BASF stock- Big player with an uncertain path?

BASF is the largest chemical company in the world in terms of revenue and one of the largest companies in Germany. The company produces in over 80 countries and employs about 118,000 people. Their slogan is “We create chemistry for a sustainable future”.

BASF stock
Logo
Country	Germany
Industry	Chemicals
Isin	DE000BASF111
Market cap.	55,1 billion $
Dividend yield	6,5%
Dividend stability	0,97 of max. 1.0
Earnings stability	0,64 of max. 1.0

The BASF stock offers a high dividend yield of approximately 6.5%. However, the high dividend yield is the result of a declining stock price, which started at a high of EUR 98 in January 2018. During the Corona crisis, the stock price temporarily fell to just EUR 41. Currently, the stock has at least fought its way back to just over EUR 50.

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Is a comeback of BASF stocks only a matter of time or is the high dividend merely compensation for the underperformance in the portfolio? I will provide the answers in this analysis.

A changing business model: How BASF makes money

In 1865 the Badische Anilin- und Sodafabrik was founded in Mannheim. The initial product range consisted of various dyes for the textile industry. Thanks to a successful course of business, the company was able to expand into other areas of the chemical industry and developed into a full-scale chemical conglomerate with a large number of different segments. Nevertheless, the business model has changed several times over the years. For example, at the beginning of 2019, a new segmentation was decided upon. BASF’s business is currently divided into six major segments.

The Chemicals segment (16 % of the revenue)

This segment is the heart of BASF because the basic chemicals and intermediates produced here are used to supply the other segments. The so-called Verbund production enables the formation of efficient value-adding chains within the company. For example, waste products from one production step are used as input material in another production step. The intermediates are used as raw materials for coatings, plastics, pharmaceuticals, and crop protection products. The segment has not only internal customers but also external customers, especially in the chemical and plastics industries. The strategy is to expand its technological leadership and focus on operational excellence. With its focus on operational excellence, the company attaches great importance to ensuring that processes are carried out as cost-effectively as possible.

Verbund-Plant location of BASF

The Materials segment (20 % of the revenue)

This segment produces modern materials and intermediate products. These include products for new applications and systems, such as isocyanates, polyamides, and inorganic basic products, of which no one without an advanced chemistry background knows what they actually are. The customers of this segment are the plastics, automotive, and construction industries. The focus is on organic growth through close cooperation with customers in order to manufacture products that perfectly meet their needs. This benefits customer loyalty.

The Industrial Solutions segment (14 % of the revenue)

This segment develops and markets ingredients and additives for industrial applications. Exemplary products are pigments, resins, electrical materials, and additives. In addition to the automotive industry, the main customers in this area are the plastics and electrical industries. The automotive industry is one of BASF’s most important customers, which is currently having a rather negative impact on ongoing business.

The Surface Technologies segment (22 % of the revenue)

This area includes chemical solutions for surfaces. The product portfolio includes coatings, catalysts, and battery materials for the automotive and chemical industries. The catalysts are used as vehicle and process catalysts. In this segment, BASF aims to become a leading and innovative supplier of battery materials. Growth is not only organic but also through targeted acquisitions and cooperations. One example of this is the battery recycling cooperation between Fortum, BASF, and Nornickel that was concluded in March. The companies hope to achieve a recovery rate of up to 80% for valuable materials in lithium-ion batteries.

The Nutrition & Care segment (10 % of the revenue)

BASF is also a leading supplier of ingredients for consumer goods. Its customers include food and animal feed manufacturers as well as producers of cosmetics and cleaning products. In this segment, BASF aims to achieve organic growth by focusing on growth markets in Asia and also makes targeted acquisitions.

The Agricultural Solutions segment (13 % of the revenue)

The product range in this segment covers herbicides, insecticides, fungicides, vitamins, and acids. The Agricultural Solutions division has recently been significantly expanded. The reason for this was the acquisition of Monsanto by Bayer. To comply with antitrust regulations, Bayer’s seed and crop protection products business had to be sold. BASF saw this business as an ideal addition to its corporate portfolio and bought it from Bayer for EUR 7.6 billion. The segment’s strategy is based on organic growth and targeted acquisitions.

The Oil and Gas segment (split off)

The Oil & Gas segment will no longer be continued. Nevertheless, I would like to mention it here briefly because it has been a key revenue driver for BASF in recent years. In 2018, the oil and gas business was merged with the company DEA into a joint venture called “Wintershall”. BASF holds a 72.7% stake in the joint venture and Wintershall is expected to be listed on the stock exchange in the second half of 2020. This initial public offering could put further money into BASF’s pocktes. However, the timing would be anything but ideal, as the oil price is low despite a recovery and the effects of the corona crisis are continuing to curb oil demand.

Oil-price Chart Source:tradingview.com

You will see that BASF’s business model is very dependent on the price of raw materials and their demand. BASF is therefore a cyclical company. Management tries to counteract this by actively managing the segments. Less well-performing businesses are sold, and promising businesses are strengthened through acquisitions to drive growth in growing markets and through special products. In recent years, attempts have been made to move away from the cyclical oil business and increasingly diversify into anti-cyclical areas. One example of this is the expansion of the food and agriculture segments. Whether this will reverse the decline in revenue and earnings, we are going to see in the coming years.

Can BASF increase profit and cash flow in the long term?

BASF was able to continuously increase its cash provided by operating activities from 2005 to 2015. However, earnings were much more volatile. In particular, during the financial crisis in 2009, earnings declined sharply, only to reach new highs in the following years. The high in terms of cash provided by operating activities was reached in 2015. Nevertheless, BASF further increased its dividend. This automatically raises the question of how long management can continue to increase dividends if profits and cash flow decline. Already today, the dividend is no longer fully covered by free cash flow.

Long-term development of earnings and cash flow of the BASF stock 

The jump in profit in the first quarter of 2020 is due to extraordinary income from the sale of the oil and gas business.

For many companies, the corona crisis is a major challenge. BASF already had to withdraw its guidance for 2020 in April. Due to the high level of uncertainty, management is holding back on concrete statements on the development of revenue and earnings. However, the figures published for the second quarter of 2020 show that BASF has to deal with the consequences of a cooling global economy. Compared with the same quarter of the previous year, earnings before special items fell from EUR 995 million to EUR 226 million.

How is the business of BASF going?

In this section, I will take a closer look at the development of revenue and margins.

Development of revenue and margins of the BASF stock

The gross margin fell from its peak in 2016 from 31% to only 26% currently. A similar picture is reflected in the operating and net margins. BASF is struggling with declining sales prices in its main segment (Chemicals) and increasing competition from China. The trade conflict between China and the United States is also having a negative impact on the globally linked company, as the threat and introduction of penalty tariffs is leading to a weakening of demand. Another trade conflict between the United States and Mexico is also having a negative impact on BASF. Some basic products are produced in Mexico and then processed in the United States. Tariffs and import regulations make this exchange of goods more difficult and expensive. In order to gain a better foothold in the growth market of China, a Verbund-Plant is under construction in Guangdong (China) for slightly more than $10 billion. China is expected to account for 50 % of global chemical production by 2030, and the construction of a new plant is therefore a strategically important step. What I see as positive is that the management recognizes the challenges and is actively seeking solutions.

From 2015 to 2016, sales fell by around EUR 10 billion. This is due to the spin-off of the gas trading and storage business to Gazprom. I welcome the separation from the cyclical oil and gas business, which was completed with Wintershall. The new BASF is “greener” and yet remains well-diversified. Unfortunately, the revenue trend shows that BASF has not yet been able to get a grip on stagnating revenue in general.

Is the BASF dividend secure?

BASF is one of the most popular German dividend stocks and the company considers itself an attractive dividend provider. The following statement can be found on the company’s Investor Relations website: “Long-term value creation with an attractive dividend policy – we aim to increase our dividend per share every year.” It is therefore worth taking a particularly close look at the dividend development and the security of the dividend.

The last dividend cut was in 2010 and the relatively large fluctuation in dividend yields is an interesting fact. In recent years, the lowest dividend yield was around 2.5 % and the highest at just below 7.4 %. However, it should be noted here that it is not the dividend paid that fluctuates so much, but rather the stock price. Let’s take a look at the dividend turbo to see how the current dividend yield can be rated.

Development of dividend yield of the BASF stock (Source: dividendstocks.cash)

The 12-month dividend corridor is between 4.4 % and 6.8 %. The current dividend yield is even slightly above the corridor. Given the current dividend yield, BASF´s stock appears to be an attractive buy. As a successful shareholder, you should not rely solely on the dividend yield.

Another important aspect linked to the dividend is the development of debt. In a healthy balance sheet, the level of debt is not too high and a certain amount of cash is available as security. Furthermore, there shouldn´t be an excessive amount of cash, as this would remain unproductively in the bank in times of zero interest. The debt, in turn, should not be too high, so that the management has sufficient reserves to be able to react dynamically to sudden changes.

In addition, the dividend should not be financed by taking on further debt, but rather through current business activities.

Development of cash, amortization power and debt ratio at BASF

BASF’s debt ratio remains constant at around 50 to 60 %. However, the increasing dividend with declining cash flows is leading to an ever decreasing amortization power. In the first quarter of 2020, it was even negative. This means that BASF was no longer able to finance the dividend from current cash flow (see also above in the presentation of earnings and cash flow per share). In my opinion, BASF’s dividend is at risk due to the decreasing amortization power as a result of declining revenue and margins.

Is the BASF stock undervalued?

I´m using the Dynamic Stock Valuation for my valuation of BASF´s stock. I apply fair values based on adjusted earnings, operating cash flow, and dividends.

Determination of the fair value of the BASF stock in the dynamic stock valuation (Source: dividendstocks.cash)

The fair values are between EUR 40 and 81 EUR. The high fair value of EUR 81 is due to the high dividend yield. This is so high because the dividend was increased despite falling profits. As already mentioned, BASF’s management attaches great importance to an increasing dividend. The fair values based on adjusted earnings and cash flow are EUR 40 and EUR 50. According to analysts’ estimates, all three underlying fair values will decline in the current financial year. In particular, the fair value of the adjusted profit will even decrease to EUR 30. According to forecasts, profits and cash flows are not expected to pick up again until fiscal year 2021, and so the fair value of the stock. However, the forecasts are subject to a high degree of uncertainty due to Corona. The current stock price is EUR 51 and for the estimated fiscal year therefore at the upper limit of fair values based on adjusted earnings and operating cash flow. The BASF stock is therefore not a bargain, as the high dividend yield leads one to believe. Instead, the stock seems to be fair or even slightly overvalued.

Conclusion: BASF stock – uncertain dividend with little upside potential

The BASF stock attracts investors with a historically high dividend yield. This is primarily due to massive stock price declines and only secondarily to real dividend growth. In addition, the effects of the corona crisis make BASF’s future business development uncertain. Although BASF is a solidly positioned company and its management is actively tackling the challenges, success has so far been a long time coming.

For me, BASF´s stock is not a buy. Even income-oriented investors should realize that their return is made up of dividends plus stock price increases. And neither of these things seems to me to be certain for the future. Those who already have BASF stock in their portfolio should keep an eye on fundamental developments. It is crucial to know whether the trend of falling margins and revenue, which has persisted since 2017, can be reversed or at least stopped. If this does not succeed, further stock price losses and a dividend cut are the logical consequence.