LyondellBasell Industries N.V. (LYB) manufactures of chemicals and polymers, refiner of crude oil, producer of gasoline blending components, and develops and licensor of technologies for production of polymers worldwide. It produces and markets olefins, including ethylene, propylene, and butadiene; polyethylene products, which consist of high-density polyethylene, low-density polyethylene, and linear low-density polyethylene; polyolefin, such as polyethylene and polypropylene (PP); and PP monomers, copolymers, and compounds. These are chemicals that are used in the manufacture of plastic products. Having developed expertise in the production of these products, the company generates additional revenue by licensing its technology companies to other companies. The company also produces and sells propylene oxide and its derivatives; oxyfuels and related products; and intermediate chemicals, such as styrene monomers, methanol products, glacial acetic acids, vinyl acetate monomers, and ethylene oxides and derivatives. Finally, it refines crude oil into gasoline, diesel, and jet fuel. In the last 12 months, the company generated profits of $3.6 million ($8.93/share) on $30.8 billion in revenue.
The share price of LYB run up nicely after the financial crisis as the US and global economy recovered. In Q3-2014 the share price advance price came to a screeching halt even as the company continued to perform nicely. For the past 3 years, the company’s share price has traded sideways ways with a negative bias and we think it will break out of this pattern to the upside at any time. Yes, revenues fell the past few years, but this was driven by a drop in the price of feedstocks, naphtha and natural gas. What matters in the refining and chemical processing business is the spread between the cost of feedstocks and the revenue generated by selling end products, in this case chemicals and fuels. Refining spreads have remained robust and we expect they will continue to do so. We think investors are overreacting to the revenue dynamics and not paying enough attention to profits and free cash flow.
Valuation is very supportive of the bullish case. The shares are priced at a PE of 9.0 based on trailing earnings and 8.6 based on analyst’s expectations of next year’s earnings. The company will be reporting earnings on or about July 28, and we think they will meet or exceed expectations of little or no growth in earnings. In addition, enterprise value as a multiple of operating cash flow (EV/EBITDA) is a very modest 6.5. indicates the shares are undervalued even for a slow growing, capital intensive company.
In the final analysis, we think LYB deserves to trade at higher levels and the technical suggest that a move higher could occur at any time. If you own the stock we suggest you keep it. If you do not, investors should consider buying it. For those wanting to take a bullish position with limited risk, we suggest selling a slightly in the money put spread. This structure provides some leverage to higher prices and a positive carry as well. With the stock trading at $79.14, we recommend the following structure.
Sell 1, 9/15/17 $80.00 Put @ $4.80
Buy 1, 9/15/17 $75.00 Put @ $2.66
for a Credit of -$2.15
To initiate this trade, the investor will collect $215 up front per put-spread which they get to keep so long as the share price stays above $80 at expiration. The breakeven level is $77.85, which is 1.6% below the current price. The efficient market hypothesis suggests there is a 52% chance of success on this trade. The most one can lose on the trade is the $285 which would occur if the share price trades below $75 at expiration, which is 5.1% below the current share price.
The chart above shows the 5-year historical return distribution of LYB stock for a holding period of 100 days (the time to expiration of the put spread). It shows that that the stock like to trade higher most of the time. While the efficient market suggests a 52% chance of success, the historical distribution suggests a 70% chance of success. But there are periods when the share price get hit hard. This downside volatility is indicated by the “fat” left tail of the distribution. LYB pays a nice 4.5% dividend and option premiums are reasonable. This makes a covered call a potentially good strategy as well. The risk in this strategy is that if we get the market correction we are looking for, the share price could trade with the market and fall more than it rightfully should. As a result, we prefer a risk limiting structure at this time. This price action suggests that gains should come in fits and starts assuming that VIAB trades going forward like it has in the past. This analysis also suggests there is a 47%% chance of success on this trade, somewhat less than a random walk.
