LSB Industries, ~8% Yield-to-Worst, Maturing August 2019
This week’s bond review focuses on a company whose revenues are derived from its nitrogen products, which it sells to the agricultural, industrial and mining industries. LSB Industries have recently released their Q1 2017 results. These results show an impressive improvement over the company’s 2016 results.
A 24.6% year-over-year increase in net sales.
A whopping 141% increase in adjusted EBITDA
A 57% increase in the amount of agricultural products sold
In addition, the company has made excellent progress on cost and debt reductions, while increasing production efficiencies. The industry as well as company outlook looks extremely positive in terms of demand for LSB’s products. The company’s short 24- month bonds, couponed at 8.50%, have a current yield to worst (YTW) of ~8%. These bonds are an excellent opportunity for investors to add diversification with a pure play chemical company and will make a solid addition to our Fixed Income 2 (FX2) managed income portfolio. View the most recent aggregate performance of our managed FX2 portfolio below.
Improved Operating Results for Q1
LSB Industries recently posted its results for the the three months ending March 31, 2017. These results show a company that is emerging from a challenging 2016 with hopes for continued year-over-year performance improvements for the balance of 2017. Here are a few of the highlights from these results.
Net sales from continuing operations increased $24.4 million, from $98.9 million in Q1 2016 to $123.3 million in Q1 2017, an increase of 24.6%.
Adjusted EBITDA from continuing operations of $20.0 million for Q1 2017, as compared to $8.3 million for the same period in 2016, representing an astounding increase of almost 141%.
Gross profit of $11.6 million, as compared to a loss of $6.2 million in Q1 2016.
A 57% increase in the amount of agricultural products sold over Q1 2016.
About the Issuer
Headquartered in Oklahoma City, Oklahoma, LSB Industries was formed in 1968. The company manufactures and distributes nitrogen fertilizer and other nitrogen products across North America. Its customers are cooperatives, independent fertilizer distributors, farmers and industrial users. LSB manufactures products for the Agriculture, Industrial and Mining industries.
Agriculture — LSB manufactures and sells urea ammonium nitrate, high density ammonium nitrate and ammonia fertilizers for application in crop production for food and biofuel feedstocks and for pasture land and forage production.
Industrial — the company is the leading merchant marketer of nitric acid in the U.S. – offering various acid concentrations, high-grade mixed acids, and sulfuric acid.
Mining — LSB manufactures and sells low-density ammonium nitrate and ammonium nitrate solution for use in explosives for the mining industry.
LSB manufactures and distributes from four facilities: three owned facilities located in El Dorado, Arkansas, Cherokee, Alabama, and Pryor, Oklahoma as well as one facility operated on behalf of Covestro AG in Baytown Texas.
During 2016, LSB actually increased the amount of agricultural products it sold. However, due to drastic declines in the selling prices of these products (anywhere from 29% to 34%), the company’s net sales actually declined. These price decreases were due in part to lower corn prices, lower natural gas prices, as well as the addition of nitrogen production capacity being added globally. In response to this, LSB instituted Sales, General and Administrative (SG&A) expense reductions of approximately $6 million per year that it will begin to realize in 2017. In addition, beginning in 2017, the company has reduced plant costs at each manufacturing facility by approximately $6 million. Considering the three manufacturing facilities as well as the SG&A savings, that totals $24 million in annual savings beginning in 2017.
In addition to the cost reductions instituted by LSB, the company is also working hard to reduce its debt and improve its balance sheet. In October 2016, LSB called debt totaling approximately $107 million (including accrued interest) of the following notes: $50 million of its 12%, 2019 Senior Secured notes as well as $50 million of the company’s 7.75%, 2019 Senior Secured notes. The proceeds for these payments came from the company’s sale in July 2016 of its climate control business. LSB is continuing to identify businesses and assets that do not complement its core business focus as strictly a chemical company. These assets include working interest in the natural gas properties in the Marcellus Shale, its engineered products business, certain pieces of equipment and certain real estate. LSB intends to sell these non-core assets in the first half of 2017 and anticipates this will generate an additional $15 million to $20 million that it can use to further reduce its outstanding debt.
The on-stream rates of LSB’s facilities affects its production, the absorption of fixed costs of each facility and sales of its products. It is a key operating metric that the company uses to manage its business. Specifically, the company closely monitors the on-stream rates of its ammonia plants as that is the basic product used to produce all of its upgraded products.
In Q2 2016, LSB completed an expansion of its manufacturing facility at El Dorado, Arkansas, adding a new ammonia plant to its existing facility. However, since that time, the plant has experiences unplanned downtime due to various causes. As a result, the average on-stream rate for this plant since becoming operational was only 64%, but http://bond-yields.com/wp-admin/post-new.phphas steadily improved. In Q4 2016, that rate climbed to 73%.
On-stream rates of the other two plants improved in 2016 and in Q1 2017 as well. In 2016, the on-stream rate at the Cherokee facility improved from 94% in 2015 to 96% in 2016. Also, the on-stream rate for the Pryor facility improved in 2016 to 86% from 83% in 2015. Fast forward to Q1 and these efficiencies have continued to improve. The company’s Cherokee and Pryor ammonia plants operated at on-stream rates of approximately 99% and 96 respectively throughout Q1. The company’s El Dorado facility had on-stream rates in Q1 of approximately 90%, and for the month of March, achieved 100%. The company expects these on-stream rates to continue for the balance of 2017.
2017 Industry and Company Outlook
Several factors are contributors to a healthy industry outlook for agricultural chemicals. These include growing populations, developing economies, along with the fact that global grain consumption continues to increase. In addition, North America is a very low cost producer of nitrogen fertilizers, due to the fact that natural gas is a primary feedstock for the production of nitrogen fertilizers and there is ample supply thanks to the large natural gas reserves contained in the shale fields. Ample supply translates to lower natural gas prices and consequently, lower production costs.
LSB management is also predicting a much improved 2017 as compared to 2016 measurements. Due to increased demand for its agricultural products, the company recently sold through its entire production through the month of May 2017 of urea ammonium nitrate.
The company expects to be at full operating rates for 2017 and it will continue to focus on reducing costs. Also, management believes LSB’s operational cash flow will more than cover its capital spending needs and interest cost. In addition, any excess funds generated by non-core asset sales will likely go towards further de-levering the balance sheet.
Liquidity and Interest Coverage
As of March 31, 2017, LSB had cash on hand of $45 million as well as $44 million available on a credit revolver for total liquidity of $89 million.
For Q1 2017, LSB had adjusted EBITDA of $20.0 million and interest expense of $9.4 million for an adjusted EBITDA / interest expense ratio of over 2x.
The default risk is tied to LSB’s ability to continue its improved trajectory begun in Q1 to the rest of 2017 and beyond. The fact that the company sold through all of its urea ammonium nitrate production through the month of May a month early (in April) is a good indication of demand for its products. In addition, the increased efficiencies of its three manufacturing facilities is encouraging as well. Finally, the estimated $24 million in annual savings from company wide cost reductions should add nicely to the bottom line beginning this year. The current yield-to-worst of ~8% on the company’s 2019 bonds appears to outweigh the risks presented here.
As one of the main feedstocks for LSB’s fertilizer products is natural gas, the company is exposed to price fluctuations in the natural gas market. If natural gas prices increase significantly, this would increase its production costs and would have an effect on the profitability of its product sales.
One of the 2017 initiatives identified by LSB management was to evaluate strategic alternatives for its business. These alternatives may include a sale, merger with another party of another strategic transaction involving some or all of the company’s assets. In its last earnings call, Dan Greenwell, LSB’s President and CEO indicated that this process is ongoing and there will be no update on the process until the Board completes its review and approves a definitive course of action or concludes the review process.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
LSB Industries posted excellent results in Q1, beginning what appears to be a new trajectory for 2017, a marked improvement over its 2016 results. It has done a fantastic job bringing down production costs, as well as reducing debt / improving its balance sheet through the use of non- core asset sales. The company has healthy liquidity levels and is improving its efficiency levels at all three of its company owned production facilities. The industry and company outlook for 2017 and beyond looks extremely positive which should contribute to improved results this year for LSB. The company’s 2019 bonds, couponed at 8.5% and with a current yield-to-worst of ~8% provides an excellent diversification opportunity for income investors and will make an excellent addition to our FX2 managed income portfolio.
Issuer: LSB Industries Inc. (LXU:NYSE)
Bond Coupon: 8.500%
Rating: Caa1 / CCC
Yield to Worst: ~7.98 %
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