BASF Well Positioned to Take Advantage of Recovery Across End Markets

Strategist

Seth Goldstein

Associate Equity Analyst

Yuyang Zhang

BASF is the world’s largest chemical company, producing commodity and specialty chemicals in nearly every major category. The firm maintains a top-three market position in over two thirds of its businesses. Its products are sold to a wide variety of end markets ranging from industrials to transportation to pharmaceuticals to agriculture. The catalysts business generated around 17% of companywide revenue in 2023, while agriculture generated roughly 15%. The remaining 11 business lines accounted for roughly 10% or less.

BASF is fairly vertically integrated, manufacturing many chemicals that serve as inputs to its other segments. It aims to increase its proportion of specialty chemicals sales over time. Specialty chemicals tend to command stronger pricing power and stickier customer relationships versus commodity chemicals due to their differentiated nature.

The agricultural solutions segment is transitioning to selling more specialty products. The segment has traditionally consisted of crop protection chemicals, but BASF acquired its seeds products in 2018 when Bayer divested the business as a regulatory condition to close the Monsanto acquisition. Genetically modified seed production typically results in highly differentiated products, and many developments often garner patent protection. BASF currently holds the fourth-largest share in the global agricultural chemicals market. The agricultural solutions segment accounts for the largest portion of research and development spending at 42% in 2023. We expect this will drive persistent growth in this business over the next several years through new product development.

BASF intends to diversify its geographic exposure which at present slightly favors European markets at 38% of 2023 revenue. The firm has set its sights on high-growth emerging markets, specifically China. In late 2020, BASF commenced construction of a Verbund site in Zhanjiang, China—its second in the region—with capacity additions scheduled through 2028. We expect the new site will drive profitable growth for the firm, while further regional diversification will mitigate profit volatility over time.

Business Strategy & Outlook

We award BASF a narrow moat rating due to a scale-based cost advantage driven by the firm’s differentiated Verbund production process, an operational concept that clusters plants together and connects them through a system of pipelines. This operational setup has led the firm to consistently generate excess returns on invested capital despite a sizable cost disadvantage from raw materials procurement. Nearly 65% of BASF’s business occurs in Europe and Asia, a region that mostly utilizes naphtha, a chemical feedstock derived from crude oil. Producers in North America almost exclusively use natural gas liquids (such as ethane) as feedstocks, which tend to be significantly less expensive than naphtha, driving a regional cost advantage that’s prevailed for over a decade. These input cost differentials aren’t an operational failure on BASF’s part, rather, they reflect global and regional market dynamics that affect BASF and its (non-American) peers alike. 

BASF has nevertheless created a cost advantage by implementing the Verbund concept to drive extremely efficient production operations. The Verbund concept is highly synergistic, facilitating shared site resources ranging from wastewater treatment to data analytics, the latter of which enables operational flexibility amid fluctuating demand. The process generates roughly EUR 1 billion in annual cost savings. Half of this is attributable to savings on wastewater treatment, steam, and electricity costs, while the remainder involves logistics costs and materials handling from chemicals integration. By linking plants together, BASF can use byproducts from one plant as feedstock for another, simultaneously reducing operational waste and production costs. For example, acrylic acid production generates a significant amount of heat. A Verbund site can convert this into steam and feed it into the pipeline network to use as an energy source for other plants. In a non-Verbund operation, it would likely be discharged into the atmosphere. At BASF’s Ludwigshafen Verbund complex, steam from acrylic acid covers around 10% of its annual energy requirements. This location also cuts about 7 million metric tons of freight each year by transporting raw materials through the pipelines, equivalent to approximately 280,000 truckloads annually. Of the firm’s 200-plus manufacturing locations, six utilize the high-efficiency Verbund process, and those six locations handle more than half of BASF’s annual production volumes. A seventh facility is underway in Zhanjiang, China. The facility’s first downstream plant came online in September 2022, but construction of additional plants will continue through at least 2028. We expect the added capacity will strengthen BASF’s overall cost advantage by fostering profitable growth in China over the next several years.

BASF’s economies of scale are the backbone of its narrow moat, but we observe elements of other moat sources in the firm’s specialty chemicals portfolio that augment its overall competitive positioning. The catalysts product line, housed in the surface technologies segment, mainly manufactures emissions control catalysts for cars and trucks, an industry in which BASF maintains the number-one market share worldwide. We see elements of switching costs in this business. Emissions control catalysts production requires extensive collaboration among the automaker, the emissions control system manufacturer, and the catalyst producer. Relationships are forged early in the design process and continue throughout the vehicle’s lifetime. The contracts awarded typically span 5-10 years or more, and automakers are often loath to change providers once a project is underway. Changing a catalyst provider is costly due to the time and investment required to develop and validate a new system, not to mention the costs incurred from operational disruption and the delayed—even forgone—revenue potential. Switching catalyst providers midprogram is also risky, especially as automakers become subject to increasingly stringent emissions regulations. In fact, management cites emissions regulations as the primary demand driver for catalysts over the next decade. 

We also observe benefits from intangible assets driven by BASF’s vigorous research and development program, which mostly focuses on the firm’s burgeoning agricultural chemicals business. In total, BASF invests around EUR 2 billion each year (3% of annual revenue, on average) in R&D, and nearly 10% of the firm’s employee base works in the R&D program. BASF’s innovations have been largely successful, as new products have driven revenue growth over the past several years. We expect the firm will continue investing at similar levels, ensuring its intellectual property portfolio remains competitive over time. BASF dedicates nearly half of its R&D expenditures to the agricultural solutions segment—about 9% of annual segment sales—which manufactures a range of fungicides, herbicides, and insecticides for crop protection, as well as seeds and traits solutions. In our view, competitive differentiation is more easily achieved in the agricultural solutions segment than in BASF’s other segments. Many products in agricultural solutions are customized for specific crop systems and regions, requiring a higher degree of specialization than products with more general industrial applications. Specifically, technological advancements in seeds and traits solutions are currently in high demand. These innovations are typically challenging to develop and often feature patent protection when achieved. BASF has secured positioning as one of the top four agricultural solutions providers worldwide, and it spends the most on R&D compared with its competitors, whose investments average around 8%-10% of total sales each year. In our view, BASF’s comparatively high R&D investment ensures a robust pipeline of product developments, and the firm will maintain its competitive intellectual property portfolio in the future. 

We don’t observe further differentiation in BASF’s remaining segments, though we contend that the entire business benefits from the synergies created through the Verbund concept. By optimizing its manufacturing operations, BASF can offset the impact of its reliance on costlier raw materials by minimizing all other costs, greatly reducing the cost base of its products versus its competitors.

Narrow

Economic Moat

BASF SE

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BASF SE engages in the provision of chemical products. It operates through the following segments: Chemicals, Materials, Industrial Solutions, Surface Technologies, Nutrition and Care, and Agricultural Solutions. The Chemicals segment supplies petrochemicals and intermediates. The Materials segment includes isocyanates and polyamides, as well as inorganic basic products and specialties for the plastics and plastics processing industries. The Industrial Solutions segment develops and markets ingredients and additives for industrial applications, such as polymer dispersions, pigments, resins, electronic materials, antioxidants, and additives. The Surface Technologies segment bundles chemical solutions for surfaces with the catalysts and coating divisions. The Nutrition and Care segment consists of ingredients and solutions for consumer applications in the areas of nutrition, home, and personal care. The Agricultural Solutions segment refers to fungicides, herbicides, insecticides, and biological crop protection products, as well as seeds and seed treatment products. The company was founded on April 6, 1865 and is headquartered in Ludwigshafen am Rhein, Germany.

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