The air crackled with nervous energy as Martin Brudermuller, outgoing CEO of BASF, faced analysts on April 25th. The preliminary Q1 results were out, showcasing a positive volume trend and a cautiously optimistic outlook for the remainder of 2024. However, beneath the veneer of cautious optimism, a darker truth lurks within the transcript OTCQX:BASFY, a truth that seems to have eluded the keen eyes of Wall Street analysts.

BASF, the behemoth of European chemicals, is engaged in a high-stakes gamble, doubling down on its German production amidst a rapidly changing global landscape. While Brudermuller repeatedly emphasized the new board's commitment to the Ludwigshafen site and its transformation into a low-carbon production hub, his own words betray a deep-seated concern about the structural challenges plaguing German manufacturing.

The crux of the issue lies in the stark reality of declining competitiveness. Brudermuller acknowledged the "serious situation" in Germany, where energy costs have become structurally higher, eroding the profitability of base chemicals, a cornerstone of BASF's upstream portfolio. The company's reliance on these energy-intensive products has become a double-edged sword, burdened by both higher production costs and the mounting pressure of CO2 emissions reduction.

This dependence on upstream production, particularly in Ludwigshafen, creates a vulnerability that's hidden in plain sight. While BASF boasts of its global reach and differentiated steering approach, its financials tell a different story. The company's capital employed has doubled since 2007, but its EBIT remains stagnant, a clear sign that the purported benefits of its integrated Verbund structure are failing to translate into tangible value.

Furthermore, the cost-cutting measures implemented in Ludwigshafen, while ambitious in scope, raise questions about their long-term efficacy. The announced €1 billion annual cost reduction by 2026, achieved through job cuts, efficiency drives, and capacity adjustments, risks creating a leaner, but ultimately weaker, production base. Trimming operations to cater solely to European demand, a market grappling with sluggish growth and relentless Chinese competition, is a strategy fraught with peril.

The transcript reveals a potential misalignment between short-term cost-cutting measures and the longer-term strategic vision for Ludwigshafen. Brudermuller highlighted the need to increase utilization rates of competitive assets to restore profitability. However, with Chinese imports flooding European markets, BASF faces an uphill battle to reclaim lost volume and pricing power.

"Consider this: BASF's earnings in Germany plummeted by €600 million in 2023, a staggering loss compared to its global performance. Even with previous plant closures and restructuring efforts, German headcount has only decreased by a meager 300 jobs, representing a mere 0.5% reduction. These numbers underscore the scale of the challenge and the limited impact of current efforts."

BASF's gamble hinges on a precarious bet: that European demand will revive, enabling the company to leverage the Verbund advantages of its German operations. However, the transcript paints a picture of a company clinging to past successes, hesitant to make the bold structural changes necessary to thrive in a new world order.

Brudermuller's parting words to his successor, urging him to "stay firm" and "not get distracted," echo with a sense of urgency. The new Board, led by Marcus Kamit, faces a daunting task: to reconcile the company's deep-rooted attachment to Ludwigshafen with the harsh realities of a global chemical industry undergoing a seismic shift.

The question remains, will BASF succeed in revitalizing its German heartland? Or will its commitment to Ludwigshafen become a millstone around its neck, dragging the company down as Asian competitors seize global dominance? The answer, hidden within the intricacies of future earnings reports, will determine the fate of Europe's chemical giant.

BASF's EBITDA Performance by Segment (Q1 2024 vs. Q1 2023)

Source: BASF Q1 2024 Earnings Call Transcript

BASF's China Conundrum

While BASF acknowledges the challenges in Germany, it is simultaneously pushing forward with a massive new Verbund site in Zhanjiang, China. This expansion highlights the company's strategic dilemma: balancing the need for cost competitiveness with the allure of high-growth markets.

"Fun Fact: The Zhanjiang Verbund site is expected to be fully operational by 2025 and will have a production capacity of up to 1 million metric tons of ethylene per year. This makes it one of the largest chemical production sites in the world."