BFFAF - BASF SE (BASFY) Q3 2022 Earnings Call Transcript

BASF SE (BASFY)

Q3 2022 Earnings Conference Call

October 26, 2022 05:00 ET

Company Participants

Stefanie Wettberg - Investor Relations

Martin Brudermuller - Chairman

Hans Engel - Chief Financial Officer

Conference Call Participants

Christian Faitz - Kepler Cheuvreux

Andrew Stott - UBS

Gunther Zechmann - Bernstein

Chetan Udeshi - JPMorgan

Laurent Favre - Exane BNP Paribas

Peter Clark - Societe Generale

Georgina Fraser - Goldman Sachs

Andreas Heine - Stifel

Markus Mayer - Baader Helvea

Jaideep Pandya - On Field Investment Research

Sebastian Bray - Berenberg

Tony Jones - Redburn

Presentation

Stefanie Wettberg

Good morning, ladies and gentlemen. On behalf of BASF, I would like to welcome you to our Conference Call on the Third Quarter 2022 Results. [Operator Instructions] This presentation contains forward-looking statements. These statements are based on current estimates and projections of the Board of Executive Directors and currently available information. Forward-looking statements are not guarantees of the future developments and results outlined therein. These are dependent on a number of factors. They involve various risks and uncertainties and they are based on assumptions that may not prove to be accurate. Such risk factors include those discussed in opportunities and risks of the BASF report 2021.

BASF does not assume any obligation to update the forward-looking statements contained in this presentation above and beyond the legal requirements. On the call with me today are Martin Brudermuller, Chairman of the Board of Executive Directors and Hans Engel, Chief Financial Officer. Please be aware that we have already posted the speech on our website at basf.com/q32022.

Now, I would like to hand over to Martin Brudermuller.

Martin Brudermuller

Good morning, ladies and gentlemen. Two weeks ago, BASF released preliminary figures for the third quarter of 2022. Today, Hans Engel and I will provide you with further details regarding our business development. Despite the continued strong headwinds from high raw materials and energy prices as well as slowing economic activity, BASF achieved solid EBIT before special items in the third quarter of 2022. Our downstream segments improved earnings considerably. In the upstream segments, however, earnings declined significantly from the very high levels in the prior year quarter.

Let’s start with a snapshot of the current challenging market environment. Compared with Q2 2022, the global macroeconomic environment was significantly weakened. There are no indications of improvement from the markets in the short-term. High inflation and the sharp increase of energy prices led to a slowdown in consumer demand, particularly in Europe. China recorded growth, but particularly because of a strong base effect due to the power shortage in the prior year quarter and its economic development continued to be impacted by the restrictions to reduce the spread of COVID infections.

Global automotive production was a positive surprise in Q3 2022. It increased in all regions compared with the prior year quarter. Q3 2021 was however the quarter in which chip shortages peaked. After the COVID related lockdowns in the second quarter of 2022, automotive production in China developed significantly better than anticipated. IHS Markit has adjusted its forecast for global automotive production in 2022 to 81.8 million units. Compared with 2021, this would be an increase of around 6%. Central banks have further raised interest rates in recent months. This will more and more dampen construction and consumer spending in the coming months and will likely result in lower growth in 2023.

Let’s now briefly look into – look at the chemical production by region in Q3 2022 before we turn to the financial performance of BASF. Based on the currently available data, global chemical production grew by 2% compared with the strong prior year quarter. While China and North America recorded growth, chemical production declined in Europe and in Asia, excluding China.

According to recent released data, growth in Mainland China was surprisingly high, partly due to the industrial power cuts in the prior year quarter of last year. In Europe, chemical production declined on account of lower demand and higher energy prices, which in some cases led to reduced or temporarily shutdown production at different stages of the value chains. Lower demand and increased energy prices were also the main reasons for the decline in Asia, excluding China.

Let’s turn to the BASF key customer industries. I will selectively comment on the most relevant developments shown on this slide. The transportation industry continues to benefit from pent-up demand globally, particularly in China. As mentioned, global automotive production increased compared with the low level of 2021, but is still restricted by semiconductor availability.

In agriculture, the demand environment looks solid overall. However, prices for some crop commodity products have come down recently, but remain on an above average level. The construction industry, particularly in North America and in Europe, is deteriorating because of interest rates. In China, the overheated residential segments continued to decline. In summary, construction and consumer spending with the exception of automotive are weakening.

I will now move on to BASF’s business development. In the third quarter of 2022, EBIT before special items declined by €570 million – €517 million and amounted to €1.3 billion. Additional costs for natural gas in Europe are one major reason for this decline. If we look at the segments, the solid EBIT before special items in Q3 came primarily from BASF’s downstream segments. They considerably improved earnings, mainly on account of further price increases. In line with our guidance for the full year, earnings in the Upstream segment declined considerably with softening demand from the very high levels in the prior year quarter.

Natural gas prices increased further compared with the already elevated levels in Q3 2021. In the first 9 months of 2022, the additional costs of BASF’s European sites amounted to around €2.2 billion compared with the same period in 2021. To mitigate these higher costs, we have implemented further price increases and we continue to work on technical optimization projects, particularly at our largest site in Ludwigshafen. Reduced plant utilization in Q3 2022 also helped to limit the burden of high natural gas prices in cases where the market did not absorb the additional costs.

I will now give you additional information on earnings development in the regions. If you look at the bar for 2015, you can see that Germany, Europe, excluding Germany and the other regions each contributed around one-third to BASF’s Group EBIT before special items in that year. In the strong year of 2021, Europe, including Germany, contributed only one-third, while the other regions contributed two-thirds.

In the course of 2022, earnings have softened further and we saw a particular deterioration in our German operations. In Q3 2022, we recorded negative EBIT before special items of €130 million in Germany. The lower earnings in Europe and in Germany in particular are due to a variety of reasons. In our recent announcement, we summarized them under the term deteriorating framework conditions. There are essentially three developments.

First, the European chemical market has been growing only weekly for about a decade. In the period from January to August 2022, the chemical market shrank by 2.1% in EU 27 and by 6.8% in Germany compared with the same period in 2021. Second, the significant increase in natural gas and electricity prices over the course of this year is putting pressure on chemical value chains. We expect structurally higher and volatile natural gas prices in Europe also in the mid and long-term. And third, uncertainties due to the enormous number of regulations planned by the EU are waiting on the chemical industry. The current development underlines once again the importance of a balanced regional footprint.

The challenging framework conditions in Europe endanger the international competitiveness of European producers and force us to adapt our cost structures as quickly as possible and also permanently. This is why we initiated a cost savings program, focusing on Europe and Germany, in particular, which we announced on October 12. With this program, we aim to streamline non-production units in operating, service and R&D divisions as well as in the corporate center.

The cost reduction measures will be fully implemented until the end of 2024. Short-term cost savings will be implemented immediately. When completed, the program is expected to generate annual cost savings of €500 million, which corresponds to around 10% of our European costs in these categories. More than half of the cost savings are to be realized at the Ludwigshafen site. We are currently developing further structural measures to adjust ESS Verbund production Verbund in Europe, in the medium and long-term to the changing framework conditions. We will thus ensure our future competitiveness and significantly reduce our consumption of gas.

We are actually making great progress on this. We expect to communicate details in the first quarter of 2023. At this point, I want to stress we cannot speak our heads into this end and hope that this difficult situation will resolve itself on its own. We, as a company, must act now. Our cost savings program aims to secure our medium and long-term competitiveness in Germany and Europe. We must take decisive action to fulfill our responsibilities to our employees, shareholders and society.

And now I would like to hand over to Hans for further details on our financial performance.

Hans Engel

Thank you, Martin. Good morning, ladies and gentlemen. Let me start with the sales bridge for the BASF Group compared with the prior year quarter. In Q3 2022, sales increased by 12% to €21.9 billion mainly on account of higher prices and positive currency effects. Sales prices increased by 10%. All divisions contributed except for catalysts. In this division, lower precious metals prices led to overall lower prices in Q3.

Currency effects of plus 8% also had a positive impact on sales and were mainly related to the U.S. dollar. Portfolio effects of plus 0.9% were related to BASF Shanshan battery materials, which was formed on August 31, 2021. Sales volumes declined by 7%. Except for Agricultural Solutions, all segments recorded lower volumes. Excluding precious metal volumes, BASF Group sales volumes, declined by 5%.

Let’s move on to our earnings development by segment in Q3 2022 compared with the prior year quarter. The overall decline in EBIT before special items resulted from considerably lower contributions from the Chemicals and Materials segments. In Q3 2022, these two segments contributed €600 million to BASF Group’s EBIT before special items compared with €1.5 billion in the prior year quarter.

As mentioned before, all downstream segments were able to improve earnings, reaching a combined total of €725 million compared with €395 million in Q3 2021. In the following, I would like to provide you with further details of BASF Group’s financial figures in the third quarter of 2022 compared with the prior year quarter.

I will start with EBITDA before special items, which decreased by €446 million and amounted to €2.3 billion. EBITDA amounted to around €2.3 billion as well, a decrease of €474 million. At €1.3 billion, EBIT before special items declined by 28%. Special items in EBIT amounted to minus €53 million compared with minus €43 million in the third quarter of 2021. EBIT decreased by 29% to €1.3 billion in Q3 2022.

Income from non-integral companies accounted for using the equity methods included a non-cash effective impairment on BASF shareholding in Wintershall Dea in the amount of about €740 million. This impairment results from the partial write-down of Wintershall Dea’s 15.5% participation in Nordstream AG, which operates the Nordstream 1 pipeline.

Compared with the third quarter of 2021, the after-tax operational result of Wintershall Dea attributable to BASF rose by €533 million to €630 million. Net income from shareholdings improved by €86 million to €102 million in Q3 2022. Net income amounted to €909 million, a decline of €344 million.

Let’s now look at the details of our cash flow development in Q3 2022. Compared with the prior year quarter, cash flows from operating activities improved by €405 million to €2.3 billion. The increase was mainly driven by cash inflows from changes in net working capital. In the prior year quarter, there were cash outflows. Cash flows from investing activities amounted to minus €680 million compared with minus €1.8 billion in Q3 2021. In the prior year quarter, we had a net cash outflow of minus €627 million for acquisitions and divestitures, mainly due to the acquisition of 51% in BASF Shanshan Battery Materials. In the third quarter of 2022, we recorded a net cash inflow of €222 million from acquisitions and divestitures, mainly related to the proceeds from the sale of the Cable & Minerals business. Payments made for property, plant and equipment and intangible assets rose by 23% to €1 billion. Free cash flow thus increased by €218 million to €1.3 billion.

Turning to our balance sheet at the end of September 2022 compared with year end 2021. Total assets increased by €9.6 billion to €97 billion. Non-current assets amounted to €54.6 billion, an increase of €2.3 billion. The increase was mainly driven by translation effects due to the depreciation of the euro. Current assets increased by €7.4 billion to €42.4 billion mainly due to higher inventories as a result of higher raw material prices and increased trade accounts receivable because of higher sales.

In addition, other receivables and miscellaneous assets contributed to the increase. Non-current liabilities decreased by €2 billion to €23.2 billion, mainly due to lower provisions for pensions and similar obligations. These provisions decreased by €4 billion to €2.1 billion because of higher interest rates. Net debt increased by €4.6 billion to €18.9 billion at the end of September 2022. The equity ratio was 50.6% compared with 48.2% at the end of 2021.

And with that, back to you, Martin.

Martin Brudermuller

Yes. Let me conclude with the outlook. In the third quarter of 2022, economic activity weakened more significantly than expected. Against this background, BASF has adjusted its assessment of the global economic environment in 2022. We now expect GDP and industrial production each to grow by 2.5%. Global chemical production is expected to grow by not more than 2%, down from our previous assumptions of 2.5%. We now anticipate an average oil price of $100 per barrel of Brent crude at an average exchange rate of $1.05 per euro.

Despite the significant weakening of the economic environment since the third quarter of 2022, we confirm BASF’s group’s forecast for the 2022 business year as published in the half year financial report of 2022. We are forecasting sales of between €86 billion and €89 billion for 2022. BASF Group’s EBIT before special items is expected between €6.8 billion and €7.2 billion. We continue to be confident that we can achieve the upper end of this range even so this has become more challenging in view of the current macroeconomic and geopolitical developments. ROCE is likely to be between 10.5% and 11% and CO2 emissions are expected between 18.4 million metric tons and 19.4 million metric tons in 2022.

And now, we are glad to take your questions.

Question-and-Answer Session

A - Stefanie Wettberg

[Operator Instructions] We will now begin with Christian Faitz, Kepler Cheuvreux. We have then Andrew Stott and then Gunther Zechmann. So now Christian Faitz, Kepler Cheuvreux. Please go ahead.

Christian Faitz

Yes. Thank you, Stefanie and good morning and also good morning, Martin and Hans. Couple of questions around the gas complex. First of all, can you share with us your view on how helpful for your Ludwigshafen plant, the first draft proposal of the gas aid scheme by the German government is? And on gas in Europe, just wanted to check that my math is right, looking at Slide 7 in your presentation and comparing this with your Q1 and Q2 charts, is it correct that the Q3 gas price burden for Europe year-on-year was just about €500 million? And then last question on gas, I promise, can you share with us the rough regional distribution of gas sources for your Ludwigshafen plant at present? Thank you.

Martin Brudermuller

Christian, maybe I will start with the first one. I mean, let me first say and this is also what I said in the speech, I think the prime task of companies is to actually help themselves and to improve – and improve their structures. That’s why I am very happy that the BASF team as always in the crisis times is exceptionally creative. I will not give you a number, but I can only tell you we are significantly down where the critical threshold for gas is. We will then report you and give you more background on that in the Q3. So, that reduces the – sorry, Q1 next year. This reduces the vulnerability of the Ludwigshafen site, first of all, because of availability of gas, but then certainly also gives us opportunity to react also on the structural side by shutting down plants and utilization for the main gas consuming products. And I mean, ammonia is the biggest one and you saw that we also adapted over there. So let me clearly say the prime target is certainly that we settle our issues, mainly ourselves. But let me also say that we very much welcome the proposals of the Gas Commission which is also this time clearly also indicating the help for the industry, not only for citizens. And I think it is a little bit early still to say how it works in details, because the proposals are great, but they also have a lot of questions. When it comes to the details, you have also seen in the last days that there was quite a reaction on other EU states. It’s also about a level playing field in Europe in terms of industry. There is also the state aid rules in process, which have to abate to. So I think there is still some work to be done and then giving clear interpretations of this. But also clear, if you look also on our customer base and the smaller SMEs, they really are in a difficult situation, which is deteriorating very, very quickly, because they come already from a difficult situation from COVID time. So, it is really important that this is quick and pragmatic.

But I also want to say very clearly, we have to ask for flexibility and not too strict rules because at the very end, it has to be a combination of both. Yes, there is public money for those companies who need this support and help, but I think there is also an obligation of each company to adapt its structure going forward. because the world is not frozen and it doesn’t make any sense now to give the company’s money and say you have to keep your structure and we wake you up in 3 years when the energy price or energy crisis is over and you just continue where you are, where you have actually stopped because the world is moving too. So I think we need this flexibility to do our own way and then we will see whether we at all needed and what the conditions are for the use of public money. So maybe I will leave it at that point and give the other two to Hans.

Hans Engel

Yes, good morning, Christian. This is Hans. So your first question, I think you did the math correctly, around about €600 million additional cost for natural gas in Europe in Q3. If we look at gas and energy in total, we are talking around about €1 billion per quarter in the first three quarters of the year. Your third question was related to the gas supply sources. We are sourcing in Europe from Western European suppliers, we do not know what their exact supply portfolio has a relatively high likelihood that this is very close to what the overall supply portfolio is in the respective countries of Europe as well as in Europe, more information than that we do not have.

Christian Faitz

Thank you. Very helpful, both/

Stefanie Wettberg

So, we move on to Andrew Stott, UBS. Your turn.

Andrew Stott

Yes. Thanks, Stefanie. Good morning, everybody. Two questions. One was really the upstream cycle in the past you have been pretty good in calling that. And just wondered what you are seeing for the next 12 months, both positives and negatives across some of the key changes. So that’s the first question. The second question comes back to the previous one from Christian. As things stand, I know, Martin, you said things are still up in the air a bit with the gas subsidy package. But as things stand, if you were to be able to use that package from the January 1 next year, could you estimate what your total cost effect would be? Thank you.

Hans Engel

Andrew, I’ll start with your second question. I don’t have exact calculations on that. But if I look at the average natural gas cost in the first three quarters of the year, rough gas is that the increase should be compared to the year 2021 should be half of that if the 70% will be supplied at a price of €70 per megawatt hour. But since there is so much uncertainty still around this, we need to see how things in the end shake out. And I think we will provide you with a better and more sound calculation once it’s really clear how the gas price break will work.

Martin Brudermuller

And I think entrepreneur, freedom is also important. So you asked about how upstream business is going forward. I mean they are very difficult to predict. But I mean, as I mentioned, there is no indication that actually there is an uptick in demand, which is eating itself through the upstream part, both I have to say, for the internal usage as raw materials for our downstream as well as on the market demand. I do not expect that this is significantly changing now over the next months going forward. It is actually a bit a global effect, but you saw also from the numbers, I mean, it’s most severe here in Europe and definitely in Germany. If you for that reason, look into the margins, then they have been coming down significantly from a very, very high level, I have to say. But if you look on the contribution from these commodities and we monitor this all the time every month, then this has come significantly down now to a relatively low level. I don’t expect that margins go down much further than we have it there, but I think a positive spark now for going forward might not come from the volume. So the question is really how the energy prices will develop going forward. But there is basically not much pricing power now on the commodity side. I hope that helps you. But I think there is not a very positive message on the upstream for the next months to come.

Andrew Stott

Thank you.

Stefanie Wettberg

So the next in the queue is Gunther Zechmann, Bernstein. We will then have Chetan Udeshi, Laurent Favre and Peter Clark. So now Gunther Zechmann, Bernstein. Please go ahead.

Gunther Zechmann

Good morning. Thank you. Martin, if I can just pick you up on one of the points in the deteriorating framework conditions, which is the regulatory uncertainty. Could you just outline what you would need regulators see do to improve those conditions? And if you think that’s realistic to happen? And the second one, maybe for Hans, on the CapEx budget. You’ve not changed the €25.6 billion CapEx over 2022 to €26 billion with inflation going up and demand weakening is the way to see that you’re building less capacity for the same amount of money. And if that’s the case, then how much less capacity are we looking in that scenario? And if I can sneak a last clarification question in the report. I was very surprised to see that by customer location, Germany is by far the fastest growing region in Q3, up almost 50%. If you could help me understand that a little bit, please?

Martin Brudermuller

Gunther, maybe a quick review on the regulatory side, I mean process is on its way to implement the green deal basically totally unaffected from the current economic development. There is no plan B. They think this is a holistic future picture. So, all the packages that are coming have no priorities for them. They basically all come at the same time. We currently have already more than 7,000 pages of regulations for the chemical industry. My guess is at the end of the process, we are with 25,000. So you can ask yourself how particularly small and medium-sized enterprises want to deal with that, maybe can because of the resources, but it is a real challenge. So we approached them and said, you cannot deny that there is a different economic reality. And the question is now whether they use this the next weeks, and I think we can see already that the national government and the council step up. There are many countries where this is actually the chemical industry, a very important one. It’s number four in Europe and in many of the countries, it’s even number two or number three. And you see maybe one indicator that shows how alarming it is, the European chemical industry was actually contributing over decades, about €40 billion to €50 billion trade surplus.

Since March, this turned around, Europe is importing more chemicals now than exporting. And I think this gives you an indication about this competitiveness. So far, no one really talks about competitiveness in process. It may be just starts now with the energy part. So what should happen? I’ll give you one example without going details. The industry admission directive. That’s the last package that actually came out. What is that? That is not only for the chemical industry, but it touches actually existing plants revoking and questioning their permits. So you have a plant that is 30 years old and you have an existing permit. And then they basically do a benchmark worldwide. They say there is now a new plant just 5 years old, new technology that has a new threshold for emissions. And that means you have to come down with your old plant and invest to actually this emission threshold of these plants.

So if you do that, you actually take away the financial strength of the current plans to finance the energy transformation going forward. We, for example, told them there is no need to open that box now. So that’s one example. I could also talk about reach and CSS where we talk about not the what all the time, but also the how. You can make things more pragmatic. And this is, I think, very much deciding on actually, whether there is a business case to invest in Europe. Because if you have a low growth environment, you have high energy costs, you have inflation and now you have also regulation. What actually gives you the confidence to invest in plants where you need security for the next 10, 20 years. So I hope that helps you a little bit. I use quite my – some of my time for – as the President of Cefic, the European Association in Brussels to actually work in that direction for the whole European chemical industry.

Gunther Zechmann

Thank you for your frank words.

Hans Engel

Gunther, your questions with respect to CapEx plan. First, we’re in the midst of the budgeting process. We will see what the outcome of that is based on what I can see currently, I don’t expect any type of major changes. You are addressing the moving pieces such as inflation, higher input cost, higher labor costs, they are offsetting costs such as, for example, the steel price, if you look at how steel prices have developed over the last 12 months, they have come down significantly. So all of this will be taken into consideration when we do our budgeting process, and we will see what the outcome of all of this will be. But my expectation is that we will not see major changes compared to what we have communicated so far for the time period 2021 through 2025.

Your question on Germany, sales by location of customer, 47% growth, significantly higher than what you see as sales by company. There is an explanation for that. That’s relatively easy. And that is the trading business that sits in other. We had significantly more trading business with customers in Germany than we had in the prior year quarter and that’s driving up the number as you can see it, and this is raw material trading that we do and that is reflected in the sales of others. But a big piece of that actually happening with customers in Germany.

Stefanie Wettberg

So we move on to Chetan Udeshi, JPMorgan. Please go ahead.

Chetan Udeshi

Yes. Hi, thanks. I was just looking at the Slide #8 again, which shows the earnings split by different regions. And I’m just curious, why is Germany so bad versus rest of Europe because the gas price dynamic is not something which is just German driven. It’s across all of Europe. So why is Germany, particularly so bad at BASF? I guess is there a reflection of maybe a lot of corporate costs at BASF actually sits in Germany. So it’s a bit of an unfair comparison. But I’m just curious underlying like-for-like why Germany so poor versus rest of Europe for BASF right now? The second question was just on Ag division, very strong top line growth, both because of higher volumes but also a very strong pricing. But when I look at the incremental EBIT growth from that top line growth, the drop-through is pretty low. It’s like 15%, 16% of incremental sales flowing through to the EBIT line. I’m just curious why did we not see a much stronger drop-through because it seems that these prices are now strong enough to cover the inflation, hopefully, that is the case. And sorry, if last small clarification is, again, going back to the previous question, €600 million increase in gas costs in Europe in Q3 is actually lower than €800 million to €900 million that we saw in Q1 and Q2, this despite the fact that the gas cost in Europe per megawatt hour was actually in terms of year-on-year increase double of what we saw in Q2. So I’m just curious what like how much production curtailments have you guys taken in Europe as a whole for that number to be closer to €600 million and maybe not even double that number? Thank you.

Hans Engel

Chetan, this is Hans. I’ll start with your question on Germany. What’s important to keep in mind is that Europe does not have one consistent natural gas price and one consistent price for power. Prices in Germany are significantly higher than what you are seeing, for example, in Belgium, in the Netherlands, in the southern part of Europe. And as a result of that, Germany suffers more. I’ll give you an example from the more recent days, Germany sits there and gas here is sold at TTF prices, which yesterday closed at €100 for the 4 months, so €100 per megawatt hour. At this very same point in time yesterday, you could buy spot gas in other countries at prices of €20 to €25 per megawatt hour. Now this is 1 day, probably not something that you can just extrapolate, but we have this – have had the significant differences depending on the regional trading prices within Europe over the last 6 months. And as I said, they are – if you look at it on a daily basis, significant in Germany suffers there in particular.

Now your next question was – since we are on gas, I’ll do the €600 million cost. We have, in fact, in Q3 reduced gas consumption significantly. We have reduced as a result of not running certain plants or running them at lower capacities substituting by way of purchases from the market. To the extent we could, we have also substituted natural gas in the – on the utility side by using alternative sources, i.e., heating oil. So we’ve done what we could. But overall, this is an expression of the fact that we’ve actually consumed significantly less gas. And if your question is how much less is in the order of magnitude of almost 40% lower gas consumption in Q3 than in the prior year quarter.

Last question then was on ag and why don’t you see stronger earnings on significantly stronger sales. So first of all, I think we have €100 million improvement compared to prior year quarter. It is the weakest quarter of the year. That is the seasonality that we have in the business. It comes with significant cost in preparing for the season that has just started in the Southern Hemisphere and then also preparing for the season in the Northern Hemisphere. And there is also a mixed topic here. So that explains why this is relatively low margin. But let me say this, compared to where we were in the prior year, I think our teams in Ag Solutions have done a very good job and €100 million earnings improvement, I think, is also a good basis for a, hopefully, a good quarter for our Ag Solutions business.

Stefanie Wettberg

So we will now have Laurent Favre, Exane BNP Paribas, and then we will go to Peter Clark and Georgina Fraser after that. So now Laurent Favre, Exane BNP Paribas.

Laurent Favre

My first question is regarding the cash flow improvement and expectations for Q4. I think you are year-to-date below €800 million. So I don’t know, €2.5 billion or so below the absolute amount of the dividend. I was wondering if you combine the expected working capital inflow of Q4 and the dividend of Wintershall Dea, if you think you can cover the dividend in free cash flow this year, let’s say, a flat dividend with free cash flow this year. That’s the number one question. And then the second question is on the Zhanjiang project. I think last year, you told us that peak CapEx would start already in 2023. And I was wondering, given what’s happening in China, if you could talk about the flexibility you have to slow down the build rate there and perhaps delay the startup of Phase 1? Thank you.

Hans Engel

Laurent, this is Hans. Thanks for your question. I’ll answer the question on the cash flow. And to start with based on what we see and one of the important points you mentioned already, which is the dividend that we are expecting to receive from Wintershall Dea in the fourth quarter. We received that in the first or second quarter of last year. So from a – when you compare quarters, you just have to keep that in mind that there is a significant amount of free cash missing when you do the comparison, and you alluded to working capital cash releases that we’ve already seen in the third quarter, and that will continue in Q4. So the short answer to your question is, we fully expect to cover the dividend with the free cash flow and the expectation is also that from a free cash flow perspective, Q4 will be a very strong quarter.

Martin Brudermuller

Laurent, there is not so much flexibility when it comes to the spending in Zhanjiang for Buns. And actually, we also don’t want because we also want to have returns as soon as possible. And actually, if you look on the fundamental data from China, they have not changed. We have a sound assessment here. We don’t expect old numbers of 6% and whatever was there. We are rather to the 4% is a solid projection going forward. It’s very much domestic driven. I think we mentioned that we expect that – most of the output of this plant is even absorbed in the province of Guangdong, not even going beyond. So for that reason, it’s our highest interest also to get the returns out of these investments and the sales from that. And if you order then the material and just remind you that at the peak of this construction, we will have about 35,000 workers working on that site. So if you dismantle that, you would have actually a lot of additional cost and the project results then come in later. So it’s not even in our interest to do that.

Laurent Favre

Excellent. Thank you.

Stefanie Wettberg

So now it’s Peter Clark, Societe Generale.

Peter Clark

Yes. Good morning, everyone. Thank you very much. I’ve got two questions. Martin, you mentioned obviously about being a business case or not for investing in Europe. I mean your investments on the 5-year CapEx projections has come down significantly in Europe, I think over 60% 10 years ago to under 40% for the last 3, as you pivoted growth towards Asia and particularly China. But obviously, the risk with China arguably are growing as well. I’m just wondering in the context if Europe continues to diminish, is North America an area that you would be revisiting thoughts again or not? Because obviously, the spend there has come down dramatically in the last few years.

And then the second question is around the cost cutting. The €500 million program, but ultimately the right sizing quite a sizable target of 10% of that cost of the non-productive assets in those units or non-productive unit cost. That implies some headcount reduction. And I thought with the focus on Ludwigshafen the site agreement precluded force redundancies for a while. So I’m just wondering how you square the circle of what you can do to believe in that €500 million then beyond that for the cost cutting? Thank you.

Martin Brudermuller

Yes, Peter, I mean, we have no exact data yet how much – how many positions will be cut off. But if you take the non-production part and the units we mentioned, they are mainly personnel costs. So it goes down into a number of people working at the site. And this is also actually what we want to do. But we have to detail it out because that’s a sensitive issue for the labor unions, certainly. The site agreement is right. That’s a framework, which does not allow us to actually fire people until 2025. But people what is also the reality is that the population in BASF is increasingly getting older. So the number of retirements in the next years goes significantly up. And we have also positions that are not filled as everywhere in the world, you have problems to get experts and well at trained people. So we have some of them released from jobs. We can then also put into, let’s say, positions where we do not get the people on the market. So I would expect that over these 2 years, the majority of these positions will be handled that way. And then let’s see whether we need severance, whether we need then also other means in paying if some people have to leave, but I’m not so worried that we cannot manage this in this time.

So when it comes to business case and the CapEx spending, I mean, I said – in Europe, if you go for capacities, new plants, this is, I think, a serious question whether this has a business case. The most of the spending we have actually here is maintaining our basis. One or the other expansion EHS, but then also very much in the area of battery materials, where there is something to come, which is a growth field for Europe. There, you have a clear business case. So the remaining business and the core, we have already mentioned that several times, we have really stripped down to what is needed, because we have now higher CapEx in the other regions.

When it comes to China, I think we can talk long about that. I think I elaborated a little bit on that. Yes, you have geopolitical risk. We look into this thoroughly in all these different dimensions, you can imagine and try to do risk mitigation measures. But what is also clear, you have also risk not to be in China. And if you would now not do these investments, you could also imagine that China is questioning what is actually the commitment of BASF in China? It would also most probably affect all the other business we have over there. And overall, we think we still have a sound business case over there. So the risk of not being in China and cutting ourselves off of 50% of the global market is also a serious question.

When it comes to North America, we don’t talk much about it, but it is also a market, we always look into. Just to remind you that we can spend a couple of hundred millions over there to actually expand our MDI plant, which is a very interesting market. We have really used the opportunity as – the market is actually very balanced, that we are building capacity to absorb that in the years to come forward. So we also not neglect North America. But if you look in the North American market, the last 5, 6 years, it was also not much growing, let’s say, from a local perspective, most of the capacity is going to export and that is also, again, a geopolitical question, whether you want to build capacities in the U.S. than to export in China, we have different assumptions here.

So we look into this regional spread very much and considering all the different aspects for the regions. And there is always some opportunity. But now clearly, and I mentioned that in my speech, also looking into the tight situation in Europe and Germany, we are actually happy that we have all these strong positions and a balanced portfolio regionally, and we want to balance that out even a little bit more by spending more now in the CapEx in Asia. I think this puts all in a little bit in the framework.

Peter Clark

Thank you. Very clear.

Stefanie Wettberg

[Operator Instructions] We will now move on to Georgina Fraser, Goldman Sachs. We then have Andreas Heine and then Markus Mayer. So now Georgina Fraser, Goldman Sachs. Please go ahead.

Georgina Fraser

Hi, thanks, Stefi and good morning, everyone. I do have two questions and they are both on the structural adjustments that you’ve been talking to this morning. Firstly, could you maybe give us an idea of how much of the drivers for the structural adjustments are attributed to higher energy prices versus the increased costs of regulation that you’re seeing for the industry margin? And then the second question on the same topic is I mean what happens to the customer industries if there is more broad-based than BASF structural adjustments for chemicals production? Would you expect these customers to invest more outside of Europe? You just also said that you would be looking to do the same with your own production may be moving more towards China? So yes, just your thoughts on that would be very helpful? Thank you.

Martin Brudermuller

So, Georgina, the energy cost is the real driver. I mean regulation is coming. I think I elaborated on the industry Emission Directive, which is an additional burden, which would also then request additional CapEx to actually update the plans that would also, I think dramatically affect the industry. And I am really confident that we get this away or at least pushed forward because that’s no priority topic. But you have to look into base chemicals here in Europe that are heavily depending on natural gas and energy prices and you have to model actually the competitiveness relative to other regions. And then you have to ask yourself producing base chemical in future, let’s say, in Europe and selling into the market, whether this thing makes sense. You have always to consider however that BASF is with the value chains actually adding value in a lot of the base materials by four, five, six, seven steps in the chain. That means you dilute these costs very much to the final products. And you know Ludwigshafen, for example, we have some 8,000 products roughly or even a little bit more, we sell to the markets. Many of them are actually evergreens whenever you do something in the industry, you need these. And we will produce them and then in the future with the PCF reduced or even zero. So, it is more about this considerations of some base chemicals. And I think the most evident one is ammonia, which has a huge part of its cost just from natural gas. And then it strongly depends you make out of ammonia let’s say, a fertilizer or you produce a specialty, a mean, which is a hardener in an epoxy system which has certainly been a much higher margin on that equivalent of ammonia. So, that is the way we look into this. And on the other hand, this is something we have always done. We have always kind ourselves, redefined ourselves with also raw material changes in the past, coal and oil and gas, now more in direct or renewables. So, I think this is a normal exercise, but the real reason for that now is certainly the threat of the energy costs. And then you are directly also with the customers because some of your customers also take consequences and might stop production. So, then you lose the demand here. That is also why we have to very intensively discuss with our customers. And you know that our strategy is actually we invest where the market is. We also look into our customer portfolio, where are the strong guys for tomorrow. It’s not necessary all the time you had served in the past. So, if they don’t have the potential, you go also to others. And then finally, because we talked about regulation, so it’s also about the CO2 price. So, that comes in if you have the energy price, but you have also the avoidance of CO2 if you don’t produce the one or the other product here. So, it’s a rather complicated picture. But at the very end, we have to come to grips and what are the right measures going forward, but it is always market-related. I hope that helps you.

Georgina Fraser

Yes. Thank you very much.

Stefanie Wettberg

So, now Andreas Heine, Stifel.

Andreas Heine

Yes. Also two, very short. If it comes to the Verbund side in China, you have quite a number of assets already in China, and that produced the cash flow. I would assume that the China Verbund side can be fully financed by your operations in China. And by taking out that locally is that a fair assumption, or can you elaborate a little bit how you finance with your assets? The second is the volume in upstream was very much down in Q3, much more than in the other businesses. Could you explain a little bit in detail why that was – is that that there is a lot of destocking in the value chain, or is it due to the fact that you have closed your plants and loss in competitiveness. So, what is the reason of this discrepancy?

Hans Engel

I will take the first one, Andreas. Andreas, your assumption is fully correct. That is indeed what we are planning, financing the investment in China with the proceeds of the Chinese business. I think that makes a lot of sense. And could you do me a favor? You broke up here and there. Could you repeat the second question, please?

Andreas Heine

Yes. Of course, the volume decline in upstream was much more than in the other business. I would like to learn a little bit more whether this is destocking across the value chain, or was it deliberate that you have to plant in size. So, why was that so much different?

Hans Engel

I would say this is all of the above. As an example, ammonia is something that we partially shut down in Europe, but – and these are – as Martin says, these are huge volumes. We had to adjust to the cost, but we also saw an element there of lower demand in particular, in all regions, and it hit the upstream business is more than the downstream businesses. And that may also mean – we see an element here of adjusting inventories. We see an element of destocking in expectation of lower prices. And then we are approaching at the end of Q3, obviously, also the end of the year, and everyone does the same for the end of the year. i.e., tries to manage the inventories as tightly as possible. So, all of the above is probably the best answer I can give.

Andreas Heine

Thanks a lot.

Stefanie Wettberg

So, now we have Markus Mayer, Baader Helvea, and he will be followed by Jaideep Pandya and then Sebastian Bray. So, now Markus Mayer. Please go ahead.

Markus Mayer

Yes. Good morning. Only one question, which is hopefully then one in which we do not have to answer next year. But if you assume for the next year similar recession as we have seen in the financial crisis and if you look at your portfolio, what would you say has materially changed? And do you think BASF has become less cyclical as in the last really sharp recession? And out of these exercises, what you would do also see as an earnings level for BASF you can say the market can draw a line in the sand to have a trough level on what valuation can be based on.

Martin Brudermuller

I will leave the second one to my CFO. So, the first one, I mean I think it’s fair to say that I think our portfolio management was a straightforward one. I think that all made sense. On the other hand, it’s also an illusion to think we are not signaling to a certain extent because you saw this now exactly with the upstream part that came down, and this will always stay like this. As long as you have these operations, you cannot get rid of that. The question might be then also when we go forward, if we may be produce less base chemicals don’t sell them to the market, but use them as internal raw material, then we might reduce this cyclicality a little bit because then it’s not affecting then the volume business into the market to third-parties. The other part is, I think we are happy about this that the downstreams actually contributed much more. We always talked about this. I hope you see that also that we have a significant management effort and restructuring and push the teams in the performance. And I think that is the lever we have to balance out. You see in some of these divisions also. And I take, for example, industrial solutions, which is a very nicely contributing segment. We don’t talk much about it, but they have really great earnings. And both of the divisions, we have actually cleaned up. So, we have divested quite a bit where it’s paper chemicals, textile and many others coolie. And this is all in this segment. And you see now that we have a portfolio which has a future, which has growth, which has diversification opportunities. And you see now the management is taking full control to really drive those businesses, and they are really, really super well positioned. And then you see also that the portfolio is getting better. That is why I think – what we have done is the right thing to clean out all that stuff that is not really having a good future, distracts management. And in that respect, I think that’s the maximum we can actually do in order to balance out, but we will always have a little bit this upstream stronger swing, I have to say, we have to accept this. But overall, I think you agree no one likes that. We also don’t like the cyclicality, but the overall return over a longer period from our upstream business is a damn good one. So, environments coming to the line in the sand, I will give to Hans.

Hans Engel

Yes. And I think, Markus, the answer that Martin provided is almost the best answer that you can get what we have done. Martin has clearly explained. I would put this under we have built a more resilient portfolio. We could now go back to 2008 and ‘09 and ask ourselves the question how has the business reacted there. We can go back to the year 2020 and the COVID-related lockdowns, and we can try to draw our conclusions from that. But I would say, overall, we have built a stronger portfolio over the years, and that should be the basis for you in calculating what the line in the sand might be.

Markus Mayer

Okay. Thanks for that.

Stefanie Wettberg

Okay. Now, Jaideep Pandya from On Field Investment Research, please.

Jaideep Pandya

Yes. First question really is on the German gas package. If there was any sort of condition attached to sort of dividend payouts, given there is a subsidy coming from the government. I just wanted to understand what are your thoughts at least at a management level when you think about an all stakeholder approach to sort of returns and capital allocation and cash distribution? So, that’s my first question. The second question, albeit is a bit complicated, but at least on my sort of calculation, these days, Europe is about 50% on average, in certain cases even more than that, maybe 100% higher in cost curve than China and North America. Have you seen any significant imports from China into Europe for any particular product change because Chinese product prices, except for polyurethanes are pretty weak. And so is there a big risk that we see a lot of product coming from China into Europe next year? And therefore, even if we see price deflation on the gas side in Europe, we actually don’t see any improvement in returns in the upstream.

Martin Brudermuller

Jaideep, I would try to answer this. I mean one of the reasons why the first half was actually working so well and we could pass on this energy cost basically completely to the market was the big orders level we had and the backlog of – and a good demand, but it was also one of the reasons that we did not have functioning supply chain. So, actually, arbitrage business did almost not work, so not enough volumes and not fast enough to react. That has changed with the ease of supply chains, more materials flying in. You can clearly see this in basically in all the lines. And this is also one of the reasons of the deterioration of the margins in the upstream business because you know that two, three big batches for a huge commodity product actually is changing the pricing power totally. And that is also, I guess not going away unless we have some unpredicted supply chain stuff coming up again. But that’s something I think we have to live from Avis. And this can only be healed, let me say, if we have an increasing demand coming up. So, the material is flowing in, certainly from all the regions. I would say yes, you see it, for example, in this reverse picture now with the European chemical industry, where since March, Europe imports more than it actually exports. One of the major products here, you can see it’s a mixture of many things. But for example, copper [ph] that comes now in from China into Europe. And in earlier times, it was actually an export product from Europe to China. So, you see many of these examples. So, very cautious or let’s say, answer on your first question. Let me say, we are entrepreneurs. And that means we want to take the decisions what is right and wrong for the company. And I don’t want to have any side strengths that we get something in that we are limited in deciding what we think is the right thing. The dividend policy is high ranking for us, you know that. And that’s also what we communicated. So, I have a hard time if anyone tells me or tells us what the right dividend policy is. So, I think this gives you some indication that whatever is possible we try to do on our own feet. I think also very clearly, there is a responsibility for everyone. That’s for a private person, but also for a company. We cannot – it cannot work that everything is paid by public. So, if everyone just opens their hand and say, give me the delta and the difference for the next 2 years or 3 years and then I continue when energy prices come down, we will be over debted and it will be a disaster for the next generations to come. And that is also why I think there is a responsibility for restructuring, for adapting yourself for future competitiveness. If you get lazy now and you get paid from public, I am quite sure in the next 3 years, you have missed the boat when it comes to adapt your structures. So, I think in this, let’s say, situation that you have support if you really are going down the drain and it’s a question of survival, then this is the right measure. But if you are powerful and you are proud and entrepreneur, and that’s our understanding, let me try to avoid whatever is possible. So, I hope that gives you a bit the framework where we are.

Jaideep Pandya

Thanks a lot. And Hans, I wish you at least a little bit less stressful few last months, although I am personally very, very sad to see you leave. But I understand that you have to retire at some point. Thanks a lot.

Hans Engel

Thank you for your kind words. But do you know what you still have to deal with me for the next six months.

Jaideep Pandya

Thank you.

Stefanie Wettberg

January calls will. So, now it is Sebastian Bray, Berenberg and we will then have Tony Jones. Sebastian Bray, please go ahead.

Sebastian Bray

Hello, good morning and thank you for taking my questions. They are mainly just numbers ones. The first, how much of the buyback is done to-date? The second is on the other segment. Am I right in saying that there is roughly a gain of €100 million realized on hedges here? And I come to this figure by comparing the production in Q1, Q2 and the 40% decline in gas figure sequentially for Q3, but it was quite far ahead of market expectations. And I just want to see if that’s the right order of magnitude. I appreciate the answer to this question might be no, but any update on when you think you can get money out of Wintershall as well would be great. Thank you.

Hans Engel

Sebastian, I will take the first one on the share buyback. We bought back order of magnitude, €1.35 billion till the end of last week. So, product or program is progressing as we had defined it in the beginning of the year on Wintershall Dea, getting the money out. So, what we will see is a, what I would call solid robust dividend payment in Q4 of this year. I had mentioned this already earlier, when Laurent asked his question, so that’s certainly one way everything else. You understand the situation as well as I do with the kind of portfolio that Wintershall Dea has – will require certain measures. Mario and Paul spoke about that yesterday at the Wintershall Dea call, we are working on it, and I can assure you we are working very diligently on that

Sebastian Bray

Thank you. And the other segment?

Hans Engel

Question on the other segment, again, was?

Sebastian Bray

What actually was the benefit from hedging gain is €100 million on energy and gas vision of being right…?

Hans Engel

The order of magnitude is okay. This is what we show another is actually a combination of energy, but also raw materials and your estimate there is about right.

Sebastian Bray

That’s helpful. Thank you for taking my questions.

Stefanie Wettberg

Okay. Now Tony Jones, Redburn, please.

Tony Jones

Yes. Good afternoon everyone. Quick one to finish up with, and on the battery materials projects in Europe, could you maybe update us on what level of ROCE you are targeting? On the one hand, the industry is getting scale, but then there is also an argument about competitive activity. And perhaps also let us know what internal level of cost of capital you are using for your growth projects? Thank you.

Hans Engel

Now, on the ROCE target for the battery materials business, it needs to meet the kind of criteria that we are applying to our entire business. And with the developments that we have seen during the course of 2022, we are quite satisfied with the progress the business is making. Cost of capital, is that a question with respect to cost of capital for the BASF Group or for was that with respect to specific businesses?

Tony Jones

Maybe for the group would be helpful. Thank you.

Hans Engel

For the group on a pretax basis, let’s say, round about 10%, between 9% and 10% pretax.

Tony Jones

Thank you. That’s great. Thank you, Hans.

Stefanie Wettberg

We have one last investor in the queue. And if you keep it short, we tried, I will probably not pronounce correctly the name. It’s Sheharyar Malik from PIMCO [ph]. Please go ahead.

Unidentified Analyst

Hello. So, the questions are very short. First question is, if you can – and apologies, you might have mentioned this at the start of the call, but I was late. What is your energy cost right now annualized based on your most recent numbers? That’s question one. Question two is on energy. If you can just give us some sort of indication of how you are purchasing energy? Is it more on spot, or is it contract and if it’s a contract, what are the tenors of the contracts? And my last question is on the German government announced fiscal help for industrial names that face spiking energy costs, there is some – we are hearing some news of restrictions from the government on potential shareholder payments that those companies can make if they want to access that fiscal package. I would like to hear your thoughts on that. And if you had to choose between shareholder returns and getting help from the government, which one – which way you would lean?

Martin Brudermuller

Yes. I don’t know when you – when you came in, but it was just elaborated on this very – in detail. So, I keep that very short entrepreneurial freedom is highest ranking for us. So, we would not like to take anyone the decision on the dividend. That is what we do from our financial strength and the outlook. So, I think this gives you enough indication where we are in this respect. And the other two, Hans?

Hans Engel

First, on your question with respect to nat gas purchases and the price basis in Europe, this is typically spot price-based and spot price base can mean anything between day ahead to month forward. As mentioned also earlier, we are buying natural gas from Western European suppliers in Europe. Your first question, I think was on the – on energy cost for the BASF Group. Annualized, I give you monthly average, order of magnitude, Q3 €600 million to €700 million per month.

End of Q&A

Stefanie Wettberg

Ladies and gentlemen, this brings us to the end of our conference call. Let me take this opportunity to draw your attention to a virtual R&D webcast for analysts and investors that we will offer on Thursday, November 17th. The one-hour webcast is scheduled to begin at 4:00 p.m. Central European Time and will follow the research press conference Melanie Maas-Brunner, member of the Board of Executive Directors and CTO, will explain why biotechnology is becoming increasingly important for the chemical industry, why BASF and LanzaTech are jointly working on producing chemicals from alternative carbon sources and why basic research on biodegradability is making an important contribution to developing sustainable products. Should you have any further questions regarding our Q3 reporting, please do not hesitate to contact a member of the BASF IR team. Thank you for joining us today and goodbye for now.

For further details see:

BASF SE (BASFY) Q3 2022 Earnings Call Transcript