BASF: 5% Dividend For A Fair Price

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About: BASF SE ADR (BASFY), BFFAF
by: David Möstl
Summary

BASF offers a higher than historical average dividend.

Currently, trading at a fair price after a 30% drop.

Low debt and long-term focused management.

BASF (OTCQX:BASFY|OTCQX:BFFAF) is one of the largest German companies and one of the largest chemical companies worldwide. It operates in over 80 countries. The company offers a high dividend yield of around 5%. Furthermore, the company has a high margin, solid management, and low debt. The corporate purpose of the company is "we create chemistry for a sustainable future".

Overview

One of the success factors is the composite principle. This means that the company is producing from the raw oil to the end product in one location (for example, at Ludwigshafen). This saves transportation costs and time.

Figure 1: Segment overview

Source: company presentation March 2018

In chemicals, the segment with the highest EBIT, BASF produces basic products for the chemical industry and the plastics industry. The product portfolio ranges from solvents, glues, raw materials for detergents, plastics, crop protection to medicines. This segment is very sensitive to the general economy. If the global economy is doing good, BASF does good.

In performance products, BASF improves everyday products with the addition of chemicals. For example, vitamins are produced and sold. Basic material for hygiene products, the paper industry, and cosmetics are produced. The earnings are more stable in comparison to the chemical segment. The close work with customers results in specific solutions and long-term contracts.

In the functional materials & solutions segment, customized solutions are developed. BASF is one of the largest automotive suppliers worldwide. It provides auto catalysts, battery materials, automotive and industrial coatings. But even with electrical cars, BASF can earn money as the batteries need a special chemical. The increasing lightweight construction made of plastic benefits the company as well.

In agricultural solutions, BASF develops, produces, and sells herbicides, insecticides, and fungicides. The segment is not making a lot of revenue (€5.6 billion) but has operative earnings of about €1 billion which equals a margin of more than 18%.

The oil & gas segment is one of the interesting segments. Because with the exploration of gas and oil, it is not very dependent on the energy prices. The segment works like a natural hedge. If the oil prices increase, the other four segments have more costs, but the oil & gas segment earns more money.

Figure 2: Revenue breakdown 2017

Source: annual report 2017

Positive aspects

As BASF is one of the largest chemical companies, they can use their enormous size to produce even more efficiently.

Another important factor is the high investment in R&D. In 2017, €1.9 billion was invested in R&D. Around 3,000 projects are in the research pipeline. Over 800 patents were filed worldwide. The company is focusing on three key aspects in research: resources, environment, and food/nutrition.

Figure 3: overview R&D expenses

Source: annual report 2017

The balance sheet looks very healthy. Inventories and accounts receivable increased slightly but still under the growth rate of revenue. The debt is very low. With a bit over one year's earnings, they would be able to pay back their debt. The low debt is a good sign in a rising interest environment. The equity ratio improved to 44% from 42.6% in 2016.

The margin stayed positive in the financial crisis of 2009. It was between 7% and 13% in the last ten years.

Between 2018 and 2022, BASF is going to invest in property, plant, and equipment totaling €19 billion. The reason behind this is that the company tries to stay ahead of competition.

Long-term strategy/Management

The chemical industry is under heavy consolidation pressure. DuPont and Dow Chemical have merged. ChemChina has bought Syngenta (OTC:SYENF) for €40 billion. Bayer (OTCPK:BAYZF) has bought Monsanto for €60 billion.

BASF did not make a large acquisition, but they did wait for the right moment. As Bayer needed to sell their own seed and herbicides business - BASF bought it. Furthermore, the vegetable seed business was bought from Bayer. Now, BASF is one of the largest providers of herbicides and insecticides - but without glyphosate and the legal risk of it.

The strategy of BASF was a very calm and balanced one without taking a too high risk. They bought already functioning business areas of a competitor for a fair price.

The CEO, Dr. Kurt Bock, stayed calm and could improve BASF through smaller acquisitions but without paying high prices or to use too much debt.

The management looks carefully if a part of the company is not providing enough potential. They divest leather chemicals to the Stahl Group and now hold a 16% share in Stahl group.

Growth

A general opinion is that the chemical sector is growing 1.5x faster than the global economy. If we take a global growth of 3% per year, the chemical sector should grow 4% per year. BASF is increasing their market share year after year, so a long-term sales growth of 5% is possible.

Analysts expect a growth of 3.8% for the next three years.

Dividend

Half of the earnings were used for paying a dividend. The free cash flow has increased over the last years. Therefore, the payment of the dividend should be relatively safe. In a crisis as in 2009, the dividend might get cut, but I do not think the whole dividend is going to be cut. With a current dividend yield of 5%, the stock looks very tempting.

Figure 4: Dividend history

Source: annual report 2017

In the past years, the average dividend yield was around 3.5%. Therefore, from a historical dividend valuation point, the stock looks cheap.

Risks

The biggest risk for BASF is a global economic slowdown which lasts for several years. But on the other hand, if the global economy accelerates, BASF is profiting from that.

Figure 5: volatile EPS and PE

Source: annual report 2017

Another risk is their largest production plant in Ludwigshafen, Germany. There are high personal and energy costs. It is possible that competition from Asia is trying to get some of the market share of BASF through cheaper production costs. The company is focusing on their refined products. Therefore, they are less and less dependent on the base chemicals.

Figure 6: general overview of the past 10 years

Source: Morningstar

As you can see in Figure 6, the revenue was volatile in the last ten years. But the income doubled and the free cash flow nearly doubled. (Please keep in mind that the dividends row from Morningstar is wrong. I have put the right dividend growth in Figure 4.) The ten years overview gives a clear picture of the cyclicality of BASF.

Valuation

I made an earnings model with the following parameters. Terminal Value of 10, a discount rate of 15%. I always use a high discount rate. The reasons behind it are to be conservative, to include the cyclicality, to compare it to other investments, and for protection against errors in my estimations and calculation.

  • The first scenario is the worst case - 3% earnings growth for the next 5 years and 1% for the other 5 years. (Probability of 25%)
  • Second scenario is the best case with 7% earnings growth for the next 5 years and 5% for the other 5 years. (Probability of 25%)
  • The third, the normal case, is 3% growth at first and then 5% over the long term. (Probability of 50%)

Figure 7: own valuation

Source: own calculation

Conclusion

All in all, BASF looks very tempting. High dividend yield, low debt, and good management for a fair price. The calculation of the three scenarios resulted in a fair value of around €60. Yes, BASF is cyclical, but, in 2009, made €4 billion in earnings and paid a dividend in the worst crisis since the 1930s. If you can stand a cyclical stock with a good dividend yield, then you should consider BASF.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BASFY over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.