LyondellBasell Industries N.V. (LYB) Earnings Call Transcript & Summary

Welcome, and thank you for standing by. This call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to your host, Jeff Zekauskas. Thank you.

Okay. Thank you very much. I'd like to welcome everyone this morning to the JPMorgan Virtual Industrials Conference. We've changed our format for our 2020 conference to a virtual one in the interest of health and safety, and thank you for attending this morning. This conference call is a public call. So whether you're a member of JPMorgan or you're not a member of JPMorgan, you may attend the call. It's my pleasure this morning to introduce Bob Patel, the Chief Executive Officer of Lyondell. Bob has been the CEO of Lyondell for 5 years now and under his leadership, Lyondell has become an exceptionally efficient manufacturer of petrochemicals. Michael McMurray, Lyondell's new Chief Financial Officer, will also participate in the call. Previously, Michael was Chief Financial Officer at Owens Corning, following a long tenure at Royal Dutch Shell. Bob will make a brief presentation, and then Bob and I will conduct a fireside chat. Bob?

All right. Thank you for your kind introduction, Jeff. To our audience, I draw your attention to Slide 2, which is our cautionary statement as we're presenting during other such venues. So I wanted to start by making a few comments about our company. For those who are not as familiar, we're a global leader in the olefin and polyolefin and intermediates and derivatives industries or businesses. We participate in the heart of a $4 trillion chemical industry. Those are based on global revenues from 2018. We have leading positions in most of our product areas. We have the largest polypropylene compounding business in the world today and our polyolefin licensing technology is very well-known globally and is a leading business as well. We have #2 position in polypropylene, propylene oxide and oxyfuels and #3 position in polyethylene and polypropylene. 2019, we had revenues of $35 billion and we have about 19,100 employees globally, and about half of those are employed outside of the U.S. So we really have a very diversified sort of global footprint. If you look at our 2019 performance as a snapshot, we reported EBITDA of $5.7 billion and net income of $3.4 billion, which led to cash from operating activities of $5 billion. That's about an 87% conversion rate from EBITDA to cash from operating activities. What's notable here is that in a somewhat challenging environment last year, we got a portfolio of diversified products, global presence, the flexibility of our assets, really showed its resilience and delivered outstanding results despite the fact that our Refining segment faced significant headwinds in terms of narrowing by heavy differentials. So we were able to still deliver very strong performance in our O&P and I&D segments. And the Advanced Polymer Solutions segment is really now coming of age, and we're building that platform. On Page 5, we show our consistent cash conversion and strong cash flow from operating activities. And I think this is one of the hallmarks of our company that we, year after year, consistently deliver very strong cash flow in a range of market environments, and I'll talk about that in a minute. But in 2019, we converted 87% of our cash -- of our EBITDA into cash flow from operating activities and about 12.5% free operating cash flow yield. Very significant and very strong and I think really underpins our steady top decile dividend and continues to afford us the opportunity to maintain our assets very well as well as continue to invest in growth projects, especially here in the U.S. On the next page, you see our capital returns compared to our peer group, our closest peers, and you can see that we outpace our peers in terms of dividend yield as well as share repurchase yield. So our dividend today is significantly higher than the 4.8% we had in '19. It's a very well covered dividend with the strong cash flows that I have mentioned. And last year, we returned $3.8 billion back to shareholders through our share repurchases, including a 10% tender of our shares in the fall. So if you look back even beyond last year, we have consistently delivered strong total capital returns to our shareholders. This is very much at the heart of our capital allocation strategy. Turning to the next slide, Page 7, I want to summarize what we talked about at Investor Day back in September. First of all, we talked about the fact that our portfolio is a leading, an advantaged portfolio and when you combine that with a very disciplined capital allocation strategy, we think that the formula for positioning LyondellBasell provide extraordinary shareholder return through a range of market conditions. One of the things that we talked about or the central theme of the Investor Day back in September last year was that we're positioned to increase cash flow based on the investments that we've made and the cash flow profile. So I want to provide some perspective on this. If you look at the period from 2015 to 2019, we've had a significant share repurchase program but in some ways, if you think about free cash flow per share, that's been offset by decline in free cash flow. And the decline in free cash flow has been partly from the earnings, or probably from an increase in CapEx. So from 2015 to 2019, our EBITDA has declined by about $2.4 billion and our CapEx has increased by about $1 billion over that period. We believe that if you look at the next 3 years, we're positioned to really reverse that trend. First of all, in terms of EBITDA, under similar market conditions as to what we've had in the past 2 quarters, we believe that we're positioned to increase EBITDA by about $1.3 billion. That's largely from earnings contribution from assets that we've invested in, whether they're built or acquired. So for example, synergies from our A. Schulman acquisition will be fully in our P&L by the end of this year on a run rate basis. So we announced at Investor Day that we expect synergies to be about $200 million run rate by end of 2020 and we're well on pace to deliver that. We also expect that our new polyethylene plant under similar conditions to what we've observed over the last quarter or 2, should deliver between $150 million and $170 million of EBITDA in 2021. And then our new PO plant will deliver another $400 million to $450 million of EBITDA starting in 2022. So when you combine all of that and some smaller projects that we're executing, we show the potential for $1.3 billion of higher EBITDA in 2022. When you apply an 80% conversion rate to free cash flow, we expect $1 billion of additional cash from operating activities. Our CapEx is planned to decline from $2.9 billion in 2019 to $1.9 billion in 2022 after our PO/TBA project is complete. We're very much on track to deliver on that CapEx profile. So when you combine the 2, we're positioned, we believe, in 2022 under similar market conditions as what we've seen in the last quarter or 2 to deliver $2 billion of higher free cash flow. And if you hold the share price constant or the share count constant with the free cash flow per share, it's positioned to increase dramatically over this period of time. So in summary, LyondellBasell has leading advantaged positions. We're one of the best operators in our space. We have attractive products in attractive end markets. Our feedstock advantage and our feedstock flexibility really led to the resilience of our portfolio and reflects quite a lot, especially in the U.S. assets, in terms of how much LPG we've cracked, in terms of our ethylene production in the past 6 months, and we've demonstrated recently our ability to crack Y-grade and the feedstock as well. So our feedstock flexibility, we believe, is one of the best in the industry and it continues to get more flexible over time. We have very disciplined financial policies, I mentioned earlier a very secure and progressive dividend, very efficient cash flow conversion, and we're committed to a strong investment-grade rating. And lastly, we have several projects that will complete or are completed now and will complete over the next 18 months that will provide more cash flow when combined with our activities with the A. Schulman integration. We're positioned to meaningfully increase our cash flow delivery, and therefore, returns to our shareholders. So with that, Jeff, I'll stop and we can move into our Q&A.

Thank you for that summary, Bob. COVID-19 is on everyone's mind these days. If you weren't reading any press accounts about COVID-19, could you detect something that had changed in demand from your business performance in Europe or maybe in Asia?

So if I look globally, Jeff, our volumes have been very resilient quarter-to-quarter. So from Q4 to Q1, we're running most of our assets at full rates. And in China, we've returned just about back to full rates in our compounding facilities. I'm also pleased to say that as of yesterday evening, our company was virus-free, none of our employees have the virus but we're taking significant measures to protect our employees and by reducing travel and how we do shift changeovers in our big sites and so on. So from what we hear from our people in Asia, and especially in China, our business is starting to resume back to normal. Activity is increasing. Our offices are now fully up. I think everyone's back in the office. So we see -- quarter-to-quarter, we don't see a lot of volume impact, frankly. I think what we may see is a more muted sort of seasonal improvement in volumes. But quarter-to-quarter, we see a lot of resilience in volume and in margins. The one area where we've seen some impact is in our Refining business, where diesel crack spreads have been compressed pretty significantly and gasoline crack spreads have also come in turn. So as I look quarter-to-quarter, our Refining segment, we'll see some impact from market effects as well as some internal downtime we've had. Actually seeing that the rest of the business looks to be pretty resilient quarter-to-quarter.

Can you speak to your European operations? Have demand change -- has demand changed there over the past several weeks?

The demand has been pretty decent, even in Europe. We're running -- except for a couple of small assets, we're essentially running at full rates. And as of this morning, our Italian operations which are polypropylene and some catalyst of production, they're still at normal. We're monitoring what the authorities require in terms of travel restrictions. But we're running at pretty full rates even in Europe.

So the other event that is affecting petrochemical company, this is the very sharp change in oil price. How do you think about the relationship between Lyondell's overall EBITDA and changes in oil prices? Do you have any rules of thumb or a sense of how the company behaves under those circumstances?

So Jeff, given our portfolio of assets and as we talked about in Investor Day back in September, we've done well in a range of low price environments, as we had some natural hedges in our portfolio. For example, when oil prices are lower, generally, our European business does better as natural prices come down. And we have a significant position in that part of -- in that geography. So -- and also, you've seen oxyfuels business do better at times and polyethylene has not done as well. So I think our portfolio and the diversity of that portfolio in terms of geography, our feedstock flexibility and the product mix that we have do provide some offset and some resiliency in terms of earnings. Furthermore, oil prices declining, I think we have to think about our business as a margin business. And so the impact on margins will have a lot to do with how supply-demand develops and how inventories develop over the next quarter or 2. Our sense is that from the warehouses and the ports that we ship through in China, we don't see unusually high inventories. We think inventories are at typical levels coming out of Chinese New Year. So I think we'll have to see how supply-demand balances develop, but I wouldn't translate lower oil pricing to lower earnings directly.

Do you have a sense of what Lyondell's trough earnings are? And is that trough earnings relative to a particular oil price?

So at our Investor Day back in 2017, we actually -- I tried to estimate what trough earnings could look like, and I think at that time, we showed trough EBITDA of $5.5 billion. Now that didn't assume a recession. So if we entered into a recession globally, perhaps there's some downside to that number. But we think somewhere in the $5 billion to $5.5 billion range with some recessionary effects is likely kind of trough EBITDA for our company. Especially, Jeff, as you think about new assets with our polyethylene plant that's nearly had started up now and with the addition of the Schulman integration and related synergies and earnings that we've acquired. So I think the $5 billion to $5.5 billion range would be maybe a big trough sort of range, including some recessionary impacts.

It's also the case that domestic natural gas prices and ethane prices and propane prices have moved lower. Is that something which is assisting you? And are you changing your feedstock slates in the light of those changes?

Well, that's certainly helped with ethane price declining, and especially propane and butane has been very competitive during the winter months. Normally, as you know, propane and butane have sort of seasonal pricing. In the winter time, they tend to be a little more expensive and in the summer months, they tend to be much more competitive as cracker feeds. This year because of the abundance of supply of NGLs, we've really seen propane and butane be very competitive. The other benefit we get when butane is cheap is that we enjoy better margins in our MTBE business, which works the benefit of I&D. So we change our feeds rate every week. And at times, we might even change within the week if there are dramatic price changes in feedstock. And I think, Jeff, this is part of what provides resilience in terms of our earnings capability is our extraordinary flexibility, especially here in the U.S. factory fleet.

Lyondell historically has been a very aggressive repurchaser of its shares. In the light of the very, very sharp changes in the oil market and economic discontinuities, is it most likely the case that you'll pause to examine the current economic environment before continuing your repurchase? Or will you look at the decrease in your share price and say, "Oh, this is an obvious opportunity." What's in the best interest of Lyondell?

Jeff, I'll step back and walk through our capital allocation strategy. First and foremost, it's important that we maintain a strong investment-grade rating. So today, we're a BBB+ rated company. And I think in times like this, that rating served us very well and it's something that we'd like to preserve. So with that as sort of the overarching philosophy, then we think grew a strong and progressive dividend policy. We're very committed to that. We have a very well covered dividend today and we do intend to have a quite sort of progressive approach to that dividend. Given the cash flow conversion that we demonstrated, that are highlighted in my prepared comments, I do think we'll have excess cash flow over the course of the year to be able to dedicate some of that to repurchasers. And then if I look further out, we have very strong conviction about the increase in cash flow related to our investments coming online and the reduction in CapEx. So if I look from here to 2022, we're very confident in our ability to deliver a meaningful increase in cash flow. And between here and there, I think we'll try to balance our desire to have a strong investment-grade rating. We have a progressive dividend and to be opportunistic in buybacks. So sort of balance all of that and be very value-minded to the extent that we undertake further buybacks.

Bob, can you speak about your joint venture investment in Bora, in that I think many investors have been a little surprised by the investment, in that they always look to the United States as the area where investment returns are the highest. Why is an investment in China a good idea at this time?

Well, this is a unique investment, Jeff, for us. First of all, it's our technology that we license to Bora. We did that 3 years ago. Since then, Bora had approached us about further participation. So our technology sort of got us in the door. What we find unique about this investment is that, first of all, the capital costs are about $2.6 billion for a 1.1 million ton cracker and related polyethylene and polypropylene capacity. So about 800,000 tons of polyethylene, 600,000 tons of polypropylene. If you think about an investment like this in the U.S., the cost could be as much as double the cost of building this particular asset in China. I had the opportunity to visit the facility back in September when we signed the MOU. And really, what I saw was a world-class site that is positioned with water access to feedstock. So it's kind of in the ports. And the infrastructure to import feedstocks, very good quality, in terms of construction is very good. And what's unique for us is that by the time we have to infuse the capital, we'll be within 2 quarters or 1 quarter of start-ups. So -- and then you think about NPV, IRR, certainly, that makes the potential for return much better than investing from the beginning of the project. Last week, for us, strategically, I think this will give us a better view into the market locally, how demand is developing trends for products and the needs of the market over time. And also, it will give us better visibility to future builds, inventory trends and the like. So I think it will make us a stronger global polyethylene company by being present there and we see very attractive returns, especially on a levered basis.

Is the speed of construction in China different than what it is on the Gulf Coast?

Yes, certainly, it is. It is faster. We would estimate that it takes something like 60% or 70% of the time that it might take in the U.S. Some have done it faster, but it's kind of 2/3 of the cost and 2/3 of the time, and maybe it's a little better than that even.

I don't know if this is a fair question but if you had to compare the -- your idea of what the Bora investment will deliver to what -- to the returns of your Hyperzone investment in the United States, are they comparable returns or very different returns?

I think, over time, they'll be very comparable. And there is one key aspect to the Hyperzone that I think provide sort of this quality in returns, which is that we already produce the ethylene. So we didn't invest in the cracker. So when you look at U.S. investments, generally, Jeff, the larger investment is in the ethylene capacity, not in the polyethylene capacity. So this is an opportunity with the Hyperzone polyethylene plant for us to further integrate and get more towards a balanced position. So you've heard me say in prior calls that we're a little over 2 billion pounds long in ethylene prior to the Hyperzone polyethylene plant start up. So we'll be about 1 billion long post the start-up. So I think that, combined with the uniqueness of the technology as we will be able to produce differentiated products that we think will create value for our customers in terms of lightweighting and efficiency in terms of the number of parts they can make per hour that we think there will be value there to be shared between us and our customers, which will also drive returns.

And so the implication of that is your returns are higher by taking your ethylene and making it into polyethylene in your Hyperzone plant rather than selling ethylene to the merchant market, is that correct?

Over the long term, we believe that will be the more profitable way to participate in ethylene, polyethylene. And I was very clear at Investor Day when I said that we would not build a new cracker in the foreseeable future. Just the CapEx is so high that we think the better priority is for us to consume the ethylene we already produce. And once we're balanced, then we could evaluate whether we would invest in an integrated complex in the U.S. But that's, in my view, probably later in the decade before we have to make that decision.

Bob, you're an observer of very wide trends in the oil markets and the chemical markets. Aramco and ExxonMobil are building a very large cracker in the United States for 2021. Do you think, over time, the oil companies will invest more in chemical projects than they have historically? Or do you think there's not something which represents a clear trend?

Well, they've certainly, Jeff, indicated their interest in participating more in the chemical space, especially given the prospect of electrification of vehicles over the next 10 or 20 years. So I've observed the same things that you have, in that we have interest in extending downstream. And if you look at the leadership in many of these oil companies, they come from the downstream. One of the things that I wonder, Jeff, and I don't have the answer to you today is, at what point do the current valuations of existing assets play a role in decision compared to the cost of new builds, especially in the U.S., new projects, a very well-executed project for ethylene and polyethylene could be in the range of $7 billion, $8 billion. Some as you know, have gone even higher than that. So when we look at that and you look at where existing assets, our price in equity markets, I would suspect that, that would have to come into one's consideration over time.

The history of the chemical industry has been one where integrated oil companies who really never buy chemical companies or chemical assets, and that they're much more interested in their own oil production. Do you think that, that's something that can change over a longer period of time? Should it be the case that gasoline demand diminishes in its rate of growth?

Well, I think, in part, you've answered your question, which is that we're in a very different environment today. In the past, the big oil companies prioritize oil production because that was their source of return over long term and petrochemicals were seen as being as much of a value driver. As you know, I spent 20 years with Chevron and affiliates, so I think times have changed and perhaps perspectives will change as a result as well as chemicals are seeing or chemical businesses are seen as more strategic to big oil. Furthermore, the prospect of participating in lightweighting of vehicles and the like also has positive ESG sort of implications. So I think we're in a very different world today compared to where we were even 5 years ago and how oil companies might have thought through this. But again, this is a CEO of a chemical company's operating views about what an oil company might do. So take it with a grain of salt.

Can you talk about the behavior of your intermediates and derivatives business in the current environment? So we've got declining propylene prices and most likely in many of the offshore markets. But at the same time, your business has historically steady returns. The I&D segment generated about $2 billion in EBITDA in 2018 and maybe $1.5 billion in 2019. What's the prospects for that business, business prospects look like for that business in 2020?

So Jeff, if we were to think about the most cyclical parts of our I&D business, it would be styrene and methanol, which once we start our PO/TBA plant, our merchant methanol will decline quite a lot. So there will impact of methanol on earnings, post '22 will be a lot less. So styrene has probably been the biggest sort of swing in earnings. And today, we're sitting at trough conditions in styrene. Could be a [indiscernible] for styrene. Probably doesn't make sense in many parts of the world today. For us, it's a co-product with propylene oxide. So the 2 together still generate good returns. The stability comes from our PO business, which where we deploy our proprietary technology, PO/SM and PO/TBA, both technologies, if you look at a technology cost curve, they're at the lowest end of the cost curve. So that builds in already some margins, given that those technologies are low-cost technologies. In addition to that, generally, the PO business tends to be very stable, more sort of cost plus sort of pricing orientation. So that provides a lot of the stability. Adding to that, our MTBE business has been very good lately because butane is cheaper. But as I look at trends going further out, the engines in automobiles, to the extent that their internal combustion engines are becoming much more sophisticated, more horsepower, higher compression and smaller engines. So they have acquired high-quality fuels. And I think that plays very well to our oxygen business and we're quite constructive about that. And so building a PO/TBA plant for butane is cheap and oxygenic demand is increasing globally. We think that the large part of our I&D business should continue to provide stable cash flow and stable earnings.

When you bring up your new PO/TBA plant, is that something that comes up and operates at full utilization? Or is it something which sort of steps up gradually over time? Is it something where you take material and sell it to the spot market? Or is your volume really contracted in advance? Or is it a combination of those things?

Yes, it's a combination of those things. So first of all, Jeff, we will have a ramp-up in terms of the operational sort of aspects of it. It may seem such a large plant. So I would think that we'll have a quarter or 2 of ramp up depending on how the commissioning goes. Beyond that, on the PO side, about 2/3 of the PO is already contracted. And 1/3 of it, we would likely sell into the spot market. And over time, as the U.S. market grows, we would repatriate that spot volume into contract volume over a period of 2, 3 years. We think that, that PO/TBA plant is coming on at a time when generally, the market demand is growing such that there is a need for kind of 1 or 2 plants every year, excluding recession periods. So we think [indiscernible], as I mentioned, from an MTBE standpoint and ETBE, we sell those to Latin America, Central America and to Asia, and we expect that there will be very good demand for that product. So think of our PO as 2/3 contracted and 1/3 spot. And that 1/3 spot will be repatriated over the first few years as the domestic market grows in the U.S.

So maybe as a last question, for a long period of time, Lyondell contemplated the purchase of Braskem and then chose not to go forward with that idea. When Lyondell thinks about its acquisition or combination possibilities, are the probabilities of larger combinations like Braskem now lower? Or are they the same? Or how do you view Lyondell as an acquirer these days?

Well, Jeff, our value-minded, disciplined approach hasn't changed. And I think this -- our decision around Braskem is an example of that. We think about how do we apply the things that we do well to create value in consolidating in existing businesses that we're in or in adjacent markets but we really think through cost and operational synergies, just like we did with Schulman. And so think of us as very value, maybe deep value-minded and very disciplined. So in the case of Braskem, really, the acquisition thesis was, first of all, our ability to generate synergies from funding in the Braskem assets into a fully global network of assets so we can now optimize trade flows more so than they could today, especially in polyethylene, given that their production is only in Brazil today. So that was one aspect. The second was our ability to buy feedstocks globally. We thought that, that could create value. Third is sort of applying our cost structure and our scale to their assets. We were -- we found that over time, Latin American position could be very attractive. We do see that as an interesting market longer term, but one that still has its challenges from time to time. Ultimately, we decided to not pursue the transaction further for a couple of reasons. One was, there was really unbound liability around the salt mining operations related to their PVC business. That's just something that we weren't willing to take. Secondly, their financial results have not been certified by their auditors and that had gone on for quite some time. And lastly, there was some degradation in the business and their results as our discussions continue. So in order, the unbound liability and the delay in the financial results gave us pause. While I think the business results could be solved through valuation, unbound liability is something that we could not tolerate as we think through, felt through the acquisition.

Okay. Thank you for that complete answer, Bob. And I think that our time is up and that will conclude our call. Thank you very much, Bob.

Thank you, Jeff.

Okay. Take care, Bob.

This will conclude today's conference. All participants may disconnect at this time. Thank you again for your participation on today's call.