Chemtrade Logistics Income 6 50 Convertible Unsecured Subordinated Debentures T.CHE.DB.E

RE:RBC downgrade after conference call

[Kherson]

hawk35 wrote: Bad news is that RBC now feels weakness is not temporary but ongoing.  They reduce forecasts and lower target price from $16 down to $12.

Payout ratio is 90% in 2019 and RBC warning a divi reduction could happen if downturn happens.

SP could see more downward pressure.



February 14, 2019
Chemtrade Logistics Income Fund
No love for Chemtrade; reducing price target to
$12
Our view: Following another disappointing quarter, we assume that the
various factors driving weak results are normal course business items
and resetting/reducing expectations of what the underlying business
can generate. We lower our price target to $12 (from $16) to reflect a
reduction in our forecast.
 
Key points:
 
Balance sheet and payout ratio look stretched. Chemtrade finished 2018
with a Net Debt (including subordinated debt) / 2018 EBITDA (before
the $100 million legal reserve) of ~4.4x and a payout ratio of ~75%. We
expect the net debt to increase in 2019 due to the cash outlays from the
recent and likely future legal settlements, resulting in a Debt/EBITDA ratio
of ~4.9x and a payout of 90%. We note that the senior debt covenants
should be fine since the calculations exclude ~40% of the debt, which are
related to convertible unsecured subordinated debentures. We believe
it could take some time to deleverage unless the company reduces the
distribution and/or grows organically (with limited capital investments).
For example, in 2020, we forecast excess cash available after distributions
of ~$30 million, compared to our 2019E year-end debt of ~$1.4 billion.
 
Waiting for that elusive "solid quarter" to show up. The company
has consistently reported lower-than-expected results or announced
negative news (e.g., legal reserves twice), which have depressed market
expectations. We believe that once the company reports one or two
solid quarters, the units should trade higher. That can be partly achieved
if management improves company disclosures and introduces annual
guidance, in our view.
 
Some progress on legal proceedings. The main class action lawsuit with
direct purchasers reached a US$51 million settlement in Q4/18 and has
received interim court approval. Management expects to deposit the
amount into a court escrow in Q1/19, and there are 3–4 ancillary lawsuits
that management continues to work on.
 
Reducing estimates. We reduce our 2019 and 2020 ACFFO/unit forecast
to $1.33 and $1.48 (from $1.65 and $1.63), respectively. We lower our
estimates across all three segments to reflect a more conservative view.
Please note that management indicated that the adoption of IFRS 16
(lease accounting) in 2019 would lead to a $55–60 million increase in
EBITDA, offset by higher interest expense and depreciation (earnings and
cash flow neutral).
 
Reducing price target to $12. We lower our price target to $12 (from $16)
to reflect a reduction in our 2020 forecast. Our price target is based on an
EV/EBITDA multiple of 8x (unchanged).

Investment summary
 
We expect units of Chemtrade Logistics to perform in line with
its peers for the following reasons:
 
Less visible cash flows from legacy business, with some
potential upside from Electrochem. Chemtrade’s legacy
business has suffered various issues over the last several
quarters, but management expects that it should generally
improve year-over-year in 2019. With respect to the
Electrochemical segment, there could be further upside to our
forecast for the chlor-alkali products due to strong demand/
pricing for caustic soda.
 
Growth driven by acquisitions rather than organic initiatives.
Chemtrade has historically grown through acquisitions rather
than organically. Management has successfully grown through
seven acquisitions ($2.6 billion) over the last 15 years. There
appears to be limited to no organic growth in the underlying
business.
 
Attractive yield, but elevated payout ratio. We estimate that
the payout ratio in 2019 will be ~90% (~80% in 2020), providing
limited financial flexibility. We believe there could be a risk of
a reduction in the distribution, particularly if there is a global
recession.
 
Levered balance sheet. We estimate that the company's Debt/
EBITDA will be in the 4–5x range in 2019/20, which is elevated
for a chemical company. However, due to the elevated payout
ratio, there is limited cash available to reduce leverage.
 
Potential catalysts
• Executing well and delivering results that meet or beat
expectations.
• Indications of a faster turnaround in the WSSC and SPPC
segments
• Further price improvement in the chlor-alkali business.
 
Key risks
• An economic slowdown leading to a decline in the volume
of sulphur-related by-products that Chemtrade would
transport and market.
• A significant reduction in the price of sulphur and sulphuric
acid (price exposure is shared).
• Non-renewal of key contracts upon expiration.
• A key counterparty becoming insolvent.
• Acquisitions that do not add value or fail to gain the
confidence of investors.
• A reduction in chlor-alkali pricing.