Bayer holds back on further Covestro disposals as share price continues to firm

LONDON (ICIS)–Bayer’s divestment of its outstanding stake in former subsidiary Covestro is considered by most a done deal but, with the acquisition of Monsanto by the Germany-based pharma and agrochems major not expected to close before the end of 2017 at the earliest, the need for cash is less pressing, according to European chemicals analysts.

Covestro’s current share price, however, would make a divestment of Bayer’s 64% stake at the former MaterialScience division, renamed in 2015 and listed on the Frankfurt Stock Exchange in October that year, a very profitable business.

The share closing price on 14 February marked the day Covestro’s stock tripled from its initial public offering (IPO) price back in 2015 – at €72.14/share, the company’s stock has rocketed from the initial €24/share.

Fourth-quarter and full-year results, due to be released on 20 February, are expected to keep investors queuing to buy stock.

However, Covestro had a positive 2016 due mostly to competitors’ outages for products like methyl di-p-phenylene isocyanate (MDI) and toluene di-isocyanate (TDI) causing earnings to rocket as prices for those two products spiked during the year (see graphs). 

However, as key TDI competitor German chemical major BASF is expected to finally get a grip on production at its large-scale plant in Ludwigshafen – with capacity production at 300,000 tonnes/year – the honeymoon for Covestro in that one product may come to an end.

BASF said on 15 February it would restart its TDI plant in “a few weeks” and sources in the market said that prices are likely to fall as a consequence.

TDI and any other markets becoming more balanced could slow down the company’s earnings growth and bring down the share price according to a chemical equity analyst at Germany’s private bank Metzler, Lars Hettche.

“I doubt this [share] price is sustainable, but a temporary phenomenon. Bayer could take advantage of the current price and place shares with some discount. It will happen at some point because Bayer indicated that it doesn’t want to keep its stake in Covestro in the long-term,” he said.

Bayer has said that it intends to divest some or all of its remaining Covestro stake in the mid-term. A company spokesperson declined to elaborate on the company’s current timeline for further disposals.

Covestro’s third-quarter results published in October caused the share price to rally further after the company reported very positive results for the nine months to September.

Covestro’s sales volumes for the January-September 2016 period improved by 8.4% year on year, which caused earnings before interest, taxes, depreciation and amortisation (EBITDA) to increase by 17% to €1.62bn, with earnings before interest and taxes (EBIT, or operating income) rose by a staggering 46% to €1.11bn.

Figures for the period’s revenue were in the red, however, down 4.4% year on year to €8.89bn mostly as a consequence of a 8% fall in selling prices, the company said.

Net income, key measure for Covestro’s dividend payments to shareholders, had accumulated large gains by September year on year, with the nine-month figure at €671m, up from €427m in the same period of 2015.

“Covestro’s 2016 performance was outstanding, better than anyone expected. Some prices for products like MDI or TDI rocketed over the year, as competitors weren’t able to bring material to the market, like BASF. It was the perfect environment for Covestro,” said Metzler’s Hettche.

“This situation could last for the first half of the year, but at some point the 20% or 25% EBITDA margins posted in the second half of 2016 will come to an end – Covestro is mainly a commodity chemicals company and those high margins don’t normally go together with commodity,” he added. 

The German bank recommends to its customers a ‘Sell’ on Covestro’s stock, placing the 12-month share target price forecast at €52.

Another German bank, Baader Bank, also expects the stock price to have depreciated in 12 months’ time at €45, and it also recommends investors to ‘Sell’ their shares. 

At the current share price, Covestro would be valued at around €14bn. Bayer still controls 64% of the company, as confirmed to ICIS this week by a spokesperson from Bayer, and the company does not have plans for the moment to divest its stake.

However, the roughly €10bn which Bayer could currently cash in from divesting its stake would ultimately help it finance its $66bn acquisition of US agrochemicals major Monsanto, which is under review by antitrust authorities in several jurisdictions, including the EU.

Most analysts, however, also believe that a delay for the transaction to be completed could be on the cards, as antitrust reviews take longer than expected. Ultimately, that would come as a positive for Bayer, who would not need urgently the €10bn it could get divesting its stake.

By waiting, however, it risks the share price will fall in coming months.  

Bayer maintains the financing to acquire Monsanto has already been secured. According to the spokesperson, it has secured a $57bn syndicated loan.

However, Bayer would still be $9bn short to the $66n it has promised to Monsanto’s shareholders. 

Some analysts have pointed that, regardless of performance, Covestro’s shares will continue to be at record highs until the actual divestment happens. They point out to everyone involved in the process wanting to keep the price inflated.

“You also have the M&A [mergers and acquisitions] part of the brokerage business being quite interested in Covestro… hence, every major brokerage company is waiting in row to get the tickets to place additional Covestro shares. Nobody is interested in talking the stock down,” said Oliver Schwarz, analyst at Germany’s Warburg Research, in an interview with ICIS.

Whatever the share price, analysts are certain Covestro’s annual results, to be published on 20 February, are likely to be the last in which the company is still majority-owned by Bayer.

Covestro’s share price since October 2015
Source: Covestro

Following the publication of its annual results, ICIS will be publishing an interview with Covestro’s CEO, Patrick Thomas

Focus article by Jonathan Lopez

Additional reporting by Pavle Popovic