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

All right. Well, look, welcome to Day 2 of the Morgan Stanley Chemicals Agriculture & Packaging Conference today with LyondellBasell. And we have Michael McMurray, CFO, to kick us off with some prepared remarks and some slides to go through, and then we'll do some Q&A. Michael, welcome.

Thank you, Vincent, and happy to be here. And for those who are following the slides, they're both on our website and I think we're webcasting as well. So again, welcome and excited to be here. So good morning, everybody. Thank you, Vincent and the entire Morgan Stanley team for having us to the conference. Before we get into questions, Vincent, let me take a few minutes to set the stage for our conversation with some brief updates on LyondellBasell. On Slide 2 are our cautionary statements. As always, we ask that you review our customary language around forward-looking statements and non-GAAP financial measures. We also provide some reconciliations of the non-GAAP financial measures in the appendix. Moving on to Slide 3, which is our performance snapshot. As you saw in recent results from LyondellBasell and our peers, the third quarter was very challenging for our industry, and September's exit rate is pointing towards lower fourth quarter results. Nonetheless, at LyondellBasell, we are very excited about our work underway to reshape our longer-term strategy and deliver value for investors. Before we discuss our strategic initiatives, let's review Slide 3 and some details around our recent performance. Despite third quarter challenges, LyondellBasell generated $7.7 billion in EBITDA over the past 12 months and converted nearly all of that EBITDA into $7.6 billion in cash from operations. In our segments, margin compression across our O&P businesses have pressured results most notably in Europe. But improved demand and margins for transportation fuels has helped our Oxyfuels business in the Intermediates & Derivatives segment and our Refining segment to deliver their best segment results since 2018. Altogether, the resilient portfolio delivered a 19% return on invested capital over the last 12 months. Moving on to Slide 4. As the CFO of LyondellBasell, I'm particularly proud of the cash generation performance from our team that is depicted on Slide 4. After we funded investments in maintenance and growth CapEx, we delivered $5.5 billion in free cash flow over the last 12 months. In the third quarter, we added $400 million in cash to the balance sheet, mostly by managing working capital, and our commitment to shareholder returns continues under Peter's leadership with $4 billion in dividends and share repurchases over the last 12 months. Moving on to Slide 5. At LyondellBasell, we think about managing the company to generate differential value and high returns under a range of economic conditions. On Slide 5, we highlight some of these sources of advantage. Our company is widely recognized for a deep commitment to safe operations, cost management and operational excellence. These values are part of our DNA. LyondellBasell's global portfolio of businesses benefits from both geographic and end market diversity. Our leading positions in diverse markets balance the portfolio and reduce risk for market concentration. I will talk about some of these extensions we are making to these positions in a few moments. On the right of the slide, I would like to emphasize our financial metrics that serve us well during these challenging times. In addition to our efficient cash generation, we prudently managed our investment-grade balance sheet. Our weighted average cost of debt currently stands at 3.9% with an average maturity of 18 years. At the core of our capital allocation planning is a secure and growing quarterly dividend. Over the past 12 months, cash from operating activities comfortably covered our quarterly dividend by a factor of 5. Moving on to Slide 6. On Slide 6 highlights one of the decisions that quickly emerged from our strategy work, the creation of our new circular and low-carbon solutions business unit. Businesses focusing on circular and renewable solutions require a differentiated business model and a more entrepreneurial mindset to succeed. We are setting up our new circular and low-carbon business solutions business unit with this in mind. Our aim is to sell at least 2 million tons per year of these products by 2030. For perspective, 2 million tons represent a material amount of our 2021 global sales of polyethylene and polypropylene, about 20%. In the past few weeks, we've announced our participation in several agreements related to new capacity for our circular and low-carbon solutions business in the U.S., Germany, China and India. In Germany, we expect the facility will provide a material amount of the feedstock required for our first advanced recycling plant using LyondellBasell's proprietary MoReTec technology. In addition, we are moving forward on partnerships for renewable power, carbon capture and low carbon hydrogen. We are quickly and methodically building a robust supply chain to support attractive growth opportunities for our circular and low-carbon solutions business. On Slide 7, let me outline the launch of our value enhancement program that is targeting $750 million in recurring annual EBITDA improvement by the end of 2025. Let me be clear, Vincent. This program is not about one-time cost cutting or deferred maintenance. We are building an evergreen continuous improvement process that will become a part of LyondellBasell's core competencies. It became clear that after 12 years with a singular focus on managing costs in our company that a significant number of untapped value opportunities have accumulated. We think this value can be unlocked with only modest incremental value -- incremental investments in resources. This program is about balancing cost and value. The program is well organized and professionally managed by newly established -- by newly established transformation office. A bottoms-up planning process generated over 2,000 ideas, and we have validated more than 1,500 initiatives to date, and we're just getting started. We look forward to sharing more details on this program during our upcoming Capital Markets Day in March. Let me summarize on Slide 9. Despite Q3 headwinds, LYB's growing asset base and diverse portfolio are delivering results, $7.7 billion in EBITDA over the last 12 months. We are quickly and decisively moving forward on opportunities in circular and low-carbon solutions. We have recognized the differential needs of these emerging businesses, and we are rapidly putting into place proper organizational design and partnerships required to establish leading positions. The third quarter was challenging, but I have no doubt we anticipate that seasonally weaker demand and volatile energy costs will provide further pressure on fourth quarter margins. In response, we are proactively lowering operating rates to match reduced demand. LyondellBasell is taking the right steps to optimize working capital and further strengthen our balance sheet flexibility to position our businesses to capture opportunity throughout the cycle. And I'm incredibly excited about all of this activity and progress underway in the company to develop our North Star to guide our strategic initiatives. We have shared a few details in our initial decisions around organizational design and value capture. We look forward to sharing more details over the coming months and at our Capital Markets Day in New York, next March should clarify your understanding of LyondellBasell's forward strategy.

Before starting Q&A, I just need to read some disclosures of my own. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So we have lawyers too. As it turns out, yes, I'm very serious about this stuff for sure. Well, look, so one of the things that's coming in to me from investors is sort of how we're supposed to think about the company through the cycle earnings power. And just sort of if we think about the most recent peak of EBITDA, $9.4 billion in 2021, obviously, a very big number. We had the COVID low of 2020. None of those seems like it's going to repeat anytime soon or should be the number that anybody should be using. Then this year is kind of a tale of 2 halves, right? You had $4.5 billion in the first half, and maybe you can do a bit more than $2 billion in the second half. Then we're kind of looking out to 2023, trying to figure it out. Is it going to be similar to 2019? Or where is it going to be? So what is the path forward? How should investors be thinking about the earnings power of the company through the cycle, particularly now that there's some changes in terms of the energy market structure, both in the U.S. and in Europe. And then obviously, there's a lot of focus on China and how it's going to come out of this COVID lockdown. So what's the right framework for us to be using?

Yes. So there no doubt there are a lot of moving pieces in the marketplace today, Vincent. Our kind of historic point of view on through-the-cycle earnings for the company, looking at '17 to '19 margins would be about $6.5 billion. And I think we've said that on a number of occasions. And then you know that over the last number of years, we've made a number of growth investments, things like Sasol, Hyperzone, our joint venture in China, Schulman. And then actually, our PO/TBA investment, which is going to be the biggest earn-out of all those is coming up early next year. And so those all taken together had probably about an incremental $1.5 billion to our kind of through the cycle average. And then as you heard me talk about, and if you heard our earnings call, we see the ability to add about $750 million of additional sustainable EBITDA improvement from our value enhancement program that's actively underway, and we expect to get there on an exit run rate basis by the end of '25. So that's 3 years from today. Kind of maybe kind of just stepping back and kind of thinking about the current environment, again, you heard in my prepared remarks, no doubt that we think the fourth quarter is going to be sequentially lower than the third for the reasons that I highlighted. Thinking about next year, and I'm not necessarily providing guidance, but it probably feels like the first quarter is not going to be kind of dissimilar to the fourth quarter. And then we're hopeful that China, which has been kind of missing in action for the better part of a year actually starts to demonstrate growth again. And so that's important from a global GDP perspective. But as you know, China is the world's largest consumer of petrochemicals, in particular, polyethylene, which is our biggest business. And so China growth actually has to come back. We hope that, that starts to happen in spring, so in the second quarter. And then -- so assuming that -- assuming China comes back and just as a reminder, polyethylene growth in China over the last decade call it, kind of 5% to 6%. This year, our perspective is kind of close to 1%. They've added significant capacity. So China needs to come back for global growth, but also to improve petrochemical margins.

Yes. No, I couldn't agree more.

If that happens, maybe next year, it looks a little bit like '19.

And more back half loaded?

But definitely more back half loaded.

And then how do we think about the Europe and the energy environment? It seems to -- the margin structure in the olefins business really seem to deteriorate exiting 2Q into 3Q and accelerated that deterioration during the latter part of 3Q. And then we've seen a decline in natural gas and electricity costs into the fourth quarter, seems to be more about warmer weather and inventory builds and something more structural. But how should we be thinking about that in terms of not just sort of the sequential change from 3Q to 4Q, but going into next year and how you're thinking about running your operations, your plant footprint and what you think might happen in the broader European chemicals industry just given some assets are a bit more challenged than others, depending on whether they're landlocked or has access to LPGs and so forth?

No. I mean, so I mean energy cost in Europe, our European businesses in 2020, we would have spent about $300 million on energy cost. Year-to-date this year, $2.1 billion. That's an incredible headwind that our businesses have faced into. The other interesting thing that people don't fully appreciate is that currency has been a pretty big headwind as well. And the biggest headwind from currency is not coming from translation, but the price of naphtha because it's dollar derived in Europe, right? And so that's been a pretty big headwind for our European businesses as well. Energy prices rapidly flew up in the third quarter as European countries were filling storage for winter months. It has eased off quite a bit here in the fourth quarter because there hasn't been much of a winter. Gas storage is pretty full. But I do think looking forward that energy costs for Europe do have implications for LyondellBasell in the broader industry as a whole. I think you may or may not be aware, we have idled one of our large integrated crackers in France and also one of our Possum joint venture units in the Netherlands for the rest of this year. We expect that they'll come back up early next year, but to be determined. But I do think it has structural implications for the European chemical industry long term.

And one of the things is I think back to the third quarter and even looking at the fourth quarter that sort of caught some of us offside was that some of the paper margins that were out there in terms of what naphtha was supposedly costing, what the co-product values were, it doesn't seem like they were actually realized by anybody in the industry, but they were being printed and you can look at it and actually look like naphtha cash costs were quite low and it turns out they weren't. Right? So is it just there's no liquidity in the co-product market? Or there's just nowhere to put the merchant naphtha or the merchant financial, I should say, sorry, in order to get those cash costs?

Kind of all the above, Vincent, yes.

And that hasn't improved at all in the fourth quarter?

No, no, but are getting some relief from energy cost, which is good.

Okay. But our assumption should be then, as we look at our models, probably that winter will come, those costs will increase as we get some drawdown so that this should not be...

But we're going to have to -- I mean, and Europe is going to have to refill storage next year.

So this is a temporary reprieve rather than a structural improvement. Okay. Can you talk a little bit about the North Star strategic process and how we just talked about this very challenging market environment, which is probably going to stay longer than we'd all like. How has that impacted the strategic review, if at all, and sort of the things you're thinking about or not thinking about?

Yes. I mean so the big reveal, obviously is coming in March, as I said. Clearly, on our earnings call and with some of the announcements we've made, we've dropped some bread crumbs. This is really about the long-term future of the company. Clearly, what's going on currently in the marketplace has implications for our long-term strategy and we're taking it into account, but it probably has bigger near-term locations. The strategy, what I will share, really has -- the stool has 3 legs. There's 1 piece around stepping up performance and culture. There's the piece that you heard me talk about around us forming a circularity and low-carbon solutions business unit. Within there is decarb because that has implications for our low-carbon business. And then the last piece is around growing and shaping the core. The information we've shared on our value enhancement program is clearly focused around stepping up performance. You heard me talk about $750 million opportunity. My expectation ultimately that as we continue to push on that, that number is going to grow with time. And my confidence is building in that space. Clearly, the announcements that we've made structurally from an organization perspective, are related to that first pillar of the stool. And the changes that we've made, one, are to drive better accountability and speed. One of the big changes that we've made as we put manufacturing under the business units and made them clearly accountable for the entire P&L. And I think that's a very good thing. And then obviously, we made structural organizational changes to actually form a circularity in low carbon business. Because, again, how you're going to make money in that business is different in our historic businesses. And then, quite frankly, we need to move swiftly with speed and to be decisive. And so we've taken it out of the O&P business, and we've made it stand-alone with a stand-alone leadership structure. So a very important step. And then to talk a little bit about growing and shaping the core, I think one of the decisions that we made earlier this year is around the refinery. You can expect that we're looking at our entire portfolio very hard. There are a few choices to make, not incredibly huge, but there are a few choices that we think we could and we will probably take. And then our focus around organic growth and M&A has narrowed, and that's probably all I'm going to say today.

Okay. Fair enough. Maybe we'll talk a little bit more about the $750 million value enhanced communities that will be tangible and things that we'll be able to understand or see in the results.

Yes. And so what's interesting, I think we're viewed as one of the best operators in the industry. We have an outstanding safety culture and safety performance and our cost performance is second to none. But we put so much focus on cost since the company emerged from bankruptcy 12 years ago that people are kind of looking beyond the value opportunities. The value opportunities never got funded because we either wouldn't make the investments from a headcount perspective, from an OpEx or from a CapEx perspective. And so ultimately, after many, many years, people quit pushing them. And so we've done an extensive multi-month review where we've identified opportunities around reliability, some more opportunities around cost even. So that's good, but right, but also things like capacity creep as well. We're also focused on some onetime opportunities, which we haven't communicated, which are in the working capital space as well, which are pretty meaningful. And so I'm excited. We're not going to lose our operating discipline. We're not going to lose our focus on cost, but we are going to create a meaningful amount of value with this program, and we have high confidence around delivery. And it's sustainable. These aren't onetime benefits.

What is the cash cost associated with getting it?

Yes. Good question. So of the $750 million on a run rate basis in year 1, pretty good confidence of delivering about 20% of that. So that would equate to about $150 million. And from a cost perspective, it's about kind of one-on-one. So onetime cost for the ongoing benefit, roughly speaking. So not a huge amount of cost. And obviously, the return profile on that investment is quite good.

We talked about China and the impact it's had on polyethylene, but maybe in the outside of the olefins business is [ 9D ], is there having -- is that having a profound effects on the performance of those businesses as well as the China lockdown.

So our other businesses, other than polyethylene?

Yes, I'm just trying to -- as we think about China reopening ultimately, clearly, there will be a snapback in polyethylene, but how should we think about the flow through to any other segments?

Yes. So I mean -- so being China is the world's largest consumer of petrochemicals. So I think as China goes, it's impactful for the industry as a whole. Our I&D business has performed much better than O&P in this environment, in part because Oxyfuels is performing well. So good demand and margins are considerably higher than kind of long-term averages. And while PO demand has weakened in the third quarter, in particular, related to durables, margins and PO are above kind of historic average, in part because there's a meaningful amount of our contracts that kind of are passed through from a cost perspective. And then the APS segment, which has operations in China, hasn't been doing terribly well in China. Demand is getting better, but margins are really, really low right now for our APS in China.

How about in the U.S.? Obviously, with the war in Russia Ukraine, between Russia and Ukraine, we've seen the run-up in U.S. gas prices as LNG has picked up, and that's flown through to Henry Hub and then to ethane. And so we've seen the bottom end of the cost curve, at least in the U.S. has come up as well. How do you think that's going to evolve over the next several years? And what does that have -- what impact does that have on any capital allocation decisions you might have?

Yes. I mean, so I think first and foremost, we think North America is going to be advantaged for a long time to come. So I want to make that point kind of loud and clear. No doubt, there has been a run-up in nat gas prices, and therefore, ethane prices in the U.S. actually kind of above kind of 10-year plus highs that they've moved off considerably here more recently. And it's our expectation as we kind of look out into '23 that nat gas and ethane prices continue to moderate. There are plenty of basins in and around the Gulf Coast that have large oil and gas reserves that are going to be drilled for many decades to come. I'm actually just kind of looking near term, rig counts up, production is up. Prices are starting to move in the right direction. Again, we do think that additional LNG export capacity will likely be built over the coming years. But we believe that there is plentiful oil and gas in the U.S., plentiful NGLs and that nat gas and ethane in particular, will normalize.

You mentioned the PO/TBA asset that you're near completion on. Just remind us on the project timing. And you said margins have weakened a little bit in the third quarter with durables. What is your expectation for the contribution of that asset for '23 and '24 as it ramps?

Yes. So we're super excited. It's been quite a journey to get to the point where we are. The asset is going to start up in the first quarter of next year. When all said and done, we'll have spent about $3.5 billion on the asset. It's our largest project ever. Even though markets have weakened a bit, you heard me say that Oxyfuel margins are quite healthy. While PO margins have moved off a bit, they're still above long-term averages. When we started up and start to ramp in '23, we'll probably recognize about 0.5 years of nameplate capacity, so about 50%. And then to the extent we need to kind of balance supply and demand, we can throttle back some of our other assets that we have around the world. And then just as a reminder, once the plant is kind of fully operational on a cycle average basis or through the cycle basis, should generate on the order of about $450 million of EBITDA. So it's going to be a significant contributor to our earnings and free cash flow going forward.

Okay. And maybe switching to the circularity initiatives. I mean, I think there are couple of things I'd really like to get into. One, you talked about setting up a separate structure of the separate segment. And so I assume that means that sort of the competition for capital now is independent, whereas before when it was in O&Ps, maybe it was competing for the O&P budget or what O&P could get and we competing as other O&P opportunities, where now it's going to compete against what's on the table for the total company. Is that correct? And that gives us sort of more of an opportunity?

Yes. I mean the decision to separate it out as a stand-alone business unit was less about capital allocation and more about recognizing that it's a business that fundamentally is going to take a different business model than our kind of our core O&P business. It is, for all practical purposes, it's a startup. It needs to be a bit more entrepreneurial. It needs to move quicker and with speed. And as I said earlier, quite frankly, how you're going to make money in that business is totally different than our other businesses. So we need to separate it out. And so again, less about capital allocation and more about setting up the right business operating model to ensure that business is going to be successful. And as part of our North Star work, we've done an incredible amount of additional work around that business, whether it's our circularity business or emerging thoughts around our low carbon opportunities as well. But again, our confidence around that opportunity and about that business being a future growth engine, both from a revenue and profitability perspective is growing in importance. And again, that will be a big focal point, one of the big focal points, which we'll talk about at our March Investor Day.

Yes. And then obviously, with the PO/TBA plant being completed, that's a lot of CapEx that's running off. It's obviously up for grabs.

Well, we're a little more sophisticated than that. We don't treat capital as a jump ball.

Well, you have talked about being close to making FID on the pilot plant and for Italy for chemical recycling. So maybe you can talk about what are you waiting for? What's left to sort of see come together before you make FID on that?

Yes. So we've -- so it's our MoReTec technology, which is proprietary technology to LyondellBasell. We have a semi-scale plant that's been in operations and for our Italy since the second half of 2020. We've made a lot of progress. What's interesting or what's differential about our technology versus the other technology that's in the industry today is, one, we're utilizing LyondellBasell proprietary catalyst, which enables us to have a process which is continuous and not batch. It also enables us to consume less energy and produce higher yields of processed oil. And we also believe our technology will be more scalable, so larger units versus the competition as well. So super excited about the technology. Actually in the fourth quarter of this year, we're taking our -- an initial investment decision around a commercial scale facility.

Okay. So that's something we might know about before the Analyst Day then.

Possibly. We might want to share something on the fourth quarter call. Certainly, it will be an area where we're heavy obviously, at the Analyst Day to help people better understand the technology and the opportunity that we see.

And is it correct that, that would target the European market first?

Most likely, that's right.

And have you put out any sort of broad CapEx costs that, that might.

We haven't officially guided, but it's in the hundreds of millions. It's just to kind of give you a bit of data around how big.

Okay. Very good then. Sticking with capital allocation...

And the mid-decade should be up and running as well.

Okay. Very good. Fair balance. Sticking with capital allocation, we look at the year, you paid the big special dividend out in the middle of the year. What was the thought process there? You mentioned earlier that you want to keep the common dividend growing. How do you think about the dividend yield? What's the target for it? Payouts? And then how do we think about just sort of the broader backdrop of now we've got a 4% 10-year bond. So what's the thought process on the dividend? How has it evolved?

Well, I wish the yield was lower with a higher stock price. So that's the goal. I mean, a couple of things. I mean, one, I'd say the company has a pretty good reputation for delivering strong cash flow and converting EBITDA into free cash flow, and the current dividend that we have has covered very, very strongly. So kind of like 5x with cash from operations. And as we look forward, it's our expectation that we're going to continue to grow the dividend every year. And so we've delivered dividend growth for the last 12 years. Moving back a little bit around the special that we did earlier in the year, and that was really Peter's kind of first act as CEO of the company. We wanted to send -- Peter wanted to send and the Board wanted to send a strong message from a capital allocation perspective that there wasn't some big shift in how we're thinking about capital allocation and specifically returning capital to shareholders with Peter joining the company. Now whether we did buybacks or special, it was an interesting discussion at the company and the Board, and -- but it was kind of a unique time in what was happening with the broader market backdrop versus LYB share price as well. So LYB share price at the time was considerably higher than it is today. And so from our perspective, the special made a lot of sense. It sent the message that we wanted to send and investors actually very much appreciated it.

Excellent. Are there any questions for anybody here in the audience? Sure, sir. Wait for the microphone please, for the webcast.

For the refining asset, you can idle asset end of next year, what's your thought about the potential usage of that? And if you will just idle asset, do nothing, what kind of annual cost carrying is that asset?

Okay. Yes. So great question. So the question was in regards to our refinery. And so we've announced that we're going to close the refinery by the end of next year. The good news is that as we sit here today, the asset is actually making pretty good earnings and pretty good cash flow. But it's a very old asset. And after next year, it would face into an incredible amount of maintenance capital if we're going to continue to run that asset. The site is 700 acres on the Houston Ship Channel. You can't find a site like that anymore on the Houston Ship Channel. It also has an incredible amount of interconnections, whether it's pipelines, tanks and obviously, waterborne access as well, and it's interconnected to our largest site in the world, which is general view. Once the operations are shut down, and we incur the cost that we guided to when we released the 8-K earlier this year. And we said that the cost midpoint would be about 750, the low end was 650. And it's kind of tracking towards the low end as we sit here today, which is good news. But kind of the carrying or holding cost of that asset going forward would be very low. And then we see a tremendous amount of opportunity for that site being part of LyondellBasell's integrated operations going forward.

Anyone else? Only once? All right. We'll leave it there. Thank you very much.

Thanks, Vincent. Thanks, everyone. Good to see you.