LSB Industries - Q2 2023

Transcript

Operator (participant)

Greetings, welcome to the LSB Industries' Q2 2023 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Fred Buonocore, Vice President of Investor Relations. Please go ahead.

Fred Buonocore (VP of Investor Relations)

Good morning, everyone. Joining me today are Mark Behrman, our Chief Executive Officer, and Cheryl Maguire, our Chief Financial Officer. Please note that today's call will include forward-looking statements, and because the statements are based on the company's current intent, expectations, and projections, they are not guarantees of future performance. A variety of factors could cause the actual results to differ materially. As this call will include references to non-GAAP results, please see the press release in the investor section of our website, lsbindustries.com, for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results. At this time, I'd like to go ahead and turn the call over to Mark.

Mark Behrman (CEO)

Thank you, Fred. We're happy to have the opportunity to speak with you today about our 2023 Q2 results and our outlook for the Q3 and full year of 2023. I'd like to start by once again congratulating our team on their outstanding safety performance. For the first six months of this year, we've had 0 recordable injuries and our trailing 12 months recordable injury rate as of June 30th, 2023, stands at 0.5. We are committed to ensuring that everything we do starts with safety. Looking at our 2023 Q2 summary on page 3 of the presentation, our manufacturing commercial teams performed very well during the quarter, which translated into a solid increase in both production and sales volume compared to Q2 2022.

I'm pleased to say that our average ammonia onstream rate for the Q2 and first half of 2023 indicates that we are making good progress towards our stated goal of operating our ammonia plants at a 95% onstream rate, reflecting the processes and procedures we've implemented, coupled with our reliability investments. We expect to see that rate continue to improve as we mature our new programs and get through next year's turnarounds. As anticipated, our financial results were lower compared to the Q2 of 2022. This was due to a decline in market prices for nitrogen products relative to last year's high pricing levels, resulting largely from the impact of lower natural gas prices in Europe and weaker industrial activity in Asia.

Additionally, during the Q2, domestic UAN demand was below our expectations headed into the period, as farmers opted to apply more urea to what had been a comparatively attractive pricing early this year for urea versus UAN. We have generated significant free cash flow over the last 24 months and expect to continue to generate free cash flow even in a lower nitrogen pricing environment, we have worked to balance investments in growth with return of capital to our shareholders. Last year, we repurchased $175 million of common stock, and during the 2Q of this year, we repurchased $125 million of our outstanding debt. Additionally, we repurchased $17 million of common stock under the $150 million stock repurchase program that our board authorized in May.

Collectively, as of the 12-month period ended June 30, 2023, we've returned in excess of $317 million to shareholders. We will continue to balance the use of our free cash flow to maximize long-term shareholder value. Lastly, as I have mentioned previously, we submitted a capacity expansion project at our El Dorado site to the USDA for funding under their Fertilizer Production Expansion Program. Our project was selected for consideration for funding and is open for public comments until the end of this month. Assuming we continue through the process, the EPA will conduct a further environmental review. While we are excited about this project, we will continue to evaluate it, taking into consideration our markets, the global economy, the timing and sequence of the expansion, and internal resources.

We would hope to decide on the next steps in this Q3, subject to the USDA's timeline. On page 4 of our presentation, we provide an overview of our end markets. Corn prices remain above multiyear averages, reflecting solid demand trends, dry conditions throughout many U.S. corn-growing regions, ongoing global uncertainties related to the war in Ukraine, and ongoing tight stocks-to-use ratios. Accordingly, we expect corn prices to remain at levels that would support strong fertilizer demand as we move towards the next planting season. In addition to strong corn prices, we believe that lower farm input costs relative to last year should further incentivize farmers to optimize fertilizer applications in the Q4 of 2023 and in the first half of 2024, as they seek to maximize yields for the next growing season. Demand for our industrial business remains steady.

Nitric acid demand is stable as global producers shift production from international facilities to the US operations in order to take advantage of lower US input costs. Demand for ammonium nitrate in mining applications is strong, as the increase in infrastructure projects increases demand for quarrying and aggregate production, and the growth in electric vehicles and other applications is increasing demand for metals in the US. Now I'll turn the call over to Cheryl, who will discuss our Q2 results and our outlook. Cheryl?

Cheryl Maguire (CFO)

Thanks, Mark, and good morning. On page 5, you'll see a summary of our Q2 financial results. We generated adjusted EBITDA of $47 million and adjusted EPS of $0.25 in the Q2, slightly below our expectations. This is largely because of a more significant decline in selling prices than we had anticipated early in the quarter, along with lower UAN sales volumes, as Mark mentioned earlier. Turning to page 6, you'll see a summary of our key balance sheet and cash flow metrics. During the Q2 of 2023, we generated cash flow from operations of $44 million and had capital expenditures of $14 million, translating into $30 million of free cash flow and a free cash flow conversion rate of approximately 64%.

Year to date, we've generated cash flow from operations and had capital expenditures of $103 million and $32 million, respectively. Our continued free cash flow generation enabled us to maintain a strong financial position. At the end of the Q2, we had approximately $314 million in cash and short-term investments. This was after we repurchased $125 million of principal amount of our senior secured notes for $114 million cash and bought back $17 million of our stock under our current $150 million share buyback program that our board authorized in May. As Mark mentioned, we are committed to a disciplined, multifaceted approach to capital allocation that balances return of capital to shareholders and investment in growth, with our focus on maintaining an appropriate level of leverage.

Relative to that, we ended the Q2 with $584 million in total debt and a net debt to trailing 12-month EBITDA leverage ratio of approximately 1 time. Page 7 bridges our 2023 Q2 adjusted EBITDA of $47 million from adjusted EBITDA for the Q2 2022 of $158 million, which was the highest adjusted EBITDA quarter in LSB's history. The lower selling prices for our products relative to last year's record highs were the primary factor in the year-over-year change in EBITDA. On the positive side, our sales volumes were higher in the 2023 Q2 relative to last year as a result of stronger ammonia operating rates at our facilities, coupled with our successful commercial initiatives. I'll outline some factors to consider when thinking about our Q3.

In terms of product selling prices, the nitrogen fertilizer industry typically sees a summer reset during the seasonally slow Q3 when the summer fill program comes out. We saw that again this year. The NOLA UAN benchmark was reset at approximately $195 a ton in early July. Having had a positive response to the first round of offers during the summer fill program, it was widely expected that offer levels would be raised. That occurred earlier this week and was aided by the persistent firmness of local and international urea markets, as well as the rebound in corn prices. At the time of the initial summer fill announcement, September NOLA urea barges were trading up to $303.30 a ton, with August trading sub $325 per ton.

The latest August, September barge trades have been $55 to $60 a ton higher, with the markets continuing to rise. This bodes well for UAN and AN pricing. However, current prices are still lower than our realized price for UAN and AN in the Q2 of 2023. The Tampa ammonia benchmark price settled at $285 per metric ton in July, below our realized average price of $370 per metric ton in Q2 of 2023. Tampa increased by $10 to $295 a metric ton for August, the first monthly increase since October of 2022. For the balance of the quarter, we expect to see continued but measured price appreciation for nitrogen products.

With respect to volume, we expect a material improvement in the Q3 of 2023 versus the 2022 Q3, as we have no turnarounds this year, and we had turnarounds at our El Dorado and Pryor facilities last year. I would note that during this Q3, the NuStar pipeline that we use to distribute ammonia from our El Dorado facility will be down for six weeks for scheduled maintenance. We will see a pretty sizable sequential decline in ammonia sales volumes, but still a material increase relative to the Q3 of 2022. We expect that additional inventory build during Q3 to be sold by the end of the year.

In thinking about costs, 90% of our natural gas feedstock costs for Q3 2023 are locked in at approximately $3.50 per MMBTU, so roughly in line with the Q2, but substantially lower than the Q2 of 2022, which was approximately $7.15. Putting it all together, given the current pricing environment I outlined, partially offset by our expectations for strong year-over-year production and sales volume improvement, we expect our Q3 adjusted EBITDA to see a similar sequential decline as what we realized in our Q3 of 2022. Looking out to the Q4, we believe that UAN and AN prices should continue to increase and that ammonia will see pricing improve with demand factors beginning to materialize. Now I'll turn it back over to Mark.

Mark Behrman (CEO)

Thank you, Cheryl. Page eight depicts the downward trend in European and Asian natural gas prices over the past 10 months. The drop in gas prices in Europe, caused largely by a combination of warmer-than-average temperatures this past winter, combined with increased storage inventories resulting from imports of LNG from the U.S., enabled European ammonia producers to come back online after curtailing production last year due to high feedstock costs. Gas prices in Europe remain significantly higher than gas prices in the U.S. At approximately $10 in MMBtu equivalent, this equates to a gas cost of ammonia production in excess of $350 per tonne for European producers. That's significantly higher than the Tampa ammonia benchmark of $295 for August, and the U.S. gas cost to produce ammonia of approximately $125 per tonne.

We believe that the disconnect is one of the multiple factors pointing to higher ammonia selling prices later this year. Page 9 provides an overview and update on our low carbon ammonia initiatives. We continue to make headway on advancing our blue ammonia project at our El Dorado facility and our green ammonia project at our Pryor facility, including entering into discussions with potential off-takers. These projects represent exciting opportunities to emerge as a leader in decarbonizing our industry. Not only do they have the potential to substantially reduce our carbon footprint, but we believe the economics of both should be very attractive. During the Q2, we were pleased to add to our low carbon ammonia activities with the announcement of our MOU with Amogy, a developer of ammonia-to-power technology.

The goal of this relationship is for the two companies to collaborate on developing low carbon ammonia as a marine fuel. Ultimately, we expect to leverage our combined capabilities to demonstrate how clean ammonia can become a primary fuel source for the commercial marine industry, and to work with additional partners to develop the ecosystem and infrastructure needed to support this transition, which would result in a major development in global efforts to reduce CO₂ emissions. We are in discussions with respect to several additional low carbon initiatives and look forward to announcing them at the appropriate time. There is no question that 2023 has been a challenging year with respect to the headwind from declining selling prices.

At the same time, however, we are very pleased with the progress we've made with our plant operations, our continued balance sheet improvement, our capital allocation program, and our new business developments in clean energy. We believe that collectively, these make us a company well positioned for growth in the coming years, irrespective of commodity price trends. Before I hand the call back to the operator for the Q&A session, I'd like to mention that we will be participating in the Seaport Virtual Summer Conference on August 22nd, the UBS Chemicals Conference on September 6th in New York, the Jefferies Industrials Conference, also in New York, on September 7th, and the RBC Industrials Conference in Las Vegas on September 12th. We look forward to seeing many of you at those events. That concludes our prepared remarks, and we will now be happy to take any questions. Thank you.

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Your first question comes from Josh Spector with UBS. Please go ahead.

Josh Spector (Director of Equity Research)

Hi, thanks for taking my question. First, I guess I just wanted to clarify some of your comments on UAN and the summer fill program. You talked about pricing kind of looking towards August and further out, $300 plus on the barge, I think you made the comment that your realized pricing is still below 2Q levels. Is that just an averaging effect, or can you explain kind of what's going on there? With the current spot rates, is there any chance you exit at a price higher than what you realized last quarter?

Mark Behrman (CEO)

Morning, Josh, how are you? You know, I think when you think about most of our products, particularly ammonia and UAN, we've got a summer reset that occurs sort of late June or really early July. We usually take an order book based on those prices for some length of time. I mean, it's not significant. It's not months out there. I think what we're gonna see in the Q3 is a lot of summer reset prices during the quarter, we'll realize a lot of these improvements in prices either late in the Q3 or early into the Q4.

Josh Spector (Director of Equity Research)

Got it. No, that makes sense. Just a question on the cost side. When we look at your cost ex gas, it looks like your costs are generally a good deal higher than they were a year ago and over the last couple of years, about, you know, $80 million a quarter, almost about $200 a tonne. From our math, that looks about almost 30% higher than where you would have been, again, ex gas costs over the past couple of years, despite having no turnarounds this year. I'm just curious if you can give us some context about what might be going on there operationally to drive costs higher, and if there's something structural or temporary driving any of that?

Mark Behrman (CEO)

Well, we'd have to take a look at that. I can't say I'm familiar with the 30% higher cost that you're referring to, so maybe we can follow up after the call. I will tell you that product mix obviously has an impact on cost, right? The reason we upgrade from ammonia is because we're making more margin. You know, I think that could be part of it, as we sold less UAN and more ammonia during the quarter.

Josh Spector (Director of Equity Research)

Okay, thanks. Yeah, I'll follow up offline. I'll, I'll turn it over and jump back in the queue. Thanks.

Mark Behrman (CEO)

Thanks.

Operator (participant)

Thank you. Next question, David Begleiter with Deutsche Bank. Please go ahead.

David Begleiter (Managing Director and Senior Equity Research Analyst)

Thank you. Mark, could you just clarify your comments and the guidance for Q3? I may have misheard the what it was expected to be versus the prior year. Thank you.

Mark Behrman (CEO)

Yeah, I think Cheryl mentioned that we would see a sequential decline that was similar to what we saw last year.

David Begleiter (Managing Director and Senior Equity Research Analyst)

Got it. Got it. On El Dorado, has anything changed in your thinking over the last three months, or again, do you expect a decision this week from, from the federal government on this project for the maximum amount? Is that still the current thinking?

Mark Behrman (CEO)

Yeah, I think, I think what I was referring to is really our comment period, right? We got selected as one of the projects that they're considering for funding, and then all of the projects that were selected have a public comment period, right? That's open for public to make comments, and then the USDA would review those comments. That will end at the end of this month. The USDA has already told us that, assuming that we move forward, they would want to do another environmental review. It's more, you know, whether it's NGOs or it's tribal, looking at any tribal issues or things like that.

After that, I'm a little more hazy on what the process is, but we would hope that by the end of September, we would have a lot more clarity as to whether they're going to fund us or not. The expectation would be that they would fund up to 25% of the total project cost, which the full project is about $400 million, so that would be $100 million.

David Begleiter (Managing Director and Senior Equity Research Analyst)

Very good. Thank you.

Mark Behrman (CEO)

Yeah.

Operator (participant)

Next question, Andrew Wong with RBC Capital Markets. Please go ahead.

Andrew Wong (Equity Research Analyst)

Hey, good morning. Could I just maybe clarify the Q3 EBITDA guidance? I think I heard Cheryl say that Q3 will be down sequentially, similar to what we saw last year. What, like, what, what does that mean? Does that mean EBITDA might be in, like, the $40 million-$50 million range, similar to what we saw in Q3 of last year? Or is there a different sequential decline that I should be thinking about?

Cheryl Maguire (CFO)

Yeah, sure. Hi, Andrew. What I was referring to is, you know, we generally see a, a pretty heavy sequential decline, as you move from Q2 to Q3, 'cause Q3 is the seasonally weakest quarter, as you know. If you look at Q2 of last year, and you look at Q2 to Q3 and what the decline was there, it was ballpark 65%-70% decline. I think you're gonna see a similar decline this year if you compare, you know, the Q3 to the second quarter of this year.

Andrew Wong (Equity Research Analyst)

Okay, that makes sense. Then I just wanted to ask, maybe following up a little bit on the cost question, maybe ask a different way. Like, how would you say, in general, your non-gas costs have been tracking this year versus maybe expectations going into this year or, or versus what you've seen in prior year levels?

Mark Behrman (CEO)

Andrew, I would say that our costs are higher this year for several reasons. One is just general inflation. We're seeing supplies increase, and we're seeing actually contractor costs increase, outside contractor costs. In addition to that, I think we elected to make some investments. I think this year we probably have $10 million-$12 million for the year of it, of additional higher costs. A bunch of, I would say it was adding technical talent and other folks to push our reliability programs and safety programs forward. It was also bringing in some outside technical talent to help us really take a look at some of our assets and analyze how we can operate them better and maintain them better.

I think those are costs that we elected to to take and rather than invest the capital, right, it just turns out they're expenses.

Andrew Wong (Equity Research Analyst)

That makes a lot of sense. Thank you.

Operator (participant)

Next question, Adam Samuelson with Goldman Sachs. Please go ahead.

Adam Samuelson (Equity Research Analyst)

Yes, thank you. Good morning, everyone. I, I guess, if I think about kind of as you're looking at waiting on the engineering designs, for the debottlenecking, have you gotten any better visibility at this juncture for just helping to frame size, scope, and thinking about the USDA, the potential USDA kind of funding contribution, kind of what proportion of project kind of capital costs that could represent as we try to think about the net capital outlay?

Mark Behrman (CEO)

Sure. If we did the full project, which would be debottlenecking our ammonia plant or nitric acid plant, and then we've actually changed the makeup of the project. Originally, it was to build a urea UAN facility, so to upgrade all of that to UAN. We're now thinking, based on really our vision for the company and really where we're going, and where the industry is going, is really to produce lower carbon products, rather than, you know, carbon, what's called carbonated products. It would be debottlenecking ammonia and nitric acid, and then building a new granulation facility to either granulate HDAN or some HDAN derivative product. If we did the full project, right now, I'd say conservatively, we're saying about $400 million to do the full project.

If we did it all at once, the USDA would give us, and we've asked for, and they've moved us along, I guess they would support it, 25% of that. That would be $100 million from the USDA. Our total capital outlay over, you know, a three to four-year period would be $300 million.

Adam Samuelson (Equity Research Analyst)

Okay. Now that's really helpful color. In the release and some of the prepared remarks, you talked about kind of some of the stronger industrial demand for nitric acid in particular. Any way to quantify that or help us frame that? I mean, there's not a lot of industrial kind of chemical chains right now showing kind of strong volume trends and demand trends. It's been pretty characterized by a tremendous amount of destocking, in the last six to 12 months. It'd be helpful just to frame kind of how, what you're seeing amongst your customer set for nitric acid, specifically.

Mark Behrman (CEO)

Yeah, I mean, I think we're seeing some variability in customers. I would agree with you, that, you know, I think customers are struggling a little bit. We do have contracts with our customers, and in a number of our contracts, there are take or pay provisions. You know, one way or the other, you know, we're gonna get paid for the product. Having said that, I think our commercial team has done a really great job. Where our customer maybe has to throttle back some of the production in their own plant, or they've had plant issues, which happens. I mean, we all have plant issues at some point in time. You know, the team has really stepped up and found other avenues for that product, right, in the spot market.

I think we're just, you know, seeing, you know, solid demand across the board. I think the other way to maybe think about it is we do have a lot of strong tailwinds in the mining market. To the extent that we could shift some of that production and upgrade that nitric acid, if we have the capacity to upgrade it to either AN solution or AN, prilled AN, and sell it as into the mining market, then we can do that, too. I think across the board, when I think about the non-fertilizer markets, you know, we've got some pretty good balance that allows us to really weather some of the variability in the straight industrial market.

Adam Samuelson (Equity Research Analyst)

Okay. All right. I appreciate that color. I'll pass it on. Thanks.

Mark Behrman (CEO)

Sure.

Operator (participant)

Next question, Laurence Alexander with Jefferies, please go ahead.

Daniel Rizzo (Equity Research Analyst)

Good morning. This is Daniel Rizzo on for Laurence. Could you tell me in the past, I mean, if corn prices are as they are, have you seen a lot of pre-buying that could provide a, a more of a near-term tailwind in the late, in the Q3 and the early Q4? Or are growers more than likely just to wait to see how things play out next year?

Mark Behrman (CEO)

Well, that's a really great question. I'd say historically, what would happen is what you mentioned first. With strong prices, farmers, ultimately, would be pre-buying. We're still seeing, you know, a fair amount of that and would expect a fair amount of that. This last year, the dynamic changed a little bit, to a bit more just-in-time buying, which, you know, is a risk for the farmer because, you know, they're not only are they betting on prices going down, but they're also having to deal with the logistical aspect of getting it just in time.

You know, in order to kind of think about that as we take a step back, we still think there'll be a fair amount of pre-buying, but we've also now taken some additional storage locations, particularly for UAN, to position product to where we think much closer to our customers, so that we can service easier and be the product of choice and handle the just in time.

Daniel Rizzo (Equity Research Analyst)

Just to follow up, so with those additional storage facilities, what does that mean anything meaningful to your inventory levels and working capital?

Mark Behrman (CEO)

No, I would say nothing meaningful. What it does do is it allows us to store product to sell at higher points of the year or in season versus out of season. I think it allows us to have the optionality to do that. Of course, when you're talking about just in time and someone really needs product, they are willing to pay sometimes a higher price for that. Again, I think it gives us optionality to try and take advantage of anomalies in the market and ultimately get some higher pricing.

Daniel Rizzo (Equity Research Analyst)

Thank you very much.

Operator (participant)

Once again, if you would like to ask a question, please press star one on your telephone keypad. Next question comes from Rob McGuire with Granite Research. Please go ahead.

Rob McGuire (Stock Analyst)

Morning, Mark, in your opinion, what, what are the leading drivers behind nitrogen prices stabilizing over the last month?

Mark Behrman (CEO)

Well, first, you know, I think when you look at urea, right? Urea is the largest used and traded fertilizer around the world. Urea prices have increased dramatically. Just looking at prices this morning, around the world, you know, urea is sold at north of $400 today. You know, it was a lot of tons in the East, and so, you know, Middle East and Asia, you know, in other parts, certainly in Europe. Here in the States this morning, you know, it drifted over $400 a ton. Higher urea prices are really, I think, being driven by increased demand, lack of Chinese exports.

There have been some plant issues around the world that have caused maybe a bit of a shortage, at least today on urea. With urea prices moving up, and again, everything, all products trade to some extent on a nitrogen equivalent basis, you're starting to see pickup in other prices and particularly UAN prices. Ammonia is a bit different. Ammonia, you know, about 30% of all ammonia is used industrially, and we are, as Adam mentioned earlier, we are seeing industrial demand globally, you know, sort of down, and particularly in Asia, where it's not picked up yet, post-COVID. It's been a really slow recovery. I think that dynamic is probably still putting some pressure on ammonia.

Rob McGuire (Stock Analyst)

Do you have a formal sale program in place for the fall for UAN right now? Can you kind of give us an idea where you're seeing fall prices for UAN relative to, say, the, the lows of summer?

Mark Behrman (CEO)

Yeah. The summer, you know, that summer reset program came out in early July. You know, almost all the producers offered limited volume. Once that was sold out, there was really a lot of unmet demand. This week, pricing moved up, you know, anywhere from $20-$40 a ton, depending on location.

Rob McGuire (Stock Analyst)

Okay, great. You talked about how farmers opted to apply more urea than UAN, just the comparable attractive pricing, differential there. Can you just tell us, how do you think UAN and urea plays out from here through the year end?

Mark Behrman (CEO)

Well, I mean, UAN prices are much more attractive right now with urea up at $400 a ton. I would think that we would see a bit more demand on the UAN side than the urea side. You know, that would be the expectation, given where pricing is today.

Rob McGuire (Stock Analyst)

Okay, thank you.

Mark Behrman (CEO)

Yeah.

Operator (participant)

There are no further questions. I would like to turn the floor over to Mark for closing remarks.

Mark Behrman (CEO)

I always, as always, appreciate everyone's interest in LSB Industries. I hope you feel like we're making improvements at the company, and we've got a significant amount of opportunity to really increase shareholder value. If you have any further questions, feel free to follow up with a call to Fred Buonocore, who leads investor relations for us, or Cheryl or myself, and hope to see you guys at some of the conferences that we're going to be attending. Thanks, and have a great day.

Operator (participant)

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.