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Changing US Gas Policy and the Chemicals Industry
Posted by: Javier Hasse (IP Logged)
Date: September 4, 2013 05:25PM

Last year, Bloomberg published an article highlighting an 8% profit advantage for Dow Chemical (DOW) and Du Pont (DD), over Basf Se (OTC: BASFY). The benefit derived from lower gas prices in the U.S. may very well disappear as the U.S. Energy Department approves the second project for gas exports. The question remains, can Basf Se close the gap? Has anything been hinted by gurus?

Restructuring Stocks No. 1

Dow Chemical is the third largest chemicals company in the industry with a market cap of $46 million. Mixed second quarter results evidence that lower feedstock prices and a favorable arbitration are not enough to push growth forward. The most telling indicator is net sales, which remains flat versus the year-ago period.

The three core segments for Dow Chemicals – feedstock & energy (20%), performance plastics (26%) and materials (24%) – [size=13px; ] continue to struggle. At the same time, a precarious European economic environment and high unemployment in the U.S. are expected to further hinder performance of basic products. The closing of 20 facilities across Europe, North and Latin America are a reflection of current difficulties.[/size]

In response, the company entered a partnership with Saudi Aramco to build a new facility, lower feedstock prices and better serve rising demands for specialty products from Mainland China and Southeast Asia. Additionally, the business model continues to move away from the business division structure and after a year of the announcement, results do not match promises and finances continue to weaken.

Guru responses to Dow Chemicals have varied. Since December 2012 Ken Fisher, John Burbank, Steve Cohen, Joel Greenblatt and Jim Simons have dropped the stock. Most importantly, Dodge & Cox with almost 30 million shares continues the downtrend started in 2008. I remain cautious about this stock because higher gas prices will automatically translate into thinner margins and greater competition, with no catalysts to push growth.

Restructuring Stock No. 2

Du Pont is the second largest chemicals producer, only second to Basf SE ($84 million). The firm’s second quarter performance is similar to Dow Chemicals: Higher sales for the agricultural segment are offset by lower year-over-year net sales and earnings. And, business restructuring is underway in an attempt to beat full-year targets. Additionally, currency headwinds and announced droppings of non-performing mar future growth.

The restructuring of the business model evidences that lower feedstock prices is not enough to curve lagging Du Pont’s segments. In line, fixed costs reduction, retrenching employees, restructuring work schedules, and improving capital returns are some of the current policies to improve future performance.

Also, the firm has placed greater focus on research and development for the agricultural segment, and recently introduced over 450 new products. At the same time, many more products remain in the pipeline to better serve demands in emerging markets. However, new products success will have to offset higher seed input prices, and expected higher energy costs.

The balance sheet for Du Pont is moderate, because indicators have not seen improvements during the last three years. While I remain bearish about the stock, James Barrow (11 million shares) and Jean-Marie Evaillerd (over 3000% increment) continue to grow their positions indicating confidence in management’s new focus on research.

Basf SE Looks Stronger

Performance during 2013 have been similar to Du Pont and Dow Chemical, but with a greater growth in its agricultural segment. However, total sales improved amid a greater competition and a lagging European market. With respect to gas, the company operates its own midstream operations and has a close relationship with Russian giant Gazprom.

The business strategy continues to be the same for Basf Se: drive away from cyclical chemicals, and improve the specialty chemicals segment. Recent acquisitions and divestitures have served the purpose. Also, the ongoing Middle Eastern project will diversify raw material suppliers while reducing operating costs.

Additionally, the company continues to diversify operations by entering the GMO business through a partnership with Monsanto. The deal sustains the growing focus placed on the agricultural segment by Basf Se. At last, the company holds a successful research pipeline that continues to introduce new products to the market.

Finances are in order for Basf Se and competition is expected to ease as gas prices rise in the US, and continue to feed growing margins. Although guru activity surrounding the company is small, Ken Fisher continues to strengthen his position within the company through 2013. This is not a minor detail since the guru reverted a four years trend. This is a strong argument for me to remain bullish about the company, in addition to the continuing strategy driven towards specialty chemicals.

Conclusion

I prefer Basf Se over the other two because the company is a tight working clock. Vertical integration and own gas & oil operations have insulated the firm from many cycles. Additionally, the emphasis placed in the agricultural segment and specialty chemicals continue to improve overall performance amid market difficulties. At last, the new partnership with Monsanto will greatly improve research capacity for the agricultural segment.



Guru Discussed: Ken Fisher: Current Portfolio, Stock Picks
James Barrow: Current Portfolio, Stock Picks
Stocks Discussed: DOW, DD, BASFY,
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