BASF stock is cheap for a reason (OTCMKTS:BASFY)

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My thesis

Many investors see the low valuation of BASF SE (OTCQX:BASFY) as a great opportunity to buy a quality company at a bargain price. However, in my opinion, this approach is wrong – BASF risks further losing its position in the petrochemical market due to strong global competition. If you believe, as I do, that the current energy and geopolitical crises won’t end anytime soon, then you shouldn’t buy BASF just yet, despite the stock’s historically low valuation.

My reasoning

As one of the largest petrochemical companies in the world, BASF does indeed trade at quite significant discounts to the broader materials sector:

In search of Alpha, the evaluation of BASFY

In search of Alpha, the evaluation of BASFY

Year-to-date, BASF has seen the biggest drop in valuation multiples among companies with a similar market capitalization. The company’s current valuation is slightly below the industry average:

Chart
Data by YCharts
Chart
Data by YCharts

Geopolitics is undoubtedly responsible for the current situation – BASF, whose operational efficiency is heavily dependent on Russian gas supplies, has been forced to look for ways to get rid of its Russian assets since the start of hostilities in Ukraine:

BASF SE is considering a plan to offload energy assets in Russia belonging to its Wintershall Dea AG unit to its Russian billionaire joint venture partner, according to people familiar with the matter.

source from BNN Bloomberg

According to the company latest factbook, Wintershall’s assets in Russia generated approximately 48% of total production from this project, while holding 63% of all proved (2P) reserves. With a 72.7% stake in this project, BASF earned 5.952 billion euros in 2021 (7.6% of total sales), of which 2.857 billion euros came from production in Russia. Divesting such assets is a necessary action, but at current oil and gas prices, it is not financially viable for BASF in terms of opportunity costs.

Additionally, while strong demand has allowed the company to pass on a significant portion of the cost increase in Q1 2022, it is far from certain that demand will remain at such high levels. Natural gas prices in Europe still have a colossal premium over US prices. This puts heavy and light industries in a very difficult position and increases the risk of demand disruption in different sectors of the EU economy.

Data by IEA.org

Data by IEA.org

Gas supplies from Russia via Nord Stream 2 began to fall sharply due to the restrictions imposed – this was particularly perceptible from the end of May 2022:

Bruegel.org

Bruegel.org

Stocks in Europe are constantly increasingwhich could indicate a drop in demand for non-perishable and non-essential goods – at some point European manufacturers, who account for 39% of BASF’s total sales, will produce less, which will mean less demand for BASF’s products. ‘company – or so the latest data (Business climate indicator) offers :

At TradingEconomics.com

At TradingEconomics.com

Given the general increase in the price of goods, mainly due to the increase in fuel prices, the interest rate of the ECB should be several times higher than the current level (the difference is 7%) – at least if we think Taylor’s rule and financial theory in general:

Twitter account of Holger Zschaepitz

Twitter account of Holger Zschaepitz

In my opinion, monetary policy for European countries is coming too late, and now the ECB must act even faster than the Fed – there is a risk that production in Europe will stagnate, causing BASF to lose its recent operational growth as quickly as he won it after COVID-19.

Another risk for BASF is the strength of global competitors

The geopolitical events mentioned above, in addition to the European crisis, have created many opportunities for BASF’s competitors from developing countries.

Even in Russia, isolated by sanctions, the development of the petrochemical industry was in full swing before the outbreak of hostilities in Ukraine. Russia’s largest petrochemical company, Sibur, recently launched a major state-of-the-art polymer production plant in Western Siberia, and I suspect it will now have huge production capacity for years to come. . Recent news about Sibur’s product line expansion suggests that my suspicions are not unfounded:

SIBUR, Russia’s largest integrated petrochemical company and one of the fastest growing companies in the global petrochemical industry, has expanded its offering of advanced and environmentally friendly polymers for use in packaging, pipe production and other industries.

Source: Macau Business

Sibur has increased its exports to China, taking advantage of its massive production capacities which are geographically well placed to export to the Asian market. The company has also diversified its offer for Asian consumers, including the development new currency payment options for Chinese partners. Even before the sanctions, Sibur – which until recently was led by experienced business executive Dmitry Konov – successfully transformed itself from an outdated Soviet-era producer into a modern international player with a clear focus on the G. And now that the choice of the key end market has become clear (Asia instead of Europe), Sibur can actively use its strong credentials to expand its market share in Asian markets. Asia is also an important market for BASF (although its product line is different from Sibur), with Greater China accounting for 15% of its total sales, according to 2021 data.

The battle for the Chinese market will also have to be fought with local companies – namely SINOPEC, the giant of the global petrochemical industry. Like BASF, it had projects in Russia, but despite all the sanctions, it didn’t have to cancel them (like BASF did). On the contrary, SINOPEC’s 11 billion dollar gasochemical complex in the Amur region (in which Sibur incidentally holds 60% of the capital) “did well”, because the south china Morning Post reported in late March 2022.

In general, China has one of the lowest inflation rates compared to European countries and the United States, which gives the People’s Bank of China more leeway to ease monetary policy and stimulate growth in a slowing economy (I’ve written about this more than once in my bulk shipping inventory articles here on Seeking Alpha). This development should give SINOPEC and its partners a momentum for growth in the months to come. It is much easier to strengthen in an environment of loose monetary policy (like in China) than in an environment of weak monetary policy (like in Europe).

In the Middle East, where BASF is present, there is also an actor who can use the situation to his advantage against the backdrop of problems: SABIC (Saudi Basic Industries Corporation). The company made a net profit of 6.47 billion rials ($1.73 billion) in Q1 2022, in line with pre-pandemic levels:

Bloomberg

Bloomberg

The recovery in operational performance has enabled SABIC to pursue the development of a few major projects which should bring real added value this year:

Extract from the recent SABIC annual report (2021)

Extract from the recent SABIC annual report (2021)

However, as CEO Yousef Al-Benyan told Bloomberg reporters, demand for chemicals in the second half of the year will come under pressure from a global economic slowdown, inflation and also rising interest rates. ‘interest. Even if a company whose geography makes it less vulnerable to the negative impact of rising oil and gas prices announces emerging difficulties, what should a European company expect that struggles daily with the distribution of the cost of natural gas price volatility?

Conclusion

You can see with the naked eye that BASF has lost a lot of value since the start of the year, not only in absolute terms (stock declines) but also in terms of valuation – multiples have fallen faster than the average of the sector.

I agree that BASF shares can be a good investment over a 5-10-15 year perspective, but I am intrigued by current geopolitical events and their potential consequences for European businesses. With high inflation and the upcoming ECB monetary tightening, BASF’s biggest market – Europe – is likely to be hit hard. At the same time, there is a risk that other markets important to the company will be taken over by competitors. The reorientation of relatively new Russian production facilities (which will not need to be renewed in the next few years) to China and SABIC’s competitive advantage in the form of access to cheap raw materials could, in my view, seriously undermine BASF’s pricing power. I think even from the current price level, BASF shares still have room to go down, so I wouldn’t buy BASF shares now.

I would be happy to read your opinion in the comments section below!

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