Why We Just Sold LyondellBasell Industries Stock

Summary

  • LYB has had strong performance momentum lately and is returning a lot of cash to shareholders while also deleveraging that balance sheet.
  • While there is a lot to like about LYB, we want a portfolio of our highest conviction picks.
  • We share why LYB is no longer a high conviction buy for us.
  • Looking for a portfolio of ideas like this one? Members of High Yield Investor get exclusive access to our model portfolio. Learn More »

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We initially purchased LyondellBasell Industries N.V. (NYSE:LYB) back on November 30th, 2021, after it had sold off aggressively from highs reached last summer:

Chart
Data by YCharts

We were bullish on LYB because it is a leading producer of essential industrial materials like polyethylene, olefins and polyolefins, polypropylene, oxyfuels, ethylene oxide and ethylene glycol, engineered plastics and composites, crude oil refining, and polyolefin catalysts. The company is headquartered in Houston, Texas and derives its revenue in a fairly balanced manner across its materials segments, helping to stabilize its cash flow generation.

While bears point to numerous risks stemming from the company's cyclicality, significant international geopolitical risk exposure, and the negative impact of rising input costs, we were highly bullish on the stock over the long-term due to the facts that:

  • LYB has a solid investment grade credit rating that it is further strengthening by paying down debt;
  • LYB has a strong track record of allocating capital prudently and creating shareholder value;
  • LYB is returning capital generously to shareholders and should see that pace pick up even faster in 2022;
  • LYB looked very attractively valued on the pullback.

The company fit in nicely with our investment profile at High Yield Investor, as it enjoys a solid BBB credit rating, generates a lot of cash, and is committed to growing its dividend and reducing its share count consistently.

As an added bonus, it further diversified our portfolio and materials sector exposure at a time when inflation is raging and negative real interest rates appear here to stay for the foreseeable future.

We believed we were buying the shares for an attractive valuation as the dividend yield was firmly above 5% after the stock price has plunged over the past 6 months.

Meanwhile, the quarterly dividend per share was increased by 7.6% earlier in 2021, and management remained committed to growing it moving forward while also opportunistically buying back shares and maintaining a strong balance sheet. As LYB stated on its latest earnings call prior to our acquisition:

Confidence around our deleveraging targets enabled us to resume share repurchases in September, and we continued to opportunistically repurchase shares during October. As of October 22nd, we have repurchased a total of 1.6 million shares...We stand by our dual commitments to a growing dividend and an investment-grade credit rating through cycles. We are confident that we can complete our deleveraging and achieve our target of reducing debt by $4 billion before the end of this year with strong cash flows and no need for further debt reduction, we expect to continue reinvesting in our Company through the opportunistic repurchase of LyondellBasell 's shares.

Despite the credit rating being recently upgraded to BBB and assigned a stable outlook, the balance sheet getting stronger than ever, and the company gushing cash that it is passing along to shareholders via dividends and what should be an accelerating pace of buybacks (due to the reduced need for paying down debt), LYB traded at a massive discount to its historical price to normalized earnings and enterprise value to EBITDA ratios.

In fact, by virtually every metric, LYB looked cheap. Its EV/EBITDA was 5.25x, which is nearly 2 turns below its 5-year average of 6.92x and 3-year average of 7.05x. Its Price to Normalized Earnings ratio of 5.58x was also well below its 5-year (9.17x) and 3-year (8.84x) averages.

Meanwhile, its long-term growth trajectory is unmistakable, and is evidenced by its solid dividend growth which has averaged a CAGR of 6% over the past 5 years. It looks set to continue for the foreseeable future thanks to strategic reinvestments, debt (and therefore interest expense) reduction, and growing share buybacks.

LYB also has some attractive growth projects underway that should significantly increase the company's cash flows in the coming years. For example, in its intermediate and derivatives segment, it has propylene oxide investments in China and Houston that are expected to come online in 2022 and 2023. These combined should generate nearly $500 million in annual EBITDA, which would be a 6.4% boost to 2022 expected EBITDA. The company also has several other initiatives underway that - combining everything in the growth pipeline today - could add up to $1.5 billion to mid-cycle EBITDA (nearly 20% of expected 2022 EBITDA).

As a result, the value was compelling. We assumed that the stock merely had to appreciate to 7x earnings on the current performance base over the next five years, grow earnings-per-share at a 5% CAGR, and continue to pay and grow its dividend commensurately with earnings-per-share in order to generate annualized total returns of nearly 15% over that span.

This prompted us to initiate a LARGE sized position in LYB at the time, and we assigned an AVERAGE RISK rating and a STRONG BUY sentiment rating to the stock with a $113 fair value estimate.

LYB 115 shares $86.56

Why We Sold LYB Stock

While we remain bullish on its fundamentals, the stock has generated tremendous returns since we bought it, even as the broader market (SPY) has sold off over that span:

Chart
Data by YCharts

As a result, LYB now trades near our Buy Under Price estimate. It offers a decent, but unimpressive, 4% dividend yield, even as other high-yielding opportunities are looking more attractive than ever.

We, therefore, decided to sell our LYB shares at a price of $111.43 to lock in very strong 30% total returns in less than half a year (77.76% annualized total returns). We recycled the capital elsewhere into opportunities trading at deep discounts to our fair value estimate and offering yields well in excess of LYB's 4%.

Investor Takeaway

While LYB is still a solid investment grade dividend growth stock with a respectable 4% yield along with strong buyback and growth potential, it is no longer a compelling, high-conviction Strong Buy in a market suddenly filled with bargains. As a result, we felt it was a good time to sell our shares and redeploy that capital into much more appetizing opportunities.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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