Covestro Benefiting From A Cyclical Surge, But Trouble May Be Looming

Germany's Covestro (OTCPK:COVTY) (1COV.DE) is a pretty interesting story to me. Nobody disputes that this is one of the largest manufacturers of key chemicals like polyurethanes, polycarbonates, and specialty inputs like isocyanates. Nor does anybody dispute the ongoing long-term growth potential in markets like autos, construction, appliances, and furniture, as polyurethane and polycarbonate products offer meaningful performance advantages (insulating ability, weight, etc.).

What is very much in dispute is how much longer the good times can last. Covestro has benefited significantly from higher spreads fueled by good market growth, relatively sluggish recent capacity growth, and outages across the industry. Now, though, a fair bit of new capacity is soon to go online and is threatening to push industry operating rates down to a point where pricing will weaken.

That Covestro will see a cyclical decline seems all but assured, but the timing, depth, and length of the downturn are far less certain. Although the shares look potentially undervalued on the basis of EV/EBITDA, I've seen enough cyclical swings to know that the virtues of Covestro will be forgotten by the market if/when that cyclical decline materializes. With that, I'd rather wait for a pullback below my DCF-based fair value (which does attempt to model some cyclicality) to build a position.

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Covestro Benefiting From A Cyclical Surge, But Trouble May Be Looming