LXU - LSB Industries: Operations Have Improved But Ammonia Prices Have Collapsed

Summary

• LXU management has done a good job of fixing past operational issues.
• Blue and green ammonia projects could help drive future growth.
• A collapse in ammonia prices to start the year and high nat gas commitments don't bode well for the stock in the near term.

LSB Industries ( LXU ) has done a nice job of turning around the ship operationally, which along with higher ammonia and nitrogen derivative prices powered results in 2022. However, with ammonia prices collapsing to start the year, I’d stay on the sideline for now.

Company Profile

LXU is a maker of fertilizer as well as industrial and mining chemicals. For the agricultural industry, it produces UAN, HDAN, and ammonia. For the industrial industry, it sells nitric acid, commercial grade ammonia, sulfuric acid, ammonium nitrate ((AN)), and CO 2 . In addition, it sells industrial grade AN and AN solutions to the mining markets.

LXU operates three facilities, all of which use natural gas as their feedstock. Its largest plant is El Dorado, which has 450,000 tons of ammonia production capacity. The facility can also upgrade its ammonia production to AN and nitric acid. In the agricultural market, El Dorado distributes its ammonia via the NuStar ammonia pipeline and can serve the Southern Plains, South Central, and Midwest markets.

LXU’s Pryor facility has 235,000 tons of ammonia production capacity, which it can upgrade to UAN. Its Cherokee plant has 180,000 tons of ammonia capacity that it can upgrade to AN and nitric acid or UAN. Both Pryor and Cherokee distribute their UAN and ammonia direct to distributors and end users. Pryor serves the Southern Plains and Corn Belt, while Cherokee serves the Eastern Corn Belt.

The company also operates a plant owned by Covestro under a long-term agreement. The facility primarily produces nitric acid.

About a third of the company’s volumes are contractual, with the rest sold on the spot market.

Opportunities

One area LXU is looking to take advantage of is with blue and green ammonia. According to the company, blue ammonia is produced using natural gas and conventional processes but includes an additional stage where the carbon dioxide emissions are captured and permanently stored in deep underground rock formations. Green ammonia is ammonia produced using renewable energy to power electrolyzers that extract hydrogen from water, resulting in zero-carbon production of ammonia.

LXU believes there is an opportunity to sell low carbon ammonia at premium prices, and that as an existing ammonia producer it is well positioned to take advantage of this opportunity. The company is currently developing a project with Lapis Energy to capture and sequester CO2 at its El Dorado facility. Lapis will make 100% of the capital investment, with no cash coming from LXU.

The project is expected to be able to capture over 450,000 metric tons of C02 and store it in underground saline aquifers on the El Dorado site, resulting in over 375,000 metric tons of annual blue ammonia production. The project is expected to go online in early 2025.

On its Q4 earnings call , CEO Mark Behrman said:

“With respect to our blue ammonia project in El Dorado, as we discussed in our third quarter call, the increase of the 45Q credit to $85 per ton of CO2 captured and sequestered has made the economics of this project very attractive. A critical step on our path towards commencing CCS and blue ammonia production is obtaining a permit to operate a Class 6 injection well. I'm happy to say that earlier this week, we achieved a milestone on this project as the application for the approval of a Class 6 injection well was filed with the EPA. We have been told that the EPA review process could take between 18 and 24 months. Based on that timing, we continue to expect to begin capturing and sequestering CO2 at our El Dorado site in 2025.”

Meanwhile, LXU is developing a green ammonia project at its Pryor facility in partnership with Bloom Energy ( BE ) and thyssenkrupp Uhde, USA. The project is expected to lead to the production of ~30,000 metric tons of green ammonia per year, which would qualify for $3/kg of federal incentives. Production is expected to begin sometime late next year or early 2025.

Commenting on the project, Behrman said:

“Regarding our green ammonia project, we continue to expect that this project will qualify for the full $3 per kilogram of CO2 federal incentives for hydrogen production rolled out as part of the inflation Reduction Act and enable us to produce approximately 30,000 tons of 0 carbon ammonia to sell to our customers. We have completed extensive work on our feasibility study of this project and expect to announce our plans for it by the end of the second quarter. To the extent we proceed as anticipated, we expect to begin producing some green ammonia in late 2024, early 2025.”

LXU also expects its facilities to be able to increase production this year, as last year it had two large turnarounds at its El Dorado and Pryor plants. The former experienced a 27-day turnaround, while the latter had a 38-day turnaround. The company also believes it has some debottling projects that can further help increase production.

Lower natural gas prices should also help it on the cost side. However, it is notable that it did lock in 75% of Q1 needs at $6.30 per MMBtu for Q1, which is well above current prices. It has also locked in 25% of its Q2 needs at between $5.50-$6.00 MMBtu.

Risks

LXU has had a history of execution issues with its plants over the years. They are older plants and LXU has worked to get them more reliable.

The company’s expansion of its EL Dorado facility back in 2015, meanwhile, was completely botched and led the company to sue its EPC contractor, which it had been very public about in its filings and earnings calls through the years. The ill-fated expansion had huge costs overruns, which forced LXU to get unplanned financing and leverage up as a result.

At one point it seemed like the El Dorado facility was just cursed. In July 2016, the facility was hit by lightning . Then in 2018, El Dorado had a steam turbine blade failure that caused downtime.

That said, management has done a good job of running the facilities better. Back in 2015, LXU’s onstream rates were in the high 70s, while the last couple of years they've be in the 90s, a marked improvement.

As I noted in my recent article on CVR Partners ( UAN ), nitrogen fertilizer prices have also been on the decline to start the year. Ammonia, though, has taken an especially big hit, with Tampa anhydrous ammonia contracts down -25% last week to $590 per metric ton, the lowest level since the Russian-Ukraine war. Ammonia prices are down -40% so far this year.

Conclusion

LXU is another fertilizer related name that on the surface looks cheap, trading at 5x the 2023 EBITDA consensus of $272.3 million. That number is a pretty far drop from the $376 million in EBITDA it generated last year, but ammonia prices have been plunging and it has some high nat gas input costs locked in for Q1 and a bit it Q2. Thus, there is no guarantee it can hit 2023 estimates if ammonia prices stay weak.

While LXU’s operational performance has improved, it has historically been one of the weaker companies in the sector. The low-carbon ammonia projects look interesting, but the company had major issues the last time in took on a major project. Fortunately, it is not paying any capital into the El Dorado blue ammonia project.

Given the current market price action in ammonia, I’d stay on the sidelines with LXU stock.

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