LyondellBasell Industries (NYSE:LYB) is a globally diversified chemicals company. That means it faces risks that are roughly similar to those of its peers. However, with a low cost structure and a U.S.-heavy production profile, there are some risks here that could be a little counterintuitive. Here's a look at some of the risks you as an investor should know before.
Just like the rest
LyondellBasell makes chemicals that get used the world over. In that regard it's no different than most of its competitors. It needs to make sure it's making the products that its customers want, its product mix is one that produces the most profits, it keeps its costs in check, and that it has enough capacity to meet demand. These are all risks you need to watch.
For example, LyondellBasell recently inked a deal to buy a company in India that focuses on the auto sector, the second such deal its made in the country. On the surface this looks like a great move, since India is working up the socioeconomic ladder and that should lead to higher car sales. But any investment of this type comes with risks. The deal could fall through, there could be integration problems, or, worse, the expected growth in the Indian auto sector might not pan out.
The company didn't say how much it paid for this particular deal, but the acquisition will double its customer base and make it the third largest producer of polypropylene compounds in the country. So, financially this deal going bad probably wouldn't be too big an issue for LyondellBasell, but if its bigger bet on India's auto sector doesn't pan out it would be much more painful. It really is harder than you might imagine to ensure you are serving the right customers with the right products.
A second example of the issues here is LyondellBasell's investment to build a propylene oxide and tertiary butyl alcohol plant in Texas. It's going to be one of the largest plants of its type in the world, and, perhaps more to the point, it is the largest project the company has ever undertaken. Construction of this sort is always fraught with risk, including delays, cost overruns, and finding out the demand you expected doesn't actually materialize.
Costs are another key issue to watch. For example, selling, general, and administrative expenses ate up around 6% of Dow Chemical (NYSE:DOW) top line last year. That number was a whopping 18% at DuPont (NYSE:DD), which helps explain why the pair is linking up so they can cut costs -- with plenty of room on the DuPont side for improvement. And only after the cost-cutting is done will the pair split up into as many as three different, and more-focused, companies.
Where does LyondellBasell sit on this metric? SG&A at the chemical maker accounted for just 2.5% of revenues last year. That's impressive, but with such a low cost structure, you'll want to pay close attention to ensure that there's no cost creep as it expands its business. Don't just assume the company can avoid the fate of DuPont in terms of cost -- keeping costs down takes a commitment to the effort and is hard work.
A different view of things
So far, the risks at LyondellBasell sound pretty much like what you'd expect from any chemical company. But here's one that's a little different. LyondellBasell has a heavy production footprint in the United States. As a result, natural gas is a key input. Increasing gas supply in the U.S. market has left gas prices near historically low levels and for a while provided LyondellBasell with a cost advantage versus peers that relied more heavily on oil.
Investors noticed this advantage and bid the shares higher. Note, too, that a good portion of the wide profits it made relative to peers was earmarked for dividends and stock buybacks, a decision shareholders clearly appreciated.
That all started to change in mid-2014 when global oil prices began to plummet. There's still a decent spread between oil prices and gas prices, so LyondellBasell continues to benefit from relatively cheap domestic natural gas. But it isn't benefiting as much as it once was compared to oil focused peers. Investors noticed this, too, and have sent the shares 33% lower since the middle of 2014.
Regardless of whether this dynamic is good, bad, or indifferent for the top and bottom lines, however, you'll want to keep this issue in mind when you're examining LyondellBasell because, in this way, it's a little different from some of its peers that are more reliant on oil.
There's one more wrinkle that makes LyondellBasell a little different, it took a trip through bankruptcy court, emerging and selling shares to the public again in 2010. While bankruptcy helped to clean up its balance sheet, long-term debt still makes up a little over half of the chemical maker's capital structure. It's a capital intensive business, so that's not the worst thing in the world. But, based on its history, you might want to watch the balance sheet, just in case.
No two companies are alike, and you need to get to know the little quirks that set them apart. In many ways LyondellBasell is a typical chemicals company. However, ultra-low costs and a heavy reliance on U.S. natural gas are two issues that could make this company riskier than you might realize. And don't forget the company's expansion efforts, either. Construction and acquisition activity are company-specific issues that always pose risks, even though they are meant to be long-term positives.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.