2023-05-19 08:30:00 ET
Summary
- Chemtrade Logistics produces specialty chemicals for the North American market.
- The demand for some of its products remained much stronger than anticipated, resulting in a very strong first quarter.
- After initially expecting a 15% YoY EBITDA decrease in 2023, Chemtrade now expects its EBITDA to remain at least stable versus last year.
- This means both the distribution as well as the growth capex will likely be fully covered by the incoming cash flow this year.
Introduction
I discussed Chemtrade Logistics Income Fund (CGIFF) ( CHE.UN:CA ) earlier this year after publishing excellent results for the financial year 2022 . Chemtrade initially made it clear investors should not expect the 2023 performance to be as strong but after posting a record result in the first quarter of this year, Chemtrade has hiked its full-year guidance and now expects its EBITDA result to be at least as high as last year's result. Plenty of reasons to have another look at Chemtrade Logistics again.
The first quarter was much stronger than I had anticipated
This article is meant as an update to my previous article, and to get a better understanding of Chemtrade's business model and growth plans, I'd like to refer you to the February article .
The first quarter of the year was surprisingly strong for Chemtrade Logistics as the company was facing the impact of increased maintenance activity levels at its customer base for the Regen acid business. Although business was pretty slow in that segment, the other business divisions definitely made up for it. Although the adjusted EBITDA in the SWC division ( Sulphur and Water Chemicals ) decreased despite the higher revenue, the electrochemicals division performed much better than anticipated thanks to elevated prices for the chlor-alkali products (chlorine, HCl and caustic soda). While the revenue in this division increased by 29%, the adjusted EBITDA increased by in excess of 50% to just under C$100M.
The total revenue in the first quarter of the year increased to just over C$471M resulting in a gross profit of just under C$110M. That's an increase of almost 40% compared to the first quarter of last year.
Chemtrade had to deal with higher SG&A expenses, but on the other hand, it was able to report a net finance income of almost C$13M compared to a finance expense of almost C$29M in the first quarter of last year. The explanation is pretty straightforward as the company recorded a C$33.2M change in the fair value of the convertible debentures and as this was included in the finance expenses and income, it also had an impact on the bottom line of the income statement.
The bottom line with a net income of almost $79.5M represents an EPS of C$0.69. While that sounds great, keep in mind it includes about C$33M in revaluation gains on the convertible debentures. And that's why we should look at Chemtrade from a distributable cash flow perspective. The image below shows how the reported operating cash flow of $54.4M is the starting point of the calculation. After adding back the working capital investments and deducting the sustaining capex and lease payments, the distributable cash flow was approximately C$87.6M or C$0.76 per unit . That's a very remarkable result although the maintenance capex incurred in the first quarter is a bit lower than what we should generally expect this year.
Chemtrade currently pays a monthly distribution of C$0.05 per unit, and it goes without saying the C$0.15 paid during the first quarter was very well-covered by the incoming distributable cash flow result as the payout ratio was less than 20%.
This resulted in a full-year guidance increase
Chemtrade must be feeling pretty comfortable the very strong Q1 result was not just a one-off as the company has increased its full-year guidance. The previous guidance called for an EBITDA of $360-400M which was a low double-digit decrease from the $431M EBITDA result generated in 2022. This decrease was well-anticipated and not a deterrent as the underlying free cash flow was expected to remain strong.
With an EBITDA result of almost $132M in the first quarter of the year, Chemtrade is now fairly confident its previous guidance was too conservative and it has now hiked the full-year EBITDA guidance to a level of 'at or above the 2022 EBITDA result', which implies an EBITDA of at least $430M.
That's a pretty serious step up from the $380M midpoint used in the previous full-year guidance, and even if we just assume a similar result as in 2022, we can expect the distributable free cash flow to come in very strong as well.
If we would start with a $430M EBITDA result and subsequently deduct $100M in sustaining capex (on the higher end of the $80-105M range), $55M in lease payments, $50M in cash interest and $20M in cash taxes, Chemtrade will generate a distributable free cash flow result of $205M. Just over half of this will be used to fund its $110-140M in growth investments, the remainder can be used to cover the distributions. Based on the current unit count, Chemtrade needs approximately $70M to cover the current monthly dividend of C$0.05 (resulting in a pro forma payout ratio of 34%). This also means that based on the updated guidance for 2023, Chemtrade's incoming cash flow will be sufficient to cover all growth capex and the dividends while there will be some 'excess' cash that could be used for debt reduction.
Investment thesis
I currently have no equity position in Chemtrade Logistics, but I participated in the recent debt offering. During the first quarter, Chemtrade Logistics issued $110M of a new series of convertible debentures. These debentures have a 7% coupon rate and mature in June 2028. The debentures are convertible into common shares at a fixed conversion price of C$12.85 per share. I'm not really counting on the conversion feature coming into play, but I'm quite happy with the 7% coupon given the current strength on the operational and financial level. One of the debentures is currently 'in the money' as the current share price exceeds the C$7.35 conversion price of the 8.5% debentures. If those debentures would all be converted into common shares, an additional 11.7M shares would be created but C$86M in debt would be removed from the liabilities side of the balance sheet. Those 8.5% debentures mature in September 2025.
I could be interested in initiating a long position in the common units as well, but I'd like to wait for the updated capex estimate for the Casa Grande project in Arizona. The capex of the Casa Grande project was originally estimated at C$150-250M, but Chemtrade has now warned the total cost will be 'significantly higher than the top end of that range'. Chemtrade will publish updated numbers towards the middle of this year, and it will be interesting to see if Chemtrade will report an updated anticipated ROIC or if it does not expect the anticipated EBITDA associated with the growth projects to increase as well.
So for now, I am sticking with the debentures and I will have another look at the common units later this year.
For further details see:
Chemtrade Logistics: A 6.8% Dividend Yield With An Anticipated 34% Payout Ratio