Ladies and gentlemen, thank you for standing by. I'm Mia, your call operator. Welcome, and thank you for joining BASF Analyst Q2 2014 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 would like to ask a question, you may press star followed by one on your touchtone telephone. When preparing to ask a question, please ensure that your phone is unmuted locally. If any participant has difficulty hearing the conference, please press the star key followed by zero on your telephone 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. BASF has based these forward-looking statements on its views and assumptions with respect to future events and financial performance. Actual financial performance could differ materially from that projected in the forward-looking statements due to the inherent uncertainty of estimates, forecasts and projections, and financial performance may be better or worse than anticipated. Given these uncertainties, readers should not put undue reliance on any forward-looking statements. The information contained in this presentation is subject to change without notice, and BASF does not undertake any duty to update the forward-looking statements and the estimates and assumptions associated with them, except to the extent required by applicable laws and regulations. I would now like to turn the conference over to Magdalena Moll, Head of Investor Relations. Please go ahead.
Yeah, thank you and good morning, ladies and gentlemen. On behalf of BASF, I would like to welcome you to our second quarter 2014 conference call. BASF increased EBIT before special items by 12% in the second quarter. The positive volume trend continued, but we again faced significant currency headwinds. With me on the call today to explain the results are Kurt Bock, our Chairman and Chief Executive Officer, and Hans-Ulrich Engel, our Chief Financial Officer. Kurt will start off and summarize the key financials, and he will also highlight important milestones during the quarter. Then Hans will review the segment results, and Kurt will conclude with the Outlook 2014. Afterwards, both gentlemen will be happy to take your questions. For your information, we have posted the long version of the speech and the charts together with the press documents on our website under www.basf.com/share.
With this, I would like to hand over to Kurt.
Yeah. Thank you, Maggie, and also good morning from my side. Thanks for joining us on our conference call. Let me start by looking at the overall economic development. The global economic environment is developing slightly better than last year. The economies in the Eurozone are partially improving, however, structural risks remain. German demand was disappointing in Q2. The economies in North America expand on a moderate level after a very weak first quarter. China growth in the second quarter has been in line with expectations, but structural imbalances persist. The major Latin American economies continue to face sluggish demand growth and economic challenges, especially related to currencies and inflation. These trends and the continued increased political risk might result in higher economic volatility in the second half of this year. Despite the challenging environment, the positive volume trend in our business continued.
The devaluation of major currencies remained an important issue and adversely impacted BASF's top and bottom line. We increased sales slightly by 1% to EUR 18.5 billion. Higher volumes, especially in the chemicals business and oil and gas, were offset by adverse currency effects in all segments and lower prices in some businesses. Sales of the Agricultural Solutions segment declined slightly as strong currency devaluation outweighed price increases. EBITDA went up 9% to EUR 2.7 billion. EBIT before special items increased by 12% to almost EUR 2.1 billion. All business segments except Agricultural Solutions contributed to this profit increase. The considerable decline of EBIT before special items in Other is related to a negative income from foreign currency transactions, as well as an increase of provisions for our long-term incentive program.
The devaluation of almost all major currencies against the euro negatively impacted earnings by roughly EUR 200 million compared to prior year. Special items amounted to -EUR 34 million, mainly in the segments Chemicals and Performance Products. EBIT grew by 14% to EUR 2 billion. Income taxes went up by 32% to EUR 507 million due to higher pretax earnings, as well as increased oil and gas production in Norway, which led to a tax rate of about 27%. At EUR 1.3 billion, net income came in 12% higher than in the second quarter of last year. Adjusted earnings per share increased to EUR 1.54 in Q2 after EUR 1.40 last year.
At almost EUR 1 billion, operating cash flow in the second quarter was significantly lower than last year due to an increase in net working capital and a swing in miscellaneous items. Before we discuss our individual business segments in more detail, please allow me to highlight a couple of milestones. On June 30th of this year, we announced that INEOS will acquire BASF's 50% share in Styrolution for a purchase price of EUR 1.1 billion. We expect to realize a mid-three-digit million EUR disposal gain. Closing of the transaction is planned for the end of this year. We progressed further with the restructuring of our Performance Products segment, particularly with respect to our Care Chemicals and Nutrition & Health businesses.
We anticipate an annual earnings improvement of about EUR 500 million from 2017 onwards from the restructuring measures announced so far, in combination with a one-time cost of about EUR 250 million-EUR 200 million and a reduction of about 2,000 positions. In the growth region Asia Pacific, we strengthened our market position through further investment. Together with our partner, Sinopec, we started the new acrylic acid and super absorbent polymer plant at our joint venture in Nanjing, and we agreed to add a plant for neopentyl glycol. We also announced that we will double the MDI capacity of our joint venture, Shanghai Lianheng, in Caojing to 480,000 tons. In the Functional Materials and Solutions segment, we expanded the technical center and production capacities for performance materials at the Pudong site in China.
Moreover, we inaugurated our largest European production plant for mobile emission catalysts in Poland, and today, we start our new coatings resin plant in Caojing. Now I would like to turn over to Hans, who will comment on the performance of the individual business segment. Hans?
Yeah, thank you, Kurt. Good morning, ladies and gentlemen, also from my side. Let me start with highlighting the financial performance of each segment in comparison to the second quarter of 2013. I'll start with Chemicals. Sales in the Chemicals segment increased slightly, driven by strong volume growth in all three divisions. Increased competition, especially in Asia, resulted in lower prices. Adverse currency effects had a negative impact on sales. EBIT before special items was up significantly as a result of better earnings in petrochemicals. Sales in Performance Products came in slightly below prior year level, as higher volumes could not compensate for strong adverse currency effects. Prices were stable. EBIT before special items increased considerably due to lower fixed costs supported by ongoing restructuring measures.
Positive special items from the divestiture of the PolyAd business more than offset negative special items related to the restructuring in the segment. Sales in Functional Materials & Solutions were stable. While prices remained flat, significantly higher volumes, especially from the automotive industry, compensated for adverse currency effects and the impact of divestitures. EBIT before special items increased substantially. In Agricultural Solutions, volumes were stable versus a very strong prior year second quarter. We were able to increase prices in all regions but faced strong currency headwinds. Consequently, sales decreased slightly. EBIT before special items came in considerably lower than in the strong second quarter of 2013. This was mainly caused by negative currency effects and higher R&D expenses. In the oil and gas segment, sales grew significantly. This was mainly driven by higher volumes and portfolio effects in exploration and production. EBIT before special items improved considerably.
Net income increased by 40% to EUR 393 million. We also would like to update you on the status of the asset swap between Gazprom and BASF. The work on restructuring and preparing the assets of the parties involved is proceeding according to plan. However, the complex legal unbundling process involving the establishment of new companies in Russia, the Netherlands and Germany is taking longer. Therefore, we expect the closing in autumn 2014, still with retroactive financial effect from April 1st, 2013. Now to Other. Sales in Other decreased by 20% to EUR 900 million. Main reasons were the force majeure at the Ellba joint venture in Moerdijk, the Netherlands, and lower raw material trading activities. EBIT before special items came in at -EUR 328 million.
The decline of EUR 111 million compared to the second quarter of 2013 was mainly due to negative income from foreign currency transactions as well as provisions for the long-term incentive program. Let me now turn to our cash flow. Please be reminded that we summarized the first half of 2014. At EUR 2.6 billion, cash provided by operating activities was 34% lower than last year. This was mainly attributable to an increase in net working capital and a swing in miscellaneous items. Net working capital went up due to build-up in inventories and trade accounts receivable, as well as lower trade accounts payable. Miscellaneous items in the first half 2014 amounted to -EUR 153 million.
This negative value resulted from the reclassification of the gain of the disposal of non-operated oil and gas producing fields in the North Sea to the Hungarian MOL Group as cash provided by divestitures. In the first half of 2013, miscellaneous items amounted to +EUR 646 million. This positive value was related to a decline in net assets in the natural gas trading business, which we have in the disposal group. Cash used in investing activities amounted to EUR 2.3 billion. CapEx increased to EUR 2.1 billion compared to EUR 1.9 billion in the prior year. Free cash flow decreased to EUR 500 million. With that, back to you, Kurt.
Yeah. Thank you, Hans. Coming to our unchanged outlook. In 2014, we expect only a slightly higher global economic growth than last year and certainly lower than anticipated just six months ago. GDP growth in the United States was very weak in the first quarter of this year, mainly due to adverse weather effects. Following a recent downward revision of the U.S. data, BASF has lowered its global GDP forecast from 2.8% to 2.5%.
Contrary to our assumption at the beginning of this year, we no longer expect that the euro will devalue. Therefore, we now anticipate a dollar-euro exchange rate of 1.35 for the entire year on average. Despite these negative changes, the continuing unfavorable currency effects and also increased political risks, we confirm our outlook for 2014. We aim to increase our sales volume excluding the effects of acquisitions and divestiture. Nonetheless, sales will decline slightly compared to last year due to the divestiture of the gas trading and storage business and negative currency effects. We expect a slight increase in EBIT before special items, especially as a result of considerably higher contribution from the Performance Products and Functional Materials & Solutions segments. We aim to earn a high premium on our cost of capital once again in 2014.
With that, thank you for your attention. We are now happy to take your questions.
Yeah. Ladies and gentlemen, I would now like to open the call for questions, and, I would ask you to please limit your question to one at a time so that we can take as many questions as possible. Of course, you're always welcome to rejoin the queue for a follow-up question. The first question I see on my screen is coming from Thomas Gilbert. Hello?
Regarding acrylics. Hello?
Hello, Thomas. Can you start over again? We didn't hear the beginning, please.
Yeah. Good morning. I just have one question on the chemical segment and the comments regarding the acrylics. You're citing price pressure in Asia. Can you comment on whether this is the only region where you see price pressure in the acrylics chain? Can you also refer to both upstream acrylics and downstream super absorbent polymers, where in the C3 acrylics chain you see price pressure regionally? Thank you.
Thomas, yes, that's the case. It's only in Asia where we see price pressure for acrylics. Acrylics is a rather more of a regional market actually. Situation in Europe is kind of okay. In South America, we will bring new capacity on stream, as you know, because we're building the first acrylic acid plant in Camaçari in the northern part of Brazil. Overall, the situation is balanced there. In the Western Hemisphere, it's really about Asia.
Thank you.
The next question is coming from James Knight, Exane.
Hi. My question's on the cash flow. Could you quantify the one-off-ish type effects both in working capital and miscellaneous or maybe give a full year forecast for either of those line items? Thank you.
Yeah, James, this is Hans. Your cash flow question, you've seen that we've used significantly more cash for our working capital requirements. Now, what is this driven by? One, the usual seasonal effects that we have there with respect to our inventories, but also, with respect to our accounts receivables. There, it's predominantly driven by our Agricultural Solutions business. We had special situations, such as, for example, we decided to increase our precious metal position significantly. That was the result of the ongoing strikes in South Africa. You know that our catalyst business is depending on South African deliveries of platinum and palladium. Seeing that these strikes were going on for more than six months, we came to the conclusion to increase our inventories there significantly.
We'll work this off in the coming months, but that was a decision which we took in order to ensure safe supplies for our catalyst business. We also had an impact that's coming from the accounts payable side to the tune of roughly EUR 500 million. You see our accounts payable coming down significantly towards the end of Q2. To a certain extent, I'd also qualify that, using your words, as a special and one-time effect that we're seeing there. The other major development with respect to cash flow is in miscellaneous. There I have to take you back to the first half of the year 2013.
There you see that we had positive cash flow to the tune of EUR 650 million, and that is the positive cash flow that we experienced from working capital in our natural gas trading business. Just to remind you, we had a very harsh winter 2013. We sold all the gas that we had in inventory in the first half. The situation is different. We don't have that effect. We just have the contrary effect in 2014, very mild winter, and we have a situation where we didn't sell everything that we had in storage.
You see a negative -EUR 135, if my memory serves me well, in miscellaneous, and that is the reallocation of the gains that we made from two divestitures, one in oil and gas, and then the PolyAd Services business in Performance Products. That explains the operating cash flow situation that we have in the first half of 2014. Rest assured that our cash flow in the year 2014 will live up to your expectation by the end of the year.
Very quick follow-up, if I may. Sorry if I missed it, but did you quantify the impact on inventories from the
The precious metals, stocking.
You didn't miss it. I did not quantify it. It is in the triple million digits.
Thank you very much.
We're moving on with Peter Clark from Société Générale. Good morning, Peter.
Yes, good morning. Thank you. It's a question on Asia. I heard the comment about China and the growth below expectations. Looking at the figures, it looks like the volume growth may be low single digits in Asia in the second quarter against the double-digit growth I think you're still seeing in Q1. Just how you feel things are on the ground and how it looks going from there for the rest of the year. It's about the volume growth, particularly in China, in Asia. Thank you.
Yeah. Hi, Peter. In China, actually, we had a pretty good development. We had volume growth of about 10%, which is pretty much in line with the overall market. We have seen a little bit of weakness in other parts of Asia, particularly ASEAN, which was very strong last year. There's a little bit of fluctuation going on as well. I don't think our concern in Asia is really about volume growth. Our concern at this point in time is certainly more about prices and margin, in particular in China, which are unsatisfactory due to the buildup of new capacities in some of our businesses. Volume-wise, we are on track, but prices are the real issue, apart from the currency topic which Hans mentioned also.
Okay, thank you.
Welcome.
Now we're moving on with Lutz Grueten from Commerzbank.
Thanks for taking a question regarding the latest sanctions from the U.S. against Gazprombank. Any impact on your operating assets, financing, CapEx from your side or your partner over there? Thank you.
No.
Okay, thanks a lot.
Welcome.
This was quick. We're coming on to Paul Walsh, Morgan Stanley.
Good morning, gents. One question as ever. Volumes are clearly improving across the business, and you haven't seen pricing coming through yet. Can you talk a little bit about that dynamic and utilization rates? Then, I guess this is one B, how you would see that within the context of your 2015 targets, to which there's no reference at the moment. That would be helpful. Thanks.
Yeah. Thank you, Paul, for the questions. Yes, volumes are okay. Prices are not coming through yet, and we don't see it really developing at this point in time. We are still very, very cautious. We would probably need a higher economic growth, which we don't see. We just reduced our global economic forecast, whatever that is worth from your point of view. We don't see really the tailwinds arriving here on the price side. Margins are kind of okay because you have also seen a little bit of softness on the raw material side, but we certainly don't see a margin improvement at this point in time kicking in. Utilization rates have been. I'd say okay.
We have had a couple of turnaround situations, also unplanned turnaround situations. You have seen the Moerdijk event in the Netherlands, which affected us. We have something similar in Asia as well, in Singapore, SMPO, which is not producing as we speak. There has been a couple of things happening which have an impact on our volume development. Coming to 2015 targets, I think it's too early to talk about this specifically. I mean, the question has been raised now at every single quarter, and our standard answer has been we are in the middle of working our butts off, so to say, to achieve our 2014 targets. As the year draws to an end, to a close, we will get a better feeling of what's going to happen in 2015.
I think that is the right point in time then to talk about how we see 2015 developing.
Very clear. Thank you.
Now we move on to Tony Jones from Redburn. Hello, Tony? Hello?
I'm sorry. He's withdrawn his question.
Okay. Sorry, I missed Andreas Heine. Oh, I apologize. Next one is Andreas Heine on the list from Barclays. I'm sorry.
I'd like to know more about Performance Products. The volume was stronger in recent quarters than it was in this one. Is anything changing here in the trends you had in the quarters before, more the 5% growth and 1%? Is it one specific area, or is it broad-based in specialty chemicals? Thanks.
Andreas, pretty much the same development there across the portfolio. Slight volume increase. As you've seen, on the top line, significant impact from currencies, but no major deviations on the volume side with respect. There's one exception, and that is, as you know, our paper chemicals business, where volumes are declining, what I would call, in line with market developments. We have a second impact in Q2, which I would consider to be a one-off, and that is in our nutrition and health business, as a result of the force majeure situation that we had in the aroma chemicals plant in Ludwigshafen.
That had an impact on volumes in that business in Q2, but that is it.
Okay, thanks.
Now we come to Tony Jones from Redburn. Hello, Tony.
Oh, good morning, everybody. Sorry, I'm not sure what happened then. Just a question on the chemical segment. There was good growth and some margin offsets from the cracker in Port Arthur. I was going to ask, is there existing planned additional CapEx projects for another furnace to start up after this tenth one sometime over this year or in 2015? Thanks.
Tony, this is Hans. Thanks for your question. No, there is not. We just start up the tenth furnace. As you know, we run our crackers to satisfy or, you know, to cover our downstream needs. That's the predominant reason. With the addition of the tenth furnace, the Port Arthur cracker, we are fine. We cover the needs that we have in ethylene in our activities in North America.
Great. Thank you very much.
The next question now comes from Geoff Haire from HSBC.
Good morning. I just wondered if you could update us on the situation in Libya with regards to, there's obviously speculation that exporting may start happening soon of oil. I'm just wondering what you're seeing on the ground there.
I would be happy if I could convey a more positive message, but at this point in time, we have no visibility actually when and how to start up our onshore production again. We had the offshore lifting, as we commented in our quarterly report. We could produce onshore where installations are ready to go, but so far, we have no real access to export facilities, and that is the biggest issue right now. Again, no visibility. We can only hope that this is going to change quite quickly.
Okay, thank you.
Now we're coming to Ronald Köhler from MainFirst.
Yes, thank you. Good morning. A quick question to Functional Materials and Solutions. You had obviously the strong volume growth, but a considerable part came from precious metal trading volumes, as I understand. Can you quantify the volume growth excluding the precious metal volumes?
Ronald, actually, we see volume growth in Functional Materials & Solutions in all areas, but for construction chemicals. In Catalysts, it's not driven by precious metals. The real driver for the volume growth that we see in Catalysts is the automotive business. There it's in particular heavy-duty diesel that's driving the volume growth in catalyst. On the precious metal trading, yep, there is an increase there in sales on the volume side that is not as strong as you see it on the sales side, because the precious metal prices compared to prior-year quarter have increased significantly.
Okay, good. Thanks.
We're coming to the tenth question, and this is Michael Rae from Goldman.
Yeah. Hi there. Thanks for taking my question. Can you provide some color on your second half expectations in functional materials? I mean, you're guiding for considerable increase in EBIT, and I'm just wondering if the first half rate of EBIT growth is sustainable when you look at the self-help measures you're undertaking and also the volume progression that you've just discussed. Thanks.
First of all, we are quite satisfied with our business in Functional Materials & Solutions in the first half of the year. Nice increase in profitability. You know that we don't guide on a quarterly basis. On a full year basis, we said that we expect a significant increase in profitability on the full year basis, and we stick exactly to that guidance.
Okay, thanks very much.
The next question comes from Martin Rüdiger from Kepler Cheuvreux. Good morning, Martin.
Good morning. Thank you for taking my question. It's on decorative paints business in South America. Of course, a small business for you. You mentioned that the business developed well when we exclude currency effects. I understood a competitor of you yesterday complaining about the difficult market environment in decorative paints in South America, calling, for example, declining market in Brazil. What's going on here in this market? Did you gain market share? Maybe you can elaborate on that.
Okay, now we get very, very specific here. I mean, yeah, we can only say that our business developed quite nicely. We cannot comment on what happened to one of our competitors. The market is not a high-growth market, that is certainly true. We have a topic in Brazil, which is in particular rising inflation, which means we also have to work quite a bit on our sales prices. Overall, the development has been a positive one, and we had a good volume growth, actually very good volume growth in Brazil. Again, this is now a very important business in Brazil, but from a group point of view, it is probably not the most dominant operation we run.
Thank you.
Welcome.
Our next question now comes from Christian Faitz from Macquarie.
Hi, thanks for taking my question. Just quickly on the pension provisions, which were at, I believe, EUR 5.6 billion in the quarter, which is almost EUR 1 billion higher versus Q2 and Q2 2013 and also sequentially. Why is that? Can you explain that?
Certainly, Christian, this is Hans. So the situation that we had in Q2 is that interest rate and the discount rate decreased by, depending on geography, somewhere between 70 and 90 basis points. Lower discount rate leads to higher pension obligation when you calculate your pension obligation, and this is what you see reflected. As a rule of thumb, a change of 50 basis points means a change in the pension obligation of roughly EUR 1.5 billion. So you see that this ties exactly with the, let's say, roughly 80 basis point change that we've experienced in Q2. By the way, a situation when you look through the quarters in last year, you've seen similar swings.
You saw towards the end of the year an increase in interest rates, which then led to a reduction of the pension benefit obligations that we have. Towards the end of the second quarter or in the second quarter, significant decrease in interest rates, which leads to almost EUR 2 billion addition to our pension benefit obligation.
Okay, great. Nothing else than interest rates. Thanks.
Now we come to Laurence Alexander from Jefferies.
Good morning. Could you give some detail on the agricultural chemicals? Volumes were flat. Can you give a little bit of context for that and your view on what's going on in the end markets, given volatility reported by your peers?
We can. Actually, we had satisfying volume growth everywhere except South America. In South America, we most probably lost a little bit of market share. That is essentially in insecticides, which is not supposed to happen, but it can happen. Apart from that, the volume in other parts of the world was okay. We got certainly hammered across the business, across the geographies, by currency effect that had a very negative impact on earnings. That's the main reason for the decline in earnings in this business. We were able to raise prices in all geographies except Latin America due to this intense competitive pressure. Overall, we see our business on track.
We certainly would have preferred to see also an earnings improvement in Q2, but you have to keep in mind that we have had now many quarters of sustainable and very strong growth and earnings improvement. We perceive this as a quarterly setback, essentially in one region, and we are working hard to make sure that we achieve our overall targets for 2014. I hope that's helpful.
Thank you.
Welcome.
The next question is from Jaideep Pandya from Berenberg.
Yeah. Thank you. Can you give us a little bit more color on the restructuring you are doing in Performance Products, just in context of, you know, the headcount, and the savings numbers? Also just, I mean, this is a division or segment where you've been in constant, you know, cost-cutting mode. Just wanna understand what is really the driving factor. Is the competition continues to intensify? Is that the reason, or, I mean, what is the reason why you haven't been able to sort of, you know, leave behind cost-cutting and move on to sort of the growth area? Because there are quite a lot of businesses in this segment which supposedly should be, you know, nicely growing. Thank you.
Yeah, thank you for the question. I think you hit a point here and make a very good point. Do we find the right balance between growth and restructuring? It feels like we have been in a restructuring mode in that segment for quite some time, which actually from our point of view is also true. We have been in a restructuring mode. We have taken out about 2,000 positions. We will improve our earnings by about EUR 500 million by 2017. We are well on track to achieve that. We do have one-time cost of about EUR 250 million-EUR 300 million. At the same time, and you mentioned this as well, this is a very diverse segment. We have lots of businesses which have excellent growth patterns and growth performance and earnings performance.
We have other businesses, where we will continue to restructure with a relatively heavy hand to make sure that we achieve return on capital, which is acceptable from our point of view. This is frankly nothing new to all of these businesses. It has been the case for many, many years, that within this field of sometimes perceived specialties, you always have to identify those businesses where obviously product and markets have become commoditized, and then first of all we have to anticipate that. That's the best solution, and to avoid it. If that is not possible always, we have to restructure sometimes, to make sure that our processes, structure and costs are in line with the competitive needs, and that's exactly what's happening within this segment.
What is important from our point of view is that over the last couple of quarters, we have demonstrated that we drive this also to the bottom line. We certainly need to see a little bit higher growth overall, and that is certainly something which is also on our mind, how to make sure that we can have a growth-oriented strategy, and at the same time, protecting our margins.
Okay, thank you.
Welcome.
Now we come to Mutlu Gundogan from ABN AMRO. Hello, Mutlu.
Hello, good morning. A question on the ag business in South America. You already talked about it, but if I look at the first half results, it looks like your revenues declined 22% year-on-year. Can you tell us what part of that 22% is driven by the competitive pressure you're seeing in insecticides in Brazil? Can you provide a little bit more detail about this pressure? Is it new entrants? Is it generics? Some color would be helpful. Thank you.
I try to provide you with a little bit of color. It's both. It's generics, which hit us in the field of insecticides. There's also a little bit of new actives coming to the market, which is again, from our point of view, the normal competitive pattern. You have seen this in the past. Sometimes we are first, sometimes other companies are first. Now, there was new entrant which took some share from us. The majority of the decline is due to currency effect.
Okay, thank you.
You're welcome.
With the maybe a quick follow-up. With the minus 22% in the first half, if I'm not mistaken, the second half is more important in Brazil. Should we take this as a run rate into the second half?
I think that's a very important point. It's good that you mentioned this. Actually, the second half is much more important. The first two quarters are always, let's say, the soft ones seasonally. Now third and fourth quarter will really demonstrate how we will perform, and I can assure you that the team is fully powered up in Brazil and South America to make sure that we have a good second half. From today's point of view, I would caution to extrapolate what you have seen in the first half into the second half.
That's very helpful. Thank you.
Thank you.
All right, now we move on with Neil Tyler from Redburn.
Yeah, good morning. Question about your coming back to your guidance, if I may. You mentioned that you've changed your macro or GDP assumptions and also your currency assumption has become less favorable. I wonder if you could talk through the components that have been able to offset those two negatives. Obviously, there's a slightly larger contribution this year, at least from leaving the gas trading business in for a few more months. Anything else that is compensating for those two negatives? Thank you.
I cannot give you the precise numbers of the different factors contributing to our earnings improvement. We have seen, however, one development which is very positive from our point of view. Fixed costs are very well under control, and this is not just currency related. In our internal reporting, we make sure that we look at the true underlying performance, and if we then take out the currency effect, fixed costs have developed very favorably, staying almost flat, which I think is a good performance in an environment where you see essentially volume growth and where you also see additional investments going on stream. That has been a positive, and this also goes back to the restructuring which we undertake and which we have discussed just a minute ago.
We, on the margin side, margins are kind of flattish, which also goes back to some softness in some raw material markets, and this also has helped to a certain degree to compensate for the unfavorable currency development. Still, the currency development going into the second half is probably our biggest concern because in some markets it makes price increases awfully difficult. You know that some markets are dollarized, which by definition should make it easy, but in reality that sometimes doesn't work automatically. This is certainly a concern which we continue to have, and that is probably those factors I have on my mind right now.
Okay. No, that's very helpful. Thank you.
We are going into the second round of questions, and this is the first one comes from James Knight, and then I have four additional questions.
Resins. You mentioned strong volume growth in Europe there. Is that simply market related, or do you think you're gaining share?
James, could you repeat your question? The first part, we couldn't really understand. You're talking about the European market volume growth and whether we took share?
Yeah, it was specifically on coatings resins.
Oh, Coatings.
It wasn't picked up. Sorry.
That's very specific, actually, and I don't have the answer at the tip of my finger. I can't really answer that one.
Okay, fair enough. Thank you.
Yeah. Thank you. Sorry.
Thomas Gilbert with the next question.
Sorry to come back to the other line. Just to give us a bit better prognosis of how to look at the components. Between the first and second quarter, the other line deteriorated by EUR 130 million.
Can you just, the currency impact was big in the first quarter. The share price movement was pronounced, but the delta in 1.30 versus the first quarter, can you break that down into roughly, qualitatively, the components, what really drove that, significant deterioration?
Thomas, this is Hans. I'm happy to do that. What you have, I'd say, three components there. The first one is in, indeed, currency, and this is the currency hedges that we have in place.
Mm-hmm.
This is simply resulting from the fact that compared to the end of Q1, we do the mark-to-market, and you've seen a slight increase of major currencies, which then drives the negative result there for our currency hedges. The second component that you have relates to our share price increase that we had, and that then has an impact on our long-term incentive program for which we build a provision. I can't actually give you more guidance on that because the amount of the provision in the end depends on the share price development.
In addition to that, we alluded to that already. We had the force majeure situation in the Ellba joint venture, 50/50 joint venture with Shell, plant operated by Shell. That has an impact on our earnings in other also. These are the three components. Sorry for not being able to provide you there with more guidance.
Can I just try to follow up on the currency hedges as the currency stand today, and as the hedges stand today, will there be more sequential swings, or are we done with? Well, obviously some of the currencies went against your hedges towards the end of the second quarter. Or are we sort of at on spot rates? Are we done?
Well, since we keep hedging going forward, you and I need to look together in our crystal ball and come to the conclusion of what's gonna happen with the currencies, and then I can provide you with a good answer.
All right. Let's stick our heads together then later.
Will do.
Hello,
Russia, obviously it's getting a bit complicated. You said the banks had no influence. I read actually that the South Stream financing has now to be refinanced, and then obviously you're involved in that. Can you a bit elaborate in general on Russia, on the economic development, on the situation South Stream, if something has changed on the project specifically and on Gazprom. You obviously said your gas trading business will be sold in autumn. But nevertheless, if there would come anything in between in terms of sanctions or whatever, you still feel absolutely confident that you will do it or a bit around Russia and the subject would be helpful. Thank you.
Yeah. Thank you, Ronald, for that question.
I will try to do my best, which is difficult given the current uncertainty and volatility. We are completely convinced that we will close the deal during the fall of this year because we are talking about technical issues which have to be resolved, and these issues can all be resolved within BASF and essentially Gazprom. Our teams are working on that. It's really a technical delay we are experiencing here. The deal, the swap of our gas trading business has been approved both by European Union and the German government. At this point in time, I cannot detect any intervention or political intention to change that.
Frankly, I think it would be good, still would be good, to integrate Gazprom further into the Western European gas market and to make them part of the competitive environment here even more. They are already a 50% partner, and from our point of view, they are a very solid and trustworthy partner going forward. The economic development in Russia certainly is a concern for us. We have seen a very lackluster growth or actually declines in Russia, which also affected our business to a certain degree. In chemicals, we have seen a pretty steep decline in our business in Ukraine, which is essentially crop protection, very profitable one.
We have no visibility how this is going to develop going forward, but I'm not a big optimist that we will see any kind of turnaround very soon with regard to the economic development in these countries. South Stream, the intention is to break ground later this year. There are a couple of preconditions to be fulfilled. The teams are working under the leadership of Gazprom. We are here a minority investor, as you know, very hard to bring or to provide all the necessary preconditions, including financing. I think at this point in time, it would be speculation whether this will be according to the timetable or whether there might be some delays. We do whatever we can within our area to make sure that this is moving into the right direction.
Regarding exploration & production in Russia, everything is going as planned or any kind of problems there as well?
We haven't seen any problems at all. Our volumes have been okay. There have been no changes in allocation of volumes. This is quite normal, I have to say.
Okay. Thank you.
Welcome.
Now we come to Laurent Favre from Bank of America Merrill Lynch.
Good morning, gentlemen. Thank you for taking a question on oil and gas. Just trying to quantify the impact from lower spot gas on E&P. I'm not talking about gas trading. The offshore lifting, I think the guidance was that sequentially, the impact would be around EUR 100 million on EBIT. Brent has gone slightly up in euros, production growth has been, you know, minor. The fact that EBIT went up sequentially by only 50, is that giving us a good, you know, feeling for the sequential impact of lower spot gas on the E&P business, minus 50?
I mean, Laurent, if you look at spot gas price development in Western Europe, I think we are currently in a range of EUR 6.50. Earlier in the year, we started the year at EUR 11. Our expectation is that we will see the natural gas price moving up again once the gas season starts, so towards the third quarter, fourth quarter. It's extremely difficult to give you any type of guidance based on current natural gas prices, in particular, the fluctuations that we've seen in natural gas prices during the course of this year, all driven by the fact that there was extremely low demand due to a very mild winter.
Okay, the bridge Q1 to Q2 is not. My bridge is not completely crazy.
You're certainly not completely crazy. No, we would never say that. What makes it a little bit more difficult to project is really that we do not just have spot pricing, we also have forward pricing.
Thank you.
We also sometimes contract well in advance of the actual delivery, which means sometimes we also get lucky because you had a forward price which was much higher than current pricing, and you can then.
Okay. At least
Buy relatively low at spot prices, yeah.
Okay, thank you.
Welcome.
Now we move on with Martin Rüdiger from Kepler Cheuvreux.
Thank you. On nutrition and health, I understood you experienced competitive pressure on vitamin E prices. You mentioned lower prices, I guess it's year-over-year. Can you talk about price evolution for vitamin E and also vitamin A year-to-date and what you are going to see forward, as far as you can look?
What we've seen on the vitamin pricing and similar developments in E and A is, it looks like we've experienced the low in prices end of Q4, early Q1. I think that we were, with respect to vitamin E prices, in the range of EUR 760-EUR 770, if I recall that correctly. We pushed for price increases. It looks like they stick. We've seen an uptick in prices in Q2. It looks like that continues into Q3. Similar development also when I think about what we've experienced with respect to vitamin A. Also there, low prices going into the first quarter of the year.
Since then, an increase of prices, and again, it looks also with respect to A like this is the trend going into Q3.
Thank you very much.
Now we move on with Paul Walsh, Morgan Stanley.
Yeah, thanks for the follow-up question. Mine was really I drew a total blank, I'm afraid, in terms of the question I was gonna. Yeah, balance sheet. You've talked about cash flow improving through the second half of the year, net debt coming down. I know what your priorities are for capital allocation. I was wondering, given the relatively lackluster global environment we're seeing right now, if the temptation was to think about different uses of your balance sheet, particularly into next year, when net debt to EBITDA really comes down quite significantly, certainly on my numbers, with the cash coming in from the Styrolution disposal, et cetera.
I'm just curious as to what your sort of medium-term thoughts are on the balance sheet above and beyond the normal priorities that you sort of give to the market. Thank you.
Paul, priorities haven't changed. As discussed, many times, full support for profitable organic growth, both with respect to CapEx, but also with respect to R&D. Returns for our shareholders, in the form of dividend. I think, if I read between the lines of your question, there might be another element of, shareholder return that you're hinting at. The answer with respect to that is that we don't have current plans to start a share buyback program.
I mean, actually, my sort of question was a bit broader than that. I know you're not particularly keen on buybacks, but there are other ways of, I mean, to put it a slightly different way, at what point would you look at your balance sheet and think it's being underutilized?
Let me turn that around with my answer that, with, the current balance sheet and an equity ratio in there of just shy of 40%, we are quite satisfied.
That's very helpful. Thanks a lot.
Now we're coming to our final question, and that comes from Markus Mayer from Baader Bank.
Yeah, thank you for the question. It's basically an add-on question on Paul's question on the balance sheet. You're running this huge investment program of EUR 20 billion until 2018. This is still lackluster demand and the worsening economic environment. Does this have any impact on this program that you're running this faster or delaying some projects?
Markus, no, it doesn't have any impact on that one. Actually, when we look at our investment, it's all about growth and earnings expectations, and those really haven't changed. When you look at the pattern of our investment, essentially emerging markets, mostly technologies, where BASF has proprietary knowledge like acrylics, and shale gas opportunities in North America, which also will take a big chunk of that investment budget. These investment budgets are not driven by financing consideration. We certainly take into consideration what does our balance sheet look like, what are our, let's say, opportunities here, but the essential factors are the PVIs, the NPVs of these projects and whether it makes sense from a market point of view.
Certainly also very important to keep in mind at this point in time, whether we have the engineering resources and the construction resources we need to complete these projects on time and on budget, because that is certainly a concern in some parts of the world where you have seen increased investment activity. Not just in our industry, that's important to keep in mind, and that means sometimes resources are constrained. These constraints are probably more important than financing. We do what we need to do to grow the company in a profitable way. At the same time, we try to maintain a sound balance sheet. As Hans said, I think we are here in a very balanced position at this point in time.
Okay, perfect. Perfect last words.
Yeah. Thanks.
Ladies and gentlemen, this brings us to the end of the question and answer session. Before we conclude this call, I would like to inform you that we have just posted the new BASF 2014 fact book on our website. Please, take a look, and we all hope, sincerely hope that this will help you in your analysis of BASF. Secondly, please mark September 18, 2014 in your calendars. On that day, we will host the oil and gas roundtable in London. Finally, we will next report on our third quarter 2014 results on October 24th, 2014. I would like to thank you for joining us at this point in time. Should you have any further questions, please contact any member of the IR team, and we will be happy to help you.
With this, I wish many of you a nice vacation, and goodbye, and hope to speak to you soon.
Ladies and gentlemen, thank you for joining. This concluded our conference call. Have a pleasant day. Goodbye.