Ladies and gentlemen, thank you for standing by. I'm Emma, your Chorus Call operator. Welcome, and thank you for joining BASF Analysts Q2 2016 conference call. Throughout today's recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. If you'd like to ask a question, you may press star followed by one. When preparing to ask your question, please ensure that your phone is unmuted locally. If any participant has difficulty hearing the conference, please press star followed by zero for operator assistance. This presentation may contain forward-looking statements that are subject to risks and uncertainties, including those pertaining to the anticipated benefits to be realized from the proposals described herein. Forward-looking statements may include, in particular, statements about future events, future financial performance, plans, strategies, expectations, prospects, competitive environment, regulation, and supply and demand.
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Good morning, ladies and gentlemen. Welcome to the BASF conference call on the second quarter of 2016. With me on the call today are Kurt Bock, Chairman of the Board of Executive Directors, and Hans-Ulrich Engel, BASF's Chief Financial Officer. We already posted a longer version of the speech on our website at basf.com/share. As in recent years, we are also publishing our new BASF fact book today. It is now available on our website. With this, I would like to hand over to Kurt Bock.
Yeah. Thank you, Steffi, and also welcome from my side to our Q2 call. The macroeconomic environment improved slightly in the second quarter, and there seemed to be some modest improvement in market confidence. The increase in oil price and slight pickup in demand since the end of March underlined these developments. We experienced robust demand from the automotive and construction industries. However, the macroeconomic situation remains fragile. In particular, U.K.'s recent Brexit decision has added to the overall economic uncertainty and market volatility. More recently, the situation in Turkey contributed to the political uncertainty. Let's look at the development in the regions. In Europe, we saw moderate growth across all sectors. Demand in North America was slightly lower than expected. However, the economic environment can still be characterized as robust. Economic development in South America remained very weak, and business confidence continued to be low.
Brazil is still in a deep recession, also that appears to be leveling off. While fundamentals in Argentina improved, the country still suffered from weak export demand, fiscal consolidation, and high inflation. In Asia, we saw an upward trend since the second half of March and an overall improvement compared to the second half of last year. Growth in China remained below the high levels of previous years but was slightly higher than we had expected at the beginning of the year. Let me now highlight BASF's business performance in Q2. Sales in the second quarter decreased by 24% to EUR 14.5 billion, in particular due to portfolio effects of -16%. These are mainly related to the asset swap with Gazprom, which we completed at the end of September 2015.
The disposed gas trading and storage activities had accounted for EUR 3 billion of sales in the previous year quarter. We were able to increase our sales volumes in all operating segments except for Agricultural Solutions, which continues to face a tough market environment. In the Chemicals business, volumes were up 4%, mainly driven by Functional Materials and Solutions and Chemicals. Sales prices declined by 7% following lower raw material prices. Currency effects amounted to -3%. The headwinds were in particular related to the U.S. dollar, Argentine peso, and the Chinese renminbi. EBITDA declined 7% to EUR 2.8 billion. EBIT before special items came in at EUR 1.7 billion, 16% lower than in the prior year quarter. Significantly higher earnings in our Chemicals business were driven by Performance Products and Functional Materials and Solutions.
However, this could not compensate for a significant earnings drop in oil and gas. Special items in EBIT amounted to +EUR 11 million. Disposal gains from divestitures, including the sale of our polyolefin catalyst business, were partially offset by expenses related to restructuring measures and other operating charges. EBIT also declined by 16% to EUR 1.7 billion. Income taxes amounted to EUR 440 million. The tax rate of roughly 27% was at the level of prior-year quarter. At EUR 1.1 billion, net income came in 14% lower than in the second quarter of last year. Reported earnings per share decreased from EUR 1.38 to EUR 1.19 in Q2 2016. Adjusted EPS amounted to EUR 1.30.
At EUR 2.3 billion, operating cash flow in Q2 was above Q1 2016 but lower than in the prior year quarter. Free cash flow increased by about EUR 130 million compared to the prior year quarter and came in at EUR 1.3 billion. This resulted from lower payments for investment projects in the second quarter. Ladies and gentlemen, let me highlight a few milestones of Q2. At the end of April, we started up our plant for the production of specialty amines in Nanjing. This asset complements our existing facilities in Germany and the U.S., and improves our ability to flexibilize our service to customers in Asia-Pacific. In mid-June, we signed an agreement to acquire Albemarle's global surface treatment business.
Chemetall is a global technology and innovation leader in the metal surface treatment market, and operates 21 production sites worldwide, 10 R&D locations, and 24 sales offices. The company offers a strong strategic fit for our coatings business by complementing our current coatings portfolio. The acquisition will support our aim to grow profitably in downstream innovation and solution-focused businesses. The purchase price is $3.2 billion. Closing is expected by end of this year. The transaction is subject to approval by the relevant authorities. End of June, we closed the previously announced transaction to divest our polyolefin catalyst business to W. R. Grace. The transaction comprises technologies, patents, trademarks, and the transfer of production plants in Pasadena, that's in Texas, and Tarragona in Spain. The disposal gain is a double-digit million EUR range.
In early July, we started commercial production in the polyTHF plant in Korla in western China, which is part of our joint venture with Xinjiang Markor. The plant provides an annual capacity of 50,000 tons and complements BASF's existing Asian production facilities in Shanghai, in Ulsan in Korea, and obviously also our production in Europe. In Korla, BASF and Markor are now jointly operating an integrated polyTHF production following the startup of the BDO plant in January of this year. BDO is the precursor for polyTHF. Now Hans will comment on the performance of the individual business segments. Hans?
Yeah, thank you, Kurt. Good morning, ladies and gentlemen, also from my side. Let me highlight the financial performance of each segment in comparison to the second quarter of 2015. I'll start with Chemicals, where sales in the Chemicals segment declined considerably. Lower prices in all divisions resulting from lower raw material prices and negative currency effects were the drivers for this development. In all divisions, volumes grew, supported by our new capacities. High cracker margins in Europe and a significant improvement of the equity result from our joint venture, BASF-YPC in Nanjing, could not compensate for lower cracker margins in North America and continued margin pressure on key commodity product lines. EBIT before special items therefore decreased considerably compared to the prior year quarter.
Despite the cost for plant turnarounds and the startup of new plants, fixed costs came in at the prior year level. Sales in Performance Products declined significantly. The slight volume increase was more than offset by lower prices, currency headwinds, and negative portfolio effects resulting from the divestiture of several businesses in 2015. Prices decreased due to lower raw material costs. The competitive pressure in the hygiene business also contributed to the lower prices. Despite this, we were able to increase EBIT before special items by about EUR 200 million or 65%, supported by lower fixed costs, improved margins, and higher volumes. In the Functional Materials and Solutions segment, sales slightly decreased. This was mainly driven by lower prices, especially in precious metals trading as well as negative currency effects.
Sales volumes, however, increased by 5% due to continued high demand from the automotive and construction industries. EBIT before special items rose by 17%. All divisions contributed to this considerable increase, particularly Performance Materials. Agricultural Solutions continues to face a challenging market environment, particularly in South America. Sales decreased considerably due to lower volumes and negative currency effects, while prices increased slightly. EBIT before special items declined considerably, mainly due to lower volumes. Sales declined considerably in Europe, mainly as a result of lower sales volumes. This was particularly true for fungicides in Germany and Poland, where demand was dampened by higher customer inventory levels and by the cool, wet weather in broad parts of the region. In North America, sales were slightly below the level of the prior second quarter, owing to negative currency effects and lower prices.
We were able to raise volumes slightly, thanks primarily to increased demand for the fungicide Xemium and F500 in Canada and the United States. Lower volumes in the insecticides and fungicides businesses were primarily responsible for the considerable sales decline in South America. These in turn were largely attributable to high inventory levels and the still critical situation of many customers, especially in Brazil. We were only partly able to offset negative currency effects with price increases. Sales in Asia were slightly reduced by negative currency effects, which could not be offset by considerable volume growth, especially of fungicides in China. Looking at the first half of 2016, sales decreased by 9%. EBIT before special items came in 3% lower than in the same period of last year.
For the remainder of 2016, we do not foresee a significant improvement in the agricultural market. Sales in oil and gas decreased significantly, mainly due to the missing contributions from the natural gas trading and storage business following the asset swap with Gazprom. In addition, lower oil and gas prices contributed to the drop in sales. Higher production volumes could not offset this price decline. The average price of Brent Crude in Q2 2016 was $46 per barrel, compared with $62 in the prior-year quarter. Gas prices in the European spot markets also fell sharply compared with the second quarter of 2015.
Compared to Q1 2016, the average price of Brent Crude increased by 34%, while gas prices on the European spot markets were almost stable and remained on a low level of about 13 EUR per MWh. In the continuing oil and gas business, price and currency effects together were -18% in Q2 2016. A strong volume increase of 9%, driven by higher production in Norway, was not able to compensate for this. Overall, EBIT before special items decreased from EUR 431 million - EUR 94 million. Strict cost containment measures partly counterbalance this decline. Please keep in mind that throughout 2016, we will have lower earnings from our share in the Yuzhno-Russkoye natural gas field.
This year, the excess amounts received over the last years will be offset by lower volumes, as contractually agreed with Gazprom. Net income in oil and gas decreased from EUR 250 million - EUR 100 million. Sales and other decreased to EUR 485 million. This was largely attributable to lower contributions from raw material trading. EBIT before special items declined to EUR -212 million, down from EUR -63 million. This was driven by a swing of over EUR 200 million related to our long-term incentive program. While earnings in Q2 2016 were negatively affected by an increase in provisions, the prior year quarter benefited significantly from the release of provisions for our long-term incentive program. Special items in other amounted to EUR +65 million and were mainly related to portfolio measures.
Let me now turn to our cash flow in the first half of 2016. Cash provided by operating activities decreased to EUR 3.3 billion. Please bear in mind our initiative to reduce net working capital in 2015. This resulted in an extraordinarily high cash inflow in the prior year period. In addition, the divestiture of our natural gas trading and storage business led to a new seasonality with respect to our inventories and trade accounts receivable. Cash used in investing activities declined by EUR 1.3 billion to EUR 2.0 billion. Payments related to tangible and intangible assets amounted to EUR 2.0 billion, compared to EUR 2.8 billion in the first half of 2015. Acquisitions and divestitures resulted in a net cash inflow of EUR 51 million.
Financing activities led to a cash outflow of around EUR 1.8 billion, mainly due to the payment of the dividend. Free cash flow amounted to EUR 1.4 billion compared to EUR 2.3 billion in the first half of 2015, reflecting the new seasonality and inventory reduction impacts that I mentioned for the first half of 2015. Free cash flow in Q2 2016 exceeded the prior year quarter by about 130 million and came in at EUR 1.3 billion. Finally, let's take a look at our balance sheet. Compared to year-end 2015, total assets grew by EUR 1.3 billion to EUR 72.2 billion.
This was mainly due to the usual seasonal increase in trade accounts receivable in our agricultural solutions business and higher deferred taxes due to the increase in pension obligations. Long-term assets were relatively stable at EUR 46.5 billion. Total equity decreased by almost EUR 2.6 billion to EUR 29 billion, driven by non-cash actuarial losses related to provisions for pension obligations following the decline in interest rates. As a result of the lower interest rates, provisions for pension obligations increased by EUR 3.3 billion. Short-term liabilities increased from EUR 14.2 billion - EUR 15.6 billion due to a reclassification of bonds from long to short term and a higher utilization of our commercial paper program.
Due to the dividend payment of around EUR 2.7 billion, as well as the seasonal pattern of our business, financial debt rose by EUR 700 million - EUR 15.9 billion. Net debt increased by roughly EUR 1.2 billion - EUR 14.1 billion. Our equity ratio remained at a healthy level and amounted to 40%. With that, back to you, Kurt, for the outlook.
Okay, I will now finish with the outlook for 2016. Our expectations for the global economic environment remain unchanged. We are confirming our 2016 sales and earnings outlook for BASF Group as provided at the end of February. Sales in 2016 will be considerably below prior year due to the divestiture of the natural gas trading and storage activities, as well as lower oil and gas prices. Excluding the effects of acquisitions and divestitures, we aim to increase sales volume supported by our increased capacities. We expect EBIT before special items to be slightly below the previous year level due to significantly lower earnings in oil and gas. In the current volatile and challenging macroeconomic environment, we continue to regard our outlook as ambitious and particularly dependent on further oil price development.
With this in mind, we remain focused on cost containment and restructuring measures which have proven effective in the first half of this year. Our recent portfolio measures will contribute to the mid and long-term success of BASF. Now we are happy to take your questions.
Ladies and gentlemen, at this time, we will begin the question and answer session. Anyone who wishes to ask a question may press star followed by one. If you wish to remove yourself from the question queue, you may press star followed by two.
To ensure the best sound quality, we kindly ask you to unmute your phone and use your headset. To ensure we can accommodate as many people as possible, please limit yourself to only one question and if necessary, one follow-up. I would now like to open the call for your questions. The first question comes from James Knight, Exane BNP Paribas.
Morning. Thanks for taking my question. In chemicals, did you have any influence in the second quarter from the condensate splitter in North America? You mentioned that in the first quarter as a headwind on volumes, and I guess the follow-up would be if there was a negative influence, given you reported pretty good volumes in the second quarter, do you think any of that was driven by restocking? Thank you.
Yeah. James, this is Hans. First on your condensate splitter question, similar situation as in Q1 2016, due to the price of condensate in the U.S. and the way we run the cracker in Port Arthur, the condensate splitter did hardly run, or in other words, did not really run. First thing. Second thing that you may want to keep in mind when you look at the Q2 results in chemicals is that we had turnarounds both in Ludwigshafen and in Antwerp. It's the steam cracker too, and then the downstream plant that we had down for the usual turnarounds, plus then the ammonia plant in Antwerp. Overall, I would describe the demand situation in our chemical segment as overall pretty healthy.
The next question is from Tony Jones, Redburn. Please go ahead.
Morning, everybody. Thanks for taking my question. I just wanted to understand the drivers behind the margin improvements in Performance Products a bit better. It looks like cost savings are taking effect, but also volumes are up a bit and there must be some raw material gain in there. On that point, it looks like the EBIT margin was sequentially lower in Q2 than Q1. To help us understand what's going on, could you perhaps weight each of those contributions in terms of how important they are, and how should we think about them as we move into the second half of the year? Thank you.
Yeah. Hi, Tony. This is Kurt. Couple of factors, and you mentioned them all. There is volume growth that was certainly helpful. Overall, we have an improvement in earnings of roughly EUR 200 million. I'd say, half of that, approximately is margin, a quarter comes from volume, and a quarter comes from cost containment measures.
Great. Thank you very much.
Welcome.
Oh, perhaps maybe any thoughts on what could reoccur in the second half of the year? I mean, how much will raw materials still be there, or will that fall away?
It's hard to say. It also depends on the raw material cost development or price development. What you normally can expect is that some contracts are renewed and then customers, in some cases, might look for lower pricing. That's too early to say. Our goal is obviously to continue the journey which we have had in Q1 and Q2, and we will certainly also continue with our cost improvement measures which are in full swing.
Thank you very much, Kurt.
You're welcome.
The next question comes from Paul Walsh, Morgan Stanley.
Yeah. Morning, guys. Thanks very much. Hi, Kurt, Hans, Stephanie. Just two questions, please. The volume growth that you reported in the second quarter, have you seen anything so far in Q3 that would warrant any concern given the increased volatility out there, automotive, construction, electronics, any of the more cyclical markets showing a bit more nervousness in the supply chain? And if so, you know, which divisions are you seeing that across? Second question, just around vitamin pricing in particular. Obviously, performance products had a great performance in the second quarter. Vitamin pricing is up both A and E. Could you help me understand how sustainable you think that is and the factors that are allowing you to secure those price increases, where over recent years they've more or less failed to gain traction? Thanks very much.
Yeah. Thank you, Paul. I'll start with the question, demand going into Q3. Our concern always has been, you know, there's a little bit of restocking and maybe then it's tapering off. So far we haven't really seen this, so it continues into July. The caveat is always that, July and August are relatively weak months, as we all know, so it's really important how we get out of the summer lull, at the end of August, and that's too early to say. At this point in time, it looks like it's okay. I repeated several times, you know, the heightened uncertainties due to the macroeconomic and political factors, and that is probably too early to judge when those really might kick in, and if. Hans?
Yeah. Hi, Paul. Vitamin A and E price is up. Certainly, I would say that's good news. Your question on how sustainable is that
I'd like to answer. Being cautious remains to be seen. We've seen
Sure
Nice price improvement in particular in E, where we were below EUR 5 per kilogram in the beginning of the year. There were first rumors about Chinese competitors shutting their activities either in or down. It's pretty clear that something happened there, but what this means and whether these capacities will come back to the market, frankly, we don't know at this point in time. The price developments in A and E are certainly welcome after many years where we've seen nothing but declines. First half of this year, the trend is up, and we hope that this will continue.
That's great. Just, did you say, Kurt, that you needed the oil price to go up from here to hit your guidance or not? Sorry, I just not sure if I interpreted that rightly or wrongly.
No, that would be an overinterpretation. We have said we continue to think that the oil price will stay on average at $40.
Sure.
Our guidance is based on that $40 per barrel. If the oil price goes up, that would be warmly welcomed.
Understood. Thanks a lot, guys. Thank you.
Even more so if the gas price goes up.
Yeah, absolutely. Thanks so much.
The next question is from Lutz Gruetjen , Commerzbank. Please go ahead.
Yeah, thanks for taking my two questions. The first one is on volumes. China has announced that around the G20 summit, there will be shutdowns in the region for, I think, two weeks or so, and you also had a shutdown yesterday or an incident, at least in Ludwigshafen. Is there anything we should expect on the third quarter regarding lower volumes in regards to these things? The second question is on the oil price sensitivity, which is quite helpful to get in the fact book. Also any chance to get a sensitivity regarding the gas price? Thank you.
Hi, Lutz. Hans will try to answer the question on the gas, but which is kind of difficult. External effect of G20. Actually, I'm not aware of any upcoming production shutdowns for us in China. I don't think this has any material impact. It hasn't been raised by anybody of our folks in Asia and in China in particular. In lieu, we had a little trip yesterday which has been resolved by now. I don't think this is material either.
Mm-hmm.
Hi, Lutz. This is Hans. On your gas price question, frankly, if we could provide you with something that is reliable, we would do so. When you look at our gas portfolio, you see that we have regulated prices, we have non-regulated prices, we have Russian domestic prices, Russian export prices, we have Argentine prices, regulated, then Argentine prices under new gas price system. We have market prices for production in northwestern Europe. Frankly, there is so much noise in that system that we don't feel comfortable with providing a clear guidance there with respect to gas price sensitivity.
Okay. Thank you.
The next question is from Martin Roediger , Kepler Cheuvreux. Please go ahead.
Yes. On the outlook for the segments, we hear you say on Reuters that the Ag Solutions business could be somewhat weaker this year than previously expected. Could EBIT in this segment also drop this year as it was down by 3% the first half? I know that first half is much more important than the second half. Do you stick to your previously given outlook for the Ag Solutions segment in spring that the EBIT will increase this year?
Okay. Yeah. Hi, Martin. Volumes were relatively weak in first half of 2016. We see some channel inventory going into the third quarter. Europe actually was a little bit disappointing, mostly weather related, I have to say. This could lead to the conclusion that it might become a little bit more difficult than previously anticipated to achieve this slight increase. We cannot rule out that maybe earnings in Ag come in slightly below last year's numbers, but that is really too early to say. The entire team is working very, very hard to make the numbers. When you look at the cost structure, you can also see that the self-help measures which we have implemented get traction. We are working extremely hard, but you cannot rule it out completely.
The forecast today is certainly more ambitious than six months ago.
Thank you.
The next question comes from Jeremy Redenius, Bernstein.
Hi, it's Jeremy Redenius from Bernstein. Thanks for taking my question. I just wondered if you could elaborate a little bit more on your comments about China's contribution to the business in the first half of the year versus the second half. In the report you talk about it, let's say growing faster than you expected or at least slowing less than you expected, with the automotive industry benefiting from some stimulus as well as the housing market. Could you talk about how much that helped you in the first half? And does that persist into the second half in your view? Thanks.
Jeremy, I couldn't hear exactly what you asked. This was about China, right? Yep.
Yep, that's right.
Okay, perfect. No, we had relatively good development in Asia, in the first half and the Q2 as well. Actually, local EBIT is already at the level of last year's entire year, which is not a bad development. A couple of reasons. We have pushed more volumes. I think this is possible and necessary. Possible also because we have capacity now available, a couple of startups in this, particular in China, and they get traction now, and we have worked also very, very diligently on our cost base. This is a combination of factors, which helped to improve earnings considerably. China continues to grow, however, a little bit slower than what we had previously expected.
For our businesses, automotive, we see good and healthy development overall, and this is obviously not just a question of market development, but also a question of market share development. In those businesses, I think BASF is quite competitive, and we are quite optimistic about pushing and moving these downstream businesses further ahead. We continue to have in some of the upstream markets unsatisfactory margins, obviously, in China, be it acrylic acid or the isocyanates. This will take some time and not just one year to be resolved.
Yeah, thank you. Also I was trying to ask, was the you know first half result boosted to some degree by stimulus measures that you might expect to fall off in the second half of the year?
I cannot say yes. I cannot say no. It's very difficult for us to make a judgment call here. We are not aware that we have benefited in any particular shape or way from specific incentive programs. There have been incentives for the automotive industry, obviously. I don't think it has had a material effect.
Okay, thank you very much.
The next question comes from Mutlu Gündoğan, ABN AMRO. Please go ahead.
Yes, good morning. I have a question, a specific one on your JV with Petronas Chemicals. I was wondering if you can update us on the progress of the integrated aroma ingredients plant in Malaysia, whether that's still on track, and also, because of the, I would say, soaring vitamin prices, is it possible to produce vitamins on that site?
On time, on budget, ready to start up in the second half. The teams are working very, very hard now to make this happen. We're quite satisfied with that development in Kuantan.
Is it possible to produce vitamins on that site, or is it only for the, what is for the consumer chemicals?
It's also this, what we call citral value chain.
Yeah.
Based on citral, you could produce all kinds of pretty sophisticated chemicals, including vitamins. This complex in Asia is really directed at aroma chemicals.
Right. Thank you.
The next question comes from Patrick Lambert at Raymond James.
Good morning, everybody. Thanks for taking my questions. A very broad one, but short term, regarding Brexit. Have you had the occasion to discuss, especially with the OEMs, automotive markets, the short-term trends in terms of production exports to U.K. and potentially impact on your overall exposure to automotive in the second half? Very short term, is there any increased volatility in terms of order patterns or projection that you have to do in automotive exposure? Thanks.
We have no information at this point in time, actually. We follow the same news flow, obviously, as you do. The automotive industry has a certain role, and the value chains connecting the U.K. and the continent are very important, but at this point in time, I'm not aware of any possible changes. From our point of view, I mean, we have production all over Europe, so it's as long as the cars are being produced, regardless of where, we should participate as BASF.
At the moment, you haven't seen any cancellation of orders or different patterns of orders?
We haven't.
Thanks.
The next question comes from Peter Spengler, DZ Bank.
Yeah, good morning, gentlemen. I have a question on your new TDI plant in Ludwigshafen and what's the current status of this plant, and maybe you can elaborate how you ramp up in the second half and how is the status with your second plant, Schwarzheide, which you want to close down at the moment?
Both-
Thank you.
Thank you, Peter, for the question. Both are obviously related. As soon as we ramp up as quickly as possible at Ludwigshafen, then we go into the shutdown mode in Schwarzheide. This is an ongoing process. That's what I can say at this point in time. It should happen any day.
Okay. Thank you very much.
The real question is how fast can you ramp up? You're aware we have the 80,000 tons available in Schwarzheide, which we then will discontinue. Currently we have exports from Asia into Europe for TDI. Those trade flows also then would change as soon as we have full capacity availability here in Europe.
Okay. Thank you very much.
You're welcome.
The next question comes from Laurence Alexander, Jefferies.
Good morning. Could you flesh out a little bit, the volumes that you're seeing in construction chemicals and automotive catalysts? Are either of those, seeing disproportionate share gains? And also can you give a little bit more detail on agriculture inventory levels and whether you think that can be worked down over the next season or whether it might take a couple of seasons to get worked through?
Hi, Laurence. This is Hans. Let me start with your question on automotive. We've seen overall, Q1 and Q2, a pretty healthy development in line with our expectation. Global growth in production roughly 3%, also distributed the way that we thought it would be. A very healthy development in North America. Little bit slower in Q2 than in Q1, but still healthy. Very weak in South America. Good, strong development in China. Also positive development in Western Europe. Russia, as South America, weak, and actually with lower volume, even lower volumes than what we experienced there last year. With respect to share gain, I assume you are referring to our business.
It's always difficult to say are you winning, are you losing share, but if you look at our automotive business overall, and how it has performed over the years, you see it with volume increases in excess of global car production, so that gives you at least there a very good indication of what's happening with our business. On construction, good positive development in particular in North America. Also, solid development in Europe. There, again, or I have to say, confirming what we already said in the first quarter, there is construction going on again in the southern part of Europe, which we see as quite positive.
In Asia, we've experienced, and there in particular in China, that after the increase in construction activity in Q1, which may have been driven by stimulus measures, we've seen a certain decline in Q2.
Obviously, Laurence, the construction is a very local, very regional market. Give you just one example in Saudi Arabia, financing is very tight and an important market for BASF, and we have seen a considerable decrease in that market, just to give you a little bit of flavor here. Different development regionally as well. For us, as I said before, Europe was relatively slow. We believe there are relatively high channel inventories, at least for fungicides in Europe. That makes us a little bit cautious for Q3. South America, we don't see any imminent recovery. Farmers are in a relatively weak position, and we have to be very careful also to manage our financial exposure, which we do quite smartly. Again, relatively high channel inventories.
North America, overall from our point of view, okay. Asia, good development for BASF this year, but, as you know, Asia for us is a relatively small market because we don't have an extremely broad portfolio in insecticides which play a bigger role in the Asian markets.
Thank you.
Welcome.
The next question comes from Markus Mayer, Baader Bank.
Yeah, good morning, gentlemen. One add-on question to this TDI ramp-up. Can you update us on the ramp-up cost? Was there any change there? Secondly, on your hygiene business and the care chemicals, for how long do you expect this very competitive environment? Thank you.
Let me start with Markus with hygiene. That will stay competitive quite some time because there is added capacity essentially for superabsorbent, and they will weigh on the market for quite some time. As you know, some of the products have been commoditized over time for BASF. The solution has been innovation, and we have launched a new product. Actually, we introduced it to the market. We are building currently the plant in Antwerp, a product which is called Saviva, and if I remember correctly, I think we even introduced it to one of our investors' days, where you can clearly see there's a benefit, quite a big benefit for consumers and therefore also for the producer of baby diapers. We are currently pushing this into the markets.
TDI startup costs, I think in Q1 call, Hans said something like EUR 200 million of startup costs in chemicals. That number, that encompasses everything, obviously some other startups as well, and that number is still valid from today's point of view.
Okay, perfect.
The next question comes from Peter Clark, Société Générale. Please go ahead.
Yes, good morning. Thank you. A quick one on CapEx is the first question. It's down 30% in the first half. Obviously you had guidance for the year, but just wondering if that could actually dip
Towards EUR 4 billion or below this year. Then the follow-up is actually Tony's question. I didn't quite catch the split of how the margin was made up in the Performance Products advance, but I think I caught the raw materials could have been about a quarter or so of the overall variable costs. Just wondering, assuming volumes are okay, you must be pretty confident then that all the work you've done there has produced a structural step-up in the margin here. You're pretty confident of a decent margin rate moving forward. Thank you.
Yeah, with regard to Performance Products, what you describe is certainly our objective to have a structural earnings leap. We are working extremely hard, the entire team, to achieve this. We had a little bit, and I mentioned this, a little bit of tailwind from the margin development that should never be taken as granted. The idea is to continuously improve the business further on, and so far it worked quite nicely in Q1 and Q2. CapEx, the run rate is currently slightly below what you would expect for the end for half of the year. 50% of the time is already behind us. We always know that, also know that, December and November are quite busy months for CapEx spending.
The goal is to reduce spending overall by about EUR 1 billion, and I think we are on track to achieve that.
Okay, thank you.
The next question comes from Andrew Benson, Citi.
Thanks very much. You mentioned on a call earlier about Ag not being for sale. Does that include any sort of potential joint ventures? I guess the other side, you presumably would be interested in bolt-on acquisitions, at least in that area. Then secondly, just a couple of points on the tax rate and 'cause it's a bit volatile first quarter, second quarter, if you can sort of provide some guidance there. Also on just on financials, you talked about one-off costs in terms of higher shutdown, startup costs. Can you just try and quantify those for us in the second quarter and sort of run rate for the full year? Thanks.
I think, Andrew, Hans will take the question on the tax rate. Even if I sound like a broken record, I mean, we have a good business, a good performing business. There are always fluctuations, and we have seen this now in Q2, but underlying growth and earnings capabilities are very good. We have an excellent pipeline. We have some good products coming to the market very soon, where we are very optimistic that this really will propel additional growth for BASF. Having said that, nevertheless, we are certainly looking for bolt-on acquisitions if possible. If businesses will be offered to the market, that needs to be seen. Due to this ongoing consolidation, there might be some opportunities and then we take a look, as I'm certain some other companies will do as well.
Other than that, I cannot really comment, and I have said the business is not for sale. Again, this sounds like a broken record. It has been true, it stays true.
The next-
Oh, if I may, Steffi.
Of course.
I think you also had a question on the tax rate. Andrew, this is Hans-Ulrich Engel. Hi. On the tax rate, I think, with respect to Q2, your comment is not really correct because the tax rate in Q2 is almost exactly where it was last quarter. 26.9% versus 26.8%, if I remember that correctly.
Oh, first thing is sequentially. Sorry.
You're absolutely right when you look at the developments that we had between Q1 and Q2, as well as on a half-year basis. That volatility that you were addressing there, that's driven by the oil and gas business, and in particular by our Norwegian activities, where we had last year a situation where gains were taxed at 78%. This year as a result of the extremely low oil prices, there are no gains to be taxed. In fact, in Q1, we had a situation where there was actually a tax gain in oil and gas business.
Factoring all of that together, I understand that it's difficult to see the full development and the full picture, but that's the underlying developments that we have in the oil and gas business.
Thanks. Just if you can, the shutdown, startups or the sort of the one-off-ish costs. I know strictly that's the third question, but.
Shutdowns and startups cost, but please understand that I don't provide you with the exact figures. Cost for turnarounds in Q2 of this year higher than in Q2 of last year. We had a turnaround in Ludwigshafen, steam cracker 2 and then downstream plants as well as the ammonia plant, Antwerp.
Thanks.
The next question comes from Andreas Heine, MainFirst.
Yeah, the first is basically on the balance sheet. Looking now that the financial debt are EUR 14 billion pension provisions, almost EUR 10 billion, Chemetall comes on top at the end of this year. That's quite a debt load, quite unusual for BASF. Could you put in context what your firepower for potential external growth is and whether you still look for external growth and how important the A rating for BASF is? If I may, one second question on Functional Materials and Solutions, that was the sector I was surprised on the strength, strong performance in the second quarter. That was already on EBIT.
The case, but the D&A was unusually high so that EBITDA was even better. Maybe you can explain a little bit, how we have to model the D&A going forward and how you see this in the second half. Is there something really special in the second quarter, or is it really that good also going forward? Thanks.
Andreas, hi, this is Hans. I'll start with your question on debt load. Actually, if you look at our net debt end of Q2 2016 and compare it to net debt that we were at at the end of Q2 2015, we are EUR 1 billion lower. We were EUR 15.1 billion net debt end of Q2 last year and are right now at EUR 14.1 billion. Our A rating is important to us. Based on the guidance that both Moody's and Standard & Poor's did after we announced the Chemetall transaction, they did not feel compelled to change our rating. Pension, yes, we've seen an increase there. I think it's roughly EUR 3.5 billion compared to the end of the year.
That's basically also the same situation that we were in at the end of Q1 2015, where we were also pension obligations in the range of EUR 9.5 billion, EUR 9.6 billion. You followed what happened with interest rates during Q2 of this year. We saw a drop of interest rates in the main geographies where pensions are relevant for us, which is Germany, the U.K., Switzerland, and the U.S., to the tune of 100 basis points. We're pretty much in the same territory with respect to interest rates that we were in at the end of Q1 2016. Do you want me to do the other question also?
On your question with respect to Functional Materials and Solutions, yes, there is a bit of an uptick in our depreciation and amortization. Please keep in mind that we had a number of new plants that's contributing to that. In addition, we had a smaller double-digit impairment in one of the businesses in Functional Materials and Solutions, and that's the explanation for the higher depreciation and amortization that we had in Q2.
Thanks.
The next question comes from Andrew Stott, UBS. Please go ahead.
Yeah, thanks for taking my question. Good morning. It was actually just around the costs. You'd mentioned fixed costs flat despite the start-up cost of EUR 200 million. I mean, actually, very impressive was the detail of that. Selling expenses down 7% and general down 10%, and R&D, which is very unusual for BASF, down double-digit year-on-year. I guess my question is fairly simple. Are we getting to a level now where you've sort of done what you can before you start to maybe move into some of the muscle?
If I may say so, good question, but I don't think we have come to a point where cost management reaches a limit. The numbers, please keep that in mind, also include a little bit of a currency effect that needs to be taken out. Nevertheless, costs have come down and we will continue to do so. I don't think there's any reason to be less aggressive going forward.
Specifically on R&D, though, can I just follow up on that? That's unusual to see you down that much, and obviously you've got a commitment to grow R&D in line with sales and keep the ratio constant. Should I expect that to flip back up?
Yeah. We don't think that R&D is going to grow in 2016. At the end of the day, it really, again, depends on currency exchange rates. We have a couple of programs in place to take costs out, and we have also some structural changes. One is, for instance, the lower spending on plant biotech, which is a U.S. operation by and large. There's a little bit of a structural effect, but going forward, R&D costs probably stay where they are in nominal terms.
Okay. Thank you.
You're welcome.
We have two more questions. First one comes from Martin Evans, JPMorgan.
Yeah, thanks. It's this time of year when the industry, the chemical industry, often focuses on August and potential customer shutdowns, plant shutdowns and so on, particularly in auto, obviously. Have you had any indication so far as to whether this year will be sort of any better or worse than last year for a few more customers? I'm assuming, given the, in some areas, the volume situation is a little bit better, you'd anticipate the shutdowns won't be any longer than last year. Thanks.
Hi, Martin. As I said before, July so far is where we expected it to be. There is this typical summer lull, very much driven by the automotive industry, obviously, but we haven't seen anything special here. We still believe that the automotive industry this year will grow globally by something like 3%, 2.6%. From our point of view, this is still moving in the right direction.
Thanks.
Welcome.
We have a follow-up question from Martin Rüdiger, Kepler Cheuvreux. Please go ahead.
Thanks. On human nutrition, you mentioned volumes went down. Can you tell us the background for the lack of demand in human nutrition?
Sorry, could you repeat?
In your quarterly report, you mentioned that the volumes in human nutrition went down in the second quarter. Can you tell us about the background why demand was so poor for human nutrition?
I will try to find the respective number for the volume development in that particular business. I don't have it at hand. Just one second. There are some timing effects, obviously, with some shutdowns, shifts in Q3. This is a turnaround we had in Ludwigshafen, a big turnaround. As we speak about it, I start to remember what was happening. We had a big turnaround here in Ludwigshafen, which is again, this trial plant, which was down for quite some time. Of course, there was the every five-year turnaround, and that is probably one of the best explanation for that development. Yeah.
Thanks.
Now we have back on the line, Laurent Favre with his question, Bank of America. Please go ahead.
Yes. Good morning, gents. Good morning, Steffi. My questions are related to the Chemetall acquisition. I was wondering if you could, you know, flesh out where you see the strongest growth opportunity beyond the underlying market growth in autos. i.e., do you think this is a market that can actually outgrow the autos industry? That's first question. The second question is on the synergy that you see from that deal. Basically, I'm wondering what kind of synergy you'd expect so that return on capital on the deal approaches cost of capital for BASF. Thank you.
Laurent, thank you for your questions. Chemetall, as I said in my little speech, we believe this is a strategically very nice fitting acquisition for BASF. The price, it didn't come cheap, so we have to manage it very, very successfully, obviously, to create value for our shareholders. It's a very well-run company and operation. We see certainly opportunities to grow the business above and beyond of what we have seen so far, especially because it can combine the surface treatment technology with our coatings technology, and this is quite an important trend in the automotive industry, how to take out additional, at the end of the day, additional layers of the coating process. There, the surface treatment also plays an important role. Please keep in mind that this is not just about auto.
Auto is important, but Chemetall is active in many, sometimes relatively small, but also very important and very attractive markets like the aircraft construction industry, where they are very important for treating the blades for the turbines of aircraft, and this is a really high tech and interesting and fascinating technology. Synergies, we have said, industry typical. You can rest assured that BASF goes through each and every potential synergy, but we haven't even yet closed the deal. We just signed it and published it, so I think it's also fair to wait for the process to start then, together with the new colleagues, which will join us hopefully as soon as possible, as soon as the authorities have waved through the deal.
We have two more.
If I may.
Sorry.
If I may, can I ask if something has changed from your perspective in this business, since the time it was for sale, a few years back? Is it just that you didn't quite fancy the package of Chemetall plus lithium, or has something changed within the Chemetall business?
As I said, it's a well-run company, but I'm not aware that it ever has been offered separately. That, I'm not aware. Now it was offered separately, and that gave us the opportunity to go after it.
That's very clear. Thank you.
Thank you.
We have two more follow-up questions which we would, we'll take, but then conclude the call. The first one is from Patrick Lambert, Raymond James. Please go ahead.
Yeah. Thanks for the follow-up. Just on oil and gas, if I strip the gas distribution contribution, were you a bit positive on the production and exploration? Thanks.
Were we positive in Q2? Is that your question?
Yeah. Well, yeah, was it?
In the exploration and production business? Yes, we were.
Yeah.
Yeah. We were.
Okay. That was a short one. Now the last and final question is from Lutz Grütjen, Commerzbank. Please go ahead.
Yeah. Thanks again, and also a short one. On MDI, the joint venture you got with Huntsman and local partners in China, to double the capacity to 480,000 tons. Is it still on budget? Is it still on time? I think you got all the permissions, but would be great to get an update on the timing here. Thank you.
Since this is a joint venture operation, it has quite a few partners, as you're aware. I would refrain from making a comment here. From our point of view, I think this should be answered then also by Huntsman.
You have got the majority with Huntsman at 70%, haven't you?
We are working on the project, yeah.
Okay. Thank you.
Ladies and gentlemen, this brings us to the end of our conference call. We will report on our third quarter results on October 27. In this regard, I would like to inform you that the German legal requirements for financial reporting in Q1 and Q3 have been eased. From October 2016 onwards, we will publish quarterly statements for the first and the third quarter based on this new legislation. These statements will be more condensed, but will of course continue to provide you with the relevant financial information. The formats of the half year and full year financial reporting will remain unchanged, and our analyst conference call will also take place as usual. One final reminder, BASF will host a round table Asia Pacific on September 23 in London.
If you have not yet registered and plan to attend, please send us the completed registration form by July 31st. Thank you for joining us today. Should you have any further questions, please contact a member of the IR team, and we will be happy to help you.
Ladies and gentlemen, the conference is now concluded and you may disconnect your telephone. Thank you for joining and have a pleasant day. Goodbye.