on the research development cost, I hand over to Thomas.

[Thomas Toepfer, Chief Financial Officer]

Yes. Christian, on R&D, they're up EUR11 million and EUR94 million to EUR105 million, in this is the effect from the impairments that I talked about in Markt Bibart, not to the full extent, but about a third of the EUR30 million impairment that we had to incur, finds its way into the R&D because it's -- it is material…..

[Markus Steilemann, Chief Executive Officer]

Intangible.

[Thomas Toepfer, Chief Financial Officer]

….intangible assets exactly which we had to impair. So essentially the full effect can be explained by this non-cash impairment of Markt Bibart.

[Carsten Intveen, Investor Relations, Director]

And the next question comes from Chetan Udeshi from J.P. Morgan. Please unmute your microphone. Chetan, so far we have not been able to hear you. Could you please unmute? [Operator Instructions] Okay. If there are issues, Chetan, you are not forgotten. Otherwise, we'll continue on the line and try again to get you into the call afterwards later on.

Then the next question comes from Matthew Yates from Bank of America.

[Matthew Yates, Bank of America]

Hey, good afternoon, gentlemen. I'd like to just dwell on the Q1 result for a minute, if that's okay, because obviously you came in double what you guided or I guess EUR150 million in absolute numbers. Can you just help me understand on that slide seven bridge, where exactly did the upside come from? Because it didn't seem to be volumes. So if it was cost, why didn't you already know about this fixed cost saving when you guided an early march? Or was it more about market conditions rather than the proactive things that, that you were doing?

And maybe if I can tie that into the slide 14 I think you had around some of the new initiatives that you've identified. Was there any aspect that the results from that were coming through faster than expected? Thanks.

[Thomas Toepfer, Chief Financial Officer]

Well, Matthew, this is Thomas. So, first of all, you are right. The positive development in Q1 was not driven by market conditions as we highlighted. We would say the demand is still pretty much depressed, specifically in Europe. So the outperformance really came from a better pricing delta and from cost savings. I would say they were equal in size maybe, the cost savings were even bigger than the pricing delta. The pricing delta improvement came very much in March and therefore at the end of the quarter. And the cost savings were driven by many small items, which then altogether summed up. So the visibility during the quarter is not always so big, but I think we also expressed already during the quarter that our guidance seemed somewhat conservative, therefore it did not come as a total surprise to us.

And I think we were indicating with page 14 is that those savings were not short-term measures, but they're really the result of also structural things, which we have implemented in the course of our LEAP program, and therefore we do think that they are also sustainable over the course of the year.

[Carsten Intveen, Investor Relations, Director]

And the next question comes from Markus Mayer from Baader Bank. Please unmute your microphone, Markus.

[Markus Mayer, Baader Bank]

So good afternoon, gentlemen. Three questions is for me. And coming back to this cost settings, which were higher than expected, of this guidance, or implicit guidance range, how much came from this cost savings and how much came basically from a better pricing delta? That would be my first question.

Then a second question is on this outlook overview from end customer industries and also GDP. Three out of four most important end market. So, at least according to the assumptions you have, the ones you had with fuller reporting, so decline in the outlook, whereas actually proofs now and puzzled. What is basically more important for you is basically at the end the [indiscernible] net zero change was your original volume assumption for the group. That's my second question.

And then the last question is on TDI, is that last year, roughly 100,000 tons have been imported to Europe, is this is net zero [ph]? Also the maximum of imports which can be imported to Europe given its chemical activity, or what would be theoretical maximum number which could be imported to Europe? That's all for my side.

[Thomas Toepfer, Chief Financial Officer]

So, Markus, let me start with the first question. The way I understood it is that, that your question is, our mark-to-market came up from this EUR1 billion to the EUR1.4 billion. If you plug in the margins as of end of march and apply to flat volumes for the full year, and this EUR400 million uplift relative to the EUR1 billion that we had given early in this year essentially comes from 50% of that is better pricing delta, and 50% of that is better cost positions that will find its their way into the 2023 results. So EUR200 million from the one and EUR200 million from the other.

Maybe on the other questions, Markus, you want to talk about TDI?

[Markus Steilemann, Chief Executive Officer]

Yeah. Absolutely. So, Markus, if you look at the TDI import capacity, what we are basically talking about is not only shipping capacity, but we -- what we need, we need storage capacity and unloading capacity in respective harbors, which is a key challenge as we're talking here about hazardous and very reactive chemicals. So having said that, it is not easy to build those capacity up. But even if it is built up, let me quickly recap on what I tried to explain a little bit earlier in one of the slides. It is absolutely necessary that we get this additional capacity imported into Europe as one of the largest sites in Europe, which represents roughly 40% of European based capacity is about to be shut down by third quarter of 2023. That means we have name played out 300,000 tons. How much real available capacity is represented by this? The jury is out. Nonetheless, we and our customers strongly believe in the growth opportunities and their demand for TDI, and therefore, we need import capacities. Otherwise we will have at least for some time temporarily maybe a shortage of TDI in Europe.

So we need this capacity, and therefore you can assume that there might be an upscaling within this year of another 50,000 tons of import capacity on top of the 100,000 tons that we have seen being imported last year. So, yeah, once again, it's difficult to judge talking about, let's say, the chemistry we are handling here. We need that import capacity and we feel in this overall situation as the -- yeah, let's say, one of the last two standing TDI suppliers with the IP protected leading cost position, let's say, very well-positioned in that market.

Then back to Thomas.

[Thomas Toepfer, Chief Financial Officer]

Yeah. So maybe just on your second question, if I understood correctly, you said, well, there's -- the outlook is slightly less positive for the Covestro industries. How does that get along with our assumption of flat volumes? So I would say two things. One is, the change in growth rate of course is very, very small. So we're talking 0.3, 0.5 percentage points per industry, which I would say is within the normal volatility range.

And secondly, I mean we're still talking about growth in all our customer industries, and our assumption for 2023 is flat volumes relative to 2022. And therefore, I would say those numbers for us were not significant enough as to change our assumption. We do think it's well based.

[Carsten Intveen, Investor Relations, Director]

And the next question comes from a British telephone number, starting with 207774. If you please could state your name, company name, followed by your question and please unmute your microphone.

[Unidentified Analyst]

Hello?

[Carsten Intveen, Investor Relations, Director]

Here -- I can hear you. It's Georgina?

[Georgina Fraser, Goldman Sachs]

Yes. It is Georgina. Sorry, I don't even know my phone number because it comes through some weird channel. Okay. Hi, Markus. Hi, Thomas. Hi, Carsten. Thanks for taking my questions.

Thomas, I actually just wanted to follow-up on your volume assumptions. So exactly the point you made, you are actually talking about growth and you even revised up your GDP growth assumption. So, why are you forecasting to under grow the end markets? And then into a little bit more detail, did notice that you had revised up the appliances outlook. Could you maybe talk a little bit about what's driving that, and if it's something that you're already seeing today or just a change in assumption that's coming later in the year?

[Thomas Toepfer, Chief Financial Officer]

Yes. Georgina, why are we undergoing the industry? And again, we're talking relatively small numbers. This is due because we, as you know, have some production issues in Germany, specifically in our Dormagen site, so that we have limited output and had to declare force majeure. Now turn it positively. The repair work is going on as planned, and we're making good progress here so that we're working on it over the course of the second and the third quarter, and we should be then in full swing back again at the end of Q3, beginning Q4. But as we, in addition, of course, to the demand environment, which is still a little somewhat slow, we also have some output issues. We do think that flat volumes year-over-year is a fair assumption.

Now, on the appliances, I'm not sure, Markus, whether you have deeper insights, what's behind this?

[Markus Steilemann, Chief Executive Officer]

Well, from my perspective, it's -- maybe a simple reason, but under appliances is not only, let's say, refrigerators under appliance, but other white goods, so to say, which means, there's other things like washing machines, -- sorry -- yeah, dishwashers. Yeah. So, my most beloved device at home. And the issue here is it's a very tiny one, availability of chips. So there is an increased production rate simply because the supply chain's getting back to more normal level with availability of, let's say, low class microchips, and semiconductors. And that's one of the reasons why this overall, let's say, provided external outlook has increased. But it is not that substantial for us as Thomas mentioned, because that's not particularly driven by the refrigerator market, which is the most important, let's say, submarket in appliances.

[Carsten Intveen, Investor Relations, Director]

And the next question comes from a British telephone number, starting with the 782787. If you please could state your name, company name, followed by your question, and please unmute your microphone.

[Charlie Webb, Morgan Stanley]

Hi, there. It's Charlie Webb from Morgan Stanley. Can you hear me?

[Carsten Intveen, Investor Relations, Director]

Very well.

[Charlie Webb, Morgan Stanley]

Brilliant. It worked. Maybe just two questions from me. So first, just thinking about the spreads, maybe you can just walk us around a little bit obviously you kind of alluded to a slightly better kind of volume indication seasonally and sequentially, looking through the year. So just how do you see spreads shaping up in terms of that balance of supply/demand across some of your key commodities? Just a sense on that regionally, and by you those -- kind of key commodities, NDI, TDI, polycarbonate would be really useful.

And then just second question, on TDI itself. Obviously, some talk around some of the limitations MOFCOM has put on TDI prices for one of your competitors to close the deal that they are currently undertaking. How do you think about that in terms of what it -- has or what implications it has for the China TDI market? And how would you calibrate that into your kind of mid-cycle thinking in its current form? Does it reduce kind of your mid-cycle as it relates to TDI earnings in in China? Does that have a small impact or not? Just trying to understand that, would be great.

[Thomas Toepfer, Chief Financial Officer]

Yeah. Charlie, let me maybe start with the -- with a spread question. So I think from an overall picture, you've seen that our mark-to-market stands at 1.4, our midpoint of the EBITDA guidance is at 1.35. So essentially what we've done, take the number and maybe reduce it slightly. I'm not going to call it a haircut, but it's a slight reduction that we've made.

If you look into the immediate future, that's also true for the second quarter. So we're essentially assuming that the uplift that we're expecting for Q2 in terms of EBITDA is purely coming from better sales volumes, which are seasonally driven. And as I said, the fact that China has no Chinese New Year, and that the construction season is kicking in, but we're essentially assuming that the margins stay flat also in the second quarter of the year.

The upper end of the guidance 1.6 would require some meaningful upside of the margin to happen the second half of the year. I think this is in the cards if demand picks up, but of course, we're not planning with it. As I said, our base assumption is still flat volumes and also, margins essentially flat forward. So -- yeah, so I think that would be it from my side on the spread.

Maybe Markus you want to talk about TDI.

[Markus Steilemann, Chief Executive Officer]

Yeah. Thanks Charlie for your question and thanks also for once again hinting on TDI. So what's the situation? One, the largest, let's say, local producer of TDI in China has bought a smaller competitor. And one of the first measures is that they will shut down a smaller capacity in the order of magnitude, I think a 30 or 40,000 tons of TDI capacity. So a kind of a small consolidation is going on there. However, given the size of those players, that has called the anti-trust authorities on stage and they have gone through a rather, let's say, sophisticated paper that kind of limits the opportunity of setting the price for TDI in China. However, that goes back, I think for, looking three to four years backwards on the pricing. And we must not forget that, for example, one of those years was 2021, where we have seen rather high prices.

So long story short, I would not expect that this overall regulation, including, let's say, this potential price cap, if I may call it that way, will have any significant impact on our ability with regard to earn money with TDI. And secondly, also on our ability with regards to our mid-cycle earnings not only because of that very specifics that I just described, but it is just one country and it's just one product which is not representing the major share of our entire product portfolio.

Let's not forget about the wonderful products like MDI, polycarbonate and the Solutions & Specialty segment. I hope that answers your question.

[Carsten Intveen, Investor Relations, Director]

In the meantime, Chetan Udeshi from JP Morgan emailed me his questions. Let me read it out for him. And thanks Chetan for doing so. First, he's surprised as you're guiding to flat net pricing in second quarter versus first quarter. As we have seen prices come down for MDI, TDI, polycarbonates in China and Europe. Do you think external pricing data don't fully reflect what you are seeing?

Second, it seems second quarter volumes need to be up 5% plus quarter-over-quarter for you to deliver the midpoint of the EBITDA guidance. Can you please clarify how much of this is better availability versus underlying demand? And related to question two, what are you assuming for second quarter year-over-year volume growth?

[Thomas Toepfer, Chief Financial Officer]

Yes, Chetan. So, we are not guiding net pricing to be flat quarter-over-quarter. We're guiding net margins to be flat. So yes, you are seeing that prices are coming down for MDI, TDI, PCs, et cetera. But as I also said in my speech, we do see some tailwind from raw materials kicking in. Remember, there's always a -- not insignificant time lag of some month in our data. So therefore, yes, I know it's always a little difficult to build the bridge between the prices that you're observing. But -- and the margins that we are guiding for, because we, of course, have some more visibility on how raw materials are coming in into our P&L and therefore, yeah, let me say we do think it's realistic that margin wise we're talking flat development quarter sequentially.

And secondly, you said volumes have to be up 5% sequentially to deliver the midpoint of the EBITDA guidance. I would say this is -- I can follow this logic and the numbers, so it does not seem to be totally off. How much of this is better availability? That is the smaller part. The bigger part is underlying demand, but again, this is not so much fundamental lift up, but it's -- there's no Chinese New Year in the second quarter and the construction season is kicking in. So we're not saying that things are getting fundamentally better, it's just seasonality that, of course, will play a role here.

[Carsten Intveen, Investor Relations, Director]

And the next question comes from Jaideep Pandya from Onfield Research. Jaideep, please unmute your microphone.

[Jaideep Pandya, Onfield Research]

Thanks. The first question is on free cash flow. If I take like EUR1.6 billion as your upper end and EUR500 million as your upper end for free cash, could you just tie those two numbers because you've hardly paid any cash tax. So if you are going to pay between EUR200 million and EUR250 million of cash tax, are you actually assuming a networking capital inflow despite volume pickup? Because otherwise I can't seem to square how you get to EUR500 million free cash from EUR1.6 billion EBITDA.

The second question is around your energy costs. So in the improvement of spreads in March and assumption of some spread improvement through the year, how much is the energy cost component playing as a role? So could you just give us some quantification of what you expect for energy cost this year versus last year?

And then the third question really is on MDI. If I just use furniture as a reference industry, do you expect growth to rebound to the sort of five-year historical average for all this MDI capacity that is coming? Or do you think that even if we under undergo maybe for the next 12 months, because it is coming from essentially one player and that player is expected to be disciplined, we won't have overcapacity issue in MDI? Thanks a lot.

[Thomas Toepfer, Chief Financial Officer]

I hope I got all the questions. Let me start with the cash flow. So the thing is, if -- let me first explain the midpoint of the guidance. So if you start with the midpoint in terms of EBITDA and then you deduct the EUR800 million of cash tax payments and then you the -- sorry -- the EUR800 million of CapEx, and you deduct EUR200 million to EUR300 million of cash tax payments and a little bit of other items, then that brings you to the midpoint of the EBITDA range. Now, if you are assuming that we are achieving the upper end of the EBITDA, the thing is that this means there will be a significant uptick in demand and that will then lead to higher working capital needs. So therefore, to your question, we're not per se, planning with a big uptick in working capital if we talk about the midpoint of our guidance, because then we will probably be at the same level end of 2023 as we were in 2022. However, of course, is there -- if there is a economic recovery which will then also lead to higher demand in 2024, that would have a somewhat counter effect in our working capital because we would have to increase our inventories in order to be able to build up or to supply the demand in 2024.

And therefore, I think key to my message is if we increase our EBITDA, that does not flow through to a 100% into a free operating cash flow that explains the upper end of the guidance for the free operating cash flow.

Energy. Sorry. Yes. I mean, just on energy, we had energy costs of EUR1.8 billion last year. That is almost double the amount than what we had two years before. Our energy costs in the first quarter of this year were roughly EUR300 million, driven by two things. One is the energy prices came slightly down, but our consumption went up because first of all, Q4 is seasonally lower, plus we have started our chlorine facility in Tarragona, which is quite energy intensive. So EUR300 million is the number based on, as I said, somewhat lower prices, but higher consumption. And our assumption for Q2 is that it will stay roughly on the same level.

It's difficult to predict it for the second half of the year. But again, energy cost is only one part of the equation. Our assumption is flat margins. And probably if you multiply 300 times four, you're not totally off, or at least we don't have a better expectation for 2023.

[Markus Steilemann, Chief Executive Officer]

Yeah. Maybe then, on -- Jaideep, on the last topic with regards to MDI. So we believe that structurally MDI growth is fully intact. We also believe that -- and you said, well, just let's take the furniture example as one example, but to really look into the MDI growth, there's two things that need to be considered. Number one is, we're not only talking about newly constructed private and commercial buildings, but also about a significant market for refurbishment of buildings. And not to forget that about 25% to 40% of global energy demand is driven by cooling and heating of buildings. So there's a huge need for more, let's say, energy efficient buildings. And that is the key driver for retrofitting of homes and new built homes for insulation materials where MDI plays a major role. And that's why looking at that demand pattern, first and foremost coming out of a crisis, there is a high chance that the market would show a very strong rebound pattern, which would then very fast lead into balanced markets.

And looking a little bit further out, there is, from today's perspective, an announcement, limited capacity built up to 2025 and 2026, and following years, in 2026 and following years, there is currently even no announcement about additional capacity being built or edited. So the market might even get short or very short in the midterm, and you cannot just turn on the tap and say, okay, let's produce some more MDI, no matter how you do it, it takes a couple of years from the first planning/announcement to really get quality MDI out of the pipes. And that's why from today's perspective, you might come to a gloomy outlook. I would say with a quick rebound, limited announcements and also the need for structural need for MDI given, let's say, the sustainable development and energy, let's say, reduction targets, the MDI market is still intact.

[Carsten Intveen, Investor Relations, Director]

And the next question comes from Sebastian Bray from Berenberg. Please unmute your microphone, Sebastian.

[Sebastian Bray, Berenberg]

Hello and thank you for taking my questions. I would have two please. The first is, if I go back to the last time, Covestro was doing well in excess of EUR2.5 billion of EBITDA back in 2018. I recall the stock bought back in that year was a little in excess of EUR1 billion, if memory serves. I appreciate the capital allocation. Technicalities have changed in the meantime, but if EBITDA does go back to that level, is that a number that you'd feel comfortable with?

And just related to that on the buyback, this EUR75 million, is there a time period over which these shares are due to be repurchase, or it's just open-ended? It'll take a few months and then you'll see how it goes. Thank you.

[Thomas Toepfer, Chief Financial Officer]

No. I mean, let me start with the last one. So, the up to EUR75 million is the normal tranche that we have, so usually this runs until -- runs for six weeks until the end of June. Remember, this is consistent with the two earlier tranches that we did in 2000 and 2022.

I'm not exactly sure whether I fully understood your question on the -- your first question on the buyback. So yes, we had an EBITDA in excess of EUR300 million. Yes, there was a buyback in excess of EUR1 billion with an average price north of EUR70. I think we have since then, as you correctly said, adjusted our capital allocation policy with the topic of buyback being a purely opportunistic and anti-cyclical measure that we would take. But we would also say that at the current share price, we do think it's an attractive investment. We do think that the share is undervalued and therefore, this is the key argument for us to restart our buyback with a tranche of EUR75 million. But our view, as to what should the order of magnitude for a buyback be and what also should be the way be it is executed, I would say has fundamentally changed since 2017, 2018.

[Markus Steilemann, Chief Executive Officer]

So, Sebastian, we're a little bit, let's say -- we were a little bit unclear about, let's say, your first part of the question. Was it related to CapEx if we would return back to mid-cycle earnings level? Can you just, please repeat it? Maybe we didn't get the question clear here.

[Sebastian Bray, Berenberg]

Yes. No, the answer was the one I was looking for, which is if you feel comfortable, let's say, if you go back to mid-cycle, what you call mid-cycle for EUR2.8 billion, is a buyback equivalent to what happened when you last did an EBITDA around that level where the number was in excess of EUR1 billion potentially on the cards. And the answer seems to be no, we fundamentally reassessed being opportunistic as regards buying back shares. Is that right or?

[Thomas Toepfer, Chief Financial Officer]

Absolutely correct. You said it nicer than I could say it.

[Sebastian Bray, Berenberg]

Okay. That's helpful. And if I may just push for one more, polycarbonate market, I don't think you've mentioned any of the comments related to that, we focused on polyurethanes. How is that trading at the moment?

[Markus Steilemann, Chief Executive Officer]

Yeah. Well, as you know, we have intensively changed our exposure in terms of what polycarbonates market we are talking about. And that's why also in modeling, let's say, the results of Covestro, it's getting maybe a little bit more difficult as we have significantly outgrown in the Solutions & Specialty polycarbonate markets and shifted significantly our portfolio to that, let's say market. So what does that mean? We have meanwhile about 70%-plus sales in the Solutions & Specialty polycarbonates segment. That means our exposure is 30% minus in the commodities area, and that commodities area is very depressed. And at the same time, we have leading assets in all regions. That means, on the one hand, that provides us with very low and cheap feed stock. And on the other hand also helps us even in, let's say, highly priced competitive markets to still be positive on modular income -- on margins for the commodities.

And it also leads to a second effect, that even though commodities are very depressed and specialties to locate, the overall down -- the overall market, sorry, the overall earnings for us is less volatile than they have historically been due to that shift in product mix in the polycarbonate exposure. And we're pushing hard to further increase the specialty share in the portfolio. You could guess that every year between 5%, 4% and 5% is shifted towards the Solutions & Specialty segments so that at one point in time soon, three, four years maybe, we only have an opportunistic exposure to the PC commodity markets.

[Carsten Intveen, Investor Relations, Director]

And we have a follow up question from Jaideep Pandya from Onfield Research. Please go ahead with your question and please unmute your microphone, Jaideep.

[Jaideep Pandya, Onfield Research]

Yes, thanks. Sorry to ask you this again, Thomas. But you had a working capital burn of 257 in Q1. So what I was actually trying to ask you is what do you expect for working capital for the rest of the year? Because otherwise, honestly, I'm a bit struggling to square the math because again, you had a CapEx of 120 and you are guiding for 800. So a lot of these numbers are a bit under what you're guiding for on a full year basis. So that's why I'm struggling a bit for bridging the EBITDA to cash. So could you give us some color on what you expect for working capital?

[Thomas Toepfer, Chief Financial Officer]

Yeah. Sorry that I was not clear. So essentially we're expecting that working capital should be neutral for the full year 2023. So, the EUR250 million that you see negative in Q1 is a seasonal buildup, which should then be neutralized over the course of the year. That is the -- yeah, the usual swing that we have. And therefore, if you take the midpoint of our guidance, the number that I will plug in for working capital is essentially zero.

[Carsten Intveen, Investor Relations, Director]

Thank you, ladies and gentlemen, for all your questions. There are no further question at this time. So handing back to Ronald.

[Ronald Koehler, Head, Investor Relations]

Yes. Thank you of all for all your interesting questions. If you have more questions, don't hesitate to come back to the IR team. And with that, I wish you all a good afternoon or going on for the next conference call, I guess. So -- yeah, goodbye from my side. Thanks. Bye.