LSB Industries (LXU) is the unlikely combination of a heating, ventilation and air conditioning (HVAC) business and a nitrogen-based chemical products company. The business mix had been more eclectic until the 1990s, when management focused the company on those businesses in which it had a more compelling market position.
The HVAC business is a market leader in geothermal and water source heat pumps, which are highly efficient heating and cooling systems. The business is leveraged to commercial, institutional and residential construction, as well as a longer-term trend towards "green" or more energyefficient construction. We think the business is under earning its potential in an economic recovery, something that we are not paying for at present.
The chemicals business provides nitrogen or ammoniabased agricultural, mining and industrial chemicals to the North American market. Low domestic natural gas prices are providing attractive feedstock costs relative to imports, while longer-term "cost plus" agreements for industrial and mining products mitigate feedstock price volatility and help provide a steadily profitable base load.
Our first encounter with LSB Industries occurred at a conference in early 2011, where we were intrigued by its resource conversion potential as a small company with disparate businesses, a healthy balance sheet with a net cash position, and apparent alignment of management with shareholders given management's ownership of more than 20% of the company. We elected to wait on the sidelines watching the business develop and business value grow until this past quarter when operational issues associated with the restart of a long dormant facility in Pryor, Oklahoma and a separate explosion at an El Dorado, Arkansas plant clouded the near-term earnings picture, providing entrée for the Fund. Earnings from the HVAC business, replacement value of the chemical assets, a longer-term feedstock cost advantage provided by U.S. shale gas production and insurance coverage appear to more than offset the near-term disruption and decline in share price. We estimate intrinsic value is north of $40 per share.
From Third Avenue's third-quarter letter, by Curtis R. Jensen, chief investment officer and portfolio manager of Third Avenue Small-Cap Value Fund.