We continue our analysis of inflation-hedge companies with LSB Industries (NYSE:LXU), a chemical company that produces ammonia-based products. The U.S. company is one of the largest domestic producers of nitrogen fertilisers used in agriculture as well as nitric and sulfuric acid compounds that are used by a wide range of end markets, such as construction, automotive, metal treatment, pharmaceuticals, semiconductor chemicals, paper, water treatment and the mining industry.
The company is divided into three business units based on the target market:
The company has not released accurate data on the geographical percentage of revenues, but they are entirely produced in the U.S., Canada, and Mexico.
In the last 10 years, LSB has been impacted by negative results from the lower revenue trend, a very volatile top line, and more importantly negative earnings and FCF. These past results achieved had made the company extremely risky, with a net debt/EBITDA reported to be as high as 8.7x in 2020. The year 2021 was revolutionary for the company, LSB was positively affected by the inflation rise and higher commodity prices, a fact that combined with good financial management allowed the company's fundamentals to improve greatly.
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 due to an increase in volumes, which decreased further by 13% compared to the previous year's level. This trend was also confirmed by the recent Q1 results in 2022 in which the company's revenues grew 102% over the previously excellent results in Q1 2021. The strong revenue growth can be attributed to the further increase in prices, in light of the fact that volumes decreased by another 15% from the previous year's first quarter.
On the costs side, the company's main cost is natural gas, a key element in ammonia production. As we know, the gas price has skyrocketed in the past year, especially as a result of the Russian invasion. However, LSB Industries has managed to contain its gas purchase costs, thanks to hedging contracts, a positive circumstance that has also led to an increase in margins from negative territory to big tech companies figures.
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 is likely to be maintained throughout 2022. These stunning results have enabled the company's management to decrease its overall risk, including through two extraordinary transactions that facilitated additional capital and a reduction in debt-related fundamentals. The company's management in FY '21 converted $296 million in preferred shares into common shares, increasing equity to $471 million at the end of 2021.
In addition, LSB Industries improved its capital structure through debt refinancing, which lowered its cost of debt by 3% and raised an additional $200 million in cash for future acquisitions and investments to make production more efficient. As a result, the company will improve its group profitability, currently, the new net debt/EBITDA ratio has been reduced to 2.34x in Q1 2022 and could move to 1.55x following expectations of $310 million EBITDA for FY '22. These are great results which have fully benefitted from the macroeconomic context in these past two years.
The company will probably be able to maintain this profitability through 2022, guiding profit to about $160 million and achieving a PE ratio of 10.81x considering the current capitalisation.
Source: LSB Industries Q1 results
As mentioned in the introduction, our internal team thinks that LSB can be an excellent investment in an inflationary environment for the following reasons:
Source: LSB Industries Q1 Press release
Based on the above, we think 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, since it would be very negatively affected by a decrease in commodities prices that are currently at all-time highs. If this inflationary pressure continues, LSB industries will be very positively affected. Therefore, we initiate coverage with a neutral rating.
This article was written by
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.