CANEXUS CORP 6.5 PCT DEBS T.CUS.DB.D

TD Downgrade - Sell - Price Target - $4.00

[ocean112]

Canexus Corporation
(CUS-T) C$4.79
New CEO Appointed; Costs at NATO Continue to Escalate
Event
Canexus Corporation (Canexus) appointed Douglas Wonnacott as President and CEO and provided an update on construction of its NATO unit train operation.
 
Impact – NEGATIVE
 
We view the appointment of Mr. Wonnacott as CEO as an incremental positive for the company as the hiring removes an element of uncertainty and given that he has extensive experience in the chemical industry, as well as with terminal operations.
 
However, cost estimates at NATO continue to inflate, now standing at $350-360mm, well above the estimate of $315mm provided in January of this year.
 
In addition, we are concerned by the company's statement that theseestimated costs are only expected within the scope of the currently contracted six to seven unit trains per week, with additional debottlenecking and incremental costs possibly required to reach activity levels of 10.5 unit trains per week.
 
We have revised our F2014 and F2015 estimates to try to take into account the additional costs for NATO and have lowered our forecasts for the chemical business. Our $4.00 target price is based on a sum-ofthe- parts valuation, which applies an 8.0x EV/EBITDA multiple to the chemicals business and a 10.0x EV/EBITDA multiple to NATO, resulting in a valuation of 8.5x our consolidated F2015 EBITDA estimate.  We are downgrading Canexus to REDUCE (from Hold).
 
TD Investment Conclusion
The bulk of Canexus' cash flow continues to be generated by its relatively stable pulp chemicals business. Although Canexus offers the potential of long-term asset value in its crude-by-rail operations, we believe that meaningful execution risk remains. With planned unit train activity levels deferred into 2015 and costs continuing to escalate, we believe that the shares do not offer an attractive risk/reward proposition at current levels and that the recently lowered dividend is not necessarily secure.
 
Outlook
Our revised financial forecasts are presented in Exhibit 1. Execution risk continues to cloud the outlook for Canexus and uncertainty remains regarding signing customers for the uncontracted 30-40% of planned capacity at NATO. However, we expect the chemicals business will remain a stable cash flow generator, particularly in Brazil where operations are anchored by a long-term fixed U.S. dollar margin contract. Given the escalating costs related to NATO and potential delays before reaching the targeted 10.5 unit train per week activity level, we believe that Canexus could reduce the dividend further. Note that our forecasted payout ratios in Exhibit 1 exclude growth capex.
 
Valuation
In Exhibit 2, we present both our base case and high case valuations. Our base case valuation is based on our current forecasts, implying a target price of $4.00. Potential upside to our target price could come through the sale of one or both segments. In the event that a sale were to occur, we believe that the shares could command a value up to ~$5.11, as illustrated in our high case valuation. This high case valuation uses a more normalized EBITDA estimate for chemicals and activity levels of 10.5 unit trains per week at NATO. However, we believe a sale of NATO is not likely to occur until the issues plaguing operations have been resolved. Also
note that our calculated high case is only a small premium to price at which Canexus currently trades.