Shares of European chemical giant BASF (OTCQX:BASFY) (OTCQX:BFFAF) are looking highly attractive trading with a valuation of only 9.6x TTM P/E as they start to recover from 3-year lows hit during the year-end 2018 stock market rout. This low valuation has pushed BASF's dividend yield all the way up to 5.3% and presents long-term value investors a great entry point into this highly profitable global company.
An Introduction to the Company
For readers that are not familiar with BASF, the company is a global chemical giant that had 2017 sales of €64 billion and net income of €6.1B. Based out of Germany, the company has operations in 80+ countries and 115,000 employees across the globe. Their business portfolio is arranged into five segments consisting of Chemicals (25% of 2017 sales), Performance Products (25%), Functional Materials & Solutions (32%), Agricultural Solutions (9%), and Oil & Gas (5%), with Corporate & Other making up the remaining 4%. BASF holds the top three market position in about 75% of its business areas and the company continues to offer customers innovative products with the help of around 10,000 employees involved in research and development that together filed 800 new patents in 2017. In terms of a geographic footprint based on 2017 sales as can be seen below, the company generates 45% of sales in Europe, 24% in North America, 22% in the Asia Pacific, and 9% in South America, Africa, and the Middle East.
Sourced from BASF Factbook 2018
A Profitable And Growing Business
BASF's strong operations have allowed the company to achieve average return on equity (ROE) and return on invested capital (ROIC) of 17.7% and 12.4%, respectively, over the past decade. While the company is cyclical along with the industry, this average level of profitability is well above my rule of thumb of 9% ROIC, allowing me to be confident that, in my opinion, the company is able to maintain and continue to increase its intrinsic value over a business cycle. Also, compared to some other chemical manufactures I have looked at, BASF is relatively less cyclical, having not had one year with an earnings deficit in the past decade, even during the 2008 financial crisis.
Source data from Morningstar
On the growth side, book value per share has grown from €19.13 in 2008 to €36.84 in the past quarter, which, when combined with the dividends paid out from equity, has an average growth of 17.2% annually which further supports the ROE and ROIC averages. With a payout ratio of 45% in the trailing twelve-month period, BASF's dividend also looks nice and secure.
BASF has decreased financial leverage markedly over the past decade and is in a strong financial position. With financial leverage currently at 2.33x and the company's interest coverage ratio a healthy 11.1x in the trailing twelve-month period, the company looks ready to handle the next cyclical downturn. With financial leverage now near lows for the past decade, it would be great to see BASF start returning more cash to shareholders through increased share repurchases or dividends.
Source data from Morningstar
Price Ratio And Potential Returns
I always like to examine the relationship between average ROE and price-to-book value. This relationship is especially important for cyclical companies and is something I consider similar to Shiller's CAPE ratio, but a little simpler to calculate in my opinion. It examines the average ROE over a business cycle and adjusts that ROE for the price investors are currently paying for the company's book value or equity per share. With BASF earning an average ROE of 17.7% over the past decade and the shares currently trading at a price to book value of 1.7x when the price is $17.93, this would yield a similar adjusted ROE of 10.1% for an investor's equity at that purchase price, if history repeats itself. This is above the 9% that I like to see, and adding a 3% growth rate to represent the company growing alongside GDP could increase this potential total return up to 13.1%.
Source data from Morningstar
BASF has been a hugely profitable company over the last decade and the shares look attractive to long-term investors trading at only 9.6x TTM P/E. The company's low leverage and strong interest coverage ratios should provide some support through the next cycle while also allowing the company to be opportunistic with acquisitions and share repurchases. BASF has grown strongly over the past decade and long-term investors willing to ride the cyclical ups and down could find themselves with a nice return when the market once again recognizes this company's growth and profitability.
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Disclaimer: While the information and data presented in my articles are obtained from company documents and/or sources believed to be reliable, they have not been independently verified. The material is intended only as general information for your convenience and should not in any way be construed as investment advice. I advise readers to conduct their own independent research to build their own independent opinions and/or consult a qualified investment advisor before making any investment decisions. I explicitly disclaim any liability that may arise from investment decisions you make based on my articles.
Disclosure: I am/we are long BASFY. 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.
Additional disclosure: I am long BASFY with an average cost base of $16.65.