Post by
incomedreamer11 on Nov 09, 2022 9:26am
CIBC upgrade
Firing On All Cylinders – Thoughts Post Q3/22
Our Conclusion
CHE.UN reported solid Q3/22 results driven by strength in both its core segments. Within the EC segment, chlor-alkali continues to benefit from high caustic pricing and higher drilling activity. Within the SWC segment, market fundamentals for all three acid products (merchant, regen and ultrapure) remain positive, and water chemicals should see a boost to margins given the sharp recent decline in input sulphur prices. While recession risk remains (and we do see financial results moderating next year vs. F2022 levels), what is different this time is the global energy crisis (elevated electricity prices in Europe and Asia) tightening the overall supply/demand balance for caustic and chlorate markets. Should energy prices remain high, we expect these positive fundamentals to extend into 2023.
We are increasing our Q4/22 and H1/23 estimates for both segments. Our price target increases to $11.00 from $9.50 and we maintain our Outperformer rating.
Key Points
Europe Energy Crisis Fundamentally Supports Outlook For EC Segment: EC segment adj. EBITDA increased 162% Y/Y in Q3/22. Increased utility costs in Europe and Asia are negatively impacting production in those regions, helping support the outlook for chlor-alkali and chlorate pricing (recall, electricity is the majority of the variable cost for producing electrochemicals). CHE.UN’s F2022 guidance now assumes a Northeast Asian caustic price of US$650/t, up US$10/t vs. previous guidance and up US$360/t vs. F2021. Also, high gas prices in Europe are supporting higher gas exports from North America, leading to increased fracking activity (positive for HCl acid demand / pricing). U.S. and Canadian rig counts improved to 980 in October 2022 vs. 606 in 2021. Sharp Decline In Input Sulphur Costs To Boost SWC Segment Margins: SWC segment adj. EBITDA increased 17% Y/Y in Q3/22. Looking ahead, the sharp decline in sulphur prices should help SWC segment margins, for both water chemicals (typically longer, one-year contracts with municipalities) and merchant acid (prices have held in well despite sulphur costs declining).
Looking into 2023, merchant acid (tied to industrial uses) and regen acid (tied to gasoline refinery utilization) may see a modest negative impact if there is a recession. But water chemicals should continue to grow and CHE.UN expects improved demand and pricing for ultrapure acid in 2023 (as the semiconductor industry continues to “onshore” their supply chain).
Balance Sheet
In Good Shape Ahead Of Higher Growth Capex Levels: CHE.UN’s balance sheet is in a much better position today, as demonstrated by a net debt / adj. EBITDA ratio of 2.4x vs. 3.2x last quarter and 6.0x one year ago, reflecting increased profitability / cash flow, the $86.5MM equity financing completed in Q3/22, and sales of non-core assets.
While growth capex spend (ultrapure acid facilities tied to the semiconductor industry) should increase in 2023, CHE.UN will target to keep leverage below 3x.
Investment Thesis
Chlore-alkali pricing should remain elevated vs. historical levels, ~7% dividend yield, improved balance sheet given improved profitability and recent equity financing (net debt / adj. EBITDA of 2.4x), long-term benefactor of increased demand from the structurally growing semi-conductor (ultrapure acid), lithium (caustic), and green hydrogen industries.
Price Target (Base Case): C$11.00 We apply a multiple of ~6x to our 2023 EBITDA estimate. We assume chlor-alkali prices remain elevated going into 2023 due to high energy costs in Europe/Asia, and margins in the SWC segment benefiting from lower input sulphur costs.
Upside Scenario: C$13.00 Our upside scenario assumes no recession, a sustained period of higher chlor-alkali (caustic and HCl) demand/pricing, and stronger SWC segement results.
Downside Scenario: C$4.00 Our downside scenario assumes a deep economic recession, negatively impacting the EC segment and sulphur products (water solutions relatively inelastic to economic growth).