LyondellBasell – Hard To Fault

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First half oil prices were almost half the levels seen in 1H 2014, yet LYB has managed to produce 17% more net income than in the prior year. EPS growth is greater because of the significant share buyback, which looks set to continue given high free cash flows and high cash on the balance sheet. The company produced good results in the US and better than expected results in Europe given operating limitations in Q2.

LYB could make close to $11 of EPS in 2015, and with the stock trading at 8.2x that number, it is hard to resist. The stock has underperformed recently because of sentiment around oil, as it did in September and October of last year. Despite the collapse in oil last year, LYB is putting up better numbers and EPS is further enhanced by the buy-back. Furthermore, the company has again increased its dividend and now has a yield of 3.5%. LYB’s ability to buy back 10% of its shares a year offsets the risk of possible lower oil prices and lower near-term US and European ethylene margins in our view and the TSR that LYB could generate looks much more interesting than for others in the space.

LYB’s return on capital has held up while WLK’s has fallen over the last two years (see chart) – WLK, LYB and DOW are exposed to the olefin and polyolefin markets – one of the few commodity subsectors where China does not have a surplus and where Chinese exports are not damaging global pricing. The difference for both DOW and WLK is that they are exposed to other markets where China is a problems – chlor-alkali and PVC for WLK and chlor-alkali and epoxies for DOW (though DOW is divesting these businesses in 2015 to OLN).

Nervousness around oil has brought LYB back down to a price that looks very attractive given earnings and cash flows. There is clearly a risk that if oil weakens further you end up fighting a more general negative sentiment, but in our view the stock offers good value here.

The secondary risk would be that the strategy changes – the share buyback stops and LYB embarks on an acquisition spree. This is unlikely, but would be very unpopular with shareholders most of whom own the stock for the return of cash to shareholders.

Note that consensus estimates going forward do not appear to account properly for the potential share buyback, suggesting that while forward estimates might be vulnerable to lower crude prices relative to natural gas, they have upside from a lower share count.

All of the ethylene names look a bit more interesting here – WLK could increase its dividend and buy back stock, given cash flows and we think the same is possible at DOW – see recent blog. LYB is probably the cleanest story today, notwithstanding the change of strategy risk highlighted above.

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