Urethane Highlights from BASF Earnings Call
October 26, 2022
BASF SE (BASFY) Q3 2022 Earnings Call Transcript
Oct. 26, 2022 11:56 AM ETBASF SE (BASFY), BFFAF
BASF SE (OTCQX:BASFY) Q3 2022 Earnings Conference Call October 26, 2022 5:00 AM ET
Stefanie Wettberg – Investor Relations
Martin Brudermuller – Chairman
Hans Engel – Chief Financial Officer
Good morning, ladies and gentlemen. Two weeks ago, BASF released preliminary figures for the third quarter of 2022. Today, Hans Engel and I will provide you with further details regarding our business development. Despite the continued strong headwinds from high raw materials and energy prices as well as slowing economic activity, BASF achieved solid EBIT before special items in the third quarter of 2022. Our downstream segments improved earnings considerably. In the upstream segments, however, earnings declined significantly from the very high levels in the prior year quarter.
Let’s start with a snapshot of the current challenging market environment. Compared with Q2 2022, the global macroeconomic environment was significantly weakened. There are no indications of improvement from the markets in the short-term. High inflation and the sharp increase of energy prices led to a slowdown in consumer demand, particularly in Europe. China recorded growth, but particularly because of a strong base effect due to the power shortage in the prior year quarter and its economic development continued to be impacted by the restrictions to reduce the spread of COVID infections.
Global automotive production was a positive surprise in Q3 2022. It increased in all regions compared with the prior year quarter. Q3 2021 was however the quarter in which chip shortages peaked. After the COVID related lockdowns in the second quarter of 2022, automotive production in China developed significantly better than anticipated. IHS Markit has adjusted its forecast for global automotive production in 2022 to 81.8 million units. Compared with 2021, this would be an increase of around 6%. Central banks have further raised interest rates in recent months. This will more and more dampen construction and consumer spending in the coming months and will likely result in lower growth in 2023.
Let’s now briefly look into – look at the chemical production by region in Q3 2022 before we turn to the financial performance of BASF. Based on the currently available data, global chemical production grew by 2% compared with the strong prior year quarter. While China and North America recorded growth, chemical production declined in Europe and in Asia, excluding China.
According to recent released data, growth in Mainland China was surprisingly high, partly due to the industrial power cuts in the prior year quarter of last year. In Europe, chemical production declined on account of lower demand and higher energy prices, which in some cases led to reduced or temporarily shutdown production at different stages of the value chains. Lower demand and increased energy prices were also the main reasons for the decline in Asia, excluding China.
Let’s turn to the BASF key customer industries. I will selectively comment on the most relevant developments shown on this slide. The transportation industry continues to benefit from pent-up demand globally, particularly in China. As mentioned, global automotive production increased compared with the low level of 2021, but is still restricted by semiconductor availability.
In agriculture, the demand environment looks solid overall. However, prices for some crop commodity products have come down recently, but remain on an above average level. The construction industry, particularly in North America and in Europe, is deteriorating because of interest rates. In China, the overheated residential segments continued to decline. In summary, construction and consumer spending with the exception of automotive are weakening.
I will now move on to BASF’s business development. In the third quarter of 2022, EBIT before special items declined by €570 million – €517 million and amounted to €1.3 billion. Additional costs for natural gas in Europe are one major reason for this decline. If we look at the segments, the solid EBIT before special items in Q3 came primarily from BASF’s downstream segments. They considerably improved earnings, mainly on account of further price increases. In line with our guidance for the full year, earnings in the Upstream segment declined considerably with softening demand from the very high levels in the prior year quarter.
Natural gas prices increased further compared with the already elevated levels in Q3 2021. In the first 9 months of 2022, the additional costs of BASF’s European sites amounted to around €2.2 billion compared with the same period in 2021. To mitigate these higher costs, we have implemented further price increases and we continue to work on technical optimization projects, particularly at our largest site in Ludwigshafen. Reduced plant utilization in Q3 2022 also helped to limit the burden of high natural gas prices in cases where the market did not absorb the additional costs.
I will now give you additional information on earnings development in the regions. If you look at the bar for 2015, you can see that Germany, Europe, excluding Germany and the other regions each contributed around one-third to BASF’s Group EBIT before special items in that year. In the strong year of 2021, Europe, including Germany, contributed only one-third, while the other regions contributed two-thirds.
In the course of 2022, earnings have softened further and we saw a particular deterioration in our German operations. In Q3 2022, we recorded negative EBIT before special items of €130 million in Germany. The lower earnings in Europe and in Germany in particular are due to a variety of reasons. In our recent announcement, we summarized them under the term deteriorating framework conditions. There are essentially three developments.
First, the European chemical market has been growing only weekly for about a decade. In the period from January to August 2022, the chemical market shrank by 2.1% in EU 27 and by 6.8% in Germany compared with the same period in 2021. Second, the significant increase in natural gas and electricity prices over the course of this year is putting pressure on chemical value chains. We expect structurally higher and volatile natural gas prices in Europe also in the mid and long-term. And third, uncertainties due to the enormous number of regulations planned by the EU are waiting on the chemical industry. The current development underlines once again the importance of a balanced regional footprint.
The challenging framework conditions in Europe endanger the international competitiveness of European producers and force us to adapt our cost structures as quickly as possible and also permanently. This is why we initiated a cost savings program, focusing on Europe and Germany, in particular, which we announced on October 12. With this program, we aim to streamline non-production units in operating, service and R&D divisions as well as in the corporate center.
The cost reduction measures will be fully implemented until the end of 2024. Short-term cost savings will be implemented immediately. When completed, the program is expected to generate annual cost savings of €500 million, which corresponds to around 10% of our European costs in these categories. More than half of the cost savings are to be realized at the Ludwigshafen site. We are currently developing further structural measures to adjust ESS Verbund production Verbund in Europe, in the medium and long-term to the changing framework conditions. We will thus ensure our future competitiveness and significantly reduce our consumption of gas.
We are actually making great progress on this. We expect to communicate details in the first quarter of 2023. At this point, I want to stress we cannot speak our heads into this end and hope that this difficult situation will resolve itself on its own. We, as a company, must act now. Our cost savings program aims to secure our medium and long-term competitiveness in Germany and Europe. We must take decisive action to fulfill our responsibilities to our employees, shareholders and society.
Yes. Let me conclude with the outlook. In the third quarter of 2022, economic activity weakened more significantly than expected. Against this background, BASF has adjusted its assessment of the global economic environment in 2022. We now expect GDP and industrial production each to grow by 2.5%. Global chemical production is expected to grow by not more than 2%, down from our previous assumptions of 2.5%. We now anticipate an average oil price of $100 per barrel of Brent crude at an average exchange rate of $1.05 per euro.
Despite the significant weakening of the economic environment since the third quarter of 2022, we confirm BASF’s group’s forecast for the 2022 business year as published in the half year financial report of 2022. We are forecasting sales of between €86 billion and €89 billion for 2022. BASF Group’s EBIT before special items is expected between €6.8 billion and €7.2 billion. We continue to be confident that we can achieve the upper end of this range even so this has become more challenging in view of the current macroeconomic and geopolitical developments. ROCE is likely to be between 10.5% and 11% and CO2 emissions are expected between 18.4 million metric tons and 19.4 million metric tons in 2022.
And now, we are glad to take your questions.
Yes. Thank you, Stefanie and good morning and also good morning, Martin and Hans. Couple of questions around the gas complex. First of all, can you share with us your view on how helpful for your Ludwigshafen plant, the first draft proposal of the gas aid scheme by the German government is? And on gas in Europe, just wanted to check that my math is right, looking at Slide 7 in your presentation and comparing this with your Q1 and Q2 charts, is it correct that the Q3 gas price burden for Europe year-on-year was just about €500 million? And then last question on gas, I promise, can you share with us the rough regional distribution of gas sources for your Ludwigshafen plant at present? Thank you.
Christian, maybe I will start with the first one. I mean, let me first say and this is also what I said in the speech, I think the prime task of companies is to actually help themselves and to improve – and improve their structures. That’s why I am very happy that the BASF team as always in the crisis times is exceptionally creative. I will not give you a number, but I can only tell you we are significantly down where the critical threshold for gas is. We will then report you and give you more background on that in the Q3. So, that reduces the – sorry, Q1 next year. This reduces the vulnerability of the Ludwigshafen site, first of all, because of availability of gas, but then certainly also gives us opportunity to react also on the structural side by shutting down plants and utilization for the main gas consuming products. And I mean, ammonia is the biggest one and you saw that we also adapted over there. So let me clearly say the prime target is certainly that we settle our issues, mainly ourselves. But let me also say that we very much welcome the proposals of the Gas Commission which is also this time clearly also indicating the help for the industry, not only for citizens. And I think it is a little bit early still to say how it works in details, because the proposals are great, but they also have a lot of questions. When it comes to the details, you have also seen in the last days that there was quite a reaction on other EU states. It’s also about a level playing field in Europe in terms of industry. There is also the state aid rules in process, which have to abate to. So I think there is still some work to be done and then giving clear interpretations of this. But also clear, if you look also on our customer base and the smaller SMEs, they really are in a difficult situation, which is deteriorating very, very quickly, because they come already from a difficult situation from COVID time. So, it is really important that this is quick and pragmatic.
But I also want to say very clearly, we have to ask for flexibility and not too strict rules because at the very end, it has to be a combination of both. Yes, there is public money for those companies who need this support and help, but I think there is also an obligation of each company to adapt its structure going forward. because the world is not frozen and it doesn’t make any sense now to give the company’s money and say you have to keep your structure and we wake you up in 3 years when the energy price or energy crisis is over and you just continue where you are, where you have actually stopped because the world is moving too. So I think we need this flexibility to do our own way and then we will see whether we at all needed and what the conditions are for the use of public money. So maybe I will leave it at that point and give the other two to Hans.
Yes, good morning, Christian. This is Hans. So your first question, I think you did the math correctly, around about €600 million additional cost for natural gas in Europe in Q3. If we look at gas and energy in total, we are talking around about €1 billion per quarter in the first three quarters of the year. Your third question was related to the gas supply sources. We are sourcing in Europe from Western European suppliers, we do not know what their exact supply portfolio has a relatively high likelihood that this is very close to what the overall supply portfolio is in the respective countries of Europe as well as in Europe, more information than that we do not have.
Yes. Hi, thanks. I was just looking at the Slide #8 again, which shows the earnings split by different regions. And I’m just curious, why is Germany so bad versus rest of Europe because the gas price dynamic is not something which is just German driven. It’s across all of Europe. So why is Germany, particularly so bad at BASF? I guess is there a reflection of maybe a lot of corporate costs at BASF actually sits in Germany. So it’s a bit of an unfair comparison. But I’m just curious underlying like-for-like why Germany so poor versus rest of Europe for BASF right now? The second question was just on Ag division, very strong top line growth, both because of higher volumes but also a very strong pricing. But when I look at the incremental EBIT growth from that top line growth, the drop-through is pretty low. It’s like 15%, 16% of incremental sales flowing through to the EBIT line. I’m just curious why did we not see a much stronger drop-through because it seems that these prices are now strong enough to cover the inflation, hopefully, that is the case. And sorry, if last small clarification is, again, going back to the previous question, €600 million increase in gas costs in Europe in Q3 is actually lower than €800 million to €900 million that we saw in Q1 and Q2, this despite the fact that the gas cost in Europe per megawatt hour was actually in terms of year-on-year increase double of what we saw in Q2. So I’m just curious what like how much production curtailments have you guys taken in Europe as a whole for that number to be closer to €600 million and maybe not even double that number? Thank you.
Chetan, this is Hans. I’ll start with your question on Germany. What’s important to keep in mind is that Europe does not have one consistent natural gas price and one consistent price for power. Prices in Germany are significantly higher than what you are seeing, for example, in Belgium, in the Netherlands, in the southern part of Europe. And as a result of that, Germany suffers more. I’ll give you an example from the more recent days, Germany sits there and gas here is sold at TTF prices, which yesterday closed at €100 for the 4 months, so €100 per megawatt hour. At this very same point in time yesterday, you could buy spot gas in other countries at prices of €20 to €25 per megawatt hour. Now this is 1 day, probably not something that you can just extrapolate, but we have this – have had the significant differences depending on the regional trading prices within Europe over the last 6 months. And as I said, they are – if you look at it on a daily basis, significant in Germany suffers there in particular.
Now your next question was – since we are on gas, I’ll do the €600 million cost. We have, in fact, in Q3 reduced gas consumption significantly. We have reduced as a result of not running certain plants or running them at lower capacities substituting by way of purchases from the market. To the extent we could, we have also substituted natural gas in the – on the utility side by using alternative sources, i.e., heating oil. So we’ve done what we could. But overall, this is an expression of the fact that we’ve actually consumed significantly less gas. And if your question is how much less is in the order of magnitude of almost 40% lower gas consumption in Q3 than in the prior year quarter.
Last question then was on ag and why don’t you see stronger earnings on significantly stronger sales. So first of all, I think we have €100 million improvement compared to prior year quarter. It is the weakest quarter of the year. That is the seasonality that we have in the business. It comes with significant cost in preparing for the season that has just started in the Southern Hemisphere and then also preparing for the season in the Northern Hemisphere. And there is also a mixed topic here. So that explains why this is relatively low margin. But let me say this, compared to where we were in the prior year, I think our teams in Ag Solutions have done a very good job and €100 million earnings improvement, I think, is also a good basis for a, hopefully, a good quarter for our Ag Solutions business.
And then the second question is around the cost cutting. The €500 million program, but ultimately the right sizing quite a sizable target of 10% of that cost of the non-productive assets in those units or non-productive unit cost. That implies some headcount reduction. And I thought with the focus on Ludwigshafen the site agreement precluded force redundancies for a while. So I’m just wondering how you square the circle of what you can do to believe in that €500 million then beyond that for the cost cutting? Thank you.
Yes, Peter, I mean, we have no exact data yet how much – how many positions will be cut off. But if you take the non-production part and the units we mentioned, they are mainly personnel costs. So it goes down into a number of people working at the site. And this is also actually what we want to do. But we have to detail it out because that’s a sensitive issue for the labor unions, certainly. The site agreement is right. That’s a framework, which does not allow us to actually fire people until 2025. But people what is also the reality is that the population in BASF is increasingly getting older. So the number of retirements in the next years goes significantly up. And we have also positions that are not filled as everywhere in the world, you have problems to get experts and well at trained people. So we have some of them released from jobs. We can then also put into, let’s say, positions where we do not get the people on the market. So I would expect that over these 2 years, the majority of these positions will be handled that way. And then let’s see whether we need severance, whether we need then also other means in paying if some people have to leave, but I’m not so worried that we cannot manage this in this time.
When it comes to North America, we don’t talk much about it, but it is also a market, we always look into. Just to remind you that we can spend a couple of hundred millions over there to actually expand our MDI plant, which is a very interesting market. We have really used the opportunity as – the market is actually very balanced, that we are building capacity to absorb that in the years to come forward. So we also not neglect North America. But if you look in the North American market, the last 5, 6 years, it was also not much growing, let’s say, from a local perspective, most of the capacity is going to export and that is also, again, a geopolitical question, whether you want to build capacities in the U.S. than to export in China, we have different assumptions here.
Hi, thanks, Stefi and good morning, everyone. I do have two questions and they are both on the structural adjustments that you’ve been talking to this morning. Firstly, could you maybe give us an idea of how much of the drivers for the structural adjustments are attributed to higher energy prices versus the increased costs of regulation that you’re seeing for the industry margin? And then the second question on the same topic is I mean what happens to the customer industries if there is more broad-based than BASF structural adjustments for chemicals production? Would you expect these customers to invest more outside of Europe? You just also said that you would be looking to do the same with your own production may be moving more towards China? So yes, just your thoughts on that would be very helpful? Thank you.
So, Georgina, the energy cost is the real driver. I mean regulation is coming. I think I elaborated on the industry Emission Directive, which is an additional burden, which would also then request additional CapEx to actually update the plans that would also, I think dramatically affect the industry. And I am really confident that we get this away or at least pushed forward because that’s no priority topic. But you have to look into base chemicals here in Europe that are heavily depending on natural gas and energy prices and you have to model actually the competitiveness relative to other regions. And then you have to ask yourself producing base chemical in future, let’s say, in Europe and selling into the market, whether this thing makes sense. You have always to consider however that BASF is with the value chains actually adding value in a lot of the base materials by four, five, six, seven steps in the chain. That means you dilute these costs very much to the final products. And you know Ludwigshafen, for example, we have some 8,000 products roughly or even a little bit more, we sell to the markets. Many of them are actually evergreens whenever you do something in the industry, you need these. And we will produce them and then in the future with the PCF reduced or even zero. So, it is more about this considerations of some base chemicals. And I think the most evident one is ammonia, which has a huge part of its cost just from natural gas. And then it strongly depends you make out of ammonia let’s say, a fertilizer or you produce a specialty, a mean, which is a hardener in an epoxy system which has certainly been a much higher margin on that equivalent of ammonia. So, that is the way we look into this. And on the other hand, this is something we have always done. We have always kind ourselves, redefined ourselves with also raw material changes in the past, coal and oil and gas, now more in direct or renewables. So, I think this is a normal exercise, but the real reason for that now is certainly the threat of the energy costs. And then you are directly also with the customers because some of your customers also take consequences and might stop production. So, then you lose the demand here. That is also why we have to very intensively discuss with our customers. And you know that our strategy is actually we invest where the market is. We also look into our customer portfolio, where are the strong guys for tomorrow. It’s not necessary all the time you had served in the past. So, if they don’t have the potential, you go also to others. And then finally, because we talked about regulation, so it’s also about the CO2 price. So, that comes in if you have the energy price, but you have also the avoidance of CO2 if you don’t produce the one or the other product here. So, it’s a rather complicated picture. But at the very end, we have to come to grips and what are the right measures going forward, but it is always market-related. I hope that helps you.