Moody's Downgrades LSB Industries (LXU) to 'Caa1'; Outlook Stable
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Moody's Investors Service, ("Moody's") downgraded LSB Industries, Inc.'s (NYSE: LXU) corporate family rating (CFR) to Caa1 from B3, its probability of default rating to Caa1-PD from B3-PD, and the $375 million guaranteed senior secured notes to Caa1 from B3. The rating actions reflect the combined negative effects of the nitrogen fertilizer industry downturn and LSB's continued operating challenges that have reduced production, increased costs and resulted in earnings losses. While new nitrogen capacity is absorbed into the market through 2018, low nitrogen fertilizer prices will continue to compress margins and leave little room for operating inconsistency, downtime, or additional costs without resulting in negative free cash flow. LSB's Speculative Grade Liquidity rating was changed to SGL-3 from SGL-4 due to the proceeds from the Climate Control business divestiture. The outlook is stable. This action concludes the review commenced on October 14, 2016.
Issuer: LSB Industries, Inc.
Corporate Family Rating, Downgraded to Caa1 from B3
Probability of Default Rating, Downgraded to Caa1-PD from B3-PD
$375 million guaranteed senior secured notes due 2019, Downgraded to Caa1 (LGD4) from B3 (LGD4)
Speculative Grade Liquidity Rating, changed to SGL-3 from SGL-4;
Outlook, Changed To Stable
LSB's Caa1 CFR rating reflects Moody's expectations that the combined uncertainty over operational reliability and the compressed margins, resulting from the low nitrogen fertilizer pricing environment, could result in continued weak financial metrics for a protracted period. While the company has significantly reduced debt and improved its liquidity position, the lower margin environment affords it little room for any unplanned downtime and added costs from repairs that have plagued LSB over that past few years. With negative earnings for the LTM period and management's expectations for negative earnings in the fourth quarter of 2016, leverage will not return to the single digits until the third quarter of 2017 at the earliest, and only if near full run rates are achieved at all facilities. If the company is able to operate at over 90% of nameplate capacity, it may achieve leverage of under 6.5x by FYE 2017 and could be returned to a single-B rating if it is able to refinance the 2019 maturities.
The rating also reflects LSB's small scale as measured by revenues (estimated at $400 million on a pro forma basis excluding the Climate Control business that was sold in July 2016) and the relatively low cost position of its three ammonia production facilities (El Dorado, Pryor and Cherokee). While its fourth facility, Baytown, has a history of consistent operations; it is a captive production unit and operates on a contract basis for one customer, thus realizes low margins due to this contractual arrangement. LSB's three ammonia production sites benefit from low cost natural gas feedstock in North America and produce various ammonia derivatives, including fertilizer and explosives. However, in 2016 operating challenges at all of the sites have significantly increased capital spending for maintenance and reduced profitability due to unplanned downtime. In the third quarter 2016, unplanned outages at all three sites resulted in $26 million of lost fixed cost absorption and additional repair expenses. Management believes that the completed repairs at Pryor and Cherokee, following the August 2016 turnarounds, will result in over 90% ammonia on-stream rates and all facilities on two-year turnaround schedules, once Pryor completes its 2017 turnaround. In order for earnings to support leverage improvements, it will be important for all three facilities to achieve consistent performance, especially since Pryor and Cherokee are smaller and combined have about the same ammonia production capacity as El Dorado.
Through the third quarter and into the fourth quarter of 2016, nitrogen fertilizer pricing has weakened due to anemic volumes resulting from delays in customer purchasing during this already seasonally low period. (US Gulf NOLA urea prices are $215/ton in November 2016 compared to $250/ton in 2015, and remain at 10-year lows. Likewise, US Gulf NOLA ammonia remains at $210/ton after dropping there in early October 2016 from $350/ton in October 2015.) Reportedly low inventory levels in the retail and distribution channel are likely to exacerbate market volatility in the fourth quarter of 2016 and into the planting season in the first half of 2017, especially while new capacity continues to start up and increase market supply. The global ammonia market will add 10% to existing capacity by 2018, exacerbating the current oversupply. Because the price of nitrogen fertilizers is set by the marginal cost producer, China high-cost coal based urea production, the timing of needed capacity shut-downs is uncertain. Therefore, it could take several years to achieve a more balanced market and bolster pricing since fundamental demand growth is around 2% per annum. Over the next two years, Moody's expects a transition period of greater price volatility. (By the end of 2017 in North America, new nitrogen fertilizer capacity will be added by: CF Industries (Port Neal site), OCI NV (unrated), Koch Nitrogen (unrated), Agrium Inc. (Baa2 RUR), and a partnership between Yara International ASA (Baa2 stable) and BASF SE(A1 stable).
The stable outlook reflects the expectation that LSB will be able to operate at 80-90% of capacity and limit any cash drain through the end of 2017 at a minimum and that management will maintain a conservative approach to liquidity during the nitrogen industry downturn, which includes prioritizing cash to support operations and to reduce debt if possible.
We would not consider upgrading the ratings until the company has demonstrated operational improvements at its three ammonia facilities, which will allow these plants to operate with minimal downtime. An upgrade would also be contingent on the company's ability to refinance its 2019 notes and maintaining leverage sustainably below 6.5x. LSB's rating would be lowered, if the company experiences significant downtime at the Cherokee, Pryor, or El Dorado facilities in 2017 and free cash flow is negative by more than $10 million. The rating could also be lowered if liquidity deteriorates.
LSB's SGL-3 reflects its adequate liquidity position supported by its $76 million of cash on the balance sheet as of September 30, 2016. LSB also has a $100 million ABL revolver, which was undrawn as of September 30, 2016, but only had availability of $22 million as a result of the lower industry pricing and downtime that has decreased the asset base calculation.
LSB is currently in the process of selling non-core assets and anticipates that it will be able to realize $20-$25 million in net proceeds from those sales by the first quarter of 2017. Additionally, LSB management estimates that various warranty items from the outages in the third quarter of 2016 will garner $3-$7 million in cash payments by early 2017.
LSB's $100 million working capital revolver matures April 13, 2018. The revolver contains a financial covenant requiring a minimum fixed charge coverage ratio greater than 1.1 to 1.0 anytime availability is less than or equal to $12.5 million. LSB management expects availability under the ABL revolver to be $30-35 million in 2017, slightly higher than current availability, due to better operating rates, but still maintaining expectations for low prices for nitrogen fertilizer.
Uses of cash include LSB's estimated capital spending of $12-$14 million for the fourth quarter of 2016. In 2017, LSB anticipates that its capex will be roughly $30-$35 million. Principal and interest expenses in the fourth quarter of 2016 will be $5 million and $41 million in 2017, which includes roughly $32 million in interest expense and about $9 million of in principal payments. Following the July 1, 2016 sale of the Climate Control business for $364 million, LSB has added cash to the balance sheet, paid down $100 million in debt and fees, reduced its preferred equity by $80 million, and is supporting capital expenditures.
While LSB has paid dividends in the past, Moody's expects that the Board of Director's will not distribute dividends while its leverage metrics are stressed and its facilities are not reliably operating. LSB has $138 million of redeemable preferred stock that has a 14% coupon that are payment-in-kind and require no cash payments. However, there is substantial incentive for management to refinance these securities as soon as they achieve operational reliability.
The Caa1 ratings on LSB's $375 million senior secured notes reflects their preponderance of the outstanding debt in the capital structure. The notes' collateral are deemed inferior to the $100 million ABL revolving credit facility, which is secured on a first-priority basis by a lien on the accounts receivable and inventory . The notes are secured on a first priority basis on essentially all assets, except for accounts receivable and inventory. There is also other secured debt of $56.7 million, which has a first priority lien on certain fixed assets.
The principal methodology used in these ratings was Global Chemical Industry Rating Methodology published in December 2013. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
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