BASFY - BASF: We See Light And Shadow In Q1

2023-04-29 22:15:09 ET

Summary

• Energy cost and FCF developments are well in line with our previous expectations.
• Net income declined mainly due to lower contributions from the upstream division.
• BASF left its guidance unchanged and so we confirm our valuation.

Before commenting on BASF SE Q1 results ( OTCQX:BASFY , OTCQX:BFFAF ), it is important to follow up on our recent publications.

Starting with 'Lower EU Gas Prices, BASF Is Our Top Pick' released in early January 2023, we highlighted how energy costs were going down. Here at the Lab, for the near-term horizon, we acknowledge that Europe is in no danger of an increase in natural gas prices. This is supported by strong reliability in the liquefied natural gas market, extra volumes from the United States, and low gas demand. However, our concern is related to the next winter. Cold temperatures, possible interruptions of Russian gas flows, and a further recovery of the Chinese economy could lead prices to over €100 per megawatt hour. In March, European TTF prices stood on average around €45/MWh, the lowest level since August 2021, while since the beginning of the year, gas prices recorded a drop of around 40%. Europe is towards the end of the colder season with gas stocks near all-time highs. If there are no major disruptions in the coming months, we are forecasting a steep decline in the upcoming second and third quarters, with nat gas prices to fall more than 70% year-on-year from today's spot prices. Even if it is still not evident, in Q1, BASF reported a €100 million lower cost in energy price (Fig 1).

Given that industrial gas companies have greater pricing power and that two-thirds of their commercial revenues are linked to selling price negotiations, here at the Lab, we might expect to see a significant increase in gross margins. Among the most energy-intensive companies that buy energy at spot prices, BASF and Covestro are on the top list; while Arkema, Evonik, and Solvay have contracts in place with a price already negotiated and will probably benefit less from gas price drop over the year.

Source: BASF Q1 results presentation (Fig 1)

Our second comment is related to our latest release called ' Disappointing Results '. BASF communicated its DPS proposal, and next week if approved by the board, the dividend will be paid out. In total, the company will cash out €3 billion, and as mentioned by the CEO , " this amount is more than covered by our free cash flow of €3.3 billion in 2022 ". Last time, we forecasted a €3 billion FCF deficit for 2023, emphasizing how BASF free cash flow will be negligible until 2025. In addition, we are expecting to see higher leverage, and forecasting a flat DPS over the period, an increase of 0.3x net debt/EBITDA per year. Looking at the quarter just released, we already see this negative trajectory (Fig 2). As a reminder, according to our calculation, BASF will trade at 2.35x 2024 Net debt on EBITDA (higher than its competitors).

Fig 2

For the above reason, we are not surprised to see that BASF management is actively pursuing cost-saving initiatives to increase the company's competitiveness.

In the quarter, the company delivered €20.0 billion in sales and was down by €3.1 billion compared to last year's end quarter. This was driven by lower demand in almost all segments. On a positive note, prices decreased by only 0.7%. This was mainly supported by Agricultural Solutions and Nutrition & Care segments; however, there were not able to offset lower prices in the remaining divisions. FX was a positive tailwind. The company's core operating profit decreased to €1.9 billion, signing a minus 33% versus the strong prior-year quarter. This negative earning development was further deteriorated by the significant profit decline in the Chemicals & Materials divisions which impacted BASF by almost €1 billion.

Conclusion and Valuation

In our last publication, we explicitly said that we were not so confident in the short-term horizon. Despite that, looking at the medium-long term horizon, the German chemical giant is still trading at a discount on the EV/EBITDA basis (12% vs 7%). Looking at the aggregate EU chemical sector, the current average price/book value ratio for cyclical stocks is at 1.1 times. And it is greater than the 0.8x seen in the great financial crisis years. A V-shape might start; however, this time is harder to forecast a reduction in raw material costs (especially in energy) over a medium timeframe. Here at the tower, we believe that too much negativity is priced in towards BASF shares, and we already cut our target price . So today, we decided to maintain our previous valuation with a price target estimate of €55 per share ($11.8 in ADR). This is derived from a Price/Earning ratio of 7 (in line with our past valuation), and an outlook unchanged on the company's forecast.

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