BASF: a chemical company’s view of 2010

Chemicals–not a fan

I’m not a big fan of chemical companies’ stocks.  This is partly because it’s a value investor’s industry, partly that I don’t know chemicals well enough.

My perception, though, is that it’s a hard industry to survive in, one dogged by chronic overcapacity.  Every ten years or so, chastened managements halt new capital investments for long enough to allow world demand to grow into existing capacity.  A boom follows for maybe two years.  But then somebody somewhere–be it China or the Middle East or someplace else, or a developed world player with unfamiliarly large cash balances burning a hole in his pocket–commissions enough new plant and equipment to create another decade’s overcapacity.  And the bust part of the cycle begins anew.

But I am interested in what BASF is saying

I like BASF.  True, I’m not sure I’d want to own the stock, even with the current dividend yield of close to 4%.  But the company has very savvy management.  It’s just in a tough industry to make money in.

I listened to the BASF yearend conference call over the weekend.  My purpose–to get the company’s view of what operating conditions would be like in 2010.  This is what I found out:

–BASF’s business has been improving sequentially since early 2009 and will likely continue to do so through 2010.

Asia and South America recovered very quickly and are now operating about 5% below pre-crisis levels. The US and Europe are better than they were, but remain about 20% below their pre-crisis performance.  (Take a look at slides 5 and 6 in the BASF analyst presentation materials.  It’s always dangerous to depend on charts, since you can change the visual impact to make it more or less dramatic by fooling around with the x and y axes, but it looks as if the US is still worse off than Europe.)

In fact, China is currently so strong, despite Beijing’s tightening measures, that the usual Chinese New Year’s slowdown was barely noticeable.

–substantial worldwide overcapacity exists (no surprise here).  Because of this, customers are able to order very close to the time they expect delivery and are building no inventories themselves (the ideal situation for them).  Therefore, BASF doesn’t have the order visibility it might normally have.  But BASF has managed to return to profitability at surprisingly low levels of utilization.

–BASF expects world GDP to grow by 2.7% in 2010.

–It thinks demand for chemicals will expand at 2x that rate, by 5.3%.

–Industrial production will grow by 4.9%.

–The best industries will be:

IT    +7.3%

Autos   +7.3%

Electronics   +3.9%

–The worst industries will be:

Construction   +1.8%

Agriculture    +1.9%

–A year ago, 40%+ of BASF’s debt had maturities of a year or less.  That has shrunk to 16%, meaning that the company expects short-term interest rates to be rising relative to longer rates.

None of this is really earth-shatteringly new news…

–Recovery is underway and has progressively gotten on firmer and firmer footing.

–Customers are still cautious but are buying.  Emerging markets are in much better shape than the US and Europe.

–Business spending (that is, IT) will be  a high spot during the year.

–The consumer is more of a mixed bag.  Autos will be ok but housing will still be down in the dumps.

…but it’s interesting to hear from a global company

that has its finger on the pulse of companies in many different industries, located all over the world.

The information encourages me to stay with a pro-cyclical sector allocation.  Still, as I mentioned in my update of Keeping Score yesterday, as investors we always have to be asking what is coming down the road next.  Ideas get old and become very close to fully discounted in the market.  So at the same time that I’m encouraged, I’m also worried that the view BASF has outlined is too close to the consensus–meaning it will turn out to be wrong.

To some degree being wrong is a given–the important question is how this forecast will turn out to be incorrect.  Maybe the consumer will end up being weaker than anticipated (I read the market as giving the opposite signal, that the error will be what it historically has been, underestimating the US consumer).

It isn’t crucial to have an answer today.  Continuing to ask the question is enough for now, I think.

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