StockBeat: Covestro-Apollo Report Strengthens the Case for Cyclicals

© Reuters.

By Geoffrey Smith — A week dominated by IPOs that showed the insatiable demand for growth is ending with a story that – just about – keeps the tired old narrative of rotation into value stocks alive.

Bloomberg reported on Thursday that Apollo Global Management (NYSE:) is looking at a possible acquisition of German chemicals company Covestro (DE:), a fine example of a beaten-down cyclical stock whose inherent strengths have been largely forgotten amidst the chaos of this year.

Covestro, which was spun out of the conglomerate Bayer (OTC:) as it pursued the higher valuations attached to life sciences stocks, is a classic cyclical. While much of the buzz around its spin-off was generated by how its advanced plastics can make the cars of the future lighter, it only generates one-fifth of its revenue from automotive. The rest is spread relatively evenly among the furniture, construction, electronics, chemicals and health and cosmetics sector. As such, its exposure is split between business investment and discretionary consumer spending.  

The cycle has been hard on Covestro for the last two years. EBITDA peaked in 2017 at 3.4 billion euros ($4.0 billion) and had already halved by 2019 as President Donald Trump’s trade assaults on China hit a market which accounts for one quarter of its revenues.

The pandemic has made things substantially worse: revenue was down 23% in the first half and the group’s lack of visibility left it forecasting full-year EBITDA for 2020 at anything between 700 million and 1.2 billion euros. Net debt, at nearly 3.2 billion, will be over four times EBITDA at the bottom of that range.

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Short-term investors tend to get rattled by such developments, and a debt downgrade from Moody’s in June to Baa2, with a negative outlook, didn’t help much either.

However, the traditional strength of private-equity buyers like Apollo is their willingness to look through cyclical volatility. Apollo has already made one killing in the chemicals sector with its investment in LyondellBasell after the financial crisis. By comparison with Lyondell’s at the time, Covestro’s balance sheet today look like a veritable fortress. If confirmed, interest in Covestro from a buyout group with that track record would therefore be a massive vote of confidence.

Even after a 7% rise on Friday in response to the news, which leaves it 74% above its March lows, Covestro’s shares are still barely at half their cyclical peak back in 2018.

While it may still be a while before the cycle turns decisively in its favor, reports of such interest are a strong argument that the downside from here is limited.

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