Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

BASF's Kurt Bock is in a bind. Investors once favored his company for its revenue and earnings growth. But its 2015 scorecard has sunk a hole in that good reputation. According to preliminary figures released on Wednesday, yearly sales fell 5 percent while ebit declined 18 per cent to 6.2 billion euros (11 percent below consensus).

Low Oil Prices and Weak Chemical Demand Hurt BASF
The shares are at their lowest since mid-2012
Bloomberg

The chief culprit was a 600 million-euro charge in its oil and gas division, reflecting a slump in oil prices to about $30 a barrel. But BASF's CEO faces a host of problems, some common to the chemical sector, some home-made.

First, chemical demand is linked to global GDP and industrial production growth: no surprise then that volumes aren't growing much. It's hard to lift earnings when your top line won't budge. You'd think plunging oil prices would boost chemical margins because of lower input costs, but price gains are passed on quickly to customers. BASF flagged lower petrochemicals margins.

Second, emerging markets are tough. Crop chemicals profit is being held back in South America by depreciating currencies. China's slowdown and a surfeit of Asian chemical production capacity has hit prices and volumes.

As for the self-made problems, BASF's capex-to-depreciation ratio was the highest in at least 25 years in 2014, according to Bloomberg Intelligence's Jason Miner. While some of that went on making BASF's thrifty production sites more efficient, bringing extra Asian capacity online just as the cycle turned looks ill-judged.

BASF has Invested lots of Money in new Plants
But chemical demand has been hit by weak emerging markets
Bloomberg data

Bock also has the unenviable claim of having shrunk the company. Revenue was 73.5 billion euros when he took over in 2011 but analysts estimate it will fall to 63.6 billion in 2016 thanks to an asset swap with Gazprom. New accounting rules are also to blame.

BASF handed Gazprom its share in a low-margin natural gas trading and storage business in October, securing exploration rights in western Siberia in return. Whether this is a good thing, given the oil price environment, is questionable. Although BASF's oil and gas division is a counterweight with high oil prices, it isn't much help right now.

Oil & Gas is a Hedge when Prices are High
But right now oil is near $30 a barrel. BASF has had to book an impairment.
Bloomberg data

Some investors have clamored for BASF to sell the division, but depressed valuations mean this wouldn't be wise. And BASF hasn't excelled at M&A. More than six years after paying $5 billion for Ciba, it was still slashing jobs until recently at the division to make it more competitive.

Given the risk of operating profit falling again this year, Bock's under pressure to act. But what can he do?

His priority must be to preserve the dividend. The yield has exceeded 3 percent every year since 2005. And with the shares at their lowest since 2012, that will rise to 4.8 per cent for the 2015 fiscal year, according to Bloomberg data.

Although capex peaked in 2014 and the company is in near-permanent cost-cutting mode, it could do more to conserve cash. Despite the awful market backdrop, it generated an impressive 8.5 billion euros in cash from operating activities in the first nine month of 2015. But it spent 4.4 billion euros on capex, exceeding management's 4 billion-euro full-year plan, according to Bloomberg Intelligence.

Still, Bock's been careful to prevent a build-up in inventory, and free cash flow is estimated to improve from 1.7 billion euros in 2014 to about 4.3 billion euros in 2015.

This prompts the question about what to do with the cash. Competitors are busy putting together vast deals. But joining the race for Syngenta would be costly and face antitrust problems. Bock has rightly shied away from big M&A, concerned about rich valuations.

Given the bleak outlook, he could do worse than return some cash to shareholders.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net