Rating rationale

The Corporate Issuer Credit Rating (CICR) on BASF Finance Europe N.V. (BASF) of A is derived from the parent company’s (BASF SE) corporate rating, reflecting the unconditional and irrevocable guarantee given to debtholders of its financing subsidiary, BASF Finance Europe N.V. The rating on the parent company (BASF SE) primarily reflects Scope’s view of the group’s strong market positions in the global chemicals market; the high degree of diversification into different end-markets, notably in the specialty chemicals segments; Scope’s expectation of a continuation of free cash flow generation; and management’s commitment to a conservative financial policy. The senior unsecured debt issued by BASF SE is also rated at A, Stable Outlook.

In Scope’s view, the business risk profile (BRP) of BASF is better than its financial risk profile (FRP). The BRP is supported by BASF’s high share of business in different specialty chemicals end-markets, representing more than half of operating income (EBIT); broad geographical reach; high customer diversification; strong market positions; and cost advantages in its upstream chemicals business resulting from the integrated “Verbund” strategy. The BRP is likewise supported by diversification benefits from the economically resilient agricultural chemicals division. Over the past decade, BASF has made a number of acquisitions in specialty chemicals and divested commodity chemicals assets. The portfolio shift has improved the share of customised products and functionalised materials, eventually leading to a better resilience of the group against cyclicality risks and to an improved share of business generated in emerging markets.

The BRP is constrained by the dependence on very cyclical end-markets, such as automotive, construction, and electronics; the strong correlation of global chemicals markets to GDP and industrial production; and risks of volatile feedstock and energy prices. In view of the shift of global chemical consumption towards Asia, Scope views BASF’s currently high presence in the rather stagnant European market as a constraint. The exploration business (Oil & Gas) is subject to earnings and cash flow volatility resulting from oil price changes.

For 2016, Scope expects BASF to report a significant decline in revenues on a reported basis. This is primarily due to the removal of the trading business in Q3 2015; lower revenues in the Oil & Gas division, driven by lower oil prices; and lower revenues in the Chemicals division that result from reduced input prices. Scope’s forecast for 2016 includes an EBITDA margin of about 16-17%, above the levels reported in previous years and effectively the result of the deconsolidation of the low-margin trading business. For 2017, Scope expects revenues to grow in line with global chemical production (about 3-4%) with an unchanged EBITDA margin in the range of 16-17%. The outlook for upstream chemicals remains weak given the worsening demand/supply situation and risks for industry overcapacity. Therefore, if pricing pressure in upstream chemicals was worse than anticipated, Scope would see risks to its forecasts. A mild deterioration of the profit margin (EBITDA) would, however, not automatically result in rating pressure.

Based on Scope’s operating forecast (EBITDA) for 2016, Scope expects BASF to report a free operating cash flow (FOCF before acquisition of Chemetall) of about EUR 3.0bn, sufficient to cover dividend payments. Scope expects FOCF to improve to about EUR 3.5bn in 2017, mainly as a result of improved operating earnings.

Scope’s assessment of the financial risk profile reflects its perception of the management’s stated financial policy and credible track record of maintaining a moderate leverage – as evidenced, for instance, by conservative credit ratios, such as Scope-adjusted debt (SaD)/EBITDA of significantly below 2.0x over the past five years. For 2016, Scope expects the key debt protection measures, SaD/EBITDA and FFO/SaD, to be at levels slightly less than 40% and about 2.0x, respectively. Credit ratios in 2016 are slightly weaker than in preceding years. This effect results from the expected closing of the Chemetall transaction at year-end 2016 with the full effect on SaD, but the full consolidation of the target’s cash flows and operating profit will occur only from the closing of the transaction. Scope’s forecast for 2017 includes the full effect of the Chemetall transaction and points to an improvement of credit metrics to levels of about 40% (FFO/SaD) and about 2.0x (SaD/EBITDA). In view of the projected FOCF generation and expected dividend payments, Scope sees only minimal potential for further significant deleveraging.

Key rating drivers

Positive

• Strong market position, holding between first and third position for about 70% of its business
• High share of specialty chemicals that are less subject to cyclicality risks and changing feedstock prices
• Broad and globally diversified business; one of the largest integrated chemical companies globally; diversification benefits from presence in agrochemicals, bulk and specialty chemicals
• History of resilient and solid free cash flow generation, high financial flexibility and proven management commitment to ratings
• Substantial coverage of future pension payments with accumulated pension plan assets covering payments well over a decade

Negative

• High dependence on general economic environment and, in particular, on economic developments in emerging markets
• Risks of sudden negative changes in feedstock prices and exposure to changes in global commodities and food prices
• Exposure to very cyclical end-markets, such as transportation (automotive) and construction, in the functional materials and solutions division

Outlook

The Outlook is Stable and incorporates Scope’s expectation that BASF should achieve debt protection measures such as a SaD/EBITDA of about 2.0x and a FFO/SaD of 40% in the medium term. In view of the expected closing of the Chemetall transaction at year-end 2016, both credit metrics are likely to be lower than these levels on a reported basis, given that the target’s cash flows and operating profit will only be consolidated from the closing of the transaction.

A positive rating action would be warranted if BASF were to significantly increase its share in the specialty chemicals business – a scenario that Scope considers unlikely to materialise in the medium term given the group’s stated acquisition policy and financial targets. A rating upgrade could also occur if BASF were to improve its debt protection measures (SaD/EBITDA, FFO/SaD) to levels of respectively about 1.5x and 50%. In view of Scope’s base case – expected free cash flow is largely used for dividend payments – the agency does not envisage any such improvement and deleveraging to materialise over the two-year outlook horizon. A negative rating action could occur if the financial risk profile were to weaken to levels of about 2.5x (SaD/EBITDA) and 30% (FFO/SaD).

Legal and regulatory disclosures

Important information
Information pursuant to Regulation (EC) No 1060/2009 on credit rating agencies, as amended by Regulations (EU) No. 513/2011 and (EU) No. 462/2013

Responsibility
The party responsible for the dissemination of the financial analysis is Scope Ratings AG, Berlin, District Court for Berlin (Charlottenburg) HRB 161306 B, Executive Board: Torsten Hinrichs (CEO), Dr. Stefan Bund and Dr. Sven Janssen.
The rating analysis has been prepared by Werner Stäblein, Lead Analyst.
Responsible for approving the rating: Olaf Tölke, Committee Chair.

Rating history
The ratings concern an issuer and newly issued financial instruments, which were evaluated for the first time by Scope Ratings AG.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Information on interests and conflicts of interest
The rating was prepared independently by Scope Ratings but for a fee based on a mandate of the rated entity.
As at the time of the analysis, neither Scope Ratings AG nor companies affiliated with it hold any interests in the rated entity or in companies directly or indirectly affiliated to it. Likewise, neither the rated entity nor companies directly or indirectly affiliated with it hold any interests in Scope Ratings AG or any companies affiliated to it. Neither the rating agency, the rating analysts who participated in this rating, nor any other persons who participated in the provision of the rating and/or its approval hold, either directly or indirectly, any shares in the rated entity or in third parties affiliated to it. Notwithstanding this, it is permitted for the above-mentioned persons to hold interests through shares in diversified undertakings for collective investment, including managed funds such as pension funds or life insurance companies, pursuant to EU Rating Regulation (EC) No 1060/2009. Neither Scope Ratings nor companies affiliated with it are involved in the brokering or distribution of capital investment products. In principle, there is a possibility that family relationships may exist between the personnel of Scope Ratings and that of the rated entity. However, no persons for whom a conflict of interests could exist due to family relationships or other close relationships will participate in the preparation or approval of a rating.

Key sources of information for the rating
- Prospectus
- Website of the rated entity/issuer
- Valuation reports, other opinions
- Annual reports/semi-annual reports of the rated entity/issuer
- Current performance record
- Detailed information provided on request
- Annual financial statements
- Data provided by external data providers
- Interview with the rated entity
- External market reports
- Interview with the issuer
- Press reports / other public information
Scope Ratings considers the quality of the available information on the evaluated company to be satisfactory. Scope ensured as far as possible that the sources are reliable before drawing upon them, but did not verify each item of information specified in the sources independently.

Examination of the rating by the rated entity prior to publication
Prior to publication, the rated entity was given the opportunity to examine the rating and the rating drivers, including the principal grounds on which the credit rating or rating outlook is based. The rated entity was subsequently provided with at least one full working day, to point out any factual errors, or to appeal the rating decision and deliver additional material information. Following that examination, the rating was not modified.

Methodology
The methodologies applicable for this rating (Corporate Rating Methodology) are available on www.scoperatings.com. The historical default rates of Scope Ratings can be viewed on the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s default rating, definitions of rating notations and further information on the analysis components of a rating can be found in the documents on methodologies on the rating agency’s website.

Conditions of use / exclusion of liability
© 2016 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings AG, Scope Analysis GmbH, Scope Investor Services GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope cannot, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided “as is” without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or otherwise damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party, as opinions on relative credit risk and not as a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings AG at Lennéstraße 5 D-10785 Berlin.

Rating issued by
Scope Ratings AG, Lennéstrasse 5, 10785 Berlin