Covestro Group at a Glance – Management
Covestro’s management system is oriented toward long-term, profitable growth and continuous value creation. The Board of Management is the main decision-maker responsible for our global business and approving the planning derived from our Group strategy. In order to plan, manage, and monitor the development of our business, we use key management indicators which enable the Group’s business performance to be evaluated in a comprehensive and holistic manner. In addition, the Board of Management uses defined sustainability goals and selected nonfinancial performance indicators to govern the Group’s sustainable orientation.
Key Management Indicators
The Covestro Group assessed its business performance using indicators in the areas of growth, liquidity, and profitability in the fiscal year under review.
Return on capital employed (ROCE) is the key management indicator used to assess the profitability of the Covestro Group, measuring the return the company achieves on the capital it uses (capital employed). ROCE is calculated as the ratio of net operating profit after taxes* (NOPAT) to average capital employed. If ROCE exceeds the weighted average cost of capital (WACC), i.e., the minimum return expected by equity and debt capital providers, the company has created value. ROCE is calculated annually at the end of each fiscal year.
* The imputed income taxes are determined by multiplying the effective tax rate by the operating result (earnings before interest and taxes, EBIT).
The ability to generate a cash surplus is measured by the free operating cash flow (FOCF). FOCF is an indicator of the company’s liquidity and ability to finance its activities. It corresponds to cash flows from operating activities less cash outflows for additions to property, plant and equipment and intangible assets. A positive FOCF serves to pay dividends and interest and to repay debt.
The growth of the Covestro Group is measured in terms of the development of core volume growth*. Unlike sales, this core volume growth key management indicator is influenced only indirectly by changes in raw material prices or currency effects.
The key management indicators are also used in Covestro’s Group-wide bonus system (Covestro Profit Sharing Plan), which is applicable uniformly to all staff from the Board of Management members to employees under collective bargaining agreements. The three areas of profitability, liquidity, and growth each account for one-third of the final assessment and bonus calculation formula. As a result, all employees whose personal efforts contribute to Covestro’s overall positive performance can share in the company’s success.
From the year 2022 onward, greenhouse gas (GHG) emissions will be comprehensively integrated into the management system. In the reporting year, an additional change was approved that stipulates incorporating environmental, social, and governance (ESG) criteria into the short-term compensation system (Covestro Profit Sharing Plan, Covestro PSP) for the Board of Management and all employees. Earnings before interest, taxes, depreciation and amortization (EBITDA) will also replace core volume growth as a key management indicator. In the future, Covestro’s management system will be made up of four components: growth measured as EBITDA, liquidity measured as FOCF, profitability measured as ROCE above the weighted average cost of capital (WACC), and sustainability measured in terms of selected ESG criteria. In the year 2022, the sustainability component will be determined by direct and indirect GHG emissions (Scope 1 and 2).
* Core volume growth refers to the core products in the Performance Materials and Solutions & Specialties segments. It is calculated as the percentage change in externally sold volumes compared with the prior year. Covestro also takes advantage of business opportunities outside its core business, for example the sale of precursors and by-products such as hydrochloric acid, sodium hydroxide solution, and styrene. Such transactions are not included in core volume growth.
Other Relevant Indicators
Throughout its financial reporting, Covestro uses further indicators such as EBITDA, capital employed, and the absolute value contribution in addition to the key management indicators to assess the business performance of the Group.
EBIT and EBITDA
EBIT, which corresponds to income after income taxes plus financial result and income taxes, allows us to assess income without the influence of the income-dependent tax liability and/or various financing activities. EBITDA is used to assess the operating profitability of Covestro and its reportable segments during the year. EBITDA is EBIT plus amortization and impairment losses on intangible assets, and depreciation and impairment losses on property, plant and equipment, less impairment loss reversals. As a result, EBITDA is adjusted for possible distortions arising from various depreciation/amortization methods and measurement options, and therefore represents earnings from operating business activities.
Capital employed, which is relevant to the calculation of ROCE, is the interest-bearing capital required by the company for its operations. It is calculated from operating noncurrent and current assets less non-interest-bearing liabilities. Non-interest-bearing liabilities include, for example, trade accounts payable and current provisions. The average capital employed is determined using the capital employed at the beginning and end of the relevant period.
Weighted Average Cost of Capital (WACC)
The weighted average cost of capital (WACC) is relevant to the calculation of the absolute value contribution and reflects the expected return on the entire company’s capital comprising both equity and debt. The cost of equity factors used in WACC is calculated by adding the risk-free interest rate to the risk premium for an equity investment. Covestro uses the returns on long-term German government bonds as the risk-free interest rate. We derive this risk premium from capital market information for comparable listed companies. The cost of debt factors is calculated by adding the risk-free interest rate to a risk premium on debt capital that Covestro calculates using the financing costs of comparable companies, and subtracting the tax benefit of interest incurred on borrowed capital. Calculation of the cost of capital generally has a long-term perspective; short-term fluctuations are evened out.
Covestro aims to steadily increase enterprise value. Value is generated if Group earnings exceed the cost of capital. The absolute value contribution is the difference between NOPAT and the cost of capital. The latter is calculated by multiplying the average capital employed by WACC. A positive value contribution means that value has been generated.
Net Financial Debt
Net financial debt is used to assess the financial position and financing requirements. It equals the sum of all financial liabilities less cash and cash equivalents, current financial assets, and receivables from financial derivatives.