BASF strategy

Getting the Chemistry Right

basf_dpa
BASF is adding a new business to its portfolio.
  • Why it matters

    Why it matters

    BASF has largely been a bystander in the recent consolidation and acquisition frenzy in the chemicals industry but may now have to get involved to remain competitive.

  • Facts

    Facts

    • As well as producing chemicals, 151-year-old BASF has interests in gas, oil and agriculture.
    • In 2015, sales were about €70.4 billion ($79.7 billion) and profits €6.7 billion.
    • Its competitors include DuPont, Dow Chemical and ChemChina.
  • Audio

    Audio

  • Pdf

The office of Kurt Bock, the chief executive of German chemicals giant BASF, is in a late 19th-century brick building in Ludwigshafen, a city on the Rhine river in western Germany. The building contrasts strongly with the company’s brand new administration and conference center next door, which is where the interview took place.

In a way, the two buildings symbolize the challenges faced by the 151-year-old company, which is the world’s largest producer of chemicals. BASF must continually modernize while relying on its traditional business base, and this paradox is causing trouble at the firm. But Mr. Bock, company head for five years and also chairman of the board of executive directors, shows a fighting spirit: BASF will succeed in transforming in the coming years.

He spoke to Handelsblatt about belt-tightening, high dividends, acquisitions, the threat from China, industry consolidation and the effects of low oil prices.

Handelsblatt: Mr. Bock, when you took office, you promised to leave BASF in better condition than you found it. You are now at the halfway point in your term in office, but BASF’s condition seems worse.

Kurt Bock: That depends on what you base it on.

Sales, profits, return on investment – everything is in decline.

At the moment, our profits are being influenced by prices over which we have no control. We are operating in a deflationary environment, not just with the oil and gas business. But the important point here is that we have continued to improve our medium- and long-term competitiveness. And it also isn’t the case that we weren’t profitable. Compared to German industry, we are quite profitable.

All the same, if it was halftime in a soccer match the team would think about changing the line-up and strategy.

Our team is in shape and also fiercely determined to push things forward within the framework of our strategy as an integrated chemicals group.

What do you see BASF looking like in five years?

I didn’t make any detailed statements about that five years ago and I’m not going to do it now. But it is still the case that we will continue to position the company toward strong growth businesses and markets – also in the interest of ensuring sustainable growth.

And what about the results?

Of course, it would be nice to adorn them year after year with wonderful business results. But the economic climate doesn’t allow this. The main task for us is to continue to improve our structural competitiveness. And when you see all that we have done in the past few years in the direction of changing our portfolio, innovations and investments, we are on the right path.

Does the team also still understand the current direction? At the moment, it’s more like they’re having to put up with a lot.

At the moment we are operating in an environment that isn’t simple and we have to tighten our belts once again, given the lack of earning power of oil and gas. But I don’t have the impression that there is a lack of understanding of the situation anywhere. We have to deal with two conflicting developments. On the one hand, a downward price trend triggered by the price of oil; on the other, a certain cost inflation caused by wage agreements.

Nevertheless, shareholders are getting higher dividends.

BASF’s dividend policy is relatively easy to describe. We want to increase dividends every year, unless the sky falls on our heads. Then at times we’ll also keep them constant. We didn’t have the feeling that was the case in 2015. Cash flow and results yield the higher dividends. The dividends are also an expression of our confidence.

And that’s something the employees understand as well?

It naturally led to some questions as to why the bonuses were reduced while dividends were increased. But we answered them.

How?

Our employees’ profit sharing is based on the company’s return on assets, and it fell in 2015. It would be nice to increase dividends and bonuses in parallel, but we weren’t able to do that last year.

So what’s the growth story you plan to tell the capital market?

The global chemicals market is growing by about 3.5 percent per year and doing it mostly in Asia and China. Europe is more or less stagnating. It remains our goal to grow slightly more than the market.

But you didn’t manage that recently.

That’s right. That had mainly to do with Europe having been very weak and we still do half of our business here. We are not able to totally divorce ourselves from that. But we have done considerable groundwork in Asia and built large new plants there. These plants will generate the growth in the next couple of years. Added to that are the positive effects of our portfolio management, meaning acquisitions and divestments.

Large new plants in Asia? Isn’t there talk about considerable overcapacity in China?

The overcapacity isn’t all that much. You periodically have phases of overcapacity in basic chemistry. There is a certain herd mentality in chemistry. As soon as the margins go up, you invest. In China you have the additional problem that people invested there who had no previous experience in chemistry and not even we had them all on the radar. Now they have a problem because they have discovered there is no market at all.

And companies like BASF also have a problem.

We have actually only been impacted in three areas: polyurethane precursor products [mostly used in furnishings], acrylic acid [plastics. paint] and caprolactam [nylon]. Many other areas, such as the automotive supply business, are performing very well in China. The crucial question for us is always how competitive are our plants. Are our costs low enough so that we are still earning money when others have run out of funds? In that we are very confident.

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Kurt Bock has been at the helm of BASF for five years. Source: DPA

 

Isn’t it also a problem for you that new competitors in China don’t care about making money?

That’s a discussion we are continually having. But I don’t think the basic assumption is correct. Everybody wants to make money. And for years that certainly worked very well in China. You simply invested a bit and the customers would come. Chemistry also got caught up in this euphoria in the end. But that will sort itself out again over the next couple of years.

Some analysts accuse BASF of also having invested too much . . .

Over the years, our investments have grown parallel to the volume of business. In the last couple of years we have acquired relatively little, but instead increased our tangible assets. And you have to look at it separately. In Europe, it’s a matter of modernizing our very large asset base. There can occasionally be certain spurts. In North America, we have primarily boosted our backward integration. That means we are replacing our procurement of upstream products like ammonia and propene with our own production. That strengthens the group.

On the other hand, by expanding your capacity in Asia you were more or less involved in the overcapacity.

What would have been the alternative? In the long term, 90 percent of growth in chemicals will come from the emerging markets. If we want to keep pace in growth, we have to invest there. Otherwise, it would be the same as bowing out of these markets. That can’t be the answer.

Perhaps it would have been better if you had invested more in mergers and acquisitions. BASF is largely left out of the consolidation.

We look at a lot of things, but we likewise calculate very precisely.

Perhaps too precisely?

We continually asked ourselves this question. But we have a very stringent capital costs concept and apply the same yardsticks everywhere. We constantly ask ourselves, is that really creating value for the shareholders or is this only a game of switching money around with a pinch of hope on top?

But apparently some are more bold . . .

Of course there are continually cases where overly motivated buyers seem to set aside their pocket calculators and want to have something no matter the cost. If you come up against someone like that, it can get troublesome.

Are you talking about the Chinese firm Chemchina, which wants to buy the fertilizer specialists Syngenta?

I don’t mean any specific company at all. But there are continually these cases because one or the other person has the feeling he has to do something now.

Perhaps you’re setting your own benchmark too high when you calculate with capital costs in a zero interest rate world. Is such a shareholder-value based approach still the right instrument to be steering the company?

I don’t know of any better; this approach has proven successful. We have to take a certain expectation of return on investment and the risk affinity of the shareholders into account in our decisions. After all, it’s also not a matter of short-term investments but rather engagements over 10 or 15 years. In the end, the money has to come back in. For a long time in the past we had the mindset that money costs nothing. What do you think it took in effort to anchor the capital costs principle and the value management system in the company? Now it is a part of everyone’s thinking. That is a strong disciplinary instrument and has resulted in one acting with more restraint in times of high asset prices.

That would primarily be the former chief financial officer speaking now.

A logical assumption. But don’t think that is an isolated, desperate opinion in the BASF executive board. On the contrary. This way of thinking is fully accepted, and the board acts as a body that works together. BASF can be bold and has proven so in many places. But we don’t want to be cocky.

But if a super opportunity just happens along sometime . . .

. . . then BASF would most certainly be in a position to properly evaluate it and act appropriately. But so far we haven’t seen one.

What would you consider to be an opportunity?

I’d rather not speculate on that.

Assuming the Chemchina and Syngenta deal doesn’t work out, would you then be interested in Syngenta?

Now you’re just fishing for a headline.

Is BASF in light of the consolidation going on in agrochemicals big enough over the long term?

 

One certainly needs a minimum size in this area. That we have in any case. Our plant protection business is one of the best in the industry, when you consider its profitability, growth and innovation pipeline. It is an integral part of our group structure, both in production as well as in research. We must continously develop new products in this area. We are good at doing that, and we will continue to be good at doing it.

Let me ask it another way. Your competitors in the United States, Dow and DuPont, are planning a fusion in order to split up into three specialized companies afterwards. Will that jeopardize the BASF model?

First of all, this transaction will take a lot of time and the success can only be judged in a couple of years. I don’t see that posing a threat to our strategy.

Thanks to higher synergy and greater focus, the new companies could become more competitive than BASF?

BASF doesn’t have to have cost efficiency and structural optimization explained to it. For example, a couple of years ago, we consciously bundled all purely cost-driven activities in the chemicals segment and combined the business with application-specific plastic mixtures in the Functional Materials & Solutions segment. In this way, we can very successfully manage very different business models under one roof. That means what some are now trying to do on the capital market can also be done within a company.

Aren’t you afraid investors could build up pressure to also try to have the BASF dinosaur restructured?

We see no signs of that happening. And we have strongly restructured our portfolio in recent years.

That seems rather harmless compared to your U.S. competitors.

We do that with comparatively little fanfare and we don’t make a big deal of everything. But we are constantly at work, optimizing our structures. Many small steps are possibly the quicker way than one big one. And moreover, we have also taken considerably larger steps.

For example?

For example, gas trading. After all, we have now given up a business with €12 billion ($13.5 billion) in sales that we took 25 years to build up ourselves. That step will change the image of BASF. By giving up gas trading, we have a considerable drop in sales in 2015 and 2016.

Which business fields do you plan to develop to fill the gaps?

We already have the largest range of products in the chemical industry; that is a very complex portfolio. In that respect, we do have to decide exactly in which areas we really want to add something on or whether it’s a matter of strengthening and developing an existing business.

Which do you prefer?

I think the further development of existing businesses to be the right approach. That’s certainly what we did by, for example, further expanding our oil and gas production and at the same time strengthening our presence in Norway.

Given the low price of oil, that doesn’t seem very serendipitous. In 2015, you were no longer earning your capital costs in oil and gas.

That is correct, and we won’t be earning them this year either. If the price of oil should stay at $40, oil and gas is not a very edifying business, we agree on that. But I assume that the price will rise again.

Considering the low prices, would now not also be the right time for the company to expand its oil and gas business?

We have invested heavily and I don’t believe that it would make sense to invest even more in it. We are fundamentally a chemicals company that just happens to produce, itself, the amount of hydrocarbon molecules it uses. About 25 percent of our investments are in oil and gas and, under normal circumstances, the division also delivers about 25 percent of our income. That is appropriate.

If you want to grow organically, you need innovations. What role does your research play?

It is a core factor in our expansion strategy. Innovations, combined with the necessary investments, drive growth and income.

In which fields are you expecting the decisive innovations?

The impetus ultimately comes from a large number of projects. Many of them are focused on improving an existing product or finding new applications, often in close cooperation with our customers.

Genuine quantum leaps are not even in sight?

You should never say never. But given the present-day scale of BASF, it would probably be presumptuous to expect that individual innovations could still change the overall image of BASF like paint, fertilizer and plastic once did.

But BASF’s innovations are not always easy to recognize . . .

It is often a matter of incremental improvements or process innovations. And we also invest to a considerable degree in exploratory research, which takes a long time. But, in total, it is extraordinarily successful.

Do you plan to increase research?

We have increased our research expenditures in the last couple of years already by half a million euros.

Would tax incentives for research help?

We believe that would have a positive influence. Experience in other countries has shown that such an incentive works. It has the effect of significantly accelerating research. The state may at first have less revenue but more comes back through the innovations. We would be pleased if that came. It does play a huge role, particularly for many of our customers, medium and small-sized companies.

 

Siegfried Hofmann is Handelsblatt’s chemical and pharmaceutical industries correspondent. Grischa Brower-Rabinowitsch heads Handelsblatt’s U.S. editorial coverage from New York. To contact the authors: hofmann@handelsblatt.com and brower@handelsblatt.com

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