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

Hello, everyone. Welcome to the Robotti & Company fireside chat with LSB Industries. I'm a Spencer Cibelli, an analyst here. I'm just going to read some important disclosures, and then we'll get right into the call. Please be advised that this event is being recorded. This presentation is for information purposes only and should not be construed as investment device or solicitation to invest. Past performance does not indicate future results, investing involves risks, including loss of principal. Robotti Securities, LLC is a member of FINRA/SIPC, providing company advisers, LCs -- as SEC registered investment adviser. We'll also be doing a Q&A section at the end after Bob and Mark Behrman, the CEO, talk for a bit. [Operator Instructions]. And yes. So Bob, Mark, do you guys want to take it away?

Appreciate it -- thanks, Spencer. Appreciate it. Thank you all for joining us. So the purpose today -- we're fortunate to have Mark Behrman here, CEO of LSB Industries is really to kind of help people focus on like the 36,000-foot view here, right? The LSB as a corporation has substantially changed, and it's been a huge evolution. And we think that today, it's really an interesting company that's extremely well positioned that has a very different [indiscernible] so it really has been a transformation. And so that's why I really want to talk about what that transformation is, what we think is a huge opportunity set in terms of the valuation being very discounted, a strong balance sheet, a huge opportunity set in front of it. They've really done things that transform the business and our position to really be -- continue to be opportunistic and grow form here.

So with that, I'm going to ask Mark to start and I asked you to give a little history, and that probably even starts in 2014 when the two of us had breakfast in a little diner in Oklahoma City, and Mark had just joined the company. So I have the good fortune to knowing Mark for a long time and have history here.

Thanks, Bob. So Bob is right, I remember that breakfast in [ Deep Deuce ] in Oklahoma City. So my background for almost 30 years actually was an investment banker...

Then you did something on it for a change.

But I got to see a lot of different businesses almost exclusively in the industrial sector. LSB actually was a client of mine for 10 years. And in 2014, I joined with the idea that within a year, I would transition into CFO. At the time -- kind of an interesting story at the time that -- between the time I accepted and the time that I actually walked in the door, we had an activist situation. Starboard approached the company. The company really didn't know how to deal with that particular situation. And I spent 6 months working with Credit Suisse on dealing with our activists. And so that was the first 6 months. But until I became CFO, which happened in mid-2015, I led Investor Relations and then started a corporate development effort. In 2015, June of 2015, I took over as Chief Financial Officer. And just for some background, the company had announced a very large expansion project at our largest facility, which is in El Dorado, Arkansas, where they were going to build a brand new ammonia plant, brand-new large nitric acid plant, nitric acid concentrator, co-gen facility and then some infrastructure and the original budget was $520 million, which was a large project for the company. And I would say 2 weeks after I took over as Chief Financial Officer, I realized that there was a cost overrun. I think people were surprised at first in the original cost overrun after 2 weeks was maybe $50 million or $60 million. So the company had a balance sheet that could support it, more digging. And unfortunately, the deficit grew larger and larger. There was a change of management in September of 2015. The Board decided to make a change at the CEO level, and we had a Board member that came off to be interim CEO and then after 3 months, he became permanent CEO. So he and I went off to really figure out how we're going to refinance the project, shut down the project, what we're going to do, right? And so...

Let me stop for a moment and put that in a little bit in context from an industry point of view. So the industry saw opportunities to build up capacity. So there may have been specific issues with LSB probably, for sure, but there was industry-wide issues, right? This CF doing the Donaldsonville and then -- still runs tremendous. So all these things was somewhat part of the process where the industry got a little ahead of itself and it was expansion and all these kind of things.

Yes. So I would say that -- so 2 points on it. The basic premise of us doing the project, basically producing ammonia versus buying ammonia was spot on. It made a lot of sense. The industry back in 2012, '13 saw that natural gas prices, which is the primary feedstock for ammonia, really, were starting to drop precipitously, primary reason was fracking. So lots of expansion. There were probably 36 -- and this is important for a conversation, I'm sure we'll have later, but 36 different ammonia plants announced, new builds, expansions, all in that 2012, 2015 time frame. At the end of the [indiscernible] that we were 1 of 7 and everyone had cost overruns. Everyone else could support it with their balance sheet. We we enforced and couldn't.

And let me digress again there, too. A concept, made a huge amount sense. And of course, that's where we are today. That opportunity and that differentiation is substantial and identifiable and quantifiable, and that's part of why the cash flows that you have today are there and probably sustainable. So the concept was right. That was an -- execution was too many people were in the door at the same time. So...

Yes, I think project management, company had done smaller projects, $520 million complex project, needed a whole different level of oversight and management. And I think it's easy to play Monday morning quarterback, but probably could have been done differently. So fast forward, we build out this facility. And before we do that, as I said, we hadn't really determined when they made a change of CEO. Did it make sense to continue? Or how are we were going to fund the gap that we had in the cost of the project. So we looked at selling at the facility. We actually had another business. The company had a very good and profitable HVAC business. They were a manufacturer of specialty HVAC products. And so we looked at could we sell that and again, my previous work pointed me to the direction and I had relationships with folks that are obvious buyers, would we sell another plant, could we do structured financing. And ultimately, everyone knew that the company was in poor shape and tried to take advantage of it, right? So selling assets wasn't going to make sense because we're giving them a...

Right.

So we did a structured financing at the end of 2015, where we raised $210 million of preferred stock and another $50 million in tack-on notes to the publicly traded debt that we had outstanding. And that was done with a group called Eldridge Industries, and away we went, we finished the project actually to buy the potential buyers and the likely buyers of the HVAC business then came back and said, "okay, we're on the kidding. We'll give you a fair value for that business." And we wound up selling it in mid-2016 for about 13x trailing EBITDA so it was a really good transaction to us. But at that point then, we were solely a nitrogen chemical player. The plant came up right before we sold that HVAC business in 2016, the ammonia plant. The rest of the plants had come up in late 2015. And so everything was up and running and we were working King South like you would do and you store them. So at that point, we looked at the assets and said, one, we have a holding company that's had a lot of businesses at one point in time. So we need to collapse the holding company to save on expenses and to rationalize all the expense issues. And then the company really had gotten into the nitrogen chemical business, so a series of acquisitions and never integrated those plants. So they really ran stand-alone. There was no EVP of manufacturing, there was no common logistics, no common procurement or consolidated anything like that. And I'd liken it to, we were now private equity investors that bought a family-owned business in a public arena, right? So we went off to do that. Along the way, I think the Board wanted to see whether selling the business made sense or not. So we actually ran a process. We had some interested folks, but quite frankly, the assets were not running very well, and were not very efficient. And the prices that we got for the company were not very attractive. So we made a decision at that point to really pull back and roll up our sleeves and really hunker down and focus on turning around the business. At the end of, I'd say, mid-2018, towards end of 2018, I had already started to get involved more in the business as more COO -- although still retain the CFO tittle, at the end of 2018, the CEO that they put in place decided that his contract was up and it was time for him to go home, we had never moved to Oklahoma City and to do something different. So the Board asked me to step up and take the CEO role, which I was flattered. But I really wanted to have a conversation with the board, which I think they were surprised about. And I have a great relationship with our Board, and I did at that time, too, but the real focus was, look, you want to sell the company and we can do that. It's kind of unexciting. But I think there's a lot of value creation by turning around this company. But it's going to take 2 to 3 years, 4 years to do that. We need to get our manufacturing rates up, right, because in the chemical business or quite frankly, in the petrochemical business. Anytime you have big plans like that, you have a lot of really sunken fixed costs, a lot of fixed cost that whether you make 1 ton or 400,000 tons need to be spread out, right? So getting rates up meant we are more reliable, but also more profitable. So we went off, the Board was very supportive of that, so we get it, go off and turn around the company. I would say, over the next 12 to 18 months, we wound up changing over or I wound up changing over a bunch of the senior management team and the next level. My philosophy, really, as you know, Bob, is really flat organization, no politics and really just get things done. This hurdles in every part of the business, and we've got to figure out how do we get around those hurdles or jump over them or run through them or whatever it's going to be. And so that's what we did. So I went out and with the help of others and some Board members recruited some really great senior leaders of the company, people that are really great at what they do. And my job is to really provide guidance and support and the resources just to get that done, so we did that. Kind of point of reference in 2017, 2018, our operating rates for our ammonia plants since everything starts with the production of ammonia were between 75% and 80%, which is really poor. The last 3 years, we've run between 90% and 92%. And there's still more room to improve. And that's our real focus where we want to be is 95% consistently. Now a lot of low-hanging fruit in the beginning, increased that rate not much low-hanging through left. What it really is, it's not a lot of capital. It's not, we've got to spend hundreds of millions of dollars to get there. But you have to put in the right policies, procedures, PM programs, preventative maintenance program, to have a really fulsome work order management system, right, because that really drives everything. And it's really just blocking and tackling to get it done. And so you won't see going from low 90s just to 95%. Every year, we should see some incremental improvement for the next couple of years to get there. So we did that first. Then the commercial strategy came next because we can't produce the product, you don't have product to sell. Historically, I think the company was really focused on selling tons and less focused on maximizing price, I don't know why. And we're all about optimizing our production. So we can sell, as most people know, half of our business, we sell is fertilizer or half of our production. The other half is non-fertilizer either as a feedstock for an industrial product or to the mining industry. Our commercial team really needs to optimize the product as to which -- where we're going to get the better pricing in each of those markets. So I brought in someone to lead that. He's done a phenomenal job as has our Head of Manufacturing, to really change the whole complexion of our commercial strategy. Once we did that, and that occurred, I'd say '20 and in the first half of 2021, pricing started to really improve in our industry, which is, of course, important. But the whole financial complexion of the company changed. We were then able to convert that preferred that I referred to. Sat down with the preferred holder, talked about where we're going and where the growth opportunities are, and they were really excited about that. So they were happy to convert into equity. That unlocked value there because the credit agencies, credit rating agencies really looked at that preferred as debt. And then we were able to go and refinance the balance sheet in September of '21 and lower our interest rate by almost 350 basis points.

So that's a critical thing in my mind. Today, the company financially is a very different company than it's been. And so therefore -- and people may even know the company and say, "I know that company, they don't," right? So the balance sheet today is really something that enables you to have all those operational advantages to have that cost advantage of being in North America to really execute on that move, right?

Absolutely...

What's the balance sheet look like today?

Yes. So we've got $700 million of gross debt, but we've got $450 million or so of cash on the balance...

Who would have thought you'd say that [indiscernible].

Yes, you probably remember when we had [ $50 million or $60 million ]. So it's been a tremendous transformation financially. EBITDA last year was over $400 million. Now we had some unprecedented pricing. But we're still -- base EBITDA for our business is $200 million plus or minus a little, depending on turnarounds and things like that.

Right. So the market cap -- the market is not recognized net backed valuations including very discounted given that kind of worst-case situation in terms of what cash flows we generate.

Well, we believe so -- sure.

And that makes sense because people have ideas. And the other thing is, of course, there's so many moving parts in your business, right? Pricing has moved and of course, the last year has accentuated all those things, right? You pointed out last yeat was a phenomenal year. And may not be -- it's clearly not going to be that every year, maybe again. But all those things, people don't get the sense, I think, in terms of base case, what you can do and upside what you have and more importantly, public growth opportunities that you have in many different ways and still plenty of levers to pull to execute to continue to at the margin, substantial improvement.

Yes, I'm really excited about the prospects going forward for our business. Yes.

So why don't you tell us, we know a couple of those that are...

Yes. So I mean, first off, I would say, because I think it's important. I mean, it's no fun turning around the business, right? I mean, you have the parts that look at what we did and everything, but it's a lot of heavy lifting. So now I think to your point, we're in a position to let's go have some fun and score other businesses, right? So what are the growth opportunities? I mean, internally, so just organically, irrespective of where the price is in the marketplace. As I mentioned, we can improve our operating rates from kind of low 90s to mid-90s, at mid-market pricing, that probably generates another $25 million a year in EBITDA. So we intend to capture that. We've also got what we'll call margin enhancement projects. So those are projects that produce or that increased production capacity, right? Because we have a finite production capacity with clients like that, we operate [ with. ] And so those margin improvement projects could be additional storage or installing loading racks in one plant site that we don't have them, and therefore, we can capture the logistics savings between one plant production versus another. It could be increasing our ability to load so that we can be more efficient and faster or without -- could be self-loading racks where we don't need our own people to do that. So there's a lot of different projects that we're working on. Keep in mind, they all have to have a really optimal return or they're not worth doing, right? So there's a big vetting process that we go through. But we think that the projects that we're sort of working -- actively working on can probably generate another $10 million to $15 million of annual EBITDA. So again, $35 million to $40 million just from that. The last, I would say, that takes us into a whole another category, and that is carbon capture. And so we do have 2 projects that we're working on. And we're big believers, and we can talk about why, but at our largest facility in Arkansas, we partnered with a company called Lapis Energy that are experts in, I'd say, subsurface geology, right? That's not our game. We don't want to operate injection wells or anything like that, but that's their background and expertise. And so we're going to put on carbon capture equipment, so we'll capture and then liquefy CO2, where we'll initially capture about 450,000 tons of CO2, and we'll inject it into a sequestration -- a Class IV sequestration well on our property. And why is that important? It's important because many of the projects that are being talked about will have to sell CO2 to someone who then is going to transport it via pipeline 15, 20, 50 miles to get to a sequestration site that a lot of folks are building. One, I think the EPA -- I don't know this, but my guess would be EPA will have to do a lot more rigorous due diligence on a sequestration site that's got a number of CO2 emitters coming in at potentially different pressures. And what they're really focused on is the well itself and the casing of the well, right? They want the CO2 to get down, right? Otherwise, it's not permanently sequestered and there could be other consequences. So our project's simple. It's on our 1,400 acres that we own there. It's good to be lucky. We have 2 great saving formations right below our property. It's actually below our property, our shut-in wells. So there's a lot of geology on it as well. And it's [indiscernible] a meter to 1 sequestration well. So the pipeline actually from our plant to the proposed sequestration well was less than a mile end. So it's really economical, but what does that do for us? A couple of things. One, it reduces our CO2 footprint as a company by 25%. So that project alone reduces our CO2 emissions by 25%. It then allows us to capture the full $85 credit from the 45Q that's in the IRA Act that's out there. So that will generate at least initially probably $15 million of annual EBITDA at $85 starting in 2026. And then we're going to be left with 375,000 tons or so of low carbon or blue ammonia that we should be able to sell at some kind of premium to what we're selling today.

And that's an optionality. They have to do one or the other, either you sell blue ammonia or you get the credit...

No, you get both.

Okay. Excellent.

Yes. So we're excited about that because just capturing the CO2 and just taking advantage of the $85 per ton CO2 credit, the 45Q credit allows us, as I said, at about $14 million, $15 million a year. So I mentioned $35 million to $40 million, add $15 million on that, and that's $50 million to $55 million of additional EBITDA. Nothing to do with price.

And that has no capital requirements on the part of LSB to do that.

Yes, the way we're set up now with Lapis, they're going to put up all the capital. There is -- I mean, I don't want to say that we never invest capital. I think we're looking at the economics now as to whether it makes sense for us to put up the capital for the capture facility. And on that incremental EBITDA that we would get...

So the optionality is you don't have to put anything and you get $15 million and you get blue ammonia or you have at some later date the option to put up some capital based on a rate of return to get incremental value.

Exactly. It would be somewhere in the neighborhood of $25 million. And so what's the return on that $25 million, what's the incremental EBITDA would be [ generated ].

Right.

Yes. So optionality. We like optionality.

So that sounds to me like CO2 products are extremely comprehensible that even a slow guy like me can understand, which is I hear a lot of comments on sequestration. I just don't know what that means and how to quantify it. But here, this is a great example of doing something that's clearly a great outcome for a great economic result.

Yes. I mean we're not going out and building at least today. We're not going out and building a 1 million ton a year plant. And hopefully, we can get offtake for all of that or build a spec plant and hope they'll come. I mean that's too speculative for us or anything that's too speculative for any one quite frankly.

Yes.

So 3 different avenues of growth, all internal, all without increasing any production capacity and $50 million to $55 million sort of at mid-market pricing. So we're pretty excited about that. Then we start talking about debottlenecking. And I know everyone gets all nervous about debottlenecking and has had bad experiences with companies who have tried to debottleneck plants. It's actually pretty standard in our industry. It's been done a lot of times, but we want to be prudent about it, and we want to be thoughtful about it. And does it make sense for us and where does it make sense? And so we had a recent Investor Day, where we laid out debottlenecking and it was kind of the full Monty what we might do. But as we look at the economy and as we look at our industry and as we look at the risks associated with doing a full debottlenecking throughout the El Dorado facility, we'll weigh that and more than likely we'll pull back some and do it maybe in stages.

And that's, of course, against the greater context of a huge advantage for your industry is the fact that the feedstock is natural gas in North America, and the feedstock in North America as people realized 10 years ago was an opportunity that would be long dated that continues to obviously be long dated, and we continue to see people moving to America to that -- will make fertilizer here seeing that opportunity. So the backdrop is truly supportive for you. And the timing, as you say, is that your election and that your option as you determine how much free cash flow you have and where best invested.

Yes. I think we're seeing a couple of things, all driven by -- or primarily by low natural gas for us this year relative to anywhere else around the world. But we think gas is low today, but even when it went to $5, $6, $7, it's still relatively low compared to others, right?

They probably had a bigger spread then, it's even got higher.

Yes. So the world looks at that and says, "okay, if I'm going to expand, where am I going to expand?" And it's really the U.S. So it helps us in a number of different ways. I mean a lot of our industrial customers are now onshoring or expanding here. And that's good because hopefully, that leads to more demand for us, right? For our products. Why? low natural gas costs but quite frankly, easy to do business here, right, that the political environment is pretty good versus maybe in the Middle East where they have very cheap or free natural gas, right? I mean so different dynamics make it really easy. So onshoring, labor, the cost of labor and the availability of labor and technical labor because I think what people don't realize and all these plants -- new plants that are announced are all -- they don't have the capital yet, most of them. But even if they did, who's going to run the plant and who's going to -- ammonia is a hazardous material, needs to be handled properly, stored properly, shipped properly. And so you need technical expertise to do all of that, and you can train people, but then you're dealing with kind of newly trained folks. So I think not just ourselves but any ammonia producer today has a leg up on everyone else that's talking about building or actually building brand-new greenfield plants.

Let me run back to, you really have built out a management team across the organization that enables you to have the people to execute in a very different place than when you took on the expansion of El Dorado.

Yes, I'm really excited. I mean I have a great management team. They're all experienced, they're all -- we've gelled. I mean it's why are people here, I always ask them all the time, why did you come to the company, like I'm always curious slightly. Maybe we can make it better, maybe there's things we need to enhance. But most people will say they came to the company because there's a lot of excitement around what we're doing. It's easy to do business. We have a really easy platform to do business. As I mentioned, there's no politics, it's flat. And quite frankly, one of the biggest things we pride ourselves on is we make decisions pretty quickly. A lot of companies, bigger companies and bigger competitors. It could take 2 weeks, 3 weeks to kind of make some decision. We get together, we sit down, we try and have the best information that we have and you make decisions. And not every decision is going to be right. But that's life and kind of -- then you change course, right? So people like coming to work here. So the management team that we have today was built this way by design is to -- can run a much larger organization, and that's really the focus, the intention.

Now you did mention debottlenecking and you talked about the savings and the opportunities that's there, but that requires some capital, right? And so I guess that's part of the equation in terms of how do you figure that out. So how do you think about it?

Yes. So when you think about any debottlenecking project or even, let's say, we were to build a replacement site or a new site or a [ foray ] plant on El Dorado. So that's anything new or anything debottlenecked. It's a project. So you got to think about -- it starts with a feasibility study. So you do some work internally and then we hire a technology provider or an EPC contractor that we use. We tend to like to use or at least lately, a firm called Black & Veatch, very well known in the industry. And so we work with them. They'll provide a feasibility study to us. We then refresh our models. We kind of look at the market and what we think about costs, what do we think about the pricing that we have in our model going forward because we have to have a view on that. Then you go to what's called a pre-FEED. And then that kind of includes some engineering. And so it kind of narrows down a plus or minus in any project, right? Then you kind of relook at things again. And then you really sit down and have a more let's say, healthy conversation even with the Board at that point because next step would be really to do a full FEED study, which generally takes 9 to 12 months to do a FEED study depending on the size of the project or the complexity of the project. And then you kind of really now -- plus or minus, call it, 15%. And you're really deciding at that point, what's my final investment decision. So the reason I'm laying this out is this isn't you're spending the capital and starting to spend globs of capital tomorrow. That's probably all of that from start to finish. It's probably 1.5 year to 2-year process. So when we look at it, any debottlenecking that we would do, right? Any big projects that would require a lot of capital, we're probably not spending that capital until 2025, we're sitting here in 2023. So we are think about, obviously, timing of cash flows, timing of cash generation, and that goes into a whole thought process when we're talking about capital allocation, right? So what we do with the funds, how do we -- how much cash do we want to keep on the balance sheet versus how much do we want to get back to shareholders in some manner and then you go from there.