BFFAF - BASF Q2 Earnings Review: Still A Buy

2023-08-02 02:13:40 ET

Summary

• BASF SE lowers its 2023 EBIT guidance by 18% due to weaker macro assumptions and FX headwind.
• Sales decline in 2Q23 was mainly driven by lower prices & volumes. Supportive Q2 FCF, but we slightly reduce FCF estimates in 2023.
• BASF's new Verbund site project in China is progressing.
• The company has a solid balance sheet and trades in a downgrade cycle scenario. Clients destocking is almost over and volumes are recovering. Our buy rating is confirmed.

Here at the Lab, we already commented on BASF Q2 preliminary figures ( BASFY , BFFAF ), but the company presented the complete information last week. Having also listened to the Q&A analyst call, we are back analyzing BASF's performances today. There are three key questions we want to answer.

1. What are the cost-saving measures able to top the new core operating profit outlook?
2. How bad could Materials and Chemicals margins be in H2?
3. Given the EBIT decline, what are the working capital requirements and cash generation estimates, given a weak volume environment?

As already anticipated in our ' 2023 Top Pick analysis ', BASF announced a cost-saving plan of approximately €500 million . In addition, the German chemical giant is implementing new measures to improve competitiveness. In February, BASF proactively worked in the VERBUND (OEZVF) industrial facility in Ludwigshafen. In the Q&A call, the CEO is also looking to optimize cost structure in the region outside the EU to adapt BASF's competitive advantage better. In the press release, management explained how key " initiatives already underway in our global service units, we will reduce fixed costs by the end of 2026 so that they will then be around €1 billion lower annually. " Following the February release, we split the €500 saving target into two equal tranches. In Q2, BASF disclosed €300 million in keeping in the current fiscal year. This has no effect on a twelve-month estimate (and on our target price); however, this is a small cheerful piece of news.

Fig 1

Regarding our second high-level question, in H2 2023, the CEO did not assume any further weakening in global demand as " inventories of chemical raw materials in customer industries have already been greatly reduced; " however, EBITDA margins are forecasted to remain under pressure. The CEO assumes a slight recovery in consumer goods and a slightly better volume due to lower client destocking activities. This has also been the DOW's Q2 case in which we anticipate a " Challenging Q3 ," with a buy reiteration. In numbers, cross-checking the company's 2023 outlook estimates (Fig 2), the implied H2 2023 EBITDA would come at €1.3 billion, which is down 26% and 45% compared to last year's results and the H1 2023, respectively. Looking at Wall Street numbers, implied EBITDA is also 35% lower than consensus estimates. Therefore, we might expect some negative stock price pressure over H2 2023. Here at the Lab, in H2 2023, we now model lower price by 3% and a subdued demand with a decline of 1%. Looking at the company's sales, BASF delivered €17.3bn in turnover, below consensus, forecasting €19.4 billion. Lower prices, declining volumes, and adverse currency headwinds mainly drove the sales decline (-25.7% on a yearly basis - Fig 3).

Fig 2

Fig 3

Regarding our third point, Q2 EBIT reached €1 billion and was 1% below consensus. Taking the core operating profit 2023 midpoint, the new EBIT guidance is 14% below consensus. Considering FX's headwind and weaker MACRO development, BASF lowered its EBIT to €4.0/4.4 billion range from a previous of €4.8/€5.4 billion. Given this decline, we believe that investors will focus on FCF development. In the Q2 press release, the CEO confirmed that BASF has a sharp " focus on cash management to optimize cash flow. Over the year, we will continue to reduce our inventory levels. "

Q2 FCF reached €905 million compared to €569 million achieved last year. This is welcome; however, we should also recall the Q1 FCF development. BASF FCF is down by approximately €977 million H1 Fig 4). Here at the Lab, we previously forecasted " a 3 billion FCF deficit for 2023, emphasizing how BASF free cash flow will be negligible until 2025. " After the Q2 results and the management's latest indication, we now anticipate €1.5 billion in H2 FCF, implying a yearly total of €460 million. We already knew FCF could not cover the current dividend payment until 2025. As a reminder, BASF DPS set at €3.4 equals a cash payment of approximately €3.2 billion. Therefore, maintaining a recurrent dividend per share, we increased BASF debt 2024 to €20.9 billion (BASF Net debt on EBITDA is 2.5x on our forecasted numbers).

Conclusion and Valuation

In our preliminary Q2 comment, with BASF's new outlook, we were still above the consensus range. Related to the chemical companies, the entry time is when you hate the company. We believe that BASF is in this situation.

While Wall Street analysts debate volume recovery time, " we see the downgrade cycle as largely over ." No more destocking activities and a recovery in volume still projected at a minus 1% in H2 is a positive sign. Inflation is easing as well as the supply chain. Even if we anticipate higher debt development and, consequently, our equity bridge should fall; however, we decided to leave our buy rating target unchanged at €55 per share ($15.4 in ADR). A positive pricing delta on cost, a low price to book value vs. its historical average (1.5x vs 3x), and Chinese expansion make BASF a company to hold.

For further details see: