BASF SE (BASFY) has been using M&A to improve its profit profile. Hedging against the cyclicality of petrochemicals is still a work in progress, but the German chemicals giant is getting closer to that goal.

The latest brick in its efforts is its agricultural business. BASF is the world's fifth largest producer of seeds and crop protection products and has been building the business on the back of its American Home Products Corp. acquisition in 2000.

Since then, it's added a sizable insecticide portfolio from Bayer AG (BAYRY) in 2003, signed a joint venture with Monsanto Co. (MON) in 2007 and added Sorex Holdings, the British pesticide maker, last year.

BASF is likely to do more deals in this space and pump more capital into this business. It has already committed $416 million to raise production.

Taken together, these acquisitions have now given BASF a portfolio that has the ability to generate earnings not correlated to GDP growth; neither is it cyclical. It's directly related to demand for corn. Despite the economic slowdown, corn demand has not budged. In the U.S., it's expected to grow 2.3% over the next year.

Demand for fungicide, which is used to attack fungal spores in crops, is increasing in North America, Europe and especially China, where demand has grown at a compound rate of 2.9% the last seven years.

The annualized sales of its ag-chem business is running around $3.64 billion. That's about 9.4% of group sales, up from 5% last year. Operating earnings at the business has risen 31% year over year, and margins, at 34%, are up 2% from last year.

Meanwhile, in the last 10 years, BASF's deal activity has been steady: having bought EUR20 billion of businesses, but it has also earned more than EUR11 billion from disposals. It is also likely to sell its Styrenics business, once its financing environment improves.

Despite being a deal machine, BASF is unlikely to buy Dow Chemical Co.'s (DOW) ag-chem business, which the U.S. chemical giant wants to sell. Dow's unit is valued at $7.5 billion and will be a stretch for BASF's balance sheet, whose current net debt/Ebitda ratio stands at 1.19x.

But more importantly, BASF's integrated approach - known as 'Verbund' - has integrated production sites in key centers in the world. A big deal like Dow's business won't fit with its strategy.

What we can expect is a mixture of small deals and organic growth. The company's current cost of capital is around 9% and no doubt it would like to raise its returns on invested capital above its current 6.5%.

Pursuing a strategy of bolt-on deals, rather than a debt finance mega deal, fits the bill.

(Kevin M. Nichols is a columnist for Dow Jones Newswires on the energy, industrial and auto sectors. He has more than seven years experience as an analyst and trader on Wall Street and was formerly an executive in the proprietary trading unit at an investment bank. He can be reached at +1 (201) 938-2417 or by email: kevin.nichols@dowjones.com. Dow Jones Newswires is enhancing its news, commentary and analysis for the investment banking community, and is providing it on this service temporarily. To ensure continued access to the best of Dow Jones news and opinion on companies, sectors and deals for bankers and research analysts, please contact investmentbanker@dowjones.com.)

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