Commodity-based businesses such as LSB Industries (LXU) are systematically treated as risky by rating agencies due to their concern about volatility. Rating agencies believe that these businesses have volatile returns and therefore high credit risk, but a different approach can be used to evaluate their credit risk. By using Uniform Accounting, we can see that LSB Industries has a much lower credit risk than rating agencies believe, as it takes into account the volatility of the company’s earnings. In today’s FA Alpha Daily, let’s look at LSB Industries using Uniform Accounting to see a more accurate picture of its profitability and credit risk.
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For the last few weeks, we have been mentioning how rating agencies are biased toward commodity-based businesses and do not analyze these businesses individually.
Another example of this is LSB Industries (LXU). The company is a diversified chemicals manufacturer.
It primarily sells ammonia and other nitrogen-based fertilizers to highly stable end markets like agriculture and increasingly for industrial production.
However, credit rating agencies take one look at LSB and they immediately get worried.
From their perspective, the company looks like a volatile commodity chemicals maker that is destined to have a high credit risk.
Despite LSB having a surge in returns in the last two years, the agencies see several years of unprofitability and get stressed.
In reality, the company has managed to stay strong during the pandemic and boosted its returns.
Due to lockdowns and restrictions, LSB was unprofitable and recorded a -1% Uniform return on assets (ROA) in 2020, but the company positioned itself well to benefit from upcoming market opportunities.
After just 2 years, its profitability jumped substantially and the company recorded a staggering 18% Uniform ROA.
In addition, as the supply-chain supercycle keeps unfolding, that demand doesn’t seem like it is going anywhere.
However, rating agencies continued to ignore this improvement in profitability and they did not even change their “stable” outlook for the business.
S&P rates the company “B”, meaning that the rating agency sees LSB as a high-yield name with around a 25% chance of bankruptcy in the next few years.
At Valens, we think that this is an exaggerated credit risk assessment for the company and that it deserves a much safer credit rating.
We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand how the company’s obligations match against its cash and cash flows.
In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
The CCFP chart shows that LSB Industries’ cash flows are more than enough to serve all its obligations going forward.
The chart shows the company does not even have any debt maturities in the next five years.
Additionally, the company has plenty of cash flows to service its operations and obligations going forward.
On top of that, the supply chain supercycle is coming. This means that the U.S. is heavily investing in infrastructure and industrial sectors, driving demand for LSB’s chemical products with its increasing emphasis on these sectors.
Due to these factors, LSB deserves to have a much safer credit rating. That is why our rating for the company is “IG3+”.
This rating shows that the company is placed within the investment-grade basket and implies a chance of bankruptcy of around just 1%.
It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.
To see Credit Cash Flow Prime ratings for thousands of companies, click here to learn more about the various subscription options now available for the full Valens Database.
SUMMARY and LSB Industries (LXU:USA) Tearsheet
As the Uniform Accounting tearsheet for LSB Industries (LXU:USA) highlights, the Uniform P/E trades at 11.0x, which is below the global corporate average of 18.4x but around its historical P/E of 10.7x.
Low P/Es require low EPS growth to sustain them. In the case of LSB, the company has recently shown a 282% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations, that in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, LSB’s Wall Street analyst-driven forecast is for a -53% and 8% EPS growth in 2023 and 2024, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify LSB’s $9 stock price. These are often referred to as market-embedded expectations.
Furthermore, the company’s earning power in 2022 was 3x the long-run corporate average. Moreover, cash flows and cash on hand 4x its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 570bps above the risk-free rate.
Overall, this signals a high credit risk.
Lastly, LSB’s Uniform earnings growth is below its peer averages and is trading in line with its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This analysis of LSB Industries (LXU)’s credit outlook is the same type of analysis that powers our macro research detailed in the member-exclusive FA Alpha Pulse.