Well Positioned Through The Cycle – Q2/23 Review
Our Conclusion
CHE.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.