Think fast: What’s the difference between cyclicality and circularity?
Both are key concepts in the business of Covestro, the big German chemical company and plastics maker that spun off from Bayer in 2015.
Many industries are subject to cyclical business patterns, of course. For Covestro and its competitors, cyclicality in the supply-and-demand equation is particularly important.
It typically takes seven years from a decision by the company to build a new production facility until the first products roll out, notes Thomas Toepfer, the company’s finance chief.
“We’re convinced that spending money on new installations is the basis for future profitable growth,” Toepfer says. “But on the supply side, there are peaks, where, for example, two new plants hit the market at the same time.”
That’s just what happened at the end of 2018 when new production capacity in Asia caused a glut in the supply of materials Covestro produces that are used in the manufacture of products as diverse as building insulation, electric vehicles, and mattresses. Consequently, market pricing for such materials fell sharply.
That put pressure on Covestro’s margins — a situation that is likely to continue in 2020, with much excess supply still to be absorbed. In response, Toepfer has stepped-up attention to cash flow with new cost-control and working capital initiatives.
“The trick is how to match a seven-year capex cycle with much shorter cyclicality in profitability, and maybe even shorter-term expectations from investors,” says Toepfer.
Because of potential investor sensitivity, Covestro is committed to keeping its dividend at least stable, regardless of economic conditions and profitability.
Part of the messaging to investors is about the necessity to invest in research and development efforts that aren’t quickly converted to profit. “It’s a delicate balance that we have to strike, which is a challenge for all the leaders in our company,” Toepfer says. “We’re pressuring people on costs and, at the same time, telling them to come up with new ideas and projects.”
As it happens, R&D is a critical element of what’s known as economic circularity, which can be considered a subset of sustainability. The term refers to the creation of systems designed to minimize waste through the continual re-use of resources.
Covestro’s strategy calls for 80% of its R&D spending to contribute in some way toward the United Nations’ Sustainable Development Goals initiative.
An End-to-End Strategy
Considering that BlackRock, the world’s largest asset manager, is changing its investment strategy because it considers sustainability to be a defining factor in companies’ long-term prospects, Covestro may be quite well-positioned.
A core element of the company’s purpose “is to find more applications for our materials that help save energy and make the world more sustainable and efficient,” Toepfer tells CFO.
Covestro makes foam for the insulation used in energy-efficient buildings. Also, its polycarbonates are used in making high-performan lightweight materials that can replace steel and iron in electric vehicles.
And the company has a coatings and adhesives business that makes hundreds of products geared toward sustainability. For example, it makes coatings for windmill blades that allow the blades to be replaced less frequently. “If the blades last 12 years instead of 7 years, it changes the entire business case for wind energy,” the CFO says.
The company is making increased use of wind energy itself. Much of the energy generated in Germany is still coal-based, so it has entered a power purchase agreement with a wind park in Denmark that so far is generating about 6% of the energy the company uses in Germany.
The wind deal was a perfect example of the tradeoffs Toepfer has to make in balancing short-term profitability with long-term attention to sustainability. “It was probably proposal No. 3 on wind energy, because Nos. 1 and 2 were declined — they weren’t profitable enough,” he says.
That’s one of many efforts to promote sustainability in procurement, logistics, and production activities. Covestro also is working on a bio-based replacement for crude oil in the production of aniline, a vital precursor product to polyurethane and other industrial chemicals. And it’s refining the energy-intensive process of breaking down saltwater into nitric acid and chlorine, another key precursor.
But true circularity involves more than sustainably producing products aimed at enhancing sustainability. Covestro is moving toward playing a meaningful role in the recycling of its materials.
The company doesn’t produce any single-use plastics of the types that wind up in the ocean. Instead, all of its materials go into products designed for long-term use. “But they do come to the end of their lifetime at some point,” Toepfer says. “What should happen with insulation material, for example, even 40 years after it was used?”
Covestro’s customers are asking for help in figuring out how to recycle obsolete materials. “Somebody else has to collect the materials, and yet somebody else might have to do the actual recycling procedures, but with our knowledge about our products, we can contribute a lot to those solutions,” says the finance chief.
He notes that people tend to think simplistically about recycling as being all about mechanical recycling — in essence, shredding materials to make new products out of them. That works for only a small portion of plastics because product quality deteriorates with each round of recycling.
Potentially more useful is chemical recycling, which involves breaking down materials’ molecular structure, which Toepfer calls “a great opportunity” that hasn’t been tapped into much so far.
The Big Picture
About 8 million metric tons of plastic enters the world’s oceans each year, according to experts. Even more is dumped into landfills.
Almost all of that is single-use plastics, but Toepfer says that as part of the plastics industry Covestro has a responsibility to help address those problems.
“Plastic is a great material that can be super helpful in promoting energy efficiency, but it doesn’t belong in the oceans or landfills,” he says. “It’s a way too valuable material to be thrown away. So we engage heavily with efforts like the Alliance to End Plastic Waste and German recycling initiatives.”
At stake in the way Covestro sources, produces, and takes post-sale responsibility for its products and, more broadly, global environmental risk is nothing less than the company’s viability, according to Toepfer.
“As a chemical company, a medium- to long-term view is that our [social] license to operate depends on our ability to be sustainable, and to be sustainable in the sense of being circular,” he says. “The message from society is loud and clear. For us, there is no way around dealing with these issues.”