BASF: Finding Upside (Or Not) In Chemicals

seekingalpha09-28

BASF remains the world's largest chemical company, maintaining solid market shares and positions despite geopolitical and industrial macro challenges, with a strong balance sheet and credit rating.The...

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J. Alexander Dear readers/followers, It's been some time since I've updated you on my position and investment in BASF SE (OTCQX:BASFY). Also, since the last few articles where I covered this German chemical major, we've seen significant changes to the company's lineup, strategy, and upside. The geopolitical macro environment has been heavy in its impacts on the company, but a few things have not changed one bit. It's those things, and that prospect, which I intend to cover here, and show you what BASF could do for your portfolio. In this article, I will be updating on the company and the latest 2Q24 results, while also forecasting 2024, and 2025-2027 to see what sort of returns we should expect from the company. BASF remains the world's largest chemical company, producing commodities and specialty chemicals in nearly every single category that matters - and many that don't matter as much. The company, despite everything that has been going on, maintains solid market shares and market positions in every single category it operates in (top three in over 2/3rd of its businesses). The company's end markets include everything from major industries, logistics and transport, to pharma, to agriculture. BASF has its \"fingers\" in a bit of everything with a very good diversification. And that, dear readers, is what we will be looking at here. Because this is a tough environment that we're in. And as you should know, tough environments create good opportunities for growth and profit, if we know what we are doing. Let's look at BASF. BASF and its upside after 2Q24 So, things for 2Q24 were better than I actually expected them to be. Sales were down - which given the current geopolitical and industrial macro was expected, and this was a result of lower prices, not actual volumes. Pricing pressure was also somewhat better than in previous periods because volumes were actually up 2.4%. The company's EBITDA (before SI) was at comparable levels at about €2B for the prior period. The company saw better earnings in the chemical business, and overall, the uptick was decent compared to YoY and 3-4Q23. BASF IR (BASF IR) The market movement aside from chemicals was pretty positive. Margins and volumes, as well as market trends, were positive or good for Materials, Industrial Solutions, Surface technologies, and nutrition and care. Reflecting problematic agricultural and fertilizer trends, the company's agricultural solutions are declining in both volume, margin, and market. This is despite the lower earnings in agricultural solutions, which is weighing down all the results (could have been above €2.1B otherwise) for the company. BASF IR (BASF IR) So what is it that's not working with agriculture? What is down here? The company's agriculture segment is seeing impacts from negative herbicide trends, particularly GA, with an 18% decline compared with far stronger YoY effects. The company has achieved cost reductions in production, but there's also a fair bit of generic competition as well as alternative technologies to GA. Also, negative raw material/input and high energy prices are on a continued basis here. We should also, given energy pricing trends, expect this to increase for the remainder of the year. The company has closed two facilities, some special charges related to these closures will come in 3Q. The most important thing is that going forward, sourcing GA from third-party suppliers is what the company will do to secure competitiveness for BASF. Net income is down 14%, OCF is down 10%, and FCF is down 48% - but the Equity ratio is down below 45%. So some negative moves, but also some positive ones. The negative OCF was primarily due to lower dividend payments from equity-accounted businesses and changes in net WC. The company's new China-located verbund-site is also moving forward, with resulting payments for PP&E, and currently, it's on time and on budget - a positive. The company's balance sheet remains strong - and BASF remains at a very good credit rating compared with competitors. The company also continues to work through its cost savings program, which was estimated to deliver over €2B in savings by the end of 2026E. What made me curious was BASF's stance on Battery materials. I have been moving away from such companies as of late. BASF believes in a continued EV push and this is a significant growth potential for the chemical industry. In the past two years, the company has established cathode production across the world, and they continue to ramp up this capacity across the world. However, BASF has also decided against some moves - such as not investing in a nickel-cobalt refining asset in Indonesia and also pausing a large-scale recycling asset in Europe until they see the EV adoption rate recovering. This is what I was looking for given the current market trends. BASF seems to be adjusting well, and this gives me more conviction. BASF remains vertically integrated, manufacturing input chemicals for other segments while focusing on specialty segments because of the margins, which are better. The agricultural segment is also moving towards these specialty products - moving from protection chemicals to a different mix. BASF now, as of 2Q24, holds the fourth-largest share In the global agricultural chemicals market, and the agri solutions segment is the largest share of R&D, at over 40% of the total. So while agri looks poor now, I believe that this will drive BASF growth going forward. BASF's core thesis here going forward, for more growth, is diversifying its geography exposure from a Eurocentric model to an APAC/International-centric model. Zhanjiang has been under construction for 4 years at this point, and it's the company's second verbund site in the region, with further capacity additions coming until 2028. Positives for the company include the Verbund concept, which drives strong returns with one of the world's best operational efficiencies in chemicals. The company's strategic shift toward specialty will reduce the company's cyclicality, with better differentiation. Risks for the company include the replication of the Verbund concept by other companies. This could lower the company's competitiveness. The company's correlation to the oil price is also a risk that deserves mentioning here because an upswing in these prices could result in significant margin compression. The company is also facing several competitors in this segment. This is especially true for the company's agriculture segment. BASF IR (BASF IR) The company has confirmed that the dividend will remain high and competitive, at least €2.25/share going forward. We have a dividend floor, which at today's level means a yield of at least 5.1% here, with at least €12B in distributions until 2028. BASF IR (BASF IR) Overall, I consider BASF to be a very attractive business with core business segments in Chemicals, Materials, Solutions, and Nutrition/care chemicals, with plenty of add-on businesses in Surface tech and Agritech. The risk here, I would say, is the high amount of correlation and/or exposure to semi-materials, battery tech, and renewable tech. Any downturn here will impact BASF to a non-trivial degree, even with the new Verbund sites. I also don't believe the company's overexposure or focus on Asia, with the current expectation that the 2035+ 80%+ of sales will come from advanced countries, including China, India, and ASEAN, is a great thing either. That's why I consider an impact on the company's valuation and growth prospects based on this. Let's look at valuation. BASF - Significant upside at a premium, decent upside with conservative estimates BASF's current price is just north of €45/share, and trades at 13.75x P/E normalized, compared to a 15x P/E or a normalized historical valuation of 13-15x. So the company trades in line with its usual valuation discount for the 5-10 year average. That means that the company, if there's no growth to be had here for the next few years, has very little potential. However, the company is currently estimated to grow around 15% per year. It's also A-rated, and despite the dividend floor, we have a dividend of €3.4/share at this time. The estimate is also for that dividend to continue even into 2024. (Source: FAST Graphs Paywalled Link). This means that the potential returns here, if you expect the growth estimates to materialize, that we at 13.5x P/E have a potential upside of 20% per year, or 50.7% until 2026E. That's with growth included. Without growth, I would say we're at 5-7% per year, or 19-22% RoR for the next few years. Current analyst targets for BASF as of 2Q24 range from €42/share on the low end to €65/share on the high end with an average of €52.5/share. Out of 20 analysts, 12 are at \"BUY\" or \"Outperform\" or similar positive, with 9 at a \"Hold\" rating. To the average, there's a 15% upside at this time (Source: Paywalled TIKR.com Link). BASF's recent result marginally missed my expectations for the top line, with a bigger miss for the EBITDA/bottom line results. Despite this though, I still expect a recovery period given the significant recovery due to 2023's impact from inventory destocking (which will not be present in the same way during this year's results). I continue to expect margins between 9-10%, which is above the segment due to the Verbund concept, which offers advantages in its usage of Naphtha and the way that Verbund assets are interconnected using clustering with pipelines, resulting in lower operating costs (Naphtha is more expensive than nat gas). I may also be too negative about the China expansion - it may work out well. In the end, I am careful about investing in BASF - as I believe you should be as well. The company is going through a number of changes in its fundamental structure and assets. It's betting big on China, on EVs, on ESG, and all of those things - which may turn out well, but also may not. But with this carefulness now communicated, I do believe that the company is undervalued here. At anything below €46/share, I would consider BASF to be so undervalued as to make it an appealing prospect. Long-term investors of BASF have not done well for themselves over the past 20 years - 7% per year isn't beating the market. However, applying a bit of valuation logic would have cushioned this, and rotating at what I consider to be obvious points of overvaluation is something that could have helped here. For now, I say the company's future prospects are clearer than they have been in over 2-5 years, and as long as the price remains conservative, I believe double-digits are entirely possible here. I'm buying more BASF, and I believe you could do the same. Thesis  BASF is the largest Chemical company in the world. It's A-rated, has substantial long-term potential and has just set the floor for the company dividend at around 5% seen to today's share price. That means that given the growth forecast the company is now setting, I believe the business to be a solid investment. The main downside risks are China and the exposure and push for ESG and EVs, as well as the continued volatility in agriculture. But I consider these risks, for the most part, to be manageable, and at any valuation below €46/share, the company is cheap enough to where it really has an upside even if it just \"trades flat\" and doesn't see growth. To lose money here would take considerable downturn performance for the company. I now consider BASF to be a \"BUY\", with a PT of around €55/share. 2024E is expected to be the trough, beyond that, we're likely to see improvements. The closer to €40/share this company goes, the better the upside potential could be.  Here are my criteria and how the company fulfills them (italicized).  This company is overall qualitative. This company is fundamentally safe/conservative & well-run. This company pays a well-covered dividend. This company is currently cheap. This company has a realistic upside that is high enough, based on earnings growth or multiple expansions/reversion.  At €40/share, the company would be cheap. But now the company is buyable, fulfilling 4/5 criteria for me.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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