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LyondellBasell: Lucky Break, But Attractively Priced

An American chemical company incorporated in the Netherlands, with the bulk of its facilities in the United States and Europe, LyondellBasell (hereafter “Lyondell”) keeps delivering phenomenal results in the wake of its reorganization seven years ago.

No less than a fifth of outstanding shares have been bought back by the company since 2013 — as they traded for 10x earnings on average — while a growing, generous and well covered dividend was paid. In that respect, returns to shareholders outmatched all peers within the industry.

Management maintains financial discipline under the inspired leadership of Bab Patel, a former top brass from Chevron. Astoundingly, average return on equity stood north of 40% over the 2010-2017 period, notwithstanding modest leverage and a sound capitalization.

Cash from operations should reach $4,5 billion this year, while capital expenditures — for the most part linked to maintenance of fixed assets — remain in the range of $1,5 billon a year. Despite expected free cash-flow of roughly $3 billion a year going forward, Lyondell trades for $32 billion, a surprisingly low multiple of roughly eleven times cash earnings and eight times GAAP earnings.

Obviously, a common mistake with cyclical companies is to extrapolate a profit at the top of the cycle, or underestimate the likehood of a reversion to the mean. Results are indeed uncommon by the chemical industry’s standards: perhaps the company has been riding an extraordinary — but temporary — wave in its specific businesses, or enjoyed some sort of first-mover advantage?

For a complete layman — such as yours truly — it’s hard to form an educated opinion about the complex, fast-moving methyl, ethyl, vinyl, polyethylene, polypropylene and other refined products markets. But it does seem that other analysts are pricing an end to Lyondell’s lucky streak, a stance that rings large with a comment once made by Stan Druckenmiller:

Very often the key factor [that makes a stock move up or down] is related to earnings. Chemical stocks, however, behave quite differently. In this industry, the key factor seems to be capacity. The ideal time to buy the chemical stocks is after a lot of capacity has left the industry and there’s a catalyst that you believe will trigger an increase in demand.

Conversely, the ideal time to sell these stocks is when there are lots of announcements for new plants, not when the earnings turn down. The reason for this behavioral pattern is that expansion plans mean that earnings will go down in two to three years, and the stock market tends to anticipate such developments.

Also, on occasion it may take years for companies to get rid of the bankruptcy stigma, so perhaps both factors conjugate here.

Absent these sophisticated reflections, and provided that a cycle downturn doesn’t occur, LyondellBasell is without a doubt the most attractively priced large capitalization in the chemical industry nowadays. On a side note, it perfectly fits Benjamin Graham’s playbook for defensive investors as laid down in The Intelligent Investor.

I expect the buyback program to cease if the share price continues to rise — as part of it has likely been financed by affordable debt — and a large acquisition to be announced whenever valuations deflate in some particular niche of the industry that would fit with Lyondell’s existing portfolio of activities.

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