LSB Industries, Inc. (LXU) Earnings Call Transcript & Summary

All right. Good afternoon, and welcome to Credit Suisse 34th Annual Basic Materials Conference. My name is Arnoud Boksteijn with Credit Suisse. And joining me today on the call is Mark Behrman, Chief Executive Officer of LSB Industries. Great to have you with us, Mark.

Thank you, Arnoud. Nice to be here.

So before we dive into the Q&A, I just want to remind folks that while there's no live Q&A functionality during this call, you do have the option to e-mail me any questions you may have for Mark, and we'll try to address those as we go along. My e-mail address will be visible on the screen. So feel free to use that. So with that housekeeping out of the way, we can dive straight into the Q&A, Mark.

I think we have quite a bit to talk about today, Mark, given it's been an eventful year for LSB so far, strong financial results. And obviously, you recently announced a transaction. Maybe just to start off with the latter. So you recently announced the preferred stock exchange transaction. Can you just give us a little bit of background kind of how that came together with Eldridge and kind of what the potential benefits to LSB are?

Sure. Back in 2015, while we were in the middle of an expansion of our El Dorado, Arkansas facility, our largest facility, we incurred some cost overruns. And ultimately, we wanted to complete the project as we felt that building a new ammonia plant down at that facility made a lot of economic sense for us and strategic sense. We ended up doing a structured financing at the time with Eldridge Industries or LSB Funding, which is a company that they set up to hold the preferred stock was $210 million of preferred stock and $50 million of senior secured notes basically a tack on to our existing high-yield notes. The whole idea there really was to complete the expansion and use that funding more as project financing and repay it back when we completed the expansion, and we've got the plant up and running. Unfortunately, as many of you know, nitrogen prices and particularly nitrogen fertilizer prices, went into a real nose dive and we hit a trough market. So we never were able to get rid of that. Now ultimately, as we moved along and came into this year, the pricing environment really improved, and we can talk about that a little bit later. But Eldridge had been invested in the company for a little over 5 years and really saw the progress that we made to turn around the operations and to really improve the business. And we sat down and had a conversation about where we're going with the business, where I think we can grow the company and we're really excited about that. And they agreed that, it's the right time to recapitalize the company and clean up our capital structure. And they agreed to become common stockholders like the rest of us common stockholders and align themselves with us which I think really, combined with refinancing of our debt as the debt capital markets are really issuer-friendly today, will allow us to really clean up our balance sheet, reduce our leverage and give us a great runway to grow internally and through M&A.

Got it. Thanks, Mark. And obviously, it's quite a vote of confidence, I would say, from Eldridge other than the financial benefits. I mean, is that -- we just say they're true believer kind of in the path that you guys have taken?

I would hope so. I mean they've had 2 representatives on the Board since 2015 so they clearly understand what our strategy is and the progress that we've made. So yes, I would take that as a vote of confidence and not just myself, but the rest of the management team. We built a really nice management team that we think has the ability to run a much larger company.

And did you mention, obviously, the capital structure, right, this will change and your upcoming -- you announced refinancing that you hope to do after that. Can you kind of just walk us through kind of how you see that refinancing and kind of what the immediate benefits would be to LSB upon completion?

Yes. So the actual shareholder vote or the special meeting to approve the conversion is next week, so next Wednesday, the 22nd. So far, we have received overwhelmingly favorable response to the tally of votes of shareholders. So I'm highly confident that we'll get this approved mix Wednesday. We'll then pretty immediately kick off a refinancing of our senior secured notes. Today, the rate is 9 and 5 days, which is extremely high. Indications are that we'll be able to refinance a 7-year piece of paper somewhere in the high 5% to low 6% range. So not only does it save us $15-or-so million of interest expense on an annual basis but it provides the flexibility, I think, that we need going forward to look at some M&A activities and acquiring some assets. Ultimately, I think it's really important for people to keep in mind that commodity businesses like ourselves that tend to have very cyclical pricing structures, really, the leverage should be anywhere between 3 and no more than 4x in those businesses. So that if the pricing environment moves quickly on the downside, you're not overlevered, and you can still handle that type of leverage. So given the really positive pricing environment for nitrogen chemicals and the performance of our first half and what we expect in the second half, we think once we're done with the refinancing by the time we get done with the year, we'll really be trending more towards 4x or less than 4x leverage.

And would you say, Mark, that's kind of your longer term or your medium-term target in terms of your leverage ratio?

Yes. 4x or below is what we'd like to say. I mean I can't say that we'd always do that if we actually saw an acquisition opportunity that threw off a lot of free cash flow, would we lever up a little bit higher, knowing that within 12 to 18 months with the generation of free cash flow, we can get back down under 4x. We'd probably consider that. But I think, again, we've had a balance sheet that's been overlevered for some period of time. We really want to fix the balance sheet and not go back to where we were.

Yes. Understood. You mentioned M&A a few times. And I guess, just growth in investments in general. As you -- with your improved capital structure and the flexibility that, that will provide, kind of what's your -- how are you thinking about kind of priorities and target areas either in terms of M&A or just growth investments in the business?

It's a great question. I mean, so most chemical -- petrochemical plants have internal growth opportunities at many of their sites. We're not -- we're very similar to that. So we have what we call debottlenecking opportunities, where we can increase the production capacity either at an ammonia plant, nitric acid plant or any of the other downstream production facilities that we have. Obviously, that would necessitate an investment of capital to do that. And we'd have to believe that the market for additional production of a particular product was there so that we could sell it. Organically, we've also been pretty open about wanting to be a first mover in the blue and green ammonia space. So we're currently looking at those spaces and discussing and hopefully soon engaging with a technology provider to do feasibility studies at 2 of our facilities. So we're very serious about that. And of course, that will take an investment of capital as well, whether it's CCS equipment and maybe pipeline for blue ammonia or electrolyzers and other equipment for green ammonia. And then, of course, there are a number of potential acquisition opportunities that we think would be very attractive for us. So we'll consider those as well. I think on the M&A front, I'm pretty disciplined. At least I think -- I'd like to think I am. Growth for growth's sake doesn't make a lot of sense, just to be bigger. Ultimately, it's got to create value for the shareholders, of which I'm a significant shareholder. So I think myself, the management team are aligned with the rest of our shareholders just given the holdings that we own. So while I'd like to grow, and I think there are really good synergistic opportunities, we're not going to overpay for something and we're going to make sure that they're accretive to shareholder value.

Makes sense. Thanks, Mark. And you mentioned just the investment in your plans. You've done quite a bit of work over the last couple of years kind of improving the operational performance and reliability of your plans. Can you just remind us quickly kind of what your focus areas were over the past couple of years and whether you see more runway to kind of further improve the performance of your existing plans?

Yes. I mean -- so investment has been including the expansion upwards of $1.2 billion. So it's been pretty extensive over the last, I'd say, 7 years. But I think the key to running these plants more reliably is making sure that you invest the right capital for anything, environmental health and safety, obviously, related and then reliability related. In the past, I think maybe some of these facilities were a little bit undercapitalized so we spent a little bit more capital to catch up. I think we've got a little bit more particularly at our prior facility, where we'd like to install some upgraded automation equipment, and we'll continue to do that. So when you think about capital, you think about maintenance capital and then you think about growth capital. And for the most part, the last 7 years, we've really focused on growth -- I'm sorry, maintenance reliability and EH&S capital to improve the reliability. So the point, like I guess I would point people towards our ammonia operating rates, which everything starts with ammonia for us, right, because we take natural gas and upgrade that to ammonia and then either sell that or upgrade that to other products. Our ammonia operating rates were not very good back in 2016, I'd say maybe high 70% or 80% operating rates, which is generally considered to be pretty poor. Over the last several years, we've moved that up to operating rates in the low 90% range. I think we still have some more room to improve that. We should, on average, be at 95%. So those next 3 or 4 percentage point in operating rate are extremely profitable tons as we already cover our fixed costs. So that's really the variable cost.

That's clear. And just going back to, I guess, the comments you made on M&A. Obviously, you don't want to be diligent, which is difficult in this environment. I'll get carried away with [indiscernible]. But can you talk to us a little bit more kind of where you see kind of your focus area? How does -- what does your ideal target look like? Is it just expanding capacity of most of your current product portfolio or going into more higher value-add products? Talk us through that.

Yes. I mean I think that down the fairway would be acquiring facilities or businesses that operate facilities that are very similar to the ones that we operate today. So we understand how to operate them and understand how to sell those products. We would not mind some of those opportunities also had a little bit more diversity in products. So today, we don't sell urea. So we're not a player at all in that. And so if there was something that in addition to maybe UAN and nitric acid and ammonia also had a urea component, that would be okay. Or some derivative of that, whether it's ammonium sulfate or ammonium thiosulfate just other fertilizer products would be product diversity and that'd be fine with us. Now we are only 50% in the ag business, the other 50% of our products go into industrial applications and mining applications. So anything that was either right down the fairway of similar products that we produce today and just gave us more volume and maybe more a different region would also be advantageous for us. We have -- we operate a small sulfuric acid plant out of our El Dorado facility. So while it's not nitrogen, we have been in that business for a long time. So anything on the sulfur side, we'd look at as well. And then I think you have to start looking at -- on the industrial side, we've got some very large industrial customers like Covestro and Dow and BASF and Ascend. And are there products that we're not producing today that they are buying from others, and we can lever that customer relationship. So I think we've got a lot of opportunity in different directions to look at M&A opportunities. There's not one specific area that we'd look at. We'll be opportunistic. But again, it's got to make sense, and it's got to be some synergy or some crossover to our existing business.

Got it. Makes sense. What is your comfort level in terms of size for kind of the acquisitions that you'd be looking at?

Well, I think our first acquisitions would be something that we could digest and show our shareholders in the market that we understand M&A, and we know how to make a good acquisition, absent that or even after that, really. I don't know that size makes a difference. There's a lot of capital out there. Our -- post our meeting next week, the expected majority shareholder, Eldridge. They've certainly got deep pockets and maybe even a willingness to invest in more capital. But access to capital, I don't think is going to be an issue for us. So again, if there was something that was really large that was strategic, that made sense, I think we'd look at it.

Okay. Very good. And just pivoting to your end markets. We talk about the agriculture markets. Obviously, ag markets have gone through quite an impressive rebound over the last year or so. I think as we sit here today, I think corn is still trading above $5 bushel, which we haven't seen in a long time. Kind of how has that supported your business so far this year? And kind of what's your outlook going into the next quarters?

Yes. So I mean high corn prices are definitely a bellwether for fertilizer prices, like corn being the largest user of nitrogen fertilizers. So at $5-plus corn, farmers are doing really well even in this high-priced fertilizer environment. There are a number of other factors, though, that are really pushing fertilizer prices up. I mean natural gas prices again being the primary feedstock for any of these nitrogen fertilizers are up. They're up, I'd say, exponentially in Europe. So high nat gas prices in Europe is really causing European producers to have to make a decision on whether they continue to produce or do they idle facilities and really become customers now and are looking to buy ammonia or other products. We've had a number of facilities that pushed off turnarounds and work last year during height of COVID that have taken them this year and they've become extended. So that's really curtailed supplies. So I think there's a number of factors. And last but not least, China is buying of a lot of commodities which is really creating a lot more demand for corn and propping up corn prices. So I think there's a lot of dynamics that certainly over the next 15 months to 2 years, look like they will keep fertilizer or commodity prices up and then ultimately fertilizer prices up as well. After that, I think none of us really have a crystal ball and I'd be speculating -- truly speculating after that.

Yes. I guess what we hear in recent reports that the South America crop may be not as good as, I guess, people expect, which obviously would be some part of the North American farming community, which we [ don't ] agree with that, but that's probably going to be supportive going into the next season.

Yes. So if that pretty severe weather down in South America, and it's really, I think, created an environment where corn crop is, I don't know if it's poor, but it's certainly not a good corn crop. We've also had bad weather or weather-related issues here in the states where we had a drought in the Western United States. And so that's really hurt some of the corn crop this year in those states as well. So you're right. I mean stock-to-use ratios will be less than what people thought. I think actually the yields per acre are going to be down ultimately. So yes, we'll be up in some states. We're -- they've got a lot of rainfall, but a lot of really good dry weather. Other states will be really down. And of course, as you said, South America, I think will have its own issues.

And in one of the recent calls, you mentioned the antidumping suits against Russia and Trinidad on the import of UAN. Do you have any update on that?

No, not other than what's public. I mean -- so to get a favorable ruling on antidumping, you need to go through a number of different steps. The first step is, is it a case worthy of spending time on basically. And the answer was yes. I think ultimately, as they go through this process, we really won't know if there's actually going to be an antidumping duty until the end of this year.

And then maybe just switching over to your industrial and mining segments. Obviously, there's a lot of different dynamics within your end markets, automotive, mining, kind of talk us through kind of what you're currently seeing, what you're expecting in each of those over the next couple of quarters?

Yes. So I mean a lot of our -- as I mentioned, a lot of our industrial -- or a lot of our products go into industrial applications, generally as a feedstock for some of the product. The 2 biggest uses of nitric acid, and we are either the top or the second largest producer of nitric acid -- producer and market of nitric acid in North America. So it's an important product for us. But nitric acid goes into the production of ultimately polyurethane. So polyurethane -- probably the 2 biggest users of polyurethane are the auto industry, lots of polyurethane in a car today. So the auto industry coming out of COVID really had a tremendous uptick. Production is up, sales are up, and that's continued throughout the summer. So we have not seen any drop-off there. And the other real big user would be -- of polyurethane would be building products. So homebuilding is up, home renovation is up. So big use of building products and therefore, big use of polyurethane. So we've had really strong demand, probably more demand than we could handle for nitric acid, which is a feedstock, as I mentioned, for polyurethane. On the mining side, people tend to think about the mining business as coal mining, and that is a big part of the business, but our team has worked really hard and done a great job over the last 4 or 5 years to diversify away from coal as we started to see coal drop off. So our end -- our product ultimately ends in the hands of coal market, probably less than 1% of our business. The main uses of our products and where our products go are metals mining, so precious metals and then copper, of course, big demand for copper with electric vehicles, battery technology and other things. And then I'd say construction and quarries are aggregates mining. And that's absent an infrastructure bill. So if an infrastructure bill actually gets passed, I think you see a lot more demand from those sectors. So it's been actually pretty good.

Good. And you mentioned natural gas prices going up. What are you seeing in general in terms of just raw material cost increases and just general inflationary costs that seem to be affecting a lot of folks? How is that impacting your business?

Yes. Well, obviously, everyone is aware of natural gas and the spike up here in the United States. Other than that, we have seen for supplies that are either lubricants that are oil-based, certainly, prices have gone up pretty dramatically there. Any kind of metals that we purchase, we're seeing pretty significant increases there. So I'd say across the board, we're seeing increases, but nothing today that really scares us and certainly from a supply chain standpoint, we're not having any trouble getting anything like other industries. So that's actually a really good thing.

So that's great to hear. Just switching to kind of, I guess, the ESG, which is a hot team nowadays and deal with just the focus globally, right on reducing greenhouse gas emissions. Do you see that as an opportunity or more as a threat to your business? And do you have any plans kind of to address the sustainability aspect?

Yes. So I would say that we've developed a plan internally on what we think sustainability means to us. So both -- I should say, both really environmental and social and even governance. On the governance, I think, we've been doing for a while now. I think if you look at our Board, it's pretty diversified. And we look -- we always look to see if it makes sense for us to diversify even more. From a sustainability standpoint, clearly, CO2 reduction and not just oxide reduction are 2 important things for us as well as water conservation and energy conservation. So we recently hired Fred Buonocore to lead Investor Relations for us, but he will also be our lead point person when it comes to ESG. And he'll work in conjunction with our Director of Clean Energy and the rest of our team to really, I'd say, determine what areas of focus we want to have and what we're able and willing to commit to. I think it's really important that if we put goals out there that they are achievable goals by certain time frames. And just coming up with a policy or throwing some goals out there, I think that maybe are a stretch. I think for the industry, for all public companies, in particular, I think it's important that if we're going to put goals out there, there are goals that we believe that we can achieve. So I think you'll see us in 2022 really focus on ESG with a point of really by the end of '22 coming out with our first sustainability report.

And kind of tied to the sustainability, as I guess like you mentioned at the beginning of the call in your blue/green ammonia strategy. You mentioned that kind of in the planning phase for potential rollout. Can you kind of talk to us about kind of the potential financial benefits or impact did you expect that to have once that's live?

Sure. Well, on the blue side, carbon capture U.S. government has been really focused on that, particularly with 45Q credits. And so today, it's $35 if you're using it, if you just capture it and it's $50 if you actually store it in the ground, other than enhanced oil recovery. There is legislation to increase that to some higher levels. So I think there's a lot of incentive for folks to really focus on carbon capture. So economically, besides using 45Q to create a return on the capital investment, it also then provides us with an upgraded product in low-carbon ammonia or blue ammonia that we can either sell as ammonia or upgrade it to other products and sell those products. So -- and we're pretty excited about that. We think we can -- given a lot of our industrial focus and big industrial customers that we have, we think there's a lot of opportunity to discuss with them about low-carbon products. On the green side, look, there's no doubt that unlike other real -- other times where there was real focus on alternative energy, I don't think this is going away today. I think that climate issues, environment issues are being discussed globally. A lot of momentum with governmental support with private capital support and then, of course, companies really focusing on that. So I think ultimately, the world wants to go green, no carbon and really reduce the global footprint. So -- but I think it's a slow-moving market. Today, it's nascent, right? I mean, there's no one that's buying any green hydrogen or green ammonia. I think it will develop over time and slowly, but I think it's worth being an early adopter and establishing yourself in that market and making that investment.

Excellent. I guess, just doing a quick time check here. I think we're running up against the clock. Let me see if there are any questions that have come in here. I think that looks like that's it. Is there anything else, Mark, that we haven't addressed that you like to mention?

No, I mean I think when I look back over the last 5 years, we've done, I think, a pretty good job on turning around the business. With the conversion that we've announced and on refinancing, I think then we would have done a good job in recapitalizing the company and really given us a great platform for growth, whether it's internal or external growth.

Very good. Well, with that, I'd like to thank you, Mark, for joining us today and addressing these questions. And I'm sure we'll speak again next time.

Absolutely. Thanks so much.

No worries. Thanks, Mark.

Bye-bye.