Desjardins Research ReportFrom David Newman, Chi Le and Evan Zhou.
Multiple catalysts to result in a 2H spontaneous reaction
The Desjardins Takeaway
CHE reported 1Q EBITDA of C$55m, a miss vs our C$64m (consensus of C$66m), challenged by (1) lower merchant acid (economic slowdown), regen acid (driving activity) and ultra-pure acid (customer loss); (2) water treatment volumes (tough comps); and (3) lower sodium chlorate volumes (work-from-home) and chlor-alkali prices (but improving). Excluding the impact of severe weather in the US, FX and corporate costs related to the former CEO’s retirement, results would have been in line.
Highlights
CHE reiterated its earnings growth strategy over the next few years, which hinges on three main pillars: (1) a market recovery post-pandemic (underway); (2) organic growth opportunities in water solutions, ultra-pure acid and hydrogen; and (3) operational efficiency (productivity and reliability). We remain constructive on the outlook (bullish toward 2H21 and 2022), with CHE noting encouraging signs in several businesses. Excluding LTIP, corporate costs should be stable at ~C$17–18m per quarter (expecting immaterial amounts from the CEWS and CERS). For each segment, CHE expects:
SPPC. (1) Flat merchant acid volumes on higher prices; (2) refinery rates which are ~10% yoy lower than pre-pandemic levels, while miles driven should return to 2019 levels in 2022 or earlier; and (3) a temporary decline in ultra-pure acid as it backfills the lost volume, while the long-term outlook remains bullish.
WSSC. While demand is resilient, margins could face short-term pressure from the spike in raw material costs (sulphur), given a lag in resetting prices on CHE’s contracts with municipalities. However, we expect expanded margins in 2022 given the stickiness of price increases.
EC. (1) Caustic soda prices should continue to rise and average US$20/MT lower than 2020 (higher today); (2) HCl demand should benefit from stronger fracking activity in western Canada (expecting a chlorine-to-HCl conversion rate of ~30% in 2H); and (3) lower volumes and prices for sodium chlorate (paper consumption).
Valuation
An excellent reopening trade. We are maintaining our target of C$12.00 based on 7.75x EV/2022 EBITDA (was 7.25x) and our DCF. CHE currently trades at 6.5x our 2022 EBITDA estimate vs its specialty chemical peers at 13.1x and commodity chemical peers at 7.1x, including OLN and WLK at 5.9x and 7.9x, respectively.
Recommendation
CHE offers a potential return of 61%