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

Hi, I'm Jeff Zekauskas. I analyze chemicals at JPMorgan. I'd like to welcome you to the JPMorgan Virtual Industrials Conference. Our format is virtual in the interest of health and safety. We're about to have a fireside chat. [Operator Instructions] It's my pleasure this afternoon to speak with Bob Patel, who's the CEO and Chairman of LyondellBasell. Bob has been CEO of Lyondell since 2015, having succeeded Jim Gallogly. Bob is going to make a few opening remarks and refer to the slide deck, and then we'll go to the fireside chat. Bob?

Thank you, Jeff. It's good to see you again, and thank you for having us. I wish we could do this in person, and maybe we'll be able to do that next year. Let's hope that's the case. What I'd like to do in my opening remarks is just refer to a few slides for our listeners to frame the conversation today. First, I'd like to start with Slide 4, which is a bit of background about our company. So for those who don't know LyondellBasell as well, I'd like to take a couple of minutes to explain who we are, what we do and how we did last year. So we're one of the largest chemical companies in the world. We play in the heart of the global chemical industry. We have a few very large value chains that we participate in. So ethylene and polyethylene globally, propylene and polypropylene globally, propylene, propylene oxide and compounding. We're one of the world's largest -- we are the world's largest compounder. Last year, we had revenue of about $28 billion, a little over 19,000 in employees. And we have manufacturing facilities in about 22 countries. I think the way to think about LyondellBasell is that we have geographic diversification. We have feedstock diversification, and we have product line diversification. All of that, when summed up, led to a very resilient performance last year. In 2020, despite the pandemic, LyondellBasell was able to fund its dividend, its CapEx and all of its expense needs from operating cash flow. In addition to that, we had funds in excess of those cash needs where we could fund most of our Chinese joint venture equity from operating cash flow. I think a terrific outcome in a very challenging year. And frankly, the first year that the new LyondellBasell was tested in a downturn. I think our feedstock flexibility, having positions in Europe, U.S. and now Asia and having these various product lines at very large scale, having industry-leading cost structure, all of that contributed to the resilient and strong results, relatively speaking last year. Next, I'd like to refer our viewers to Slide 7. So Jeff, when I have conversations with investors, it's inevitable that we get into a discussion about the cycle. And I just wanted to take a few minutes to describe what our hypothesis on Slide 7. We showed the same slide at the earnings call at the end of January. And the idea here is that if you look at the last 5 years, if you go back 5 years ago, industry consultants were predicting a downturn in the polyethylene cycle. But actually, what happened were the operating rates were relatively flat at very high levels throughout the entire period. In other words, the cycle really didn't materialize in terms of operating rates. So why is that? Well, both supply and demand contributed to that. On the supply side, projects were delayed, some projects were canceled towards the end of this period. And so the timing of supply coming to market was later than what was predicted. On the demand side, demand grew at a higher rate, given that packaging continues to play a very important role in enabling kind of the middle class around the world. And then, of course, during the pandemic, we saw the value of plastics that really came to life. Now if you look at the next 5 years, once again, remarkably, the consultant forecasts are showing a similar cycle. And what we're suggesting in our forecast over the next 5 years is that if the demand growth from '20 to '21 is 7%, not 4%, then the result is the dotted orange or red line in operating rates, meaning there's not much of a downturn. Now add to that the supply disruption that occurred along the Gulf Coast, mainly here in Texas, over February, March, and I would say that this hypothesis could very well become reality even if we don't get 7% in demand growth this year. Because potentially, 10% to 14% of supply along the Gulf Coast was taken out this year as a result of the freezing. So my point in all of this is that, certainly, we keep a watchful eye on new supply coming to market, but our sense is that there's not much of a cycle ahead. And as it relates to China, what we anticipate and what we expect is that even with all the expansions that are projected over the next 5 years for polyethylene in China, we think at a 5% growth rate in demand, China's import needs actually grow on an absolute basis over the 5-year period. So they need to import more if demand turns out to be 5% growth year-over-year. Now just to frame that 5%, last year, even with the first quarter that was impacted by the pandemic in China, demand for polyethylene grew high single digits from '19 to '20. If you look at first quarter 2019 and compare that to first quarter 2021, polyethylene demand has grown more than 20% over the quarter-to-quarter, Q1 '19 to Q1 '21, significant growth. And we're assuming 5% growth after 2021 in China. So I think it very well could be that the past 5 years could be very similar to what the outcome is for the next 5 years, a flatter operating rate cycle. I want to spend a few minutes next talking about our sustainability efforts and ESG. So on Slide 10, we show you our areas of focus. I would categorize our focus on the E part of ESG in 2 areas, circularity and climate. On the circularity side, our focus is on mechanical recycling, molecular recycling and bio-based or renewable feedstocks for the crackers. Let me take each very briefly and explain our progress. On the mechanical recycling, we've established a joint venture in the Netherlands called QCP. We are now fully operational in that joint venture, it's making money. Last year, we acquired another recycler called Tivaco in Belgium, and we have plans this year to either acquire more recyclers or to begin construction on greenfield facilities to continue to build out our recycling network in Europe. Our ambitions in mechanical recycling go far beyond Europe. We're also thinking about U.S., we're thinking about Asia and specifically China in partnership with Bora, who is our new partner there. So LyondellBasell, 5 years from now, should have mechanical recycling presence in all the major regions of the world. Our ambition that we've expressed in our last sustainability report was to have 2 million tons of recycled products by the end of this decade by 2030. The second prong of our approach on circularity is molecular recycling. So we had a pilot plant that we're conducting research on in our research and development center in Italy where we endeavor to take mixed plastic waste, convert that back to feedstock. This, I believe, will be kind of the game changer, whether it's us who discovers it or somebody else. I think there are many benefits to molecular recycling. First and foremost, we can bring in mixed plastic waste. It doesn't have to be presorted like what's required for mechanical recycling. Secondly, when you employ molecular recycling, because you're creating feedstock, the polyethylene that's produced is the same as the polyethylene that's produced from new feedstock. In other words, it's FDA approved, and it's virgin polymer, if you will. And the third benefit is that I think this can be done at a much larger scale than mechanical recycling can be. And so with mechanical recycling, molecular recycling, we endeavor to close the loop. And circularity will be a big part of who we are and what we do as this decade progresses. We've also cracked some bio-based feedstocks in our cracker in Germany in Wesseling. That continues to ramp up with great success. On the CO2 front, we have quite a bit of work going on, on CO2 reduction. We have some pilot programs in Europe, some pilot programs in the U.S. And our commitment is to reduce our CO2 emissions by 15% by 2030 when compared to 2015. So that, in a nutshell, sort of summarizes our sustainability efforts and the E part of ESG. I'd like to refer to one more slide, and then, Jeff, we can move into our Q&A. That slide is Page 21. So on Page 21, what I wanted to highlight here is the new cash flows from the investments that we've been making. So I was saying earlier to Jeff that 2021 is the year when we really now start to see the benefits of the investments we've been making over the last 4 or 5 years. Now I'd like to just take a minute to describe those and how we see their economic benefit or cash flow benefit in 2021. So first is the new polyethylene plant here in Houston. It's our new Hyperzone Polyethylene technology. By the way, the grades that we produce now, they really show great promise in terms of delivering differential properties, which will allow our customers to do more light-weighting of their parts without sacrificing efficiency. In fact, in many cases, we're seeing gains in terms of how many widgets per hour can be produced. So both strength and processability are being delivered by these products. So at mid-cycle margins, we estimate that this new plant should deliver about $170 million of EBITDA. By a mid-cycle, I would reference as the 2017 to 2019 time frame. Last year, we had very little EBITDA contribution because we were really proving out the technology. We started up about midyear. So this $170 million in mid-cycle would be new earnings for 2021. Secondly, the Sasol joint venture that we formed in December, what we call the Louisiana Integrated Polymers -- Polyethylene Joint Venture, that will see a full year of benefit this year. We closed in the first week of December. So again, at mid-cycle margins, we expect that JV or half of the EBITDA to be about $330 million. Those will essentially be all new earnings this year. The third is the project -- is our JV in China with Bora. So we closed that in Q3 last year. At mid-cycle earnings -- at mid-cycle margins, we would expect the EBITDA contribution to be about $150 million. In addition to that, the Advanced Polymer Solutions segment completed its integration work last year. And we exited last year with a run rate of synergies of $200 million. I would estimate that about half of those synergies were in the P&L last year and another $100 million should accrue this year. And then further out, we have our new PO plant, which will start-up in '23, with an estimated annual contribution of $450 million of EBITDA and our Sinopec PO/SM joint venture in '22. Let me add that in addition to these mid-cycle level earnings from these new projects, certainly, the market tightness that we're seeing and the margins that we project over the next couple of quarters at a minimum should further boost cash generation at our company. So in summary, I would say that strong, diverse company, able to fund dividend and CapEx for operating cash flow in one of the most challenging years in the past decade, one that's focused on sustainability, leaning into circularity. And in 2021, the investments that we've been making over the last 5 years are now coming into the P&L, and we should enjoy the benefits of those for years to come. So Jeff, with that, I'd be happy to move into the Q&A.

Thanks. It's a very nice summary, Bob, and I remember the years of Jim Gallogly running the company, and there was a tremendous focus on Lyondell being a lean entity. And there was some debottlenecking of capacity over a longer period of time. But in your tenure as CEO, what you've done is you've relied on that low-cost structure and really built up the asset base. And that's quite different than what some other companies have done that are in your space. And now you have the pleasure of seeing the assets come on stream and do what they can do. I was struck by your comment that you thought about 12% of PE capacity was lost. In that -- I think about Braskem-Idesa being -- having its challenges this year. And there's a fair amount of ethylene and polyethylene capacity that's offline, just for turnarounds on top of that. Is there -- do you think about it as greater than the 12% that's offline? How short do you think is the market in the United States? And what will it take to be in a more balanced position?

So first of all, today, I think because demand -- because supply is so constrained, we don't know what true demand is. And I know that, unfortunately, we and likely the industry is not able to meet the underlying demand today. And so what's happening, Jeff, is that as a result, the entire value chain is reducing inventory. That will take quite a long time. I think we'll be well into the fourth quarter before we see conditions back to normal in terms of adequate inventory levels across the value chain and assets running because we'll have another turnaround season in the fall as well. So the 12% that I mentioned earlier, that's, I think, just related to the freeze that occurred here, right, along the Gulf Coast, mostly impacted Texas, but there were some short-term impacts even in Louisiana. So this will take quite some time. And remember, the context was that coming into the year before the freeze, market conditions are already quite tight because of the hurricanes that we had later part of last year and demand increasing related to packaging. And we still have reopening in front of us. So in the U.S., in Europe, as vaccines are rolled out, the year-over-year demand growth and the additional recovery-related growth in demand is still in front of us. And supply is going to have to catch up all year-long to meet this level of demand that we expect this year.

I had always thought that as a base case, U.S. polyethylene prices would trade at something of a discount to Chinese polyethylene prices. And I think where we are today is maybe polyethylene out of Houston is about $1,600 a ton. And delivered tonnage to China is maybe around $1,200 a ton, maybe it's $1,250 now. What do you think will happen to that gap, if you have an opinion, between now and the end of the year? Do you -- how do you think it will close?

Well, based on what we're seeing in Europe, prices are rising globally. So margins are expanding in Europe. And I think the same will have to happen in China because today, Jeff, our priority is to supply domestic customers. So typically, most of our export is kind of spot export. Today, we don't have enough volume to even meet the needs of the domestic customers. So in other words, I think the price in China is going to have to rise to attract supply. And we're going into the seasonal kind of strong period in April, May, June, with kind of summer in the Northern Hemisphere. And again, I think reopening, both in the U.S. and in Europe, will provide another leg up in terms of demand growth.

So you're idea is that part of what's pulling the Chinese prices up is they can't get all of the polymer that they want because the other regions are constrained in their supply and selling at higher prices to their domestic markets.

And I think they'll have to come up more to close the gap.

And they'll have to come up more to close the gap. What about Europe? Is Europe facing its own challenges in terms of being able to supply as much polymer to the market as it needs to?

So Europe is also very tight. There have been some price increase initiatives there. We've realized margin increase in Europe. I think that this tightness is a global story, and I think it will stay with us for some time. And Europe is no exception. What's been interesting about Europe, Jeff, is that even though several of the larger, more populated countries are in lockdown, we haven't seen a significant reduction in demand. I think it speaks to the role of packaging during the pandemic. They stay at home, people go into the grocery stores more and not going out to eat as much as restaurants, that all favors packaging and polyethylene demand and even polypropylene demand. And I think that will be sticky. I don't think all of that unwinds post-COVID because people will maybe work from home more. And I think the value of the packaging or the benefits that packaging provide are really seen today. And I think they'll be lasting.

So the parallel to the -- just one last thing. So I was looking at my Bloomberg and I think spot ethylene prices are $0.59 a pound. And maybe a year ago, they were $0.10, $0.15, right? And Lyondell's long ethylene, so I would imagine that this would be a pretty good market for you in trying to deliver ethylene to the system where it's so short, no?

Well, it is. So our -- when we acquired Sasol, we actually acquired another 320,000 tons of ethylene, merchant ethylene. So that really benefits us as well. But today, Jeff, because our polymer units, our startups are running ahead of the cracker startups, we're really kind of preserving the ethylene to feed our polyethylene units while the crackers still come up. So 2 of our 3 crackers are now up and running. And the last one down in Corpus Christi will still be a couple or 3 weeks before we see that start up.

Okay. So just to sort of to flip over to the propylene side, that's also been an exceptionally tight market where maybe propylene prices have -- maybe they've gone from $0.40 a pound to $0.90 a pound, maybe in the spot market to $1 and now maybe they're at $0.65. Can you talk about why propylene has moved up so high? And then more recently, why it jumped lower?

Well, so with refineries running at lower rates, there's less refinery-grade propylene finding its way into the system. Combine that with feedstocks being fairly light in the U.S. and you have less propylene production. Because propane got pretty expensive this winter, and so propane was really not in the mix, same with butane. So we have this kind of, what I call a barbell feedslate, very heavy or very light, but not really LPGs in between, which tend to produce more propylene. So -- and then on the demand side, every propylene derivative has been very strong in terms of demand, not just polypropylene related to the auto industry coming back and the industrial sector coming back. So I think until we get through turnaround season, propylene prices will probably be on the higher side of historical levels. There's large PDH turnaround going on right now here. And -- but for our company, what's more important is the spread between polypropylene and propylene, that is a bigger earnings driver than the flat propylene price itself. Certainly, the propylene price helps because it's a co-product and we do crack heavier feeds. But if I were to think about the bigger driver, the bigger driver is the spread between propylene and polypropylene. And that's expanding, including recent increase announcements for April. And I think that will stay elevated much like polyethylene for most of this year.

So earlier today, Bob, we were interviewing Howard Ungerleider from Dow Chemical. And the Dow Chemical people said, second quarter EBITDA should be about $400 million higher than consensus. And in my opinion, you're subject to the same kinds of profit dynamics like Dow. It's not exactly -- you have more propylene or propylene and polypropylene are more meaningful. But those are also very -- has very strong conditions. So I mean, it looks to me like you'll have maybe record earnings for some of the quarters of 2021. Is that possible?

Yes. So let me kind of walk you through Q1 and Q2 and then maybe more generally. So first, let me start with the impact in Q1 and help kind of bracket earnings without guiding for Q1. I don't have a specific number for you today, but I'll help you kind of range it, right? So we're estimating that the lost profit in Q1 related to this freeze event will be somewhere between $430 million and $450 million. Now about 15% of that is maintenance cost, and the rest of it is just lost volume against kind of the margins as they played out in Q1. Now where does that land us for Q1 then? So Q1 '21 will be a lot better than Q1 '20 and will be kind of in the neighborhood or approximately where Q1 '19 was. So it may be moderately higher but around Q1 '19. Now if you took that as kind of a range for Q1 '19, you add back -- or Q1 '21, you add the $440 million of impact from the storm. And then you add to that the higher margins as these price increases come through, Q2 certainly sets up to be potentially one of the best quarters in the history of our company. Beyond that, I think this sort of margin profile and EBITDA could persist into Q3 and maybe even the early part of Q4. And I think, Jeff, what really drives beyond kind of the margins that I've described here, we have more assets this year than we did last year. So we really have to think about the impact of having more volume going into Q2 and Q3. So again, Q1 impact, $430 million to $450 million. We end up kind of in a range of where we were in Q1 '19. For Q2 '21, add back the $440 million, assuming everything runs, right? And then add to that the higher margins in Q2 globally, not just in the U.S. but also in Europe, and probably in China, where we have our Bora JV and maybe we kind of hold there in Q3. It provides, I think, our company an opportunity to generate really outstanding cash flow this year.

Thank you for that. That's quite clear. So in your opinion, Bob, as a base case, maybe sometime in the second quarter, things begin to level out. And the analytical issue is, is the downward slope sharp? Or is the -- is it slightly up? Or is it flat? But we're ending a period of shortage having to do with supply, and we're going to go into a period where demand is more elevated and supply is more elevated, and then we'll see how the cards fall. Yes?

Yes. I mean, I think if we level out sometime later in Q2 and we hold there for Q3, and then there's kind of a modest ramp down in Q4, I think that could be a reasonable base case. Now remember, Jeff, for us, there's other unique drivers of earnings in the second half and that's in the fuels area, right? So our refinery last year had a loss of about $290 million in EBITDA.

I remember. Yes.

Right. I remember that very well also. This year, Q1 will be a loss. Potentially, Q2 could get closer to breakeven. And in the second half of the year, we could have positive earnings such that for the full year, we could be breakeven or somewhat positive, tens of millions positive for the full year. When you think about sequentially from '20 to '21, that's potentially a $300 million swing in EBITDA, right? Now add to that the oxyfuels business, which last year really contributed no EBITDA in the first half...

In the first half of the year before, right? Something like that?

Yes. Yes. And kind of normally, we should be $400 million to $450 million. So I'm thinking that in the second half of the year, if we could see more normal earnings for half of the year, that's potentially another $150 million to $200 million of additional EBITDA that's not related to the polyolefins part of the business. So I think for us, as you think about earnings kind of coming off from the high levels and sometime in Q4, we still have more reopening benefits from the fuel side of the business that will accrue to us later in the year.

Also, I would imagine demand for propylene oxide should be in pretty good shape this year.

Very good. Very strong. Today, we can't meet all the demand.

Does that give you a little bit of pricing flexibility? Or the contracts are structured so that it's harder to capture that?

It's -- most of it is structured, but we were able to adjust some contracts at the beginning of this year. And we do sell some spot. On the spot, we can move it month by month.

So Bob, you now own -- or you're now part of a joint venture in the United States with Sasol. You now own Bora as [ part of a ] joint venture with Bora in China. Have those business relationships given you greater insight into the petrochemicals industry in the United States and in China?

Well, probably more so in China. Here in the U.S., because of our large presence, we have very good insights into how things work here in terms of feedstocks and products. Sasol has been a great partner. We're working very constructively together to maximize kind of value from that asset. I think what's different about our presence in China is that now we're a very large seller of locally produced product. And that gives us a different vantage point in terms of end-use markets and how we engage customers in China because we have local production of both polyethylene and polypropylene. And I see both of those as platforms for the future. In the case of the Sasol JV, at some point, we'll acquire the other half so there's potential to grow there. And in China, our partner is keen to continue to build Phase 2, Phase 3 over the next decade, let's say. So what I like about both of those is that they're platforms for future growth as well. And they're both situated where either we have feedstock advantage, in the case of the Sasol joint venture, or we have proximity to growing markets like the JV with Bora, and we like both.

Now that you're the manager of the Sasol assets, is the material produced going to different geographic jurisdictions or different customers? Have you reorganized how that product is sold?

So the agreement is basically, we sell 100% of the offtake in a similar way that we would sell what we produce in all our other assets. So it just becomes a part of the pool of polyethylene that we sell globally. So we could sell through our network in Europe. We could sell through our marketing people in China. We could supplement here in the U.S. We treat it as part of the entire system essentially.

Okay. So you're going to have probably a much better balance sheet coming up over the next couple of years. Do you have an idea of where you want your leverage targets to be? Do you have an idea of how to -- how to approach that issue?

So Jeff, I mean, if there's one thing we've learned in this last down cycle is a strong balance sheet in the kind of business we're in serves us well at the right times. So delevering is really our priority this year. When we think about targets, I think about, first of all, strong investment-grade rating, BBB, BBB flat, BBB+ outlook, something like that. In terms of absolute debt levels, $10 billion to $12 billion of gross debt, 1.5 to 2x levered, something like that. I think that gives us capacity to do things if there are opportunities. I think it provides strength to be resilient if there are other unexpected events that occur. I think in commodity businesses like this that are cyclical, strong balance sheet through the cycle is a very important part of being a strong company long term.

If you had to do it over again, going into the 2020 downturn, did you wish you would have had less financial leverage? And as you go forward, do you want to run with a leaner balance sheet?

Yes. I mean, I think maybe $1 billion or $2 billion but not significantly different. I think we were reasonably well positioned coming into the downturn. And as evidenced by the fact that we could hold our rating and we still did the Bora, we did the Sasol JV, so I think not materially different. No regrets, frankly, looking back. I think we made the right decisions. I think we were disciplined on our growth. We had a mix of organic and inorganic. Equally, we were disciplined to say no on certain things, and that was also very deliberate. We decided not to undertake certain larger acquisitions because we weren't satisfied with the risk profile. And we didn't think that, that was something we needed to take on. So I guess the bottom line for us, Jeff, is when I think about M&A, it's really about being opportunistic, and it's about applying our strengths to create more value for our shareholders. I don't feel like we need to acquire something to further strengthen the company. I think it's more about how do we create more value. So it's more about playing offense, if you will, and be opportunistic.

So Lyondell -- in Lyondell's history, you've repurchased enormous amounts of shares. But more recently, much less, and there's been more of an emphasis on acquisition, in my opinion. When you reflect on the history of the company and what the acquisitions are doing for you and what the share repurchases have done for you, do you reach any conclusions about how the company might go forward?

Well, I think whether it's the Schulman acquisition or the Sasol JV, what it says is that we want to be opportunistic with M&A and add that to the mix. Before that, we were basically just doing buybacks, right? We had the same amount that we did month after month after month. And so what's different is that the LyondellBasell of today has all those levers in front of it to create value for shareholders, whether it's buybacks, progressive dividend, pay down debt or do acquisitions. And so we'll look at that whole range and undertake our decisions in a very disciplined way, like I think we have. And I think you're seeing the benefits of that. And as I said in my opening remarks, what's really gratifying to me is that in 2021, we're really kind of seeing all this come together. These investments we've undertaken for the most part are going to be fully in the P&L this year. And as we go forward, while delevering is a priority, we expect to continue to grow the dividend this year as well. And when we reach or get closer to our leverage targets, we'll consider whether we should do buybacks or delever, should we further increase dividend. But with respect to the dividend, one thing is very important that I want all of the investors to hear, which is that we want to size our dividend to be able to pay it through a cycle. So we don't want to overextend on the dividend, knowing the kind of industry we're in. And so we want to be able to do exactly what we did last year, fund the dividend, fund the CapEx from operating cash flow. And all the while maintain the stronger balance sheet. So I mean, I think we'll pull whatever lever makes the most sense to create shareholder value.

The share repurchase is complicated because there's just tremendous volatility in share prices. But you also do pay a good dividend. And so you capture that in your share repurchase. So maybe if you could just make a concluding comment on how you might see the way Lyondell looks, say, 3 years from now? Not so far away. Is it more you're going to bring more assets up? Or is there anything else special that you have in mind?

So in terms of the portfolio, I mean, certainly, we're thinking through our position in refining what to do there. Beyond that, I mean, I don't see the portfolio being dramatically different. I think 3 years from now, what will be different is the LyondellBasell 3 years from now will have done and demonstrated a lot more in the area of circularity. We'll have a lot more mechanical recycling. My hope is we're on the verge of making a final investment decision on our first molecular recycling plant to be built probably in Europe, and that we'll have a clear line of sight to a net 0 by a certain date in terms of CO2, and we will have already implemented some CO2 reduction by -- in 3 years.

Okay. Thank you very much, Bob. It was a very comprehensive presentation. We wish you good fortune, and we hope to see you next year live.

Thank you for having us. Good to see you.

Okay. Take good care.