LXU - LSB Industries: A New FEED Engineering Report Could Push The Price Up

2023-12-22 23:53:02 ET

Summary

• LSB Industries may have a new Front End Engineering Design for the Houston project ready by Q2 2024.
• Capacity extensions through debottlenecking of existing plants could lead to increased net sales expectations.
• The stock is currently undervalued, despite risks related to agricultural product prices, labor conditions, and environmental laws.

LSB Industries, Inc. ( LXU ) recently announced that a new Front End Engineering Design for the Houston project may be ready from Q2 2024. Management also promised capacity extensions thanks to debottlenecking of existing plants, which I believe could bring net sales expectations increases. These are great reasons to buy the stock if we have a look at the current price valuation. There are some risks related to large changes in the price of agricultural products, changes in labor conditions, or environmental law changes, however I believe that LXU is quite cheap right now.

LSB Industries

The company was incorporated in 1968 as an Oklahoma corporation, and became a Delaware corporation in 1977. It manufactures and markets chemical products for the agricultural, industrial, and mining markets. Its products are sold through distributors and directly to end customers throughout the United States and parts of Mexico, Canada, and the Caribbean.

The business manufactures products for three main markets. For agricultural markets, it produces ammonia, fertilizer grade ammonium nitrate, and urea ammonia nitrate, which have applications in fertilizers and fertilizer blends for corn and other crops as well as NPK fertilizer mixtures.

In another area, for industrial markets, company’s offering includes high purity and commercial grade ammonia, sulfuric acids, among many other products. These products have uses in a number of highly diverse application areas such as semiconductors, polyurethane, ammunition, pulp and paper, alumina, water treatment, metal and vanadium processing, or power plant emissions’ reduction.

Finally, LSB Industries manufactures industrial grade ammonia solutions with applications in the production of ammonium nitrate and fuel oil along with specialized emulsions for applications in mining, surface mining, quarries, and construction.

The products manufactured in the company’s facilities are mainly derived from natural gas as a raw material. Its facilities and production processes have been designed to develop products that are marketable at almost every stage of production. This design allows the development and implementation of a business model that optimizes the product mix to capture value opportunities in the end markets it serves, thus balancing the location of its offer.

Latest Earnings Release Was Better Than Expected, And Analysts Expect FCF Margin Increases And Operating Margin Increases

LSB industries delivered better than expected EPS GAAP as well as a revenue surprise. Quarterly revenue stood at close to $114 million. I really do not think that the market reacted well to the news as the stock price is still trading only a bit higher than before the release.

The fact that the company lost most of its market capitalization in the last three years is what made me conduct certain research on the stock. I suspected that LSB could be trading close to its fair market valuation. It trades now at close to $9-$10 per share, but it traded at close to $25-$27 per share in the past.

It is also worth noting that analysts out there are expecting better operating margin and FCF margin in 2025 than that in 2023. In particular, they expect 2025 net sales of $569 million, with 2025 EBITDA of $153 million, 2025 EBIT close to $103 million, net income worth $75 million, and 2025 free cash flow of about $75 million.

Pricing Strategies Will Most Likely Lower Net Sales Volatility

LSB Industries' strategy is to balance the sale of products such as fertilizers in agricultural markets at spot prices or short-term pre-sales, while developing industrial and mining clients who purchase substantial quantities of products, mainly under contractual obligations or pricing agreements. This product and market diversification strategy is considered to maintain more consistent production levels as compared to some of its competitors, and helps reduce the risk of volatility inherent in raw material prices and/or changes in demand for its products. Under this strategy, I would expect lower net sales volatility in the coming years.

The company has key assets that constitute important competitive advantages such as access to the Nustar ammonia pipeline from the US Gulf. It also produces ammonia at its El Dorado, Cherokee, and Pryor facilities, allowing it to take advantage of the difference between producing and purchasing ammonia.

Agricultural Markets May Not Correlate That Much To Natural Gas Prices, Offering Even More Diversification

The strategy of developing industrial and mining projects helps moderate the risk inherent in agricultural markets, where spot sales prices for the company’s agricultural products may not correlate with natural gas raw material costs, but rather reflect the market conditions for similar and competing nitrogen sources.

The price at which our agricultural products are ultimately sold depends on numerous factors, including the supply and demand for nitrogen fertilizers which, in turn, depends upon world grain demand and production levels, the cost and availability of transportation and storage, weather conditions, competitive pricing and the availability of imports. Source: 10-k

Potential Capacity Expansion Projects Could Be Announced In 2024, Which May Accelerate Demand For The Stock

With a significant amount of cash, short term investments, and stable FCF, LSB appears to be in a position to announce new capacity expansion projects that seem under evaluation right now. The expectations about capacity increases could accelerate the demand for the stock. As a result, we may see certain increases in the stock price.

Despite the headwinds encountered so far in 2023, we continue to generate positive cash flow and maintain a strong balance sheet, providing us with significant financial flexibility to allocate capital, including the repurchase of equity and debt and advancing multiple growth initiatives. These include several potential capacity expansion projects that we currently have under evaluation. We expect to determine our next steps on these projects in the first quarter of 2024. Source: LSB Industries, Inc. Reports Operating Results for the 2023 Third Quarter | LSB Industries

The Houston project is, in my view, the most meaningful promise offered by LSB to the markets. We are not only talking about a large low-carbon ammonia project, LSB did partner with large and established conglomerates in the gas industry like Air Liquide ( AIQUF ) or INPEX. According to the last presentations, I believe that we could see some news from Q2 2024 about the new Front End Engineering Design , which may serve as driver for the stock price.

Further Inorganic Growth And Organic Growth Promised Could Bring Operating Margin Enhancements And Capacity Growth

In a recent presentation, LSB made several promises with respect to capacity extensions thanks to debottlenecking of existing plants and new products. Besides, management noted that it is in a position to leverage existing ammonia capacity. Considering the current balance sheet and FCF generation, I believe that LSB is in a position to deliver some of these initiatives. As a result, new capacity or new products could bring revenue growth potential and FCF expectations increase.

Healthy Balance Sheet

As of September 30, 2023, the company reported cash and cash equivalents of about $46 million, short-term investments close to $270 million, and accounts receivable of about $47 million. With total inventories of close to $24 million, total current assets stand at close to $437 million. Given the total amount of cash, the short-term investments, and the current ratio, which is larger than 4x, I believe that LSB does report a sufficient amount of liquidity.

The largest part of the total amount of assets is property, plant, and equipment worth close to $828 million. The total amount of debt appears to be significantly lower than the total amount of PP&E, so I think that investors would not worry about the total amount of debt. Total assets stand at close to $1.292 billion, and the asset/liability ratio is equal to more than 2x.

I am really not concerned about the total amount of liabilities and debt. It is also worth noting that the total amount of debt recently decreased substantially. In particular, the company reported accounts payable worth $56 million, accrued and other liabilities close to $37 million, and long-term debt of $577 million.

The long term debt includes debt financing with senior secured notes close to 6% and 8%. However, the largest part of the company’s debt includes notes of 6.25%. With this in mind, I assumed a cost of capital close to 4% and 7% in my financial model.

My Cash Flow Expectations Based On My Previous Assumptions, And Previous Financial Statements

For the assessment of future FCF and cash flow expectations, I took into account previous financial statements, the expectations of other financial analysts, and the guidance given by LSB. In a recent presentation, the company announced significant FCF expectations for 2023.

My cash flow statement expectations include net income of about $174 million, deferred income taxes of close to $147 million, and depreciation and amortization of property, plant, and equipment worth $55 million. Note that I did not include amortization of intangible and other assets or charge on extinguishments of debt because I believe that it is not part of the recurrent business of LSB.

Also, with stock-based compensation of about $9 million, changes in accounts receivable of -$112 million, and changes in inventories close to -$97 million, I included changes in accounts payable worth $127 million.

Finally, also taking into account changes in other assets and other liabilities worth $11 million, I obtained net cash provided by operating activities of about $262 million, and with expenditures for property, plant, and equipment of -$112 million, 2030 FCF would be $150 million.

Now, with FCF between $49 million and $151 million, exit multiples ranging between 7x and 11x, and a WACC of 4%-7%, I obtained a fair forecast price ranging from $13 to $23 per share. The median fair price forecast would stand at close to $17 per share. Note that for the calculation of the enterprise value, I included cash, short term investments, short term debt, and long term debt.

Please note that my stream of FCFs is not far from what the company reported in the past. LSB reported more than $240 million a few years ago.

The internal return of return obtained would be a maximum of close to 20% with a median IRR close to 9.99% and 11%. The minimum IRR would be close to 6%. With these figures, I believe that LSB appears undervalued. Other investors may come with different assumptions, but I believe that most of them will reach similar conclusions.

Competitors

The firm operates in a highly competitive market with many other larger chemical companies. Some of the largest competitors are AdvanSix, Inc. ( ASIX ), Austin Powder Company, CF Industries Holdings, Inc. ( CF ), Chemtrade Logistics L.L.C., Cornerstone Chemical, CVR Partners ( UAN ), Dyno Nobel, Ecovyst, Inc. ( ECVT ), Eurochem North America, or Fertinal and Yara International ( YARIY ). Some of these competitors are also clients of LSB Industries.

Risks

The company notes that its business depends on a limited number of key facilities. Its nitrogen production is concentrated in four separate complexes. The suspension of operations at any of these complexes or significant impacts on any of their operations as a result of a supply chain disruption could adversely affect production capacity. Additionally, in the local context of the United States, an increase in imported agricultural products could adversely affect the business of the company.

The company also highlights that a substantial part of its sales depends on a limited number of customers. Additionally, the cost and unavailability of raw materials could materially affect the business. This volatility in the sales prices of agricultural products can, at times, compromise the ability to recover the full cost of production of the product.

Finally, unforeseen events that may arise from international conflicts or limitations of global economic activity must be considered, specifically in relation to agricultural and energy markets, climate regulations, and the development of technological advances that structurally modify the logic of the sectors of operations.

Conclusion

LSB Industries recently noted that the new Front End Engineering Design for the Houston project may be ready from Q2 2024, which I believe could trigger the interest of investors. With a stable balance sheet and recent debt reduction, I believe that LSB is in a position to bring capacity extensions thanks to debottlenecking of existing plants. As a result, I think that we may see an increase in capacity expectations and revenue growth expectations. There are obvious risks from volatility in the sales prices of agricultural products, changes in labor conditions, or new climate regulations. However, LSB does trade at much undervalued price marks.

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