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

RE:Scotia comments after conference

[Red_Deer]

We recommend investors take profits now and look to re-load at a more attractive entry point.

Most ANALYSTs Do NOT Come OUT With SUCH STRONG ADVICE eh !!!!

BUT__His DETAILED Analysis SEEMS to SUPPORT This For the TRADERS

BUY & HOLDERS of Course WILL CONTINUE Collecting the Monthly Pay Outs

incomedreamer11 wrote:

Lots to Like Mid-Term, But Moving to Sidelines For Now as Outlook Weakens

OUR TAKE: Negative. We have downgraded CHE to Sector Perform, with no change to our $10 PT. Chemtrade has made tangible strides forward over the past year, irrespective of commodity price moves. Examples include: improved leverage, more evident capital discipline, a clear growth strategy, better disclosure/messaging, etc. But, while all of that is true, it is equally true the near-term outlook for CHE has, not only deteriorated, but continues to do so. We recommend investors take profits now and look to re-load at a more attractive entry point.

First, we’re seeing market softness in the chlor-alkali market, and in particular, caustic soda. The relevant benchmark is now down to the low-$300s/mt (FOB NE Asia) vs. the mid-$500s in ‘21/22, but also vs. the upper-$200s for many years prior to ‘21/22. Prices increased in ‘21 due to the COVID recovery demand surge for all petchems, weather-related outages in the U.S., as well as rising EU TTF prices. In ‘22, Russia’s war led to both elevated and volatile EU TTF prices, which in turn, made electricity input costs too expensive for local chlor-alkali producers. While it’s true that EU TTF gas is set to rise sharply in Q4, supporting higher electricity costs (and our nitrogen thesis), it may not matter much. Why? In this weak macro environment demand is, for now, insufficient to require the Europeans to run capacity (unlike nitrogen pre-spring). Separately, the recovery of the PVC market largely hinges on China breaking out of its economic funk. As this occurs, demand for chlorine will improve, leading to increased chlor-alkali production. The associated caustic production is unlikely to see demand sufficient to soak it all up, leading to further price erosion. While chlorine and HCl margin strength helped mute the impact of a weaker caustic market, CHE flagged that 2H won’t be as strong for either.

Second, sodium chlorate volume remains under pressure, and may not see relief anytime soon. As a reminder, the main commercial use of chlorate is in the production of chlorine dioxide, and to a much lesser extent, herbicide production (i.e., weed killer). The largest application of chlorine dioxide is bleaching pulp, which is part of the process for the manufacture of paper (via the kraft process). In Western Canada, the pulp industry is under immense pressure. Earlier this year, Canfor permanently closed its pulp line in Prince George, with 300 jobs lost. This follows the permanent closure of the Mackenzie Pulp Mill a few years ago. While it’s tough to say who could be next on the chopping block, the availability of economic fibre supply for pulp mills in central B.C. is declining. There are two reasons why: (1) a reduction in the Annual Allowable Cut (AAC) in the Mackenzie Timber Supply Area; and (2) sawmill curtailments/closures in the region. On this point, there are many examples, including Canfor’s permanent shutdown of the Chetwynd Sawmill, the removal of a shift at Tolko’s Williams Lake operation, and of course, Sinclair’s temporary curtailments at a saw mill in Prince George. Some investors believe next on the hit list is the Cariboo Pulp & Paper Mill, which already faced curtailments earlier in the year. All of these issues are located in and around Prince George – where CHE’s sodium chlorate plant is located.

Third, sodium chlorate margins/spreads may also be under pressure, given a shift in customer mix. Specifically, some of CHE’s higher priced or higher margin customers have taken shutdowns. While that volume can be replaced, at least for now, it hasn’t enjoyed the same attractive margins as before. This may persist indefinitely – a safe assumption for now, given the second point above.

Fourth, there are few catalysts to propel the stock forward: (1) the Cairo project won’t see commercial production hit the P&L until ‘25; (2) CHE’s flagship growth project has been shelved due to soaring costs; we think it’s unlikely this project will return – but we’re hopeful; (3) CHE believes low EU TTF gas prices are transient in nature – we agree 100%, but are not convinced it will matter much if demand weakness means the Europeans are needed to run chlor-alkali; (4) other than a few small debottlenecking or improvement projects here and there, CHE provided no other updates on growth or catalysts near-term.

Fifth, we expect to see leverage deteriorate. Starting at 1.8x today, we see net debt to EBITDA moving toward 2.2x by the end of Q4, and then continuing to rise further from there through ‘24, at least in the absence of a meaningful recovery in CHE’s key markets. That said, the B/S has been well-managed, such that CHE is at a healthy starting point to face further macro pressure.

What about valuation? The company used to suggest mid-cycle EBITDA was $300M to $350M, and a 2H implied guide of $175M certainly supports that view. The record $275M generated in 2H ($550M run-rate) is more reflective of peak conditions. If we assume low-$400s is now run-rate EBITDA, and using the long-term average multiple of 6.6x would give us fair value of $11.50 (unsurprisingly, this is the Street’s PT). While we don’t think this is unreasonable for fair value, we’re not convinced why the stock should rise >35% to get there, given a weakening near-term backdrop.

What we learned on the call: (1) elevated overseas energy costs continues to benefit the EC segment, which combined with CHE’s access to renewable hydroelectric energy is advantageous for the company; (2) sodium chlorate prices have risen in North America as high-cost producers in Europe idled production (given high energy costs); (3) the focus on on-shoring semiconductor components in the U.S. should see ultrapure acid demand over the next five years increasing by 2x to 3x; and (4) as non-discretionary product, CHE expects water solutions margins to improve in a recessionary environment as costs fall.