Mr. Europe Says: 'Buy' 2 BBB+ Rated Companies With 5-7% Yield And Upside

Dear readers/followers,

A subscriber recently came up with the quip/name "Mr. Europe", suggesting that I cover the continent in terms of interesting, dividend-paying businesses for both native NA followers and visitors, as well as for readers who like myself, hail from Europe but want more international diversification by adding NA to the mix.

I'm happy to adopt the name, especially during a time like this, when I'm advocating and rating two very strong European companies as "BUY".

I've always been a strong advocate of diversifying on an international basis - bringing an appealing mix in currencies, sectors, nations, DGR/High-yield - pretty much diversification in most ways you can find it. The one exception is that I don't use ETFs or funds of any sort in my investments. This isn't an ETF article, but I can quickly tell you that the main reason aside from fees that I don't use ETFs is market risk - it's just a wrapper for their underlying investments, and I believe I can pick investments individually in a way that makes more sense for my personal circumstances, and also provides me with better over-time returns. Thus far, my portfolio returns on a 1-5 year basis have proven this stance to be correct. There are ETFs I may consider in the future, but thus far I haven't found one that really would make a logical addition to my portfolio.

However, this article is about two excellent investments - not high-level macro as such, and because of that, let's get into it.

• Both of these investments are either BBB+ or A-rated.
• Both have dividends over 5%.
• Both have conservative upsides of over 20% per year going forward

First off, we have BASF.

1. BASF (OTCQX:BASFY)

BASF reported FY22 today, less than 10 hours ago. I've been pouring over the numbers since then, updating my assumptions, my models, and my expectations for what this company, which happens to be almost 5.5% of my portfolio, will give me over the next few years, and why it's a great investment at this particular time.

I've been reporting on and calling BASF (OTCQX:BASFY), among others, to be one of the more interesting plays available in the EU since the war in Ukraine began. the company might not have looked the part, given everything that's going on, and I've had to impair it a few times, as well as update and invest more in my position given new attractive pricing levels.

Before we get too far into this, I want to remind you that for any argument relating to Wintershall DEA and energy troubles, I've impaired and discounted my overall targets for BASF several times, accounting for Wintershall DEA, for energy troubles, for other issues several times now. BASF previously had a realistic PT of around €90/share - and given where we're at today, that impairment is well-justified.

Given the market reaction we're seeing, I wish I could say that there are significant negatives that I did not count on happening - but that would be a lie. In fact, the company did better than I expected, with a backdrop of global chemical production increase of 2.2% for the full year, with some weakness in 4Q22 (again though, this was expected/accounted for).

FY22 sales revenues were up 11%, but the EBITDA gross of special items was down 5.2%, with a double-digit EBIT decline and a negative net income position for the year (although not as large as I expected).

Nothing about the 2022 trends was unexpected. Higher energy costs, the next steps of exiting Russia for Wintershall DEA with a non-cash impact of over €4.5B, but also with a €1B dividend position from the company to BASF's cash flow. BASF is still in the mindset of selling off its share in the company and monetizing what's left, though it's of course not the same deal or consideration as it was only a year back.

Despite all of the impacts, BASF saw impressive levels of operating and free cash flow for the year, with €3.3B worth of 2022 FCF. That means that the company's dividend is actually fully covered by FCF, though the company in no way is in "the clear" yet.

What we're doing now from a macro level is entering a period of higher CapEx for BASF, where CapEx to support future organic growth is expected to go up from 2023, peak in 2024, and start going down in 2025 again, to normalized levels in 2026 and beyond. These investments are a mix of investments in existing businesses, battery materials, Zhanjiang Verbund in China, and investments in net zero (the last is the smallest of these).

These plans likely mean that EBIT, ROCE, and other metrics won't be moving the needle overly much for the next few years or so.

However, the way BASF was valued and the way it was argued only a year ago or so when this started, were some analysts and investors seriously considering BASF, the largest chemical company on earth, to be in serious danger of bankruptcy.

Nothing like that has happened. In fact, the company's credit rating hasn't moved an inch. BASF has credit ratings from all three majors, and they're at, A, A, and A3, with a 66% "stable" outlook with very recently updated stances. The company also retained its dividend take care of the dividend doubters, which expected a cut or elimination.

That didn't happen either.

Going into 2023, here are the assumptions for BASF - and you'll note at what prices these assumptions are based.

As I said - the company has plenty left to do. And given CapEx plans, I don't expect a massive resurgence in the next year or so. However, I invest in BASF for the longer term, and from that perspective, there is a lot to like here.

It's entirely possible that the current time marks the last time you can buy BASF close to €50/share for the foreseeable future. Even using significantly more negative forecasts than the native GAAP forecasts for the German ticker, you can see a massive upside to where the company is currently trading. BASF has traded at the sub-€60 PT mark on an average analyst PT for going on a year soon. The latest conservative PT is around €55/share, with 11 out of 22 analysts at a "BUY" or equivalent rating. Only one rate BASF as a "SELL" here.

I interpret this as uncertainty about the near term, which I can understand. In the case of BASF though, I focus beyond the near term, because not only will BASF rise up to earnings that have seen it trading closer to €85/share, it may do so quite quickly under the right circumstances.

An upside is quite easy to see here from an average valuation perspective, and you'll notice clear trends in how the company's share price, even ADRs, move in tandem with its results and valuation.

Keep in mind that I am not saying BASF will not go down again - but I am saying I believe it will repeat the pattern it has followed for the past 10-20 years, where increased earnings, as we are likely to see in 2023-2025E, result in an increase in valuation for the company.

Even on a conservative forecasted basis, this implies an upside of 30.75% per year, or 115% until 2025E.

You could, thanks to generous company dividends, go all the way to forecasting at 10-11x P/E, and still find an upside of over 20% per year, or 75% until 2025E in the case of reversal.

So, BASF is a 7%-yielding chemical powerhouse - the largest in the world - with a recently-confirmed dividend and a very realistic upside, despite problematic macro.

I believe the case is easily made for BASF, and that this one is a "BUY".

That's why over 5% of my private portfolio is BASF, and why 3.5% of my corporate portfolio is BASF as well.

BASF Is a "BUY", and my PT is €74/share. I'm raising it based on these 2022 results.

Let's look at #2.

2. Evonik Industries (OTCPK:EVKIY)

Many of you might not know Evonik - but fear not, I have recently published a "baseline" article on the company that covers A-Z of the company's operations and what it does as well as what you can expect.

Like BASF, Evonik is chemicals. Like BASF, its traditions and company pasts are over 100 years old at this point. Evonik, despite its lack of coverage, is the second-largest chemicals business in Germany, and one of the largest specialty chemicals businesses on earth.

It's not as large as BASF - revenues of around €18B guarantee that which is less than a third of what BASF manages, but unlike BASF, Evonik has not seen significant earnings decline and chaos due to Russia and unprofitable ventures into Energy. In fact, Evonik's venture into energy, because the company primarily works towards the renewables sector, has been excellent, all of them. The company hasn't had negative GAAP for a single year reported since at least 2013 and has been able to pay a competitive, growing dividend for many years.

Evonik has a different focus from BASF. It focuses on manufacturing speciality chemicals for a variety of fields, but all of them have something in common - namely that they're mostly aimed at a circular, ESG-advantage/lightweight future with appeal to industries that work in the "green shift" we're going through. The company has strong positioning in key segments in Additives, Nutrition, and Smart materials.

What's more, the company's margins in these segments are substantially better than the legacy chemical margins we're currently seeing - that also includes margins we're seeing in BASF and similar legacy companies. This is a relatively new development for Evonik, and it's likely that this new focus will serve to flatten out some of the ups and downs we typically see in this field. Once the company is done with this transformation, because it's actually currently in the middle of it, it's likely we'll see substantial improvements here.

'The company is targeting its growth segments more heavily and seeking to exit performance materials entirely, with a focus entirely on the growth divisions. The company has ESG targets, CO2 targets, and solid financial targets seeking to get an EBITDA margin upwards of 20%.

I also want to point out that Evonik has not cut their dividend - not once - at least since 2008, and I have a hard time believing given quarterly results that they would be cutting it here.

Evonik is in the midst of a transformation, working to change its EBITDA and sales mix towards growth rather than legacy. It's already at 80% specialty, and the recent moves are going some way towards de-commoditizing the company's sales - and it's doing far better than BASF in this respect.

These specialty businesses are growing far better and quicker than legacy, having averaged 3 pp higher annualized 10-year growth rates in terms of organic earnings.

There are a couple of moves left for Evonik, and a few divestments to do before everything is said and done - but that still leaves the company in quite an excellent overall position going into the next few years.

A quick glance at the upside here, and we can use F.A.S.T graphs for this one, confirms the double digits and more...

Even only on 8.5x conservative/discount P/E, this company has an upside of over 140% until 2025E. The company currently trades at around €20/share for the native, with a PT range starting at €15 but going to €35, with an average of €24. That's a 15.6% conservative upside from analysts, with 11 out of 20 analysts at a "BUY" or equivalent. That PT was over €34 less than a year ago, and that's closer to where I view it being, from a justified earnings potential.

DCF is a bit dicey used here due to the volatility we've seen in earnings, but even a simple DCF with a high, 11%+ risk-free interest/discount rate gives a fair value of over €40/share using a terminal growth rate of only 3.8%. While I wouldn't go by such a DCF alone, it adds to the overall picture I believe I'm seeing here - that of an undervalued chemicals company with great fundamentals, and a high yield, that's being undervalued at this time.

I invested heavily in my corporate portfolio and am at 6% Evonik there, and 2.5% Evonik in my personal portfolio at this time. I intend to add to at least the latter position, and build up a 3-4% exposure to the company.

EVKIY Is a "BUY", and my PT is €27.5/share for the native.

Wrapping up

These are two excellent companies with superb yields and upsides that I see as being available and undervalued today. They're both companies that I've already invested in, and am going to continue to invest in going forward.

I wanted to highlight these here, as I don't see that they're receiving adequate attention from investors compared to what they offer.

Any questions about either of these - feel free to add them to the comments below!

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

The company discussed in this article is only one potential investment in the sector. Members of iREIT on Alpha get access to investment ideas with upsides that I view as significantly higher/better than this one. Consider subscribing and learning more here.