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

Hi, it's Vincent Andrews, and welcome back. Our next fireside chat is with LyondellBasell. And we're very pleased today to have Bob Patel, the CEO with us. Before we get into it, I just have to do 2 housekeeping items. The first would be to let you know that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. Secondly, we do have Q&A capabilities from the audience. [Operator Instructions] Please go ahead and please do it sooner rather than later, both so that there's no delay in getting to us and also because sometimes it's just better for me to feather your questions in with the ongoing dialogue rather than sort of asking them at the end piecemeal. And with that, Bob is going to go through a handful of slides and then we will do some Q&A from there. So Bob, over to you.

Perfect. Thank you, Vincent. Thank you for having me. Good afternoon, everybody. Our slide deck was distributed to everybody. So I just want to draw your attention to Page 2, which is our cautionary statement. And some of the things that I'll say today are based on the best knowledge we have today, definition of EBITDA, things like that. So let me first start by just talking about how our company, LyondellBasell, has emerged very strong coming out of the pandemic. Now in some ways, we're still in it. However, the worst of it, hopefully, is behind us. And last year, I think our company was really put to the test with -- in the new structure. Since 2010, we haven't been through a downturn. And a couple of things, I think, we showed last year was our agility and, very importantly, our ability to pay our dividend from operating cash flow and maintain investment-grade rating through the downturn. We've already been upgraded by both agencies. So we came through it. I think, quite well. And it's a testament to the portfolio and the cost structure we've built. We've talked about leading in advantaged positions that we have today in LyondellBasell. What that means to me -- this is on Page 3. What that means to me is that we have a global footprint, we have large-scale assets and we have a significant position in the U.S. where there is feedstock advantage. In addition to that, we have significant feedstock flexibility to be able to be resilient and deliver resilient earnings in a range of energy price environments. And I think, again, we've shown that over the last 12 to 24 months. Consistent financial strategy. We've said this often that we aim to be an investment-grade company through the cycle, pay our dividend from operating cash flow. And we've been -- we've shown that we're very disciplined with M&A. And we're very disciplined with our discretionary cash flow. In fact, with the amount of delevering that we've -- that's taking place in the company today, we think by year-end we will have reduced our gross debt from $16 billion to $12 billion. We now have our tax refund in the bank account, so to speak. So the path to $12 billion in gross debt at the end of the year is now very clear. In addition to that, we will dedicate our discretionary cash flow to share repurchases. And we expect that net debt by year-end will be less than $10 billion. We've talked a lot about cash flow and increase in cash flow from the investments. I'll come to that in a little bit. But I think we're just now on the front end of the momentum building from these new investments. On Page 4, you see a performance snapshot and the most recent earnings. I won't go through all these numbers, but clearly very, very strong cash flow generation from the company. And what I'm most pleased to report to you today is that the refinery has now turned positive. And we continue to see good earnings momentum from the refinery and positive cash flow. Page 4 (sic) [ Page 5 ] just shows our recent climate ambitions and circularity and our strategy around sustainability. Now what I would say to you is that there are kind of 2 big pillars in our sustainability strategy: circularity and CO2 reduction. Our aim is to lead in circularity. It's an area where we want to be a developer of technology because we think that it plays to our strengths of being basic in polyolefin technology, catalysts, where we operate polyolefin plants all around the world. So we think that we're well-suited to develop technologies, whether it's mechanical recycling, molecular recycling, which is our MoReTec technology and, of course, use of renewable-based feedstocks. We will spend a good bit of energy around leading in circularity. On CO2 reduction, our aim is to be more of a fast follower. We are doing some work in that area. We have some pilots going on in Europe, possibly some alliances with process owners to work on electrification. But likely, when you think about development, we will focus on circularity. And on CO2, we'll likely more focus on licensing in for working through alliances. On Page 5, you'll find our growth trajectory and -- sorry, Page 6. Page 6, you see the investments that we've been making and the expected earnings from those investments. So prior to 2018, our view was that LyondellBasell had mid-cycle earnings power of about $6.5 billion. As of now, with the investments that are already online, we've increased EBITDA at mid-cycle by about $1 billion. So we believe today's footprint has a mid-cycle earnings power of $7.5 billion. After the PO/TBA project starts at the end of next year and has a full year in '23, that will add another $0.5 billion of mid-cycle EBITDA, taking us to $8 billion. And when you think about that, if you take $8 billion -- $7.5 billion today and you convert to cash at 80% and you have a $1.5 billion dividend, that still leaves $2 billion to $2.5 billion of discretionary cash flow. If all of that was dedicated to buybacks, we would be providing a yield of 12%, 13% if you include buybacks plus the 5% dividend that we have. And as I mentioned earlier, in terms of capital allocation and cash deployment, we expect to be at our target in terms of debt at the end of this year. And we do not plan to do more delevering next year nor do we have any maturities -- or bonds maturing next year. On Page 7, you will find our EBITDA profile. And you can see clearly that our earnings are at their highest level since we emerged from bankruptcy 12 years ago. And I've been with the company through this whole period of time. And I think we've really built an incredible foundation in terms of focus on safety, reliability, cost efficiency. All of that has stayed with us. And now we've built upon that foundation, adding the A. Schulman acquisition, the Bora JV, Sasol JV, the Hyperzone plant and soon-to-be the PO/TBA plant in 2023. I think the momentum in our company is just incredible. And when you take that cash flow and -- Page 8 kind of summarizes all of these points. But the way I think about it is that when you take this asset base and the amount of cash it can generate, plug in our disciplined capital allocation strategy, I think we're poised to deliver strong returns to our shareholders through cycles. So Vincent, I'll turn it over to you for the Q&A.

That was great. And it kind of gets to the heart of, I think, somewhere that we should get started with, which is just the various cycles within your businesses. I mean you have some things that are very much in peak cycle conditions and other things that are still trying to recover from some of the COVID-induced or supply chain-induced challenges. So maybe we could start with the O&P segments and maybe just start with polyethylene in particular, where my take is that we've had extraordinary supply outages over the past 12, 15 months or so. And they have an extraordinary and they've had an impact on supply and, therefore, on prices. But there's been a very important demand story that's kind of gotten overlooked because it's just so easy to discuss the supply situation. And there's a lot of anxiety about supply normalizing and what's going to happen to margins. So maybe you could help us bridge sort of the supply and the demand to where you think things might smooth out to maybe by this time next year?

Sure. So you made a very good point in terms of demand. And we've talked about this in various forms that we see demand staying stronger for longer. And if you think about it today, all of us as consumers are facing shortages of things we want to buy, whether it's automobiles, furniture. Come holiday season, lots of the things that we want to buy as gifts won't be available because of supply chain or raw material shortages. And I think that's all pent-up demand or deferred demand that will continue to provide a strong demand environment well into next year. And when you couple that with the reopening, that's still happening around the world and people starting to travel more. The U.S., for example, just opened their borders for international travelers yesterday, I believe. So I still think there are recovery elements in front of us, reopening-related demand, also deferred demand because of shortages and supply chain disruptions. All of that really sets up well for demand well into next year. On the supply side, definitely, the disturbance we had earlier in the year with hurricanes, the freeze, all of that is kind of normalized. And I think we're getting to a place where assets are running reasonably well. The only area that I think could still cause some challenges, not weather-related, is additive shortages. For example, yesterday, we declared force majeure on polypropylene in the U.S. for certain grades that require peroxide. We can't get enough peroxide. And so -- and it comes from China. A couple of containers missed. They didn't get on the ship that was headed this way. And we just don't have enough, so we're on allocation. Antioxidants are that way. So I think these sorts of supply constraints likely will continue to roll into Q1, which will likely keep supply and demand imbalance or tight. And I think we'll have these periods where things feel a bit looser and then there will be something else. So if you cut through kind of all the noise, it seems to me that with strong demand well into next year, I still think we end up at something better than mid-cycle kind of conditions in polyethylene and polypropylene globally. And one other point, Vincent, is that today we still don't have normal flows of containers. There are a lot of containers -- empty containers stuck in the U.S. Shipping costs are high. So when you think about finished goods from China to Europe or to the U.S., between container availability and high shipping costs, in many cases, they're just not making the finished goods because they can't get them out or they can't pass on the freight cost. And so I think getting back to a more normal trade pattern will in itself create more demand. And I think it will smoothen out some of these disruptions, which I think are a net good in terms of the health of the market.

And then also, we've seen -- in the last few months, we've seen a real run-up in the price of Brent crude oil, which obviously provides some support at the high end of the cost curve. We've also seen some increase in U.S. natural gas prices and, subsequently, ethane. But the spread is widening. So how much comfort does the $85 a barrel of Brent give you as you look into next year and think about if supply is really normalizing and we're starting to see some seasonal declines in pricing? Does that $85 Brent -- does that really raise the floor in terms of where things can normalize back to?

Yes. I think -- our view is that oil will be tight for some time. We're not seeing the drilling activity come back as strongly as we would have expected. I think the measures have been very disciplined in terms of drilling activity here in the U.S. I think you could paint a scenario where oil prices are $80, plus or minus. The Permian is maybe the best place to start up production, which means more gas and more NGLs for the U.S., which could actually widen the oil-to-gas ratio. So today, you have an oil-to-gas ratio that's 25-plus, and parity is somewhere around 6 to 8. So there's already quite a bit of slope in the cost curve when you think globally. And I think you could make a case that by summer next year, you can still have persistently $80 oil price. But maybe gas steps back to $4 or $3.50, and that gives a very good advantage. And in that environment, with the kind of demand that we're looking at, I think our O&P business could still be above prior kind of mid-cycle benchmarks in terms of spreads and margins.

We're not -- in polypropylene, where there's a fair amount of polypro that goes into the auto chain. And obviously, auto builds have been problematic with the chip shortage. But polypropylene margins have been quite strong. Some of that spend there has been a supply issue. So how do we bridge, well, maybe the supply is going to normalize, but hopefully next year, auto production improves so we get a bit of a demand pull? Is that sort of a zero-sum game and we stay about where we are? Or should there be some softening in the polypro margins as things normalize on the supply side?

I think, relatively, polypropylene is tighter than polyethylene. And I think the polypropylene tightness will persist for longer because a lot of that deferred demand is durable goods. And I think auto is so depressed this year that when it comes back, when the chip shortages alleviate themselves, I think polypropylene, relative to polyethylene, probably stronger next year and will stay that way. And it's still kind of a regional business, right? I mean you don't see a lot of trade from Asia to U.S. It's opportunistic, but often, buyers find that they can't take bags of polypropylene into the U.S. or polyethylene for that matter. There's price risk while the product is on the water. So -- maybe a few cargoes show up but not enough to impact the business. And again, as China ramps up exports of finished goods, I think a lot of the polypropylene will be needed locally to produce those finished goods. So I think polypropylene is stronger than polyethylene next year and both above mid-cycle.

Okay. And building on that durable goods and auto dynamic, as we look at your Advanced Polymer Solutions segment, there's been demand disruption here as well. And you've also been in process of continuing to integrate and synergize your business with the acquired A. Schulman asset. So where do those -- where does that sit right now in its evolution? And how much will you benefit as demand comes back in terms of sort of filling out the fixed cost absorption?

Sure. So in terms of integration, we're 95% complete. We've got a little bit more to do in Asia but largely complete. The headwind that we face on earnings is twofold. One is the legacy LyondellBasell business, which was primarily automotive. We're earning half of what we did in 2018 in that business. And this, Vincent, I think, really proves out our logic for acquiring A. Schulman. It was to broaden our participation in compounding. And we've achieved that because, actually, what we acquired from A. Schulman has been pretty resilient because a lot of it goes into medical packaging, food packaging, masterbatch and things like that. However, when volumes are lower like this, a lot of our synergies are tied to procurement. And so we have to buy more and produce more to realize those synergies. And so I think over the next couple of years, there's easily a $200 million step-up in earnings as the auto market comes back and we see kind of the extra benefit of a synergized APS platform. So I think we've bottomed, and the trajectory could be quite nice in APS as auto comes back. That's the part that's failing us today.

Okay. If we switch gears to the Intermediates and Derivatives segment, you mentioned before the PO/TBA facility that you're bringing online. It's always interesting with long lead time investments that you have to take a view on the cycle when you make FID. And now here we are coming up, getting closer to the launch of that plant. Where are we in the PO cycle? And how well-suited is that plant going to be for the environment?

So a year ago, my team told me that in '23, when our plant has a full year of operation, likely, we'd see some moderation in operating rates and, therefore, margins. Today, there's so much tightness in the market. And we think that, that capacity will likely come on when it's needed, if not needed sooner, not later. Also, what's happening is chlorine prices have gone up a lot. So chlorohydrin technology-based PO has become more expensive. You're seeing some rationalization of capacity. The dual controls are impacting some production in China. So our sense is more and more that the market is going to remain tight. And then on the demand side, as you think about the deferred demand, whether it's for mattresses or for foam and seat cushions in automobiles, there's a lot of deferred demand still ahead of us. So our view is that the market has strengthened to a point where we think that every bit of that capacity is needed in '23, if not sooner.

Okay. If we look at the balance of the I&D segment, the acetyl chain has been quite strong. Oxyfuels are finally starting to come back. So where do you think the overall segment is in terms of getting its earnings power back to sort of pre-COVID levels?

Yes. Oxyfuels is really the missing link right now. I mean, we -- because of high butane prices today, oxyfuels is essentially back to breakeven in Q4. We had a nice run in Q3, almost got back to typical Q3 levels. But that's been wiped out by higher butane prices. So if I think about all of I&D, propylene oxide remains strong, acetyls remain strong and oxyfuels back to kind of breakeven in Q4. And my guess is probably Q1 will be similar. We need to get through the winter to get the LPG prices back down. And when driving season kicks in late spring, early summer, is when I think we'll see oxyfuels contributing again. Until then, likely going to be around breakeven. And styrene, just to kind of complete the picture. Styrene, likely kind of breakeven with -- if there's operating issues, it could be positive. If everyone runs, it's probably slightly negative.

Okay. You mentioned earlier Circulen and your green efforts from a plastics perspective. So maybe we could touch based on those in terms of what you're doing? I know you have the molecular recycling pilot plant in Italy. So maybe you could just give us an update on your various mechanical and molecular recycling initiatives?

Sure. So on mechanical recycling, we continue to think of ways to build out our footprint in Europe through -- either through acquisition with SUEZ as a partner and, in the future, likely Veolia. We're thinking about, either through acquisition or through greenfield construction, building out a network of mechanical recycling plants in Europe. We're in early stages of some discussions in the U.S. as well. And ultimately, I think we'll have a mechanical recycling presence in China and India as well over the next year or 2. So I think, continue to build on what we have in mechanical recycling. On MoReTec, we -- the pilot plant is about to start up in Italy. We'll know over the next 4, 5 months what we have in terms of technology. And I think the range of outcomes is it works but the yields are not as good as we want, or it works and the yields are really great. And we're going to try to figure out how to optimize the yield of feedstock for the cracker. So I don't think we're concerned about is this going to work or not. It's more about how much usable feedstock can we make out of it that can be put in the front end of a cracker. And I would think by mid next year, we're in a position to talk to you about how we're thinking about investing in an industrial plant.

So you have -- the yields are not where you would like them to be. Does that mean you just have to go to kind of a Plan B to try to continue to improve those yields? So it doesn't...

Continue to work -- sorry.

That means it might take longer. So you have to get back...

Exactly. Just -- exactly. It doesn't mean that we won't be able to deploy the technology. I think we'll probably need another 6, 12 months to work the technology further. But we think that we can get yields north of 70%. It would be good to get into the 80s and be able to build 200,000, 300,000 tons of waste as input in the first kind of medium-sized plant.

Could you talk a little bit about -- I think it was last week or the week before, there was an agreement between yourselves, Berry and Wendy's on plastic cups. I thought that was a really fascinating announcement because it was kind of counterintuitive to, I think, what the consensus in the investment community was in terms of -- all of a sudden, plastic is going to be a bigger problem. I'll let you explain it.

Well, this -- it's really about taking plastic waste and converting into usable plastics again, right? And so this is using molecular recycling or basically having feedstock come in the front end of the cracker. And Vincent, I mean, this is where -- we've talked about this many times is that molecular recycling, that's -- the unique difference is that you make food-grade polyethylene and polypropylene when it comes out of the -- out of our polypropylene unit. The same as the virgin product we make today compared to mechanical recycling. And I think it's -- I hope that it's a platform that shows that with good collection capability of waste, reasonable sortation, molecular recycling, the circular economy is really possible. I mean we can do this at scale and enjoy the benefits of plastics and address the issue of plastic waste.

Okay. You also mentioned on the second quarter call that there would be some incremental CapEx to spend over time to decarbonize the company. Can you talk about what that level of spend is and when and how it will take place at various assets over what period of time?

Sure. So at the company level, maybe I can frame CapEx for you. Over the next 4 years, including 2025, we will be $2 billion of CapEx, let's say, plus or minus 10%. And I don't think that's going to change a lot. So as you think about 2023, the PO/TBA project, there won't be any spending because it will be finished in '22. That will be offset with, hopefully, real money being spent on a new MoReTec plant, maybe even some greenfield investment on mechanical recycling. We have some pilots that we're doing on CO2 reduction. We'll start to spend a bit on that as well. But I think even with circularity and CO2 reduction investment in '23, '24, '25, we expect CapEx to be around $2 billion. In the second half of the decade, as we really kind of lean into, potentially, electrification, for example, furnaces and things like that, you could see a step-up more so in Europe than the U.S. where we get to $2.5 billion per year of investment and likely maybe another polyethylene plant somewhere in the second half of the decade, another Hyperzone here in the U.S. or something like that. But if you think about CapEx for the decade, $2 billion through '25 looks really solid. Even if we wanted to do more organic, we couldn't mobilize until maybe '24, '25, right, if the strategy were to somehow lean more to organic. And then in the second half of the decade, about $2.5 billion a year in CapEx. So it's not a significant step-up from the kind of number we've been targeting, which is $2 billion.

And is -- the carbon strategy, is it to see whether electrification really becomes practical versus going full bore on carbon capture and sequestration today? Is that -- you're kind of waiting to see how those things kind of...

Exactly. Yes, exactly. Exactly. And as I said earlier, we will have some partnerships where we'll help technology developers prove out their technology in our furnaces and things like that. But I think we'll be very selective in that. And I don't see us spending $1 billion a year to develop technology on CO2 reduction. I think we'll be likely more licensing in the technology. And as you say, let's see how CCS develops. So we're following that very closely.

Okay. Okay. So -- and I put it all together and it sort of circles back to what you were saying before in terms of the free cash flow you're generating. You do have a line of sight on a variety of different growth initiatives, carbon or green initiatives. But they all sort of fit neatly within a CapEx range that's very similar to what you're doing today. And so it then just begs the question, where does all that excess cash flow go to? You sort of hypothesized a world where all you could do is buy stock back. I'm not sure that that's the world we're going to live in. But you have been raising the dividend fairly consistent -- or consistently and aggressively in certain years. So how do we want to think about the balance of that cash flow? I guess you still have the other half of the Sasol JV out there. But it doesn't seem like there's any other material M&A that's on the horizon or anything like that. So maybe you can just frame that for us.

Sure. So first of all, investment-grade credit rating through the cycle, progressive dividend in the year. Some years, we may be a little bit more aggressive but kind of plus or minus the 5% range, I would think, in terms of dividend raise each year. Well-positioned to do that. And the way we think about our dividend is when we think about an increase, we want to be able to pay that dividend through the cycle, right? So we do a lot of kind of stress tests and think through different scenarios. Now it's hard to predict a pandemic. But even in a pandemic year, we paid the dividend from operating cash flow, and we funded most of the Bora equity from operating cash flow. So I think it shows how much we can generate even in more challenging times. Then what remains could help fund smaller APS M&A. And I think we're going to continue to be opportunistic on buybacks. Today we're trading at 5x, 5.5x. I still think that the market hasn't given us credit for reducing leverage by $4 billion in 1 year. We've gone from $16 billion of debt to $12 billion of debt. And we could debate where are we in polyethylene today, tomorrow, next month, next quarter. But kind of the fact is LyondellBasell will end the year with $12 billion of gross debt and less than $10 billion of net debt. So today, we think our shares are very compelling and a good use of our discretionary cash flow in conjunction with getting to the $4 billion in reduction of debt by the end of the year. As we go into next year, we do not have plans to delever further. We don't have any big -- on maturities coming up next year. So likely, it will be looking for small-scale APS M&A, be willing to accumulate cash, be opportunistic on buybacks. And over time, if we accumulate enough in a couple, 3 years, we could maybe even fund the other half of the Sasol acquisition from cash. So we have an array of options. And I think, Vincent, we've shown that we're very disciplined, we're value-minded. And I can tell you today, our value-mindedness puts us firmly in the camp of buying back LyondellBasell at 5.5x.

Okay. That sounds very good. That's actually -- we're up on time. So thank you, as always, Bob, for your time, your thoughts and your candidness. I really appreciate it.

Thank you, Vincent.