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Fall Press Conference 2005 |
BASF continues to grow profitably
- Higher sales (+11 percent) and EBIT before special items (+13 percent)
- Earnings impacted by high raw material prices and hurricanes in the United States
- Cost saving goals increased in North America
- Growth impetus from new Verbund site in Nanjing
- Outlook for full year 2005 improved further:
- Significant increase in sales and EBIT before special items
- Further increase in premium on cost of capital
Speech by Dr. Jürgen Hambrecht, Chairman of the Board of Executive Directors of BASF Aktiengesellschaft, Ludwigshafen
Speech by Dr. Kurt Bock, Chief Financial Officer of BASF
Aktiengesellschaft, Ludwigshafen
Speech by Dr. John Feldmann, member of the Board of Executive Directors of BASF Aktiengesellschaft, Ludwigshafen
The spoken word applies!
Ladies and gentlemen,
BASF has continued on its profitable growth path in the third quarter of 2005. This is reflected in the further improvement in our results. In addition, we are again able to report on a number of milestones that we have achieved on our path to further increasing the value and sustainability of our company:
- the signing of a basic agreement with our partner Gazprom on the construction of the gas pipeline through the Baltic Sea,
- the inauguration of our Verbund site in Nanjing, China, and
- a new cost saving goal for North America, which targets additional savings of $150 million per year.
Nevertheless, the business environment in which we had to operate in the third quarter was anything but simple:
- We were confronted with further severe increases in raw material and energy costs, in some cases to record levels.
- Economic growth in Europe declined further and consumption stagnated, in particular among German consumers.
- And we saw hurricane damage in the Gulf of Mexico that impacted our business throughout North America.
The BASF team met these challenges. The capital markets are recognizing our progress, and our share price was never as high as in the third quarter of this year.
Please allow me a few words on our figures at this point: The strong business performance seen in the first half of 2005 continued in the third quarter. The summer lull was less pronounced than we expected. With strong demand on the one hand and high and very volatile oil prices on the other, necessary price increases could be passed on to the market only to a limited degree.
Compared with the same quarter of 2004, sales increased by 11 percent to €10.4 billion. Income from operations (EBIT) before special items rose by 13 percent to more than €1.3 billion.
Cumulative sales for the first nine months of the year rose by more than 12 percent to €31 billion. BASF’s profitable growth is underlined by the fact that EBIT before special items increased by 26 percent to €4.5 billion. I would like to thank the entire BASF team worldwide for this outstanding achievement.
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Optimistic outlook for the full year 2005
So how will the year continue? Demand for our products remains strong. Further increases in raw material and energy costs continue to put pressure on our margins. For the full year 2005, we are expecting significantly higher sales and EBIT before special items compared with the previous year’s strong level. We therefore expect to further increase the premium earned on our cost of capital.
In the fourth quarter of 2005, we do not anticipate earnings to reach the strong level posted in 2004. Reasons for this include:
- Expected earnings impairments of €120 million as a result of production losses due to the hurricanes in the United States.
- The lack of gains of €80 million posted in the fourth quarter of 2004 as a result of mark-to-market accounting for derivatives associated with the weak U.S. dollar.
Kurt Bock will now provide you with more financial details on the third quarter.
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[Speech by Dr. Kurt Bock]
Ladies and gentlemen,
[Chart 1]
BASF’s profitable growth is also reflected in the key line items of our income statement. Let me explain what I mean by this.
First: We posted double-digit sales growth in the third quarter of 2005 compared with the same period of 2004. This was the third quarter in succession in which we recorded sales of more than €10 billion, and cumulative sales in the first nine months of this year totaled just over €31 billion.
Second: Earnings before interests and taxes, or EBIT, were €1,327 million before special items. This corresponds to an increase of €155 million compared with the same quarter of 2004, and €934 million more than in the first nine months of last year.
Third: Our third-quarter net income amounted to €808 million, or more than double the figure of €366 million we posted in the same quarter of 2004. Among other things, this shows the influence of the tax-free gain from the sale of our stake in Basell, which is included in the financial result. At €2.5 billion, net income in the first nine months of 2005 exceeded the strong level for full year 2004 by almost half a billion euros.
[chart 2]
Sales growth was due to necessary and, in some cases, overdue price increases in all our chemical segments. With these price increases, we responded to massively higher raw material prices, which resulted in additional costs of more than €1 billion in the first nine months of this year, and which are reflected in higher costs of sales. In addition, sales growth was due to the significant increase in oil prices and stronger sales volumes for our products overall, in particular in the Petrochemicals division.
[Chart 3]
It is worth noting that this was the sixth quarter in succession in which we succeeded in increasing both prices and volumes. Currency effects had a slightly positive effect on sales for the first time since the beginning of 2002.
After special items of €65 million, third-quarter EBIT rose by 17 percent to €1,262 million. The level of special items was comparable to that in previous quarters. Special items were related to restructuring measures and programs to increase efficiency at a number of sites. As usual, the special items will be assigned to the relevant segments in the current quarter following concretion of the various measures.
The financial result increased by €303 million to €176 million. About two-thirds of this increase is due to special income from the sale of our stake in Basell, which was completed on August 1, 2005.
Income from financial assets thus improved, as did the interest result, due to lower average net debt. The other financial result rose because of the higher market value of derivatives used to hedge interest rates and currency risks.
Net income improved disproportionately thanks to the higher financial result and the lower tax rate compared with the third quarter of 2004. At 43 percent, the tax rate in the third quarter of 2005 was at a normal level for BASF. It contains two opposing effects:
On the one hand, there was a significant increase in noncompensable oil production taxes that are coupled with the price of oil; these taxes rose by €120 million to €317 million. On the other hand, there was the tax-free gain in the financial result that I mentioned earlier. If these two effects are not taken into account, then the tax rate was 34 percent, or almost exactly at the same level as in past quarters.
The increase in earnings per share to €1.55 from 67 euro cents is also due to our continued share buyback program and the associated reduction in the number of outstanding shares.
Let me say just a few words about the balance sheet. Compared with the 2004 financial statements, the balance sheet total increased by €2.8 billion to €38 billion. This was primarily due to the increase in liquid funds to €4.3 billion as well as to an increase in inventories. This contrasts with a decline in investments accounted for using the equity method as a result of the sale of our stake in Basell.
The increase in inventories compared with the end of 2004 was primarily due to the significant expansion of our business. Days of inventory valued – our key performance indicator for inventories – was slightly lower compared with both the third quarter of 2004 and the end of 2004.
As announced on October 17, we are planning to reassign some of our comfortable liquidity by paying €3.7 billion into a Contractual Trust Arrangement, or CTA, by the end of the year. The majority of our pension obligations will thus be financed externally. The liquid funds and pension provisions shown on BASF’s balance sheet will be reduced.
I would now like to talk briefly about the key points of this financial optimization measure:
First: It will improve the international comparability of our financial reporting. Second: It will optimize our balance sheet structure and increase financial transparency. Third: It will have a positive effect on operational cash flow in the coming years. And finally, to rule out any possible misunderstandings, it will not affect strategic options such as acquisitions or investments. We will continue to buy back shares and pursue a shareholder-oriented dividend policy. The ratings agencies have just confirmed our excellent financial rating, and, since last Tuesday, we are incidentally the only chemical company in the world to have AA- and Aa3 ratings.
[Chart 4]
At €4,010 million, cash provided by operating activities was €225 million higher than in the strong third quarter of 2004 thanks to the high level of earnings after tax.
Net working capital decreased in the first nine months. This was due entirely to activities in the third quarter, in particular to the decline in trade accounts receivable as a result of our more rigorous credit management. This approach is also clearly reflected in the decline in days sales outstanding to 54 days compared with 59 days in the third quarter of 2004.
[Chart 5]
Miscellaneous items contain capital gains from divestitures that were deducted from the operational cash flow and assigned to cash used in investing activities.
Payments related to tangible and intangible fixed assets in the first nine months amounted to €1,285 million. They were thus lower than in the same period of 2004 and, as planned, below the corresponding level of amortization and depreciation.
The net effect of divestitures and acquisitions resulted in a cash inflow of €1,017 million. We spent a total of €2.1 billion on share buybacks and dividend payments in the first nine months of 2005. This is a sign of our financial strength and profitability, and of our efforts to ensure that our shareholders benefit from our success.
These developments and measures led to a net cash inflow of approximately €2 billion in the first nine months of the year.
Please allow me to say a few words about the current status of our share buyback program. In the third quarter we have bought back shares for €250 million. From January to the end of October 2005 (cutoff: October 27), we have bought back shares for €1,228 million at an average share price of €54.24. As a result, we have repurchased 19.3 percent of our shares since starting our share buyback program in 1999.
[Chart 6]
As usual, I would like to compare the performance of BASF’s share price since the beginning of the year with that of various indexes. This chart shows the percentage change in total return.
In more concrete terms: If you had invested €10,000 in BASF shares at the beginning of the year, your holding would now be worth €11,387 – a pretty respectable performance, as I think you will agree.
Ladies and gentlemen,
We set ourselves the highest standards for the transparency of our reporting to satisfy our shareholders and, not least, journalists like you. This year, our efforts were recognized. For example, Manager Magazin ranked BASF number one in Germany for its 2004 financial and corporate reports. As you can see, both the numbers and the way we present them are on the right track at BASF. And this is not going to change in the future.
I would now like to hand back to Jürgen Hambrecht, who will provide an explanation of the individual segments.
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[Continuation of Dr. Jürgen Hambrecht’s speech]
You can find detailed information on the performance of our segments in our current interim report. As usual, I will therefore report on just a few of the highlights.
Thanks to higher sales volumes from our new plants in Nanjing, China, and the expansion of our electronic chemicals business, we increased sales in the Chemicals segment to a new record of more than €2 billion. Lower prices for olefins, in particular in Europe, and a simultaneous increase in the cost of naphtha put significant pressure on margins in the Petrochemicals division. In addition, costs were incurred in the third quarter for shutdowns of world-scale plants in North America as a result of the hurricanes. EBIT before special items therefore declined by 27 percent compared with the same period of 2004.
In our Plastics segment, we increased sales due to higher sales prices in the Polyurethanes division as well as higher sales volumes in the Performance Polymers division. The significant rise in EBIT before special items was mainly due to the improvement in the polyurethanes business.
We increased sales by 2 percent in the Performance Products segment despite the divestiture of the printing systems business in November 2004. EBIT before special items remained at the previous year’s level. The figures for ongoing business were therefore higher compared with the same period of 2004.
In the Agricultural Products division, sales and earnings were slightly lower than in the same period of 2004. Soybean rust did not spread as extensively as we expected in North America. Sales volumes declined slightly. We systematically increased spending on research and development expenses in this division. In South America, the business made a good start to the new season.
The Fine Chemicals division continued to suffer from enormous price pressure for the important products lysine and vitamin C. This had a negative impact on sales and earnings. Earnings were also affected by a further increase in raw material costs.
Sales in the Oil & Gas segment climbed 40 percent. This was due to the high oil price, higher production volumes and a significant expansion in natural gas trading. John Feldmann will now explain in detail why earnings in this segment increased by only 29 percent.
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[Speech by Dr. John Feldmann]
In our natural gas trading business, we increased year-on-year sales volumes by almost 5 percent in the third quarter, mainly by expanding our foreign activities. Sales increased by nearly 40 percent, driven primarily by higher prices.
Third-quarter EBIT, however, was only €22 million, compared with €88 million in the same quarter of 2004. These earnings are unsatisfactory, even if one disregards the high positive one-time effect of an arbitration settlement in the third quarter of 2004.
[Chart 1, Dr Feldmann]
This may appear surprising in view of the current debate on gas prices. So what’s the explanation?
Today, the countries in the European Union import 50 percent of the gas they need. This proportion is likely to increase to 75 percent by 2015. The main sources of supplies are Russia, Norway and North Africa. WINGAS currently imports around 70 percent of the gas it trades from Russia, which has the world’s largest national natural gas reserves. To secure our sales volumes, we have signed long-term supply contracts, generally until 2030. And to establish such contracts, one needs underlying figures for the pricing formulas.
Link between oil and gas prices reasonable and logical
Because oil and gas compete with one another in their most common applications and because oil is traded on the world’s commodity markets, it is reasonable and logical to link the gas price to the price of oil. We are also convinced that this orientation on the oil price is the better alternative in tighter markets and with increasing competition for gas resources. The few countries that supply the world with gas today and in the future also regard this linking with oil prices to be a logical and necessary basis for long-term contracts. And these are the countries that generally define the rules for the global gas business.
[Chart 2, Dr. Feldmann]
On the purchasing side, the course of the average oil price in the past nine months is the significant factor for our contracts. A look at oil prices over the last 35 years shows that the nominal oil price has recently been extremely volatile and has risen enormously. As a result, our import prices for natural gas have also risen. Please also note the fact that the real oil price, in other words calculated on the basis of 2004, is still significantly lower than in 1980.
What is the situation like from the sales side?
Since we entered the natural gas trading business at the beginning of the 1990s with WINGAS, our joint venture between Gazprom and Wintershall, we have offered our customers contracts that are flexible both with regard to duration and pricing. Our customers are not domestic consumers, but power plant operators, industrial companies as well as regional and communal utility companies.
Majority of WINGAS customers favor link with oil prices
We offer different pricing formulas that include prices based on spot markets, for example in Zeebrugge, Belgium, or fixed-price components as well as prices linked to the price of oil. The majority of our customers, however, opt for a link to the price of oil as the key pricing component. In contrast to the situation on the purchasing side, average prices are used for the half year three months previously. In periods with rising oil prices, this means that we have a reference period with significantly higher average prices on the purchasing side than on the sales side.
In a long phase of rising average oil prices we therefore have to live with narrowing margins in the gas trading business. When oil prices stabilize, the trend disappears, and it even reverses when oil prices start to decline.
Although the effect is unfavorable for us at the moment, we generally support linking the gas price to that of oil, since it offers clear long-term advantages to all parties involved.
[Chart 3, Dr. Feldmann]
This becomes apparent when we look at markets in which gas prices on the sales side are not linked to the oil price. The United Kingdom and the United States are two such examples. The chart shows the price obtained by importers and producers, in other words before transport, storage and distribution to the end user. In the past, gas prices in the United Kingdom especially were often significantly lower than in Germany. Both the UK and the United States were able to cover their own gas requirements, but this is no longer the case. Both countries now import gas, whose price depends on the spot markets. This explains why gas prices are now significantly higher in these two markets. On the German gas market, the link to oil prices currently results in relatively low import prices.
[Chart 4, Dr. Feldmann]
So how does the import price affect domestic customers?
As shown on this chart, the gas import price in the first half of 2005 accounted for around 30 percent of the gas price paid by domestic customers. Taxes and duties account for approximately the same proportion of the price, while charges for storage, transport and distribution in Germany make up around 40 percent. This shows that one cannot assess current gas prices only on the basis of the link with oil prices.
We are convinced that competition in the European gas market is an important element in achieving fair prices for all parties involved. Fifteen years ago, the lack of competition in the German gas trading business led us to our partnership with Gazprom. Our clear intention was to introduce real competition into the German gas market. We have therefore always supported efforts to remove constraints on competition.
We have separated our natural gas trading and transport activities. Our gas trading business offers its customers contracts with flexible pricing and durations in accordance with their individual needs. At the same time, our transport business provides interested third parties with pipeline capacities at competitive terms. With its subsidiary Wintershall and its partner Gazprom, BASF is a key driver of competition in gas trading and helps to ensure gas supply security in Western Europe.
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[Continuation of Dr. Jürgen Hambrecht’s speech]
We are setting ourselves ambitious goals in all regions
In the third quarter of 2005, BASF recorded higher sales in all regions. Asia remains dynamic, and the economic environment in North America was robust despite the hurricanes. In parts of Europe, however, economic growth was weak, especially in Germany. The interim report provides further information, and I will therefore limit my comments to a few strategic and operational details:
In Europe, we aim to grow much faster than the market in the coming years. This applies equally to Western Europe – with its rather low growth of around 2 percent – and to Eastern Europe, whose economies are growing much faster. We recently announced the key measures by which we want to achieve this:
- We will invest approximately €1 billion per year in the region. For example in the construction of the pipeline through the Baltic Sea, in the development of new gas fields in Siberia, and in the construction of an HPPO plant in Antwerp.
- We will work more closely with our customers. To do this, we will focus our know-how and offer products and solutions for an entire industry. We are already doing this in the automotive and paper industries and we are in the process of expanding this approach to construction and packaging.
- In addition to achieving our annual cost savings, we aim to ensure profitable growth by constantly increasing the efficiency of our production, service and marketing and sales units, and our infrastructure.
In North America, our successful restructuring measures are continuing to bear fruit. This is highlighted by the 25 percent increase in EBIT before special items to €110 million despite the hurricanes in the Gulf of Mexico. Although the damage to our plants was relatively minor, production losses due to plant shutdowns at BASF sites and those of our suppliers and customers were more significant. We currently expect total earning impairments of €140 million. Of this amount, €20 million was booked in the third quarter, and the remaining €120 million will impact fourth-quarter earnings.
Thanks to new technologies, leaner production processes and simpler business processes we reached our goal of reducing costs by $250 million per year 18 months ahead of schedule. And in implementing these measures we identified additional savings potential of $150 million per year, which we want to achieve by mid-2007. This will incur one-time costs of around $80 million. From 2007 onward, our costs in North America will be $400 million lower each year as a result of these measures.
To achieve this we will further consolidate our business and close sites in Enka, North Carolina; Aberdeen, Mississippi; and Portsmouth, Virginia. Capacities at these sites will be replaced by new, expanded plants at our Verbund sites in Freeport, Texas, and Geismar, Louisiana. In this way, we aim to derive further advantages from our Verbund.
On top of this, we have initiated steps to increase our EBIT by $200 million per year by the end of 2007. We want to use our Commercial Effectiveness program to make our marketing activities more efficient. In other words we want to take some of the complexity out of our business. To do this, we are adjusting price structures, logistics, warehousing and business models to reflect altered market conditions. With this program, we aim to concentrate above all on those business areas where we can offer our customers the greatest additional benefits.
At the same time, we plan to invest continuously in North America in order to build on the success we have achieved thus far.
We have reaffirmed our goals for Asia following the inauguration of our site in Nanjing, China. For us, Nanjing is the gateway to Asia – the world’s fastest growing region. By 2010, we aim to generate 20 percent of sales and earnings in our chemical businesses in Asia, with half coming from the dynamic Chinese market. In particular, the new capacities in Nanjing and in Caojing will help us to achieve this goal. Since starting operations in June, the Nanjing site has performed extremely well and is expected to post a profit by the end of the year. We therefore plan to expand our Nanjing Verbund site further.
In order to meet the strong demand for chemical products in Asia, we will also continue to supply the region with high value chemicals and polymers, primarily from our plants in Europe. This will help to secure jobs in our home market.
More future for Germany
The chemical industry needs a climate that encourages innovation. We need more confidence in the future and dependable conditions that will give the industry a perspective.
It is not sufficient just to make a few minor changes. We need extensive reforms for more education, more growth and more investments. These are the crucial foundations for more jobs. We therefore call on all those responsible, in particular in politics, to do their utmost to ensure greater knowledge, more innovation and a brighter future.
We want to state expressly that we are committed to Germany. This is where we want to continue to develop and produce competitive products. We will do this under our own efforts today and tomorrow. We are not calling for protectionism against the global competition. But what we do need are fair competitive conditions and policies that finally take the brakes off innovation and investment. I therefore call once again today for a practicable approach to the new chemical legislation REACH, for an integrated, competitive energy policy, and for a future-oriented approach to legislation on genetic engineering. The global competition will not wait for us to catch up.
Thank you for your attention.
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