Master investor John Neff doesn't give out a lot of stock tips. So when I came across a SmartMoney article this weekend in which Neff suggested that shares of Lyondell Chemical (NYSE: LYO ) are undervalued and offer an attractive 3.9% yield, I had to see for myself.
The business
Lyondell doesn't garner a ton of attention for being cutting-edge or exciting, but its products show up in things we use every day, from plastics to beverages. In addition to its chemicals businesses, the company owns a refinery with Citgo that specifically handles heavy (or sour) crude. However, the partnership agreement with Citgo's Venezuelan ownership hasn't exactly been harmonious, and the two companies are looking for a buyer for its refining operations. Thus far, Tesoro (NYSE: TSO ) is the most likely bidder, but a sale does not appear imminent.
What makes Lyondell different from competitors such as ExxonMobil (NYSE: XOM ) , Huntsman (NYSE: HUN ) , and Income Investor selection Dow Chemical (NYSE: DOW ) , is the cost advantage it gets from its ability to use what it calls heavy liquids (heavy crude) as an input to its processes. This is often cheaper than using natural gas when the sales of the co-products from the heavy liquids are taken into account.
The financials
Lyondell carries a fair amount of debt, but as the table below shows, the company isn't having much of a problem covering the interest and working down the principal.
|
2005
|
2004
|
2003
|
|
Revenue
|
$18,606
|
$5,946
|
$3,781
|
|
EBIT
|
$1,392
|
$601
|
-$120
|
|
Interest
|
$603
|
$449
|
$392
|
|
Interest Coverage
|
2.1x
|
1.3x
|
NM
|
|
Long-Term Debt
|
$5,974
|
$7,412
|
$4,151
|
|
Free Cash Flow
|
$1,345
|
$284
|
-$165
|
|
Dividends Paid
|
$222
|
$127
|
$116
|
Data from Capital IQ, a Division of S&P.
Dollar figures in millions; interest coverage = EBIT/interest.
The company's late-2004 acquisition of Millennium accounts for the large jump in the scale of the financials from 2004 to 2005. This acquisition broadened the company's product line and gave it ownership of the remainder of Equistar (Lyondell owned a portion of Equistar prior to the acquisition). Most importantly, the overall financial health of the business is improving, and selling the refining business may help this rebound continue.
The company's annual dividend is currently capped at $0.90 per share under its credit agreement. But this could change if the company refinances its debt; that seems likely, since achieving an investment-grade credit rating is one of the company's goals.
Valuation and final thoughts
Doing a quick back-of-the-envelope valuation, I find Lyondell to be a bit undervalued, and I have to give the company credit for providing a straightforward 10-K and spelling out its goals. That said, the acquisition of Millennium and the pending sale of the refining business mean I have a lot more research to do. For now, I'm happy to add this to my watch list as I dig in further and determine whether I'd like to start receiving the plump 3.9% yield.
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Nathan Parmelee
has no financial stake in any of the companies mentioned in this article. The Motley Fool has a
disclosure policy
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