BMO analyst update in its entiretyCHE.UN-TSX
Rating ↑ Outperform
Price: Nov-18 $8.92
Target ↑ $10.50
Total Rtn 24%
Upgrading to Outperform; Distribution Cushion and Mid-Term Plan Earns Re-think
Bottom Line:
Raising rating to Outperform and target price to $10.50 following the investor event. CHE has earned a re-think from investors, in our view. First, it's an attractive distribution (~7% yield) with ample cushion. 2022 earnings may serve as a high-water mark for a few years assuming commodities moderate, but the payout still seems sub-50% on lower 2023/24E earnings, and even in bear case scenarios (2021 levels) it's well below 100%. Second, investors are paid to wait for mid-term growth opportunities. Our $10.50 target (representing ~6% yield) splits ~5.5x 2023/24E EV/EBITDA.
Key Points
The investor event didn't necessarily introduce new strategies/focus, but nicely put together an attractive investment scenario. First, record 2022 earnings likely need to reset lower first (though it's possible record caustic/chlorine prices stay elevated because of higher European energy/electricity prices and Europe becoming a net importer of more chemicals). Second, the water business seems relatively defensive with CHE potentially on the cusp of finally making headway on high-value water treatment products (PACl, ACH, etc.) after finally figuring out a better and safer process (pellets). Third, though the 5-yr growth capital budget is $270M (with maybe $100M in 2023E), the expectation is for $45M/$75M of new EBITDA by 2025/2027, more than half if from the ultrapure sulphuric acid investments (greater on-shoring of chip fabs), but also from water treatment and green hydrogen.
Distribution safe/attractive. We model EBITDA slipping to $350-360M levels in 2023/24E from ~$425M guidance for 2022E on lower commodity prices though then after these years we assume stabilization, normal growth and the $45-75M incremental contribution from the growth capital budget. This should bring up CHE's mid-cycle earnings range by the back half of the decade. At ~$350-360M, the payout is only sub-50%, and even if EBITDA falls back to 2021 levels (~$263M), the payout would still be well below 100%. All-in leverage in our base case is in the mid-2s.
Risks to this upgrade (though again the distribution seems to have ample cushion for bear case scenarios). First, if chlor-alkali (caustic/chlorine/HCl) prices fall more than expected (sensitivity is $18M EBITDA per $100/t MECU or $10M per $50/t caustic). Second, if the ultrapure opportunity fizzles out (i.e., trend of on-shoring of chip fab in the U.S. fizzles plus there are now concerns of high chip/semi inventories). Third, operational issues and capex overruns.