CIBC commentsCHE.UN reported solid Q2/23 results, though H2/23 implied adj. EBITDA guidance was a bit softer than our expectations. As the top supplier of water chemicals to North American municipal water plants (very defensible), the lowest cost producer of chlorate globally, the top chlor-alkali supplier in Canada (strength in hydrochloric acid and chlorine more than offsetting caustic weakness), and the number one supplier for ultrapure acid to the North American semiconductor industry (strong growth prospects ahead), we think CHE.UN is very well positioned. Post Q2/23 results, we are tweaking our F2023 and F2024 estimates. Our $12 price target and Outperformer rating remain unchanged. At ~5x 2024 EV/EBITDA (on our revised estimates) vs. the longer-term average of 6x-7x, valuation remains attractive.
Key Points
2023 Likely Peak Earnings, But Trough Earnings Should Be Higher Than Historic: CHE.UN indicated that 2024 adj. EBITDA should be above the full-year run rate (i.e., over $348MM) implied by H2/23 guidance (i.e., over $174MM). We forecast $383MM in 2024. Historically, CHE.UN had messaged that adj. EBITDA should range between $300MM-$350MM. But management believes that this range has now moved higher and should help results in 2024 given: 1) higher energy prices in Europe (keeping North American chlorate prices strong and leading to the normalization of chlorate volumes) and 2) anticipated improvements in caustic pricing (vs. low levels for much of 2023). Longer term, CHE.UN will benefit from higher ultrapure acid volumes (brownfield and greenfield expansions) given strong demand supported by the U.S. semiconductor industry.
Rationale For Implied H2/23 Adj. EBITDA Guidance Being ~$100MM Lower Than H1/23: After a record H1/23, CHE.UN is guiding for H2/23 adj. EBITDA being ~$100MM lower due to: 1) lower Northeast Asian caustic prices; 2) weakness in the Canadian pulp industry resulting in two-three pulp mill closures (impacting chlorate margins); and 3) more turnaround activity in Q3/23 vs. Q2/23. The pulp mill closures shouldn’t lead to lower volumes, but will temporarily lead to a shift from higher margin customers to lower margin customers. CHE.UN also has the ability to increase chlorate exports given it is the lowest cost producer of chlorate globally.
Arizona Ultrapure Greenfield (Currently On Pause) Will Eventually Get Built: CHE.UN believes the project will go ahead eventually (not included in our forecast at this point), and is in discussions with its JV partner and customers to ensure an adequate rate of return. The project is now estimated to cost the JV US$300MM-US$380MM (or C$400MM-C$515MM), likely over a two-year period. Between internal FCF and debt (CHE.UN previously said it could raise leverage to ~3x net debt/EBITDA vs. 1.8x now), funding will likely be tight, and we suspect CHE.UN may need to raise funds should it decide to pursue other brownfield/greenfield projects in this period.
Investment Thesis Factors supporting our rating include: electrochemical pricing should remain elevated vs. historical levels; dividend (currently yielding ~7%); recently improved balance sheet given improved profitability, asset sales and equity financing (net debt / adj. EBITDA of 1.8x); we expect the company to be a long-term beneficiary of increased demand from the structurally growing semiconductor (ultrapure acid), lithium (caustic), and green hydrogen industries.
Price Target (Base Case): C$12.00 We apply a multiple of ~6x to our 2024 EBITDA estimate. We assume EC segment results to remain elevated supported by chlorate, chlorine and HCl acid pricing (offseting lower caustic prices), and margins in the SWC segment benefitting from lower raw material costs.
Upside Scenario: C$13.50 Our upside scenario assumes no recession, a sustained period of higher chlor-alkali (caustic and HCl) demand/pricing, and stronger SWC segment results.
Downside Scenario: C$4.50 Our downside scenario assumes a deep economic recession, negatively impacting the EC segment and sulphur product C