Covestro initiation with Overweight

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1 Credit Flash HG Chemicals Covestro initiation with Overweight We initiate our coverage on Covestro with an overweight recommendation. Covestro is a public company with global leading market positions in polyurethanes (No.1) and polycarbonates (joint No.1), a diversified worldwide customer base, a comprehensive product portfolio mix, efficient cost-management capacity and a global footprint. Thus, we are positive about the group s FCF-generation ability in the coming quarters and that its credit profile will be in line with, or further strengthened within, the mid-bbb rating category. Our views are backed by the group s commitment to cost control and net-debt reduction. We do not think the group will face M&A risk to a degree that might impair its credit metrics in the coming years. Though the group has implied that it might undertake bolt-on acquisitions to boost R&D and business development, smaller acquisitions will be supported by the group s firm commitment to maintaining an investment grade credit rating and Covestro s limited need for capex until We also do not regard an (potentially accelerated) exit of Bayer (which currently owns 64% of Covestro) as a risk to the group s credit profile. COVEGR bonds feature a change-of-control clause with a rating trigger but we expect Bayer to sell down its stake via the market. The bonds are retail size. Within the COVEGR bond structure, we prefer the COVEGR 1.75% 09/24 bond. The bond is offered at an indicative ASW level of 80bp and a YTM of 1.0%. While COVEGR bonds trade in line with similarly rated AKEFP peers (we expect rating outlooks at Arkema to stabilize), we believe COVEGR spreads still have room for relative outperformance in the coming quarters, based on the factors discussed above. Long-term growth for Covestro s end-markets should be supported by macro trends, such as climate change, the scarcity of fossil resources, increasing global population, urbanization and mobility. Covestro believes that, across its three business units, it should be able to achieve a CAGR of 4% in With the completion of its strategic capital expenditure program in FY15, Covestro is now capable of taking advantage of improving industry demand in its main business markets, by raising utilization rates and securing the group s profitability in the coming years. Covestro is currently rated Baa2 by Moody s, with a stable rating outlook. The group aims to maintain a solid investment-grade rating in the future. This is to be supported by 1. a prudent financial policy; 2. the capacity to generate robust free operating cash flow over the cycle; and 3. the group s solid liquidity, with a cash balance of around EUR 1.03bn at end-1q16, a fully undrawn revolving credit facility of EUR 1.5bn (maturing in September 2020) and additional availability under its EUR 5bn Debt Issuance Program (utilized by EUR 1.5bn). While short-term maturities amount to EUR 1.33bn at end-1q16, we note that the group repaid the remaining EUR 0.8bn Bayer intra-group loan in 2Q16 with available cash. Covestro s credit metrics had remained solid as of end-march Reported net financial debt of Covestro, as of 31 March 2016, was around EUR 2.1bn. Based on reported 1Q16 adj. EBITDA of EUR 478mn (+15% yoy, excl. EUR 30mn insurance settlement), and including UniCredit s standard adjustments, adj. net debt/ebitda was marginally higher in 1Q16 at 2.57x (vs. 2.55x at FYE 2015) despite furtherincreased pension obligations. Recommendation Overweight (Initiation of coverage) Major bond issues Mat Cpn DM/ASW COVEGR Oct 18 E+60bp 37/43bp COVEGR Oct /54bp COVEGR Sep /87bp Ratings L-T S-T Outlook Moody's Baa2 - STABLE Company website Financial calendar July 2Q16 results 25 October 3Q16 results COVESTRO REVENUES EVOLVEMENT EUR mn Group Revenues Group Adj.EBITDA Margin (%) 14,000 20% 17.7% 18% 12, % 15.6% 16% 13.6% 13.6% 10, % 14% 10.7% 8, % 9.9% 10.6% 12% 10% 9.1% 9.0% 6, % 8% 4,000 6% 4% 2,000 2% 0 0% Source: company data, UniCredit Research CASH SNAPSHOT: COVEGR VS. PEERS (ASW) Source: iboxx, Bloomberg, UniCredit Research Author Christian Aust, CFA (UniCredit Bank) christian.aust@unicredit.de Bloomberg UCGR Q14 2Q14 COVEGR AKEFP SOLBBB LXSGR AKZANA COVEGR 1.75% 9/ COVEGR 1% 10/ mdur bp Internet 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 UniCredit Research page 1 See last pages for disclaimer.

2 SWOT Analysis Strength/Opportunities The polymer industry is characterized by high barriers to entry. The group enjoys a leading and defendable industry position across the high-tech material sector, and its Polyurethanes business unit is ranked No.1, based on total nameplate capacity for diphenylmethane diisocyanate (MDI), toluene diisocyanate (TDI) and polyether polyols within the unit. The Polycarbonates unit of Covestro has a joint No.1 position with SABIC, based on total capacity. Furthermore, the group is the market leader in the markets served by its Coatings, Adhesives and Specialties unit and its business entities Aliphatic isocynate derivatives and Polyurethane dispersions. It is also the market leader in its three business regions: EMLA, APAC and NAFTA. It enjoys a comprehensive and focused portfolio and global production network. Covestro is a global leader in the polymer industry. This is a result of its product portfolio (composed of higher-value engineering polymers and niche downstream chemicals). It operates a global production platform with eight world-scale production facilities in Germany (4), Belgium (1), the U.S. (1), China (1) and Thailand (1). A broad range of end-markets ensures profitability growth and diversify cyclicality risk. Covestro targets a wide spectrum of end-markets to gain access to high-growth end-markets and to reduce the group s risk exposure to the cyclicality of single-customer industries. Covestro s competitive cost position delivers profitable growth. The group s cost advantage is underpinned by its world-scale facilities, feedstock integration and efficient process technologies. Its financial-management strategy is prudent and flexible. Covestro targets a capital structure and financial ratios that support a solid investment-grade rating for the future. Strong liquidity is supported by 1. reported cash and cash equivalents of EUR 1.03bn (as of 31 March 2016), 2. the availability of EUR 1.5bn via its credit facilities (as of 31 March 2016), 3. the group s ability to generate resilient free operating cash flow and 4. proven access to capital markets a successful debt-issuance program on 3 March 2016, with a total volume of EUR1.5bn, significantly prolonged the maturity of the group s financial debt. Strong future cash-flow growth is expected thanks to the group s disciplined cost management. The group aims to achieve around EUR 420mn of gross savings through its ongoing Asset-Optimization Plan and cost-improvement measures. Weakness/Risks Covestro depends on a few cyclical and seasonal end-markets, particularly automotive/transport, construction, wood/furniture, electrical/electronics and chemicals. This can expose Covestro to potential business volatility. Economic slowdown in its main business regions (e.g. the Chinese market) could affect business. Exposure to the U.K. and GBP currency should be very limited (we estimate a small single-digit percentage of sales). Periodic imbalances of supply/demand in the industry could put the group s pricing power under pressure. Fluctuations of certain raw materials and energy prices and any disruptions of those resources suppliers could have a remarkably negative effect on Covestro s operational results. Existing competition from other well established peer companies and potential new local entrants in each business region could limit Covestro s pricing power, which would further squeeze margins. Covestro is exposed to FX movements. Covestro operates across the globe and in several local currencies. This inevitably exposes the group to FX risk. Covestro has limited experience as a stand-alone company. UniCredit Research page 2 See last pages for disclaimer.

3 Company Overview Company description Following its spinoff from Bayer AG in September 2015, Germany-based Covestro) is among the world s leading suppliers of high-tech polymer materials and application solutions for many areas of modern life.. Covestro AG (the holding company and also the parent company of Covestro Group holds all the shares in Covestro Deutschland AG (formerly Bayer MaterialScience AG). The group has three main reportable business units: Polyurethanes (PUR); Polycarbonates (PCS) and Coatings, adhesives, specialties (CAS)These mainly serve industries across automotive manufacturing and supply, electrical engineering and electronics, construction, home products and sports and leisure. Its product portfolio includes niche products such as thermoplastische polyurethane TPU, polycarbonate and TPU-based films; hot cast elastomers and other products tailored to textile, cosmetic and medical applications. The group has a strong track record of process and product innovation and enjoys close customer relationships, which underpin its tradition of developing market-driven solutions. Covestro is present across 30 sites worldwide and employed around 15,750 people at the end of 1Q16. It has a regional sales and marketing structure, with supply-chain centers and local operations. In FY15, Covestro reported revenues of around EUR 12.1bn, 2.7% up from the FY14 level. Reported adjusted EBITDA jumped to EUR 1.64bn, having increased by 41.3% to that of FY14. Reported free operating cash flow stood at EUR 964mn at FYE 2015, triple that of FY14. With its three product lines CAS (17% of FY15 revenues), PCS (26% of FY15 revenues) and PUR (50% of FY15 revenues) the group serves customers across the following sectors: sports/leisure (27% of FY15 revenues), chemicals, electrics/electronics (12% of FY15 revenues), automotive/transportations (20% of FY15 revenues), construction (17% of FY15 revenues) and wood and furniture (16% of FY15 revenues). Revenues in FY15 were split among the group s three business regions: EMLA (44%), APAC (28%) and NAFTA (28%). USA, China and Germany are the group s top-three single markets, representing, respectively, 23%, 18% and 16% of its annual revenues. Since 6 October 2015, the company has been listed in the Prime Standard on the Frankfurt Stock Exchange. As of June 2016, Covestro s main shareholders are Bayer AG (64.2%), BlackRock (3.88%) and Standard Life (3.12%). GROUP REVENUE PERFORMANCE & CORE VOLUME GROWTH (%) GROUP ADJ. EBITDA & MARGIN 12,200 12,000 11,800 11,600 11,400 11,200 11,000 10,800 Group Revenues +2,7% +5,3% +1% 11,610 11,357 11,761 12, % 5% 4% 3% 2% 1% 0% 1,800 1,500 1, Adjusted EBITDA Group Adj.EBITDA Margin % (rs) 13.6% 10.7% 9.9% 9.3% 1,641 1,244 1,056 1, % 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Note: Core volume growth refers to the core products in the PUR, PCS and CAS segments. It is calculated as the percentage change from the prior year in externally sold volumes in thousands of tons. Covestro also takes advantage of business opportunities outside its core business. Source: company data, UniCredit Research UniCredit Research page 3 See last pages for disclaimer.

4 FY15 REVENUES BY END-MARKET FY15 REVENUES BY REGION Wood/Furniture Sports/leisure, 16% Cosmetics, China 15.5% Health, others EMLA 27% ex.germany 30.7% Construction 17% APAC ex.china 12.4% Automotives/tra nsportations 20% Chemicals 8% Electrical/electr onics 12% Germany 13.6% NAFTA ex. USA 5.0% USA 22.7% Source: company data, UniCredit Research History of Covestro Covestro was previously the MaterialScience business (consisting of the activities in the area of polymer materials and certain inorganic basic chemicals) of Bayer Group. On 18 September 2014, Bayer AG announced plans to contribute its MaterialScience business into a new stock corporation (Aktiengesellschaft) and to list the shares of this new stock corporation on a stock exchange. As a division of the Bayer Group, MaterialScience has historically used certain services provided by Bayer AG and its service companies, Bayer Business Services, Bayer Group Platform and Bayer Technology Services. Having been recast as the Covestro group, this business has continued to expand internationally. In 2006, the Covestro Group began operating a polycarbonate production facility in Shanghai, China, where, in 2008, it established what it believed to be the world s largest MDI production facility. In addition, the Covestro Group moved the global and regional APAC headquarters of its PCS business unit to Shanghai, China, in On 31 August 2015, the carving out of Bayer s MaterialScience and its transfer to Covestro were finalized. In early October 2015, Covestro was listed on the Frankfurt Stock Exchange by way of an IPO, which raised gross cash proceeds of EUR 1.5bn. Covestro is headquartered in Leverkusen, Germany. UniCredit Research page 4 See last pages for disclaimer.

5 Segments Three regions, three business units The group has a regional sales and marketing structure with supply-chain centers and local operations. It reports according to three regional segments: APAC (27.9% of FY15 revenues), EMLA (44.3%), and NAFTA (27.8%). Covestro s customers include global, regional and local operating businesses, many of which are long-term customers. The group s business is also divided into three business units: CAS, PCS and PUR. Business units At the end of FY15, these three business units (PUR; PCS and CAS) contributed, respectively, 52%, 27% and 18% to group revenues. The adj. EBITDA margin of the CAS and PCS segments has maintained an upward trend over the past four years, with margins of above 15% in FY15, whereas PUR's adj. EBITDA margin recovered to 10.2%, from 9.4% a year ago. REVENUES & WEIGHT BY BUSINESS UNIT (FY12-15) ADJ. EBITDA MARGIN BY BUSINESS UNIT 14,000 12,000 Others PUR=Polyurethanes revenues PCS=Polycarbonates revenues CAS=Coatings, adhesives, specialities revenues % 25% Group Adj.EBITDA Margin (%) CAS Adj.EBITDA Margin (%) PCS Adj.EBITDA Margin (%) PUR Adj.EBITDA Margin (%) 22.7% 23.5% 10,000 8,000 6,000 4,000 2,000 EUR 0 mn 5,993 6,052 6,282 2,822 2,645 2,822 6,088 3,172 1,984 1,876 1,928 2, % 15% 10% 5% 0% 18.3% 19.6% 17.7% 12.1% 10.6% 9.4% 10.2% 6.6% 5.7% 3.6% 10.7% 9.3% 9.9% 13.6% Source: company data UniCredit Research Polyurethanes The PUR business unit is specialized in the development, production and marketing of high-quality precursors for flexible and rigid polyurethane foam. Flexible foam is mainly used in the furniture and automotive industries (e.g. for cushions, mattresses and automobile seats), while rigid foam is used, in particular, as insulation material in the construction industry and in logistics to optimize refrigeration chains. Covestro is the leading global producer of polyurethane raw materials. It is the second largest global producer of MDI, the largest global producer of TDI and the second largest global producer of polyether polyols, controlling respectively 22%, 25% and 15% of global nameplate production capacity, according to the Industry Report Analyses of Certain Aspects of the Polymer Industry of Nexant Inc. and Orr & Boss Ltd. dated July PUR operates a worldwide production platform with 21 production facilities across Europe, the US and Asia. Total nameplate production in 2014 reached around 3,400mn tons of isocyanates and polyether polyols. In FY15, PUR reported revenues of around EUR 6.1bn and an adjusted EBITDA margin of 10.2%. Comfort/furniture, construction and automotive are the unit s top three end-markets and made up 70% of its revenues as of FY15. In terms of regions, EMLA accounts for the biggest share of the unit s revenues (43% in FY15); NAFTA accounted for 33% and APAC 24%. UniCredit Research page 5 See last pages for disclaimer.

6 Global demand for MDI, TDI and polyether polyols is expected to grow above the rate of GDP growth until 2020, according to the Industry report. To capture this industry trend, PUR intends to increase the utilization of its asset base of MDI and TDI, leverage its broad global customer base and comprehensive product portfolio and improve its cost position and efficiency in innovation. PUR REVENUES BY END-MARKET (FY15) PUR REVENUES BY REGION (FY15) Others 10% Chemicals 10% Comfort/ furniture 30% NAFTA 33% APAC 24% Appliances 10% Automotive 15% Construction 25% EMLA 43% Source: company data, UniCredit Research Polycarbonates PCS business unit is focused on the development, production and marketing of the engineering plastic polycarbonate in the form of granules and semi-finished products. It is the joint No.1 producer of polycarbonate globally. Polycarbonate is used primarily in the automobile (light-weight construction, glazing) and construction industries (e.g. large roof structures). It is also used in the electrical and electronics industry (e.g. computer cases, DVDs), the medical technology sector and the lighting industry (e.g. for LED components). The business unit is also active in application-technology development with customers, in connection with polycarbonate processing. PCS is headquartered in Shanghai, China, and operates within a global network of five world-class production sites, five R&D centers and seven compounding centers. This network possess approximately 1.3mn tons of polycarbonate resins. The segment has experienced an upswing in industry margins thanks to the increasing industry utilization rates, as shown in the chart below. In FY15, PCS generated revenues of around EUR 3.2bn, with an adjusted EBITDA margin of 17.7%. EMLA (+6.5% yoy) NAFTA (+18.4% yoy) and APAC (+14.6%) contributed, respectively, 36%, 24% and 40% to the segment s revenues. The primary end-markets of PCS are automotive/transportation, construction and electrical/electronic. These provided 77% of PCS s revenues as of FYE PCS has a global asset footprint and world-scale plants in key regions. This ensures the group s access to high-growth end-markets and optimizes asset utilization and business risk. PCS s strong technology know-how allows Covestro to demand premium prices in select industries (for example, in the automotive industry) and affords it future growth potential. In addition, PCS is the cost leader in North America, western Europe and China. which brought the leader benefit to the group, such as regional sourcing advantages (excl. transportation costs), technology and backward integration. UniCredit Research page 6 See last pages for disclaimer.

7 PCS REVENUES BY END-MARKET (FY15) PCS REVENUES BY REGION (FY15) Others 23% Automotive/ transporation 33% NAFTA 24% APAC 40% Construction 17% EMLA 36% Electrical/ electronics 27% Source: company data, UniCredit Research Coatings, adhesives, specialties The CAS business unit is a leading global supplier of high-performance materials to the industrial coatings, adhesives, sealants and other specialties industry segments. It is the No.1 producer of aliphatic isocyanates worldwide. The unit mainly produces aliphatic isocyanates and their derivatives, aromatic isocyanate derivatives, polyurethane dispersions, etc. These products are used primarily in the transportation and construction industries, where the materials serve as corrosion protection, for instance. Special raw materials are used in the cosmetics, textiles and health-care sectors. As a niche specialty material provider, CAS is strongly focused on technology and innovation, which is as a key element to producing high value-added products that provide superior performance relative to the products of other peer companies. CAS produces approximately 2,300 products (which are primarily based on six monomers) for more than 4,300 customers across more than 10 high-end end-markets. Product pricing is driven by value-added consumer as CAS materials are critical to the function of final products but accounts for a small proportion of the overall costs. Throughout the past years, the segment has delivered high, robust and strong cash flow and returns to Covestro as shown in the chart below. In FY15, CAS published revenues of around EUR 2.1bn and an adjusted EBTIDA of EUR 491mn, with an adjusted EBITDA margin of 23.5%. Due to higher volume growth and stable selling prices, 51% of the unit s revenues, as of FYE 2015, came from the automotive/transportation, construction and wood and furniture industries. CAS should remain a resilient unit for Covestro in the coming quarters. This projection is based on the following factors: 1. Its global asset base allows it to work in proximity to customers in a fragmented industry (so as to establish a long-term relationship with customers). 2. CAS s high-value product portfolio and low-cost technology ensure high margin resilience and low capex requirements, and thus solid profitability in the long run. 3. Its well diversified end-market footprint across three business regions greatly mitigates the business risk. UniCredit Research page 7 See last pages for disclaimer.

8 CAS REVENUES BY END-MARKET (FY15) CAS REVENUES BY REGION (FY15) Others Automotive/ NAFTA 36.0% transportation 30.0% APAC 26.0% 24.5% Electrical& electronics 5.0% Footwear& texiles 8.0% Wood&furniture 11.0% Construction 14.0% EMLA 45.5% Source: company data, UniCredit Research Regional performance overview Covestro currently operates across three regions: APAC, EMLA and NAFTA. The EMLA region comprises Europe, Middle East, Africa and Latin America. Mexico, together with United States and Canada, forms the NAFTA region. Asia and Pacific areas are within the APAC region. As of FY15, 44.3% of group revenues came from EMLA, 27.9% from APAC and 27.8% from NAFTA. Based on historical data of regional performance (shown in the following charts), the APAC and NAFTA regions are growing business areas for the group, while EMLA is maturing with its weight decreasing from 48% in FY12 to 44% in FY15. BUSINESS REGION REVENUES: HISTORICAL PERFORMANCE BUSINESS REGIONS WEIGHT (% of revenues) 6, EMLA APAC NAFTA 60.0% EMLA APAC NAFTA 5, % 48.2% 48.1% 46.6% 44.3% 4, % 3, % 27.3% 27.0% 27.7% 27.9% 2, % 24.6% 24.9% 25.7% 27.8% 1, EUR mn 10.0% % Source: company data, UniCredit Research Demand has remained solid in all regions By the end of FY15, APAC generated revenues of around EUR 3.37bn, with a volume increase of 2%, of which approximately EUR1.9bn came from China (with a 4% volumegrowth rate). NAFTA saw revenues of EUR 3.36bn (+3% in volume), of which revenues from the US made up EUR 2.75bn. In EMLA, Covestro reported revenues of around EUR 5.36bn, of which the German market contributed revenues of around 1.65bn (with a volume-growth rate of 1% yoy). During FY15, market demand in China remained solid (volume-growth rate was 4% and accounted for 16% of revenues), while the US market saw robust revenues growth and accounted for 23% of revenues. EMLA, Covestro s biggest market, managed to achieve 3% volume growth despite suffering from a double-digit decline in Latin America. UniCredit Research page 8 See last pages for disclaimer.

9 Ongoing European economic recovery EMLA The EMLA region is the biggest market for Covestro, representing 44.3% of total revenues in FY15. In FY15, EMLA reported revenues of around EUR 5.36bn, which was slightly lower than FY14 revenues of around EUR 5.48bn. Covestro expects further economic recovery (at a 2.6% growth rate) in the EU, alongside low inflation and the depreciation of euro. The United Kingdom and Germany should demonstrate stronger growth momentum in the coming year, while a deteriorating economic situation is forecasted for Latin America. We hold the view that, in the coming quarters, the European chemical industry will experience a slight uptick compared to the previous year, mainly due to sizable profits afforded by the low oil price and by the favorable EUR-USD exchange rate. From the end-market perspective, North America will remain the growth driver for the automotive industry, while Latin America, it is believed, has reached the bottom of the cycle. For the Latin American construction and furniture sectors, a slight improvement is expected, but Latin America s electronics industry will continue to face difficulties. All eyes on China APAC Covestro anticipates rather-stable market demand from APAC based on its economic outlook for the group s primary end markets: a 3-4% growth rate in the automotive industry, with China being the main growth driver; a 2% growth rate in the construction sector, where improvement is expected due to the stable investment climate in the area; a 4% growth rate in the global electrical/electronics industry on the back of product innovation, where APAC will remain the primary growth driver (with India and the ESAP countries as the main contributors). However, Covestro expects slightly weaker development in the Asian furniture market, primarily due to slow economic growth in China. In FY15, EUR 3.37bn of Covestro s revenues came from the APAC region (up by 3.5% compared to FY14). We think that, in the APAC region, China could continue to present a risk to Covestro s operating performance in the coming quarters. China accounted for 16% of Covestro s FY15 revenues and for over 30% of global chemical demand. Therefore, any slowdown in China would place further pressure on Covestro s prices, margins and profitability. Robust results, 2016 outlook NAFTA NAFTA remains the Covestro region posting the strongest growth. In FY15, revenues from NAFTA rose 11.1% to EUR 3.36bn (compared to FY14), thanks to the economic recovery in the US, low oil and raw-material costs and the strong USD. In the coming year, we believe Covestro s operating profitability will continue to improve on yoy basis. This should be underpinned by the ongoing weakness of EUR-USD, the group s cost-saving measures and its comprehensive product mix. To be more specific, the US market will continue to see some improvement across the automotive and construction sectors, but slower growth is expected in the electronics and furniture sectors due to mature market conditions in the US. UniCredit Research page 9 See last pages for disclaimer.

10 Market and competition Industry characteristics Seasonality Competitive market position The global polymer spectrum (especially the polyurethanes, polycarbonates and aliphatic isocyanate derivatives segments) consists of relatively consolidated markets with stable structures that have changed little over the last five years. First, the market is characterized by high barriers to entry mainly due to the sizeable investment requirement, the need for backward integration into feedstock, intense pressure to advance process technology as well as strict environmental regulations. That said, the global polymer market is inherently vulnerable to periodic market changes (supply/demand imbalances) stemming from the potential for industry overcapacity due to extended investment cycles. Covestro s business performance is exposed to some seasonal fluctuations in industry demand during the course of a year. Generally speaking, 2Q and 3Q revenues are higher than the other two quarters of the year due to holiday periods and severe weather exerting an inhibiting effect on the market demand in the group s main business regions. To be more specific, revenues are typically lower from November to February due to the sluggish construction industry demand (less construction activity in the winter) for polyurethanes construction insulation in EMLA and NAFT. Because of the Chinese New Year, revenues in the APAC region are also lower in February, while in EMLA and NAFTA, the group generates lower revenues in December as a result of Christmas holidays and stock optimization measures. In September and October, the group sees some increase in demand thanks to rising end-market demand. Moody s comments that Covestro has the leading positions in the global polyurethane and polycarbonate markets, as shown in the chart below. It confirms the company s strong product mix and highly diversified geographic and end-market diversification. Moody s regards the cost position as competitive and affirms that the group s advanced process technologies together with the partial backward integration mitigates business risk associated with raw material volatility. GLOBAL INDUSTRY POSITION Covestro Global Position (2015) Regional capacity share position Polyurethanes MDI TDI Polyether Polyols Polycarbonates PC Coatings, Adhesives, Specialties Aliphatic isocynate derivatives Polyurethane dispersions #2 #2 #2 Joint #1 #1 #1 20% 27% 15% 27% 47% 17% #2 in Americas #1 in EMEA # in APAC #1 in Americas #2 in EMEA # 2in APAC #2 in Americas #2 in EMEA >#10 in APAC #2 in Americas #2 in EMEA #2 in APAC #1 in Americas #1 in EMEA #1 in APAC Source: company data, UniCredit Research Main competitors are Wanhua, SABIC, Trinseo, BASF, Dow Chemicals, Evonik and Henkel Covestro may remain exposed to the cyclicality of the polymer industry as a whole. Yet, we are positive about the robust long-term market demand that will support the group s future profitability. Moreover, Covestro possesses the world s largest polyurethane raw materials producer and the second largest producer of polycarbonate products, which would, to some extent, protect the group s pricing power across the market. Covestro s main competitors are SABIC and Trinseo (key PCS competitors) and Wanhua, BASF and Dow Chemicals (key PUR competitors) as well as Evonik and Henkel (CAS competitors) UniCredit Research page 10 See last pages for disclaimer.

11 Peer Group analysis Mid BBB rated Chemicals peer group We compare Covestro to the other mid-bbb rated Chemical peers in our coverage Arkema (France), Lanxess (Germany) and Solvay (Belgium). From a revenues perspective, Covestro ranks No.1 against the other three, although the group s FY15 EBITDA margin is around 11.7%, lower than Arkema s 12.2% and Solvay s 16.2%. However, considering the group s leading market position across its product portfolio and a global footprint with highly diversified customer markets, we believe Covestro will see stronger profitability in the coming years. In terms of credit metrics, we also regard Covestro s position as competitive among its Chemicals peers. At the end of FY15, Covestro s net debt/adj. EBITDA ratio remained solid at 2.5x, slightly higher than Arkema s 2.1x. We expect this ratio to improve in the coming years as result of the group s commitment of further reducing net debt and its positive profitability outlook. PEER COMPANIES COMPARISON Covestro AG Arkema Lanxess AG Solvay SA Country Germany France Germany Belgium Rating Baa2s/--/-- Baa2n/BBBn/-- Baa3s/BBB-p/-- Baa2n/BBB-s/BBBn Description Segments (as a percentage of revenues) Focus of activities Industrial end-markets (as a percentage of revenues) Geographical end-markets (as a percentage of revenues) Manufacturers of polymers and high performance plastics 17% Coatings, Adhesives and Specialties; 26% Polycarbonates;50% Polyurethanes Polymers and High Performance Plastics (coatings, adhesives, insulating materials, sealants, polycarbonates, and polyurethanes) 27% Sport/Leisure, Cosmetics, Health, Others; 8% Chemicals;12% Electrical/Electronics; 20% Automotive/ Transportation; 17% Construction; 16% Wood/furniture 44.3% EMLA; 27.9% APAC; 27.8% NAFTA Manufacturer of a wide-range of chemicals 44% High Performance Materials, 32% Industrial Specialties, 24% Coating Solutions Specialty Chemicals with a number of niche businesses (fluorogases, acrylic monomers, coating resins etc.) 20% Consumer Goods, 18% Chemicals, Plastics, 15% Industrial Coatings, 11% Decorative Paints, 7% Transportation, 7% Energy, 6% Construction, 5% Nutrition, 3% Electronics, 4% Water, 4% Others 38% Europe (thereof, 10% in France and 7% in Southern Europe), 34% North America, 24% Asia, 4% ROW Manufacturer of specialty chemicals 50% Performance Polymers; 26% Performance Chemicals, 23% Advanced Intermediates Specialty Chemicals (synthetic rubber, PA-based plastics, fine and basic chemicals, application-oriented specialty chemicals) ~20%: Tires, Automotive, Others (cumulative share); ~15%: Chemicals, Construction, Electrical/Electronics, Leather/Footwear; ~10%: Agrochemicals 29% EMEA (excl. Germany), 17% Germany, 17% North America, 11% Latin America, 26% Asia Pacific Manufacturer of chemicals and plastics 32% Advanced Materials, 29% Performance Chemicals, 25% Advanced Formulations, 14% Functional Polymers Specialty Chemicals (PA 6.6, cellulose, acetate fiber, soda ash, surfactants, hydrogen peroxide, silicas etc.) 26% Automotive & Aeronautics, 21% Consumer Goods & Healthcare, 11% Building and Construction, 10% Agro, Feed and Food, 18% Industrial Applications, 8% Energy and Environment, 6% Electricals & Electronics 34% Europe, 23% North America, 10% Latin America, 35% Asia and ROW" Financials FY15 (EUR mn) Revenues 12,028 7,683 7,902 11,047 EBITDA 1, ,788 EBITDA margin 11.7% 12.2% 10.5% 16.2% Net debt/ebitda adjusted 2.5x 2.1x 2.6x 4.5x Moody s downside trigger (RCF/net debt) RCF/net debt in the low 20% RCF/net debt below high 20s RCF/net debt <20% RCF/net debt below high-teens LTM figures (UniCredit) 27.7% 20.8% 21.1% 11.4% Source: UniCredit Research UniCredit Research page 11 See last pages for disclaimer.

12 Group s outlook in 2016 and in the medium term Covestro s medium-term target is to increase both revenues and adj. EBITDA in absolute terms. The group expects to expand its MDI capacity (by 2016/17) and ramp-up additional polycarbonate and HDI capacity (by 2016) at its production facility in Shanghai, China. Covestro is restructuring its TDI operations and exploring the approach of restructuring some of its existing MDI operations so as to better capture industry growth and achieve higher utilization rates. The group aims to increase its revenues by capturing growth in the industry and increasing the utilization rates of its production facilities. Covestro expects core volume growth in the mid-single-digit percentage range in 2016, primarily driven by development in the PUR and PCS segments, as the CAS segment will be impacted by the contractual termination of its trading operations with Laxness (after adjustment for this effect, the group also expects the same growth rate for CAS as for its PUR and PCS segments). Besides this, high and above-average free operating cash flow is anticipated in 2016, with a substantial increase at PCS but a significant drop in PUR, which is driven by volume growth, high asset utilization, a limited requirement for further capex until 2019 and the group s focus on margin expansion through operational leverage and profitability enhancement actions. The group also expects ROCE to exceed the capital costs but to be below the FY15 level. In addition, with the first dividend payment of EUR 0.7 per share for the stub year FY15, Covestro aims to have a dividend pay-out ratio of 30-50% based on its IFRS net income in FY16. UniCredit Research page 12 See last pages for disclaimer.

13 Group development strategy Covestro emphasizes the group s primary goal and the foundation of its corporate strategy is to achieve the long-term profitable growth. The group s endeavors to reach this target are reflected in the following aspects. Capture industry growth Covestro intends to fully explore the growth potential of the polymer industry over the next five years with existing world-class assets. Covestro foresees macro trends such as climate change, the scarcity of fossil resources, the expansion of global population, urbanization and mobility as the main drivers of above-gdp growth for group s main customer markets. The group wants to leverage its worldwide footprint and comprehensive product and solutions offering to cater to these trends in its end-markets. With the completion of the strategic capital expenditure program in FY15, Covestro intends to take advantage of the improving industry demand in its main business markets to raise utilization rates and secure the group s profitability in the coming years. INDUSTRY DEMAND OUTLOOK ( E) CAGR:4% E 18.5Mt 15.2Mt CAGR:4% CAGR:4% 3.8Mt 4.7Mt 2.7Mt 3.3Mt PUR PUC CAS Source: company data; UniCredit Research Protect and build up competitive advantages via product R&D and innovation Improve asset and cost position Maintaining and expanding the group s market position is another significant goal. To achieve this, Covestro emphasizes innovation and ongoing product R&D as a core element of the group. The company intends to improve its production processes and expand its products into adjacent end-markets and to develop new product and solutions to better meet customers needs via collaborating closely with external partners, as well as looking for potential bolt-on acquisitions to boost R&D and business development. Covestro aims to sustainably improve profitability. The group is continuing to implement its profitability enhancement program, which could lead to the net saving ramping up in 2017, resulting in gross savings of EUR 420mn by This program comprised the asset optimization plan and cost improvement measures. The asset optimization plan comprises site consolidation, restructuring and efficiency projects to optimize its asset footprint. UniCredit Research page 13 See last pages for disclaimer.

14 Cost improvement measures combine corporate overhead cost savings with business units level specific savings to align the group s overall costs with best-in-class chemical industry benchmarks. Covestro has been working hard to rank among the cost leaders in chemical industry. For example, the group is further optimizing its service functions and IT infrastructure and streamlining its sales organization at the segment level. All these efforts are expected to improve the organic profitability of the group in the future. UniCredit Research page 14 See last pages for disclaimer.

15 Solid historical profitability and strong core volume growth Financial profile Covestro has demonstrated quite a solid profitability path over the past four years, driven by core volume growth across all segments. As we see from the chart below, revenues of the group have seen dynamic core volume growth yoy (in 1Q16, core volume growth was 8.5% yoy) across the quarters in FY15 driven by underlying demand improvements, but also due to the low prior year base, a mild winter and outages experienced by competitors. In 1Q16, the reported adjusted EBITDA margin significantly increased to 17.7% from 13.6% in 1Q15, which is mainly due to positive volumes, operating leverage and a EUR 30mn insurance settlement in PUR (16.6% margin excl. insurance settlement) and it keeps a growing trend in the past quarters as indicated in the chart below. GROUP REVENUE DEVELOPMENT GROUP ADJ.EBITDA AND MARGIN EUR mn 14,000 12,000 10,000 8,000 6,000 4,000 2, % 2014 Group Revenues 5% % 1Q % 2Q % 4.50% 3Q14 Core volume growth (rs) 4Q % 1.7% 1Q15 2Q15 6.7% 3Q15-0.6% 4Q % 3.0% 1Q EUR mn Group Revenues Group Adj.EBITDA Margin (%) 14,000 12,000 10,000 8,000 6,000 4,000 2, % 9.3% 9.9% % 12.9% 9.0% 1Q14 2Q % 3Q14 4Q % 7.0% 1Q % 15.6% 2Q15 3Q15 4Q % 9.1% 1Q % 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Source: Company data, UniCredit Research Polyurethanes PUR REVENUE DEVELOPMENT As of 1Q16, revenues of PUR saw a stable historical development, 1.3% up to EUR 1.4bn from EUR 1.38bn in 4Q15. Core volume growth jumped by 10.4% yoy in 1Q16 based on the adjusted data of the previous year. TDI and MDI product groups contributed most to this increase, whereas Polyols increased only at a low-single-digit rate. Meanwhile, selling prices in 1Q16 declined by 15.7% yoy due to the fact that in a largely stable supply/demand market, selling prices in all regions decreased in line with raw materials prices. In 1Q16, reported adj. EBITDA at Polyurethanes increased by 31.3% to EUR 214mn from an adjusted EUR 63mn EBITDA in 1Q15, mainly thanks to higher volumes and the insurance settlement (excl. the insurance payment, adj. EBITDA still increased 13% yoy with a margin of 13.1%). PUR ADJ.EBITDA AND MARGIN EUR mn PUR=Polyurethanes revenues Core volume growth (PUR) 7, % 6, % 8.0% 5, % 4, % 3, % 4.0% 2, % 4.2% 3.0% 1, % 2.0% % 1.0% % Q14 4Q14 2Q15 4Q15 EUR mn PUR Adj. EBITDA PUR Adj.EBITDA Margin (%) % 10.6% 9.4% 10.2% 14.3% 7.4% 9.8% 6.3% 10.5% 13.6% 11.6% 4.5% 15.3% Q142Q143Q144Q141Q152Q153Q154Q151Q % 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Source: company data, UniCredit Research UniCredit Research page 15 See last pages for disclaimer.

16 Polycarbonates Revenues in the PCS segment increased slightly by 2.7% yoy to EUR 786mn in 1Q16. Core volume growth rose by 8.5% due to higher demand from the automotive and construction industries across all the three geographic regions. Revenues in the APAC region improved mainly due to significantly higher revenues volumes from the electrical industry. All these factors combined resulted in the adj. EBITDA of this segment jumping by 52.6% to EUR 177mn compared to 1Q15 and margins were also higher than in the first quarter of PCS REVENUE DEVELOPMENT PCS REVENUE DEVELOPMENT EUR mn 3,500 PCS=Polycarbonates revenues Core volume growth (PCS) 15.0% EUR mn PCS Adj.EBITDA PCS Adj.EBITDA Margin (%) % 3,000 2,500 2,000 1,500 1, % 3.0% -3.2% 5.1% 13.0% 11.0% 9.0% 7.0% 5.0% 3.0% 1.0% -1.0% -3.0% % 6.6% 5.7% 3.6% 20.9% 18.1% 15.2% 6.7% 6.3% 5.4% 4.4% 22.5% 16.2% 25.0% 20.0% 15.0% 10.0% 5.0% Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16-5.0% Q142Q143Q144Q141Q152Q153Q154Q151Q16 0.0% Source: UniCredit Research Coatings, Adhesives and Specialties In 1Q16, revenues at CAS dropped by 4.3% against the prior-year quarter to EUR 512mn. Core volume growth for this unit was affected by the contractual termination of trading operations. Selling prices were 2.4% lower than in1q15, mainly because of lower prices in the APAC region. As of 1Q16, EBITDA from the CAS segment amounted to EUR 139mn. Lower raw materials prices had a positive effect on EBITDA and partially offset the effect of lower selling prices and volumes. CAS REVENUE DEVELOPMENT CAS ADJ. EBITDA AND MARGIN EUR mn 2,500 2,000 1,500 1, % % % CAS=Coatings, adhesives, specialities revenues Core volume growth (CAS) 2.7% 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q % 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% EUR mn CAS Adj.EBITDA CAS Adj.EBITDA Margin (%) %23.5% 24.5% 24.7%24.4% 26.4% 27.1% 23.4%23.0% 18.3% 19.6% 19.6% 17.6% Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q % 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Source: UniCredit Research UniCredit Research page 16 See last pages for disclaimer.

17 Free operating cash flow on track In 1Q16, reported free operating cash flow declined slightly yoy from EUR 90mn in 1Q15 to EUR 77mn mainly due to higher working capital (Working capital to revenues ratio showed usual seasonal increase to 17.8% (12-months rolling) ) and cash out for income tax over this quarter. As a result of phasing, Capex of EUR 47mn in 1Q16 was much lower than EUR 94mn in 1Q15, which was consistent with budget. During , Covestro s reported free operating cash flow was positive and moved consistently upwards, from EUR 181mn in 2012 to EUR 964mn in 2015 demonstrating the group s proven capability to adapt earnings volatility through short-term measures. Record free operating cash flow in FY2015 was attributable to the robust EBITDA contribution and disciplined change in working capital and Capital expenditures. From a business-unit perspective, in 1Q16, FOCF in PUR went down to EUR -8mn (1Q15: EUR 88mn). This drop was due to an increase of cash tied up in working capital, which substantially outweighed the contribution from the added EBITDA. FOCF at PCS was up to EUR 82mn (1Q15: EUR -12mn), which largely resulted from an EBITDA increase and the planned reduction in expenditure for property, plant, equipment and intangible assets. Thanks to the improved EBITDA, the decrease in cash tied up in working capital and reduced expenditure on fixed assets, FOCF at CAS specialties more than doubled to EUR 43mn vs. EUR 17mn a year ago. REP. ADJ. EBITDA VS. FREE OPERATING CASH FLOW 1,900 1,700 1,500 1,300 1, EUR mn Group adj. EBITDA Free operating cash flow Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 Source: company data, UniCredit Research Robust financial ratios Covestro s total reported gross debt stood at EUR 3.2bn at end-1q16, up from EUR 2.9bn at FYE 2015 due to the EUR 1.5bn bond issuance in March Pension provisions were also up by EUR 414mn in 1Q16 to EUR 1.87bn due to lower interest rates. Hence, fully-adj. net debt increased to EUR 4.3bn at end-march 2016 despite FCF remaining positive in 1Q16. However, Covestro s credit metrics remained solid as of end-march Based on reported 1Q16 adj. EBITDA of EUR 508mn and deducting the EUR 30mn insurance one-off as well as including UniCredit s standard adjustment, adj. net debt/adj. EBITDA (UniCredit model) was marginally higher in 1Q16 at 2.57x vs. 2.55x at FYE 2015, despite the higher pension provisions. Also adj. RCF/net debt (according to UniCredit) remained sequentially broadly stable at around 28% in 1Q16. We note that Covestro s balance sheet has weakened marginally since FYE 2015 with an equity/total assets ratio of 31.4% as of 1Q16 (vs. 34.3% at FYE 2015) and a gearing ratio of 62.4% (vs. 62% by the end of FY15), which is, again, mainly attributable to the reassessment of pension obligations (resulting in a EUR 182mn decrease in equity in 1Q16). UniCredit Research page 17 See last pages for disclaimer.

18 The group s liquidity remained solid, with a cash balance of around EUR 1.03bn at end-1q16, a fully undrawn revolving credit facility of EUR 1.5bn maturing in September 2020 and additional availability under its EUR 5bn debt issuance program (EUR 1.5bn utilized). While short-term maturities amounted to EUR 1.33bn at end-1q16, we note that the group has repaid the remaining EUR 0.8bn of the Bayer intra-group loan in 2Q16 with available cash. CREDIT METRICS REMAIN SOLID BALANCE SHEET SHOWS STABILITY 6.0x Net debt adj./ebitda adj. FFO adj./net debt adj. (rs) 30.0% 14.0x EBIT net interest cover adj. Equity/total assets (rs) 40.0% 5.0x 25.0% 12.0x 35.0% 4.0x 3.0x 2.0x 1.0x 20.0% 15.0% 10.0% 5.0% 10.0x 8.0x 6.0x 4.0x 2.0x 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0x LTM 3M16 0.0% 0.0x LTM 3M16 0.0% Source: UniCredit Research Financial flexibility The successful debt issuance program on 3 March with a total volume of EUR 1.5bn significantly prolonged the group s financial debt maturity, indicating that the group remains supported by proven access to debt capital markets (48% of debt consisted of bonds as of FYE 2015). The acquired liquidity was used to replace the financial liabilities to Bayer AG. DEBT MATURITY PROFILE AS OF 31 MARCH 2016 DEBT SPLIT BY INSTRUMENT AS OF 31 MARCH ,000 Cash Undrawn, committed lines Financial liabilities 2,500 2,000 1,500 Others 47% Bank loans 34% 1,500 1,000 1,325 1, EUR mn 1,030 Liquidity as of 1Q16 Shortterm debt as of 1Q >2020 Derivatives 2% Finance leases 17% Source: UniCredit Research Prudent financial policy Covestro pursues a prudent and flexibility-oriented financial management strategy and aims to achieve a balanced financing portfolio. As a result, Covestro targets a capital structure and financial ratios commensurate with a solid investment-grade rating in the future. With its solid 1Q16 results, the group indicated that it would further reduce the group s net debt and optimize its capital structure. On the other hand, the group confirmed its clear commitment to sustainable dividend growth in the coming quarters or at least a stable dividend payout in difficult economic times. Covestro maintained its dividend pay-out ratio of 30-50% of net income as confirmed during their CMD in May. UniCredit Research page 18 See last pages for disclaimer.

19 Rating agencies view Covestro is currently externally rated by Moody s and received a Baa2 investment grade rating on 12 October 2015 for both its issuer rating and the debt issuance program. RATING OVERVIEW LafargeHolcim Ltd Long-term Rating Issuer rating Outlook Moody's Baa2 Baa2 Stable Source: Moody s, UniCredit Research Moody s Baa2/stable (January 2016) Credit Opinion from 11 January 2016 (excerpts): The Baa2 issuer rating reflects Covestro's leading positions in the global polyurethane and polycarbonate markets, which benefit from oligopolistic structures and significant barriers to entry as well as solid long-term demand fundamentals underpinned by global megatrends, despite some vulnerability to periodic, mainly supply driven imbalances. While exhibiting some degree of product concentration, Covestro's portfolio enjoys significant geographical and endmarket diversification. The group's cost position is underpinned by world scale production facilities, efficient process technologies and backward integration into some key feedstocks. Following the recent partial IPO, the capital structure of Covestro is positioned in line with its conservative financial policies, which target leverage as measured by reported net financial liabilities (including EUR 1.5 billion of net pension liabilities) to EBITDA of 2.5x to 3.0x. Covestro's future operating profitability should benefit from leveraging recently added production capacity, while continuing to focus on asset optimization and cost efficiency. Given its limited capex requirements and moderate dividend pay-out, we expect Covestro to generate positive free cash flow and build financial headroom enabling it to withstand any potential future cyclical downturn and protect its Baa2 rating. While any future upside on the rating of Covestro is likely to be constrained by its business risk profile, (i) confirmation of its ability to successfully leverage its new capacity and lift its mid-cycle EBITDA margins back into to the mid to high teens in parallel with (ii) some permanent debt reduction driving its debt to EBITDA ratio below 2.0x and RCF to net debt above 40% on a sustainable basis, may lead to a rating upgrade to Baa1. The Baa2 rating could come under pressure should Covestro's future utilisation rates and EBITDA margins fall short of our current expectations resulting in some prolonged weakness in operating profitability and cash flow generation pushing debt to EBITDA above 3.0x and RCF to net debt in the low twenties in percentage terms. UniCredit Research page 19 See last pages for disclaimer.