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LXU - LSB Industries


TonyG
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LSB could be priming itself for a potential sale of the company, spinoff, or conversion of chemical assets into MLP. LSB has been a nepotistic company and consistently had operational problems with some of their facilities, which has attracted some investors to call for a strategic committee in order to increase shareholder value.

 

LSB operates two different types of business: 1) Chemical Business, 2) Climate Control Business

 

The chemical business operates out of 4 facilities located just outside the corn belt and mainly sells nitrogen fertilizers to the agricultural market where farmers need these fertilizers in order to obtain a higher crop yield for it’s harvest. The nitrogen fertilizer business has good underlying trends such as growing population, increase in meat consumption/ improvement in people’s diets, which roughly grows at 1-3% a year.  Farmers are always going to need nitrogen fertilizers because after crops are harvested, the crop takes most of the nitrogen from the soil and so next planting season you need these fertilizers to replenish that lack of nutrients. LSB has been plagued by misfortunes at it’s chemical facilities such as pipe ruptures and a reactor explosion which leads to downtime at these plants and less revenue. The company did $381m in revenues in 2013 and 111m in EBITDA. Without operational problems, this business can do roughly 150-200m in EBITDA.

 

The Climate Control Business sells HVAC products (geothermal and water source heat pumps). This segment has averaged around 30-40m EBITDA past 8 years and did 285m sales in 2013. WaterFurnace was acquired this past summer for C$378m and had revenues of US$119m and did US$20.23m in EBIT. Roughly 17x EBIT and 3x Rev.

 

The board of directors has been materially restructured from 14 to 10 and out of those 10, three new board members with relative experience in the lines of business have been added.  The former CFO and the former VP of manufacturing of Terra Industries have been added as board members. Terra Industries sold itself to CF Industries in 2010. The other board member is CEO of Comfort Systems USA, an HVAC company. The board has also formed a 4 man strategic committee in June with 2 of those being 2 new board members – the former CFO of Terra and CEO of Comfort Systems. The shareholders involved who have created this change have been Engine Capital, Red Alder, and Starboard Value. All have been tremendously successful in creating shareholder value in other situations. Just this past month, Starboard, which recently increased it’s stake to 7.2% of the company, has been instrumental in merging MeadWestvaco’s packaging business and spinning off it’s chemical business and also the merger of Staples and Office Depot announced today.

 

 

 

Valuation                                                   

 

Climate Segment 2014 EBITDA              30M

EBITDA Multiple                                    10x

Value                                                  300M

 

Chemical Segment EBITDA 2014            160M

EBITDA Multiple                                  9x

Value                                                  1.44B

 

Corp. Overhead Expense                        12M

  Corp. Overhead Multiple at 9x              108M 

 

Enterprise Value                                  1.644B

Add:Cash(Including Nat.Gas Prop.)        371M

Less: Debt                                            448.7M

Shares Outstanding                              23.6M

 

Share Price                                            $66

Implied Upside                                        103%

 

This is just a quick summary of the fundamentals of the situation. Would be interested if anyone has ever looked at this or a fertilizer company before and would like to share their thoughts.

 

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I have looked at RNF (and RTK), UAN, and CF for several years now.  I posted my investment thesis on CF about 15 months ago on that thread which may help in understanding the nitrogen business.  I really like the domestic nitrogen producers at the moment for several reasons.  i) They have a cost advantaged position due to lower natural gas prices and ii) North American imports roughly 35% of the nitrogen demanded which is sold at the global marginal producers cost of production.

 

These dynamics have caused current producers (CF, Agrium, Orascom, Potash Corp) to increase supply domestically.  Beyond the incumbent producers there is substantial capital going into greenfield expansion, some up to $3,500 per gross ammonia ton (the CHS Spiritwood plant).  CF Industries' brownfield expansions and Orascom's Wever, IA greenfield plant provide good benchmarks for the value of current plants which were built at $1,800 and $2,500 per gross ammonia ton respectively.  Beyond that, many companies have cancelled potential greenfield or brownfield plants due to increasing costs.

 

LXU will spend roughly $345m to expand their El Dorado facility with will bring total gross ammonia capacity to 850k tons.  I know nothing about their climate control business however with LXU trading at a $1b enterprise value, and assuming a value of ~$200 for climate control, the market values their nitrogen assets between $1,100 and $1,200 per gross ammonia ton (net of the $345 needed too expand their El Dorado facility).  Coincidentally, most of the "world class" greenfield builds are for roughly 800k of ammonia which have ranged in prices of  $1.2b to $3b.

 

The question then becomes, why build when you can buy for much cheaper?  I would note that in speaking with UAN's investor relations, the joke in the industry is "it's news when the Pryor plant is actually running, not when it's down."  So perhaps these are just busted assets incapable of ever running with the efficiency of a new plant.  My opinion is that a more seasoned operator such as CF or Agrium should purchase these assets and improve the efficiency and reduce downtime.  I believe greenfield builders more inclined to buy vs build at the moment and will consolidate the North American nitrogen industry soon.  It is far more attractive to buy assets selling for $1,200 per gross ammonia ton than build for $2,500.  In addition to simply the price tag, you have to factor in time value of money (immediate cash flowing assets vs 4-5 years of construction) and the risks inherent in building over a longer time frame.  LXU, RNF, and UAN being smaller guys are likely to be picked off by larger operators.

 

 

PPT_Slides_-_Nitrogen_Industry.pdf

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Nielfiel, interesting insight about the Pryor Facility. It’s definitely had its problems. Are you long any of those names or just CF? I think you are right in thinking LSB is a prime takeout candidate because of the time to build and costs less than starting from scratch. Management (The Ghosen Group) is aligned with shareholders, in that they own just under 20% of the company, to maximize value. That being said, they might not want to give up the family business that was started 50 years ago just to appease some shareholders. Even if this company doesn’t get bought, the board has a lot more experience now in guiding management into running a better operational company that will limit downtime at facilities. I think there are multiple ways to win here.

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Nielfiel, interesting insight about the Pryor Facility. It’s definitely had its problems. Are you long any of those names or just CF? I think you are right in thinking LSB is a prime takeout candidate because of the time to build and costs less than starting from scratch. Management (The Ghosen Group) is aligned with shareholders, in that they own just under 20% of the company, to maximize value. That being said, they might not want to give up the family business that was started 50 years ago just to appease some shareholders. Even if this company doesn’t get bought, the board has a lot more experience now in guiding management into running a better operational company that will limit downtime at facilities. I think there are multiple ways to win here.

 

Tony - I do own the others mentioned, RTK - 6%, CF - 4.75%, RNF - 4.35%, and UAN - 4.0% so as a group they account for nearly 20% of my portfolio.,  I've allocated even more capital to this basket however, probably close to 25% of my portfolio.  Both RTK and RNF fell throughout last year and I continued to add to those positions.  I don't own TNH because CF has the incentive distribution rights.  The other MLP out there is OCIP which I don't own (haven't looked closely).  Just a quick note regarding RTK & RNF - they were targeted by activist investor Engaged Capital and were able to get some momentum in terms of board seats.  Blackstone however agreed to fund RTK's wood pellet MLP venture and took board seats, which calmed the activists.  The company also made a CEO change which I am thrilled about.  The old CEO, Hunt Ramsbottom, seemed to destroy value every year.

 

Since your post I did look a bit more into LSB, and I have to agree with you, their new board members seem to have significant experience in the nitrogen space and will likely operate those assets much better.  One comment regarding the ownership.  As you said the family ownership seems to align shareholders however I always wonder if they are actually in it for maximizing shareholder value (through a sale perhaps) or are they in it for the recurring salary?

 

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I agree that is a potential downfall. The father CEO just retired and passed the role on to his son. But management now has to be more accountable due to the new board members and also Starboard has option of putting up some more board candidates by March 1st.

 

Also, just happened to read the latest edition of Value Investor Insight and they interviewed Scott Hood who works at First Wilshire Securities and they own LSB. Some highlights from the interview about LSB:

- Visited the head offices and commented on how he liked the office space. The people working there seemed embarrassed 

  and said they didn’t want to waste money on nice office space.

- Market is uneasy about the stock due to production problems at facilities and fall in commodity prices, which hurts the       

  farmers and miners.

- If gas prices are low and fertilizer prices are high, think company can earn $6 in EPS.

 

 

Going to look into the Rentech situation more though as well. 

 

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  • 2 weeks later...

Important comparison here, RNF said it is exploring strategic options including a sale.  The price of RNF stock has risen 30% above it's 30 day VWAP prior to the announcement.  I take this as a sign that their assets are worth more than they are priced in the market, which I believe on a per share basis is in the high teens, equating to a ~$2,500 per ton of gross ammonia value. 

 

Additionally CF Industries reported a cost increase to their nitrogen expansion projects of "just under 10%" from $3.8b to $4.2b.  The headline is misleading however as the entire increase relates to their Port Neal, IA expansion and amounts to a 24% increase in costs rising from $2,000 per gross ammonia ton to $2,470 per gross ammonia ton.  The evidence seems clear that costs to build nitrogen capacity in the corn-belt are at least $2,500 per gross ammonia ton.

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Thank you, Tony, for kicking off this thread. I have been looking with special interest at LSB because of the activist play by Starboard. However I could not find the hidden value in this company. How do you get at an estimated 160M EBITDA for the chemical segment?

 

Looking at chemical segment EBITDA for the last three years LSB  has done:

- 2013: 111.3M of which 66M was insurance proceeds of the explosion in 2012.

- 2012: 98.5

- 2011: 131.2

 

Admittedly EBITDA for 2012 and 2013 is lower due the plant disruption, but I cannot see more than 130M EBITDA instrinsic profitability for the chemical segment.

 

On top of this, when I look at EV/EBITDA for f.e. CF industries it is currently at 6 and this multiple has hardly been higher over the last 5 years. And compared to LSB, CF seems to be much better run: proven excellence in operation, investments in new plants with clear roic targets, expansion mostly in Urea (the product which is 65% imported as opposed to f.e. ammonia which is 35% imported, thnx Nielfiel for the ppt) and very aggressive share buyback.

 

So, taking EBITDA 130M x 6  = 780M EV for chemical segment and other assumptions the same as original valuation, I get 984M EV and implied share price of $ 38. And that is where the share price is pretty much at.

 

But... Engine Capital and Starboard are no fools and they have put their money where their mouth is. Why are these guys taking this high hurdle of turning LXU around, while just buying CF seems to be the lower hurdle to get the result without activism. What am I missing?

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Farbelow,

 

The company said in a presentation, when it was doing its bond offering, that it could do 150-200m in EBITDA. An analyst also mentioned it on a conference call I believe last year. Also, this company has not had fully operational plants every year, which have depressed EBITDA. So even buying in at this price with depressed EBITDA presents little downside. One other thing, MLP’s usually trade at higher multiples and if they do convert their chemical assets into an MLP, they could garner a higher multiple than 6 I believe.

 

I attached the letter Engine Capital wrote to the board. In it they also state 150-200m in EBITDA.

 

http://www.businesswire.com/news/home/20131230005229/en/Engine-Capital-Issues-Open-Letter-Board-LSB#.VOzxyUsrhg0

 

The company reports earnings this week on Friday I believe. With the stock running up from 31 to 36 this past month, I think investors are expecting some kind of announcement with regards to their strategic committee.

 

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  • 2 months later...

TNH is a possible play too (spinoff from CF holdings).

 

I had concerns about low inputs reducing outputs. IE Munger's lower cost structure in a competitive industry passes savings to the consumer (not to the producer).

 

I never could get comfortable w/that risk so I skipped on this whole sector

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  • 5 months later...

I'm following.  Seems this is just getting absolutely puked out at this point. I think at this point the market is pricing in an equity raise, further el dorado cost/time overruns, absolutely no recovery from suing/settling with the general contractor, and perhaps more of the same general issues at Pryor.  I like that they're basically cleaning house.

 

I don't like the fact that starboard was selling with board seats 2 days prior to pooping the bed on q2 earnings.

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Thanks for the input--I don't have much to add really but I also noticed (and didn't like) Starboard selling. I didn't figure an equity might be on the table seeing as they have a somewhat healthy cash balance, but I didn't check how much of El Dorado that has been funded already.

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An equity raise is not for sure.  If you take the high end of their current cost estimates, they need to come up with a little cash.  If you look at the history, they came out with one revised cost estimate and then another, much higher, a few weeks later.  I suspect they may have high-balled the second estimate as part of the house cleaning.

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Ccap, I was just stating what I perceive to be priced into the stock.  I personally think there's a 60% chance of an equity raise.  So I'm hoping for a few more strong days of share price performance so that a raise won't be quite as dilutive. There is a shelf filed, btw.  And this management team simply has no credibility.  Further, I don't think the el dorado cost estimate was a high ball.  I wouldn't be surprised if it gets bumped up again, and/or this gets pushed later into q2, or even q3+.

 

that's what happens when you hire a general contractor out of nepotism (a current board member was a vp at saic, now known as leidos).  Why not hire a gc chock full of fertilizer experience??

 

Scott hood and Murray stahl might have different perceptions of management quality, but I come out on the starboard, engine, red adler side of the argument. 

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  • 3 weeks later...

It looks like Leidos is offering short term financing of $50M so that LSB doesn't have to borrow under adverse conditions.  This would cover the upper bound on estimated required liquidity.  After construction is completed, LSB has a month or so to borrow the required funds.  I expect issuing debt or stock will be much easier with completed construction.  Overall, this doesn't eliminate the chance of dilution, but it does reduce the odds.

 

LSB's maximum gain from the lower markup is less than the additional it is paying in overhead.  Maybe this is a hidden fee to extend the financing.  I'm not sure what the motivations for this change were.

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  • 2 weeks later...

It isn't a great situation.  On the positive side, they locked up financing to complete the project.  On the negative side, they took on a lot more debt and gave away 20% of the business.

 

Reading the earnings call would have been comical had I not owned any of this.  It appears they began building the plant without any engineering work.  They basically made up their estimated completion price and did not give error bars on it.  With guys like this running businesses, it is very clear how Ichan has made a fortune by pushing them out.

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It isn't a great situation.  On the positive side, they locked up financing to complete the project.  On the negative side, they took on a lot more debt and gave away 20% of the business.

 

Reading the earnings call would have been comical had I not owned any of this.  It appears they began building the plant without any engineering work.  They basically made up their estimated completion price and did not give error bars on it.  With guys like this running businesses, it is very clear how Ichan has made a fortune by pushing them out.

 

So what to do?  I pose the question in the spirit of F*ck, Marry, or Kill.  Should current LXU shareholders: Buy, Capitulate, or Kill Themselves?  If $855 is the right number and they cross the finish line, pro forma for everything, this is more than a double from where I sit.  I'd guess they can go up to about 875 without needing to go back to Security Benefit hat in hand.  The trading in this, and Starboard's apparent disgust, seem to think I'm the only one with this mindset.  I'm all for being a contrarian, but as Howard Marks astutely points out, it's not enough to simply be different. One needs to be different *and* right.

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