We continue our analysis of inflation hedge companies with LSB Industries (NYSE: LXU), a chemical company that manufactures ammonia-based products. The American company is one of the largest domestic producers of nitrogen fertilizers used in agriculture, as well as nitric and sulfuric acid. compounds used by a wide range of end markets, such as construction, automotive, metal processing, pharmaceuticals, semiconductor chemicals, paper, water treatment, and mining .
The company is divided into three business units based on the target market:
- Agriculture (48% of Total FY21 Revenues: Ammonia, Urea, Ammonium Nitrate, and High Density Ammonium Nitrate are sold to growers of corn and other crops;
- Industrial (42% of FY21 total revenue: ammonia, nitric and sulfuric acid, diesel exhaust fluid and carbon dioxide used in automotive, pharmaceutical and semiconductor markets;
- Mining (10% of 21) Total Revenues: High-density ammonium nitrate and ammonium nitrate are mainly used by mining companies to produce gold, copper, coal and other base materials.
The company has not released specific data on the geographic percentage of revenue, but they are produced entirely in the United States, Canada and Mexico.
Exercise 21 And Q1 2022 results
Over the past 10 years, LSB has been impacted by negative results due to a declining revenue trend, highly volatile revenue and, most importantly, negative earnings and FCF. These past results had made the business extremely risky, with net debt/EBITDA reported at 8.7x in 2020. 2021 was a groundbreaking year for the business, LSB was positively impacted by rising inflation and the rise in raw material prices, a fact which, combined with good financial management, has enabled the company’s fundamentals to improve significantly.
Between 2020 and 2021, the company’s revenues increased by 58%, a growth that can be attributed to the company’s pricing power and not to an increase in volumes, which were still down by 13% compared to the level of the previous year. This trend was also confirmed by the recent first quarter 2022 results, in which the company’s revenue increased by 102% compared to the previous excellent results of the first quarter 2021. The strong revenue growth can be attributed to the further price increase, taking into account the fact that volumes fell by another 15% compared to the first quarter of the previous year.
On the cost side, the company’s primary cost is natural gas, a key input to ammonia production. As we know, the price of gas has skyrocketed over the past year, especially following the Russian invasion. However, LSB Industries managed to contain its gas purchase costs, thanks to hedging contracts, a positive circumstance which also led to an increase in margins from negative territory to the figures of the big technology companies.
In 2020, the company had a profit margin of -17.62%, compared to 7.82% in FY ’21 and the astonishing 29.5% achieved in the first quarter of 2022, a margin that should be maintained throughout 2022. These astonishing results have enabled the management of the company to reduce its overall risk, in particular thanks to two extraordinary transactions that facilitated additional capital and reduced debt fundamentals. The management of the company Fiscal 2021 converted $296 million of preferred stock into common stock, bringing equity to $471 million at the end of 2021.
Additionally, LSB Industries improved its capital structure through debt refinancing, which reduced its cost of debt by 3% and raised an additional $200 million in cash for future acquisitions and investments to make the more efficient production. As a result, the company will improve the profitability of its group, currently the new net debt to EBITDA ratio has been reduced to 2.34x in the first quarter of 2022 and could increase to 1.55x following expectations of an EBITDA of 310 million dollars for Financial year 22. These are very good results which have fully benefited from the macroeconomic context of the past two years.
The company will likely be able to maintain this profitability through 2022, guiding earnings to around $160 million and achieving a PE ratio of 10.81x given current capitalization.
Source: LSB Industries Q1 results
As mentioned in the introduction, our internal team believes that LSB can be an excellent investment in an inflationary environment for the following reasons:
- The positive mismatch between entry and exit costs, natural gas being the company’s main production input. Between Q1 2021 and Q1 2022, the cost paid by LSB industries increased by 50%. On the other hand, the main products sold by the company, i.e. anhydrous and nitric acid, urea, ammonium nitrate and ammonia increased by 85%, 251% and 202% respectively. . This leads to a continuous and sustained increase in profitability;
Source: LSB Industries Q1 press release
- Rising gas prices mainly affect the European continent, which imports 40% of its natural gas from Russia, and much less from North America. As already mentioned, this factor results in higher margins for LSB Industries and a consequent increase in competitiveness against European competitors such as BASF and Jara. The conflict in Ukraine will drastically reduce the amount of wheat and corn produced globally, causing a sharp rise in food prices and possible global food shortages. It will therefore be necessary to increase the productivity of existing crops by favoring the sale of nitrogenous fertilizers;
- The sharp rise in prices of food commodities, such as maize, which is reaching a record high, is pushing many farmers to increase their productivity, motivated by the possibility of making large profits for each additional quantity produced;
- LSB Industries sells mainly in North America, where it also has its own production sites. This means less impact on transport costs, which are mainly done by trains and trucks rather than by sea transport, a more expensive method.
Based on the above, we believe that LSB Industries can be a good investment to defend your portfolio against inflation risk. Based on history and fundamentals, we don’t think the company is a good standalone buy, as it would be very negatively affected by a decline in commodity prices which are currently at all-time highs. If this inflationary pressure continues, LSB industries will be very positively affected. Therefore, we are initiating a hedge with a neutral rating.