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

Good afternoon. I'm Roger Spitz, and I cover the high-yield chemicals and paper and packaging sectors at Bank of America and have the pleasure of hosting a fireside chat with LSB Industries. And with us today is President and Chief Executive Officer, Mark Behrman. So we have a presentation that you can look, but we're only going to use that to reference if we need to, but you can find it on the Veracast website. And as you have questions, please go ahead and put it into the Veracast portal, and I can read it out to read them out to Mark. With that, perhaps I will start it off.

So Mark, perhaps is at the table. Maybe I'd like to give a brief review of where you are as a company and what you've been doing? There's obviously been a lot going on.

Well, Thanks, Roger, and good afternoon, everyone. Yes, we've had kind of really interesting year so far. And to take all of you back to maybe 2015, '16, we were in the middle of an expansion of our largest facility back then and had a cost overrun had to raise some capital to finish that expansion, and we did that in the form of preferred stock, which was actually pretty expensive. We finished the expansion. And of course, we entered into a very low pricing environment for nitrogen chemicals. And really started to execute an operational turnaround, which was important for us because I think when you go back and look, we were I'd say it's a marginal producer with very marginal operating rates and really needed to focus internally on improving the reliability and the operability of our plans. So I think the team did a really nice job in significantly improving those operating rates that really start to bear fruit in 2019 and last year, of course, this year. And along the way, once we completed the operational turnaround, it was really time to address our balance sheet. And so we had an opportunity to work with our preferred holder to convert the preferred stock that they owned into common stock, clean up that high cost preferred and with that, get an upgrade from our rating agency and refinance our debt. So we completed that at the end of September. And we're kind of excited now that rather than being defensive with an over balance sheet, we can actually be offensive and take advantage of some opportunities in the marketplace.

Excellent. So nitrogen prices, eternalize prices have been going a little crazy here, in a good way for us. Can you speak to what you think review the main drivers of what's been going on? And then how you see the outlook going forward?

Sure. So reminding people that the pricing of nitrogen chemical products is really a global pricing. So while we're North American-centric -- We still -- North America is still an importer of urea and ammonia. And depending on production out of facilities could be an importer of UAN as well. And so when that happens, and you need imports coming in, the pricing here for those products is impacted by the pricing in other parts of the world. What's driving an increase in nitrogen chemical prices, fertilizer prices I think it's a confluence of events. I think a buildup of COVID hitting last year and really delaying the number of plant turnarounds in a year where many of us really would rather not have extra people in our facilities coming in from the outside as we're trying to control the environment to not have any spread of COVID through the facilities. So you had the plant turnarounds really delayed by a year and put off to this year. But combining that, we had a number of weather events here in North America that really caused a loss of production. So we had the freeze back in February. We had Hurricane Ida. And then, we had a significant weather storm that came through the Midwest sort of midyear. And that's really carried a shortage of products here in the United States. And globally, again, turnarounds that didn't occur last year that occurred this year, there were some extended turnarounds and some issues -- And then lastly, I would point to natural gas prices. And so natural gas being the primary feedstock for all nitrogen products has increased here in the United States, but has exponentially increased in Europe and Europe being a significant producer of nitrogen products has really experienced a cost that's, to some degree, prohibitive of producing nitrogen products. So we've seen a number of shutdowns of plants throughout Europe, whether it's curtailed rates or total shutdowns or folks being in turnaround and not bringing their plants up. So supply curtailed there, and they became buyers instead of sellers. So a number of different issues that have really cause fertilizer prices to be at these robust levels.

That's great. And I guess the high Chinese coal prices and Chinese energy pressure in China by the Chinese government to use less energy may have also helped, I suspect?

Yes. That plus less exports, right? So China being a big exporter of urea. They've curtailed product going out of the country and governments really mandated making sure that they had enough fertilizer to be used internally. We've seen that in a number of countries, most recently Russia that last week came out with export maximums and really putting a limitation on how much product can be exported.

And the last bit of that was India and maybe I don't have this quite right. It feels like India is trying to import more nitrogen. Is that -- is that right or a drive that a bit confused?

No, I think you've seen demand from India increase, and they don't have the domestic production capabilities. So yes, they've been importing more.

Got it. One thing I have noticed is that contained nitrogen and ammonia is selling cheaper, if I have this right, then contained nitrogen in urea or UAN, is that a normal thing? And is that because of the challenge of and handling a gas, which ammonia is typically in natural conditions versus UAN liquid or urea solid?

Well, I think it's a function of -- ammonia is sort of the building block here and the first product made and generally speaking, in order to upgrade to another product and incur some more costs, you're going to do that because there's more profitability or more margin in it. So generally, ammonia on a nitrogen content basis has traded at a discount to both urea and UAN, but not as severe discount as you've had today. we saw that some of the dynamics have been a little wacky as well. I mean we saw last year and maybe for the previous year as well, UAN would generally trade at a premium to urea. And we saw that actually at a discount. And how that's changed in the relationship today back to more historical levels.

Got it. Actually, that brings me to the UAN potential duties against Russian and Trinidadian UAN. Can you speak a little bit about that? What's going on? And how much of an impact those 2 countries have had on UAN pricing in particular?

Yes, I'd say historically, there were large imports of UAN coming into the U.S. from Russia and Trinidad and we've seen that curtail a bit over the last 12 months. There was an anti-dumping duty that was filed led by CF Industries related to UAN the focus was really on imported product coming in at less than cash costs, which is usually why folks for filing the dumping duty. What I would say is I know that the first level of review was passed and they're still in the review process. Although given the increase in fertilizer prices in general and UAN in particular, I would caution saying that it may be hard to really point a finger at imported product coming in and driving prices down.

Is Q3 typically the slowest period in terms of sales with Q4 than Q1 than Q2 being stronger in terms of volumes? Or what is the typical seasonality you guys see?

Yes, you're spot on. So Q3 is typically our weakest quarter, followed by Q4, Q1 and Q2.

Okay. And I -- can now here, sorry. All right. Can you review the fall in any spring fill seasons and discuss how that works, when pricing is set, when is -- when the company -- customers actually take product?

Yes. So when you think about fertilizer, is 2 heavy buying periods. One would be pre-plant in the spring. So using corn as an example, since it's the largest row crop that uses nitrogen fertilizers. You would see a lot of heavy buying starting sometime in February and then through a period in May or even early June. And then once the season sort of all the plant things have occurred in the fertilizer season, so it takes a breather for a month or 2, then you would see what we would call the fall summer field program, which historically has been when producers sell forward for a number of months to ensure that they've got sales during the slow period so that we don't have to turn down our production facilities. So I think the dynamics of that are changing a little bit, whether it used to be that summer fill programs might have sold 3, 4 months forward and maybe even through the end of the year. With the recent expansions in '15, '16 and '17 of production facilities here in the United States, new facilities coming up. I think those dynamics have changed, and you're seeing producers sell less forward during that period, which is typically the lowest pricing environment. So that requires ample storage to store the products so that you can sell it at more attractive times of the year.

Why would the new capacity produce -- producers want to do things in the fall season?

Well, I think that the new production that we've had here in North America has pushed out some imported product. So you're less -- I guess you're less worried about imported product coming in at lower prices, pushing prices down. And willing to take the risk that there's more rationality in the marketplace.

Okay. Got it. Okay. That makes sense. I -- typically, what is the cost of bringing UAN and on -- and excuse me, urea, up the Mississippi, say, from Nola to the corn belt. What is that -- what does that add to -- what does that freight cost these days?

Well, we're -- we typically don't move UAN or urea up from the Gulf given where our facilities are. But typical freight would cost $20 to $30 a ton.

And has that -- has that increased given all the logistics problems? Because it feels like it wasn't -- that wasn't terribly different than sort of what it used to be.

Yes. I mean I think with the demand for fertilizer products being as robust as it is. We've got a finite number of barges that are out there. So I would think that the cost has gone up some, although not dramatic.

Okay. Interesting. My understanding was that kind of freight cost provides something of an umbrella for prices in the corn belt. Is that still fair to say?

Yes.

Okay. So -- you have -- turning to the turnarounds in 2022. I think you said in the last call that El Dorado is mid to late summer and prior is late summer to fall, if I heard that right. So what is the sort of the EBITDA and cash flow impact of those turnarounds that we should keep in mind when we think about it?

Well, from a pure cash standpoint, I'd say each turnaround on average will be $15 million to $20 million in cash impact. So we've got 2 of them. At Pryor, it's a full turnaround on all of our plants at that facility. El Dorado, during the turnaround, it will just be -- we've got some intermittent plant turnarounds during the year, but the large turnaround would just be our ammonia plant. So on average, we're going to think about 30 days from for a turnaround and that would be ammonia down to ammonia producing. So it's going to be the cost of -- the cash cost of the turnaround and then, of course, the impact of 30 days of production -- lost production during those turnarounds for each of those facilities.

Were you able to produce above so you can minimize that lost production, so the main cash cost is just the cost of the turnaround itself? Or is that not as easy to do?

Well, I mean the key is to produce as much product as you can at all times, right? So when you lose 30 days of production, it's gone, you can make that up.

Got it. And do you capitalize and amortize so it has a less direct impact on EBITDA?

Yes, that's a great question. So historically, up until maybe 3, 4 years ago, LSB did annual turnarounds and they did that for a number of years, which is not very efficient. But -- so based on that, they had an accounting practice that any of the costs incurred during a turnaround that were not able to be capitalized were expensed. Many of our competitors capitalized all of those costs. So you can -- Roger, you can see in adjusted EBITDA, we add back the actual expense portion in adjusted EBITDA to compare on an apples-to-apples basis. We've talked to the SEC about changing our accounting practices to match what many of our competitors do. I would tell you that I think that not too enamored of changing accounting practices. So we'll continue to work on that and see if we can match the accounting practices of our competitors. But you're right. We tend to -- in true EBITDA, we tend to not be compared on an apples-to-apples basis because we do expense that.

Okay. What is your current nonannual turnaround schedule. For instance, how often do you turn -- is it a 2- or 3-year turnaround schedule now? Perhaps it depends on the plant.

Yes. So let me step back by saying, as you know, Roger, our goal here is to be a best-in-class chemical manufacturer, and so there's a number of different ways to define that. But when you think about turnarounds, as best-in-class would be every 4 years. We're not there yet. Two of our plants are on 3-year turnaround cycles, so that would be Cherokee and El Dorado. We skipped the turnaround at Pryor last year, and so we've gone 3 years. We'll have the turnaround in '22. We'll make a determination at that point whether we continue with 1 more 2-year or go to a 3-year or whether we move to a 3-year and have all of our plans on 3-year turnaround cycles.

Got it. You say it's currently on 2 -- I mean, not currently, but it had been on 2-year and you want to try to move it to a 3-year considering that. Did I hear that right?

Yes.

Got it. And then if we can talk about maybe nitric acid. I think you said in the past that nitric acid is used a lot in the auto and construction industry. what are they -- where in those industries is nitric gas user, did I not get that right at all?

No, you're pretty close. So nitric acid is used as a feedstock for the production of polyurethane.

Okay. It's all polyurethanes, what you're referring to, and it's polyurethanes going into okay. Now, I got it. Okay.

Yes. And so 2 biggest users of polyurethane would be auto and building products.

Right. Okay. Makes sense. I would have thought bedding would be -- well, I guess maybe including bedding and construction would make sense, I don't know. But a lot of home using betting.

That's true.

Let's see, or the other major nitric acid players that settle nonfertilizer end markets? Or are they guys who are integrated mainly like buyer or someone like that?

So you're asking who else produces nitric acid, but uses it internally?

No. Who doesn't like yourselves, you're a merchant nitric acid producer in terms of nonfertilizer and are guys like Bayer who, yes, because they make the stuff and use the stuff, but I'm trying to figure out who are the other merchant players. Maybe Bayer is also a merchant player for right now.

No. So we are, if not the largest merchant marketer in North America, which I believe we are, we would be #2. And we're sort of neck and neck with Nutrient. So Nutrient indefinitely is a merchant marketer of nitric acid. CF also sells some nitric acid but on a much smaller basis. And then you've got a few other smaller players here in North America, but they would be more minority players.

And is the merchant market predominantly polyurethane?

Yes, I'd say that's the biggest user here in the United States.

I mean or should I say what size polyurethanes, what are the other uses of nitric acid nonfertilizer markets?

Yes. I mean it's using the semiconductor industry. It's used in the steel industry. in the investor presentation. I'm just trying to think about the slides. We've got a page. I think it's Page 11, that talks about other uses other than fertilizer. It's used to manufacture ammonium nitrate for the mining industry. So there are a number of other uses of nitric acid, polyurethane being the predominant user of merchant nitric.

Got it. And then -- and maybe switch to M&A or industry consolidation really. You've kind of suggested that I think really recently that you still wouldn't mind being part of that. How should we think about that? I mean there's not -- at least in North America, there's not a lot of flexibility. And I think CF has suggested they don't want to go to something like that, of course, you can say what you want, what you do is something different. But how should we think about industry consolidation going forward here?

So you're right. I mean North America, nitrogen production is dominated by 3 players. It would be CF Industries, nutrient and in Coke industries. And then there are a number of other plants and facilities that are out there that are like us 1, 2 or 3 company plants. And I think if you talk to many of those manufacturers being part of a larger platform that may have some large regional presence since the fertilizer industry, in particular, is very regional so that we're not price takers, but maybe more price makers would be advantageous. So I think people see the benefits of maybe being part of a larger organization or you may have some facilities that are not strategic to some of the owners today, and they'd rather redeploy that capital into some other use that's going to be more advantageous for their business. So I think we're involved in some of those conversations. And I think we'll be very disciplined in our approach to making acquisitions, right, I think from my perspective, I mean, a relatively meaningful shareholder, and I think I'm pretty aligned with all of our stakeholders in not wanting to make something -- make an acquisition just for growth's sake. I don't think that ever makes sense. It's got to be accretive and it's got to be financed properly. We're not looking to releverage the company up and put ourselves at risk. I think we at enough of managing through an overlevered situation.

We've got -- look, I think when this conversation got started, I don't mean today, but I mean way back when, prices are pretty low and now prices are very high. And so we've sort of been to the full gamut of price levels to make a deal. So it's obvious -- and it always is hard to make a deal when prices are highly volatile, although that's probably not going to change much anytime soon, at least in this particular part of the industry. I mean is the way to do it here something like swap stock? So no one is taking specific direct price risk?

Yes. I mean I think the way to think about making an acquisition in a robust commodity markets, is both sides need to be reasonable, right? I mean a buyer is not going to pay a high multiple based on high market prices, might pay a multiple -- a fair multiple of mid-market pricing right? And the seller is not going to sell, prices were low, trough pricing, no one's going to sell it at low trough pricing. So I think there's got to be a meeting of the minds where someone is looking to sell. If someone is looking to be part of a consolidation, I think you're right. I think a stock swap could make a lot of sense.

Got it. Actually, I see we've kind of run at a time here. So I want to Mark, thank you very much for speaking with us this afternoon. It's been very informative and always good to match up with you.

Great. Thanks so much, Roger, and thanks for everyone's interest in LSB Industries.

Thank you.