Despite its size -- $34.3 billion market capitalization, $45.6 billion 2014 revenue -- few people have ever heard of LyondellBasell Industries (LYB +0.54%). It's not that it's secretive (its enormous plants can hardly be hidden), but its business of supplying manufactured commodities to other companies keeps it below most people's radar. They probably use its products daily without knowing it. Incorporated in Rotterdam, managed from Houston and London, assembled since 1985 from an amalgam of spinoffs, buyouts, carve-outs, and asset swaps, it's no great surprise that it's not better known, although it's the third-largest chemical company in the United States.
LyondellBasell refines petroleum fuels for sale to bulk purchasers and independent marketers, produces chemical intermediaries, notably styrene monomer, for sale to other chemical companies, and bulk plastics, especially polypropylene, of which it is the world's largest producer. In other words, it takes crude oil and natural gas as inputs, separates them into their components, makes relatively minor chemical alterations to these, and sells the results either as fuel, as a chemical that will in turn be transformed into other chemicals, or as raw material for makers of plastic products.
Most investors are troubled by an aspect of this business that shouldn't bother them. None of LyondellBasell's customers is unaware that its business consists of adding limited value to crude oil. When crude oil is expensive, LyondellBasell's products are expensive; when it is cheap, its customers expect the cost savings to be passed through to them. Most of them are. Yet when investors see a report that shows revenue down 27.3%, as the nine-month 2015 report did, they're horrified, even though operating income rose 8.8%. Petrochemical manufacturers and oil refiners make their money from the spread between raw material and product prices: Their revenue can change dramatically without much effect on income. In general, falling crude oil and natural gas prices allow them temporarily to capture extra margin before oil cost decreases are passed through to their customers. Yet their revenues decline during such periods, even if volumes increase.
In the following chart, costs include labor and capital items, stable factors that smooth the volatile trend in hydrocarbons: The spread varied from 13.1 cents to 37.3 cents per pound. Ethylene is the chemical precursor to high-volume products including styrene, vinyl acetate, and polyethylene: LyondellBasell has capacity to produce 8.6 million tons of it annually.
Data source: LyondellBasell quarterly reports.
Despite the fairly broad international spread of its operations, LyondellBasell is far less sensitive to currency movements than might be expected.
Data source: LyondellBasell.
Its principal raw materials and most of its other chemical inputs are dollar-denominated, as are the prices of almost all of its products. LyondellBasell manufactures at sites in 14 countries and has joint ventures in four others, where it incurs local currency costs for labor, depreciation, taxation, and the like. In addition to the large amounts of gas- or oil-derived energy that its production processes employ, gas, petroleum and closely related petrochemical inputs, all of which are dollar-denominated, constitute virtually all of its variable costs. The company may actually be more vulnerable to dollar weakness (which would magnify its non-U.S. fixed costs) than to dollar strength.
LyondellBasell's share price has had quite a ride over the past couple of years, with well over twice the volatility of the S&P 500 index. It appears as though it has experienced waves of excessive enthusiasm followed by abrupt reconsideration:
Data source: Yahoo! Finance.
Some of this may be the result of investors' misinterpretation of revenue signals, as suggested, but as much or more is probably the result of overemphasis on the importance of China to plastics producers. There is no denying that Chinese demand is extremely important in plastics markets: China is the world's largest producer of plastics, and its plastic converters are the world's largest consumers. Yet the Chinese economic slowdown has not, to date, affected either production or consumption. Domestic final consumption is heavily tilted toward packaging, demand for which has remained buoyant. But a great deal of Chinese production is destined to be exported as finished products, and Chinese exports have been surprisingly strong. In the context of a nearly 4% dividend yield and a price-to-earnings ratio of only 7.7 times Yahoo! Finance's consensus estimate for 2016, LyondellBasell's most recent price swoon may be a buying opportunity. But not for the faint-hearted: Petrochemicals and plastics are highly cyclical industries, and the shares' volatility is unlikely to evaporate.
