Solid Fundamentals And Valuation – Q2/24 Review
Our Conclusion
CHE.UN reported solid Q2/24 results, reflecting strong margins in the SWC
segment and, to a lesser extent, EC segment customers building inventory
ahead of a potential Canadian rail strike. We increase our 2024E EBITDA to
reflect CHE.UN’s guidance raise and strong H1/24 results, but reduce our
H2/24 estimate slightly to reflect the impact of destocking and a minor impact
from a rail strike. Our 2025E EBITDA is adjusted slightly higher to reflect
better SWC margins and caustic pricing. Our price target increases from
$13.50 to $14.00, and we maintain our Outperformer rating. We like CHE.UN
given its valuation (~4.7x 2025E EV/EBITDA, well below its historical
average and chemical peers), improved balance sheet/cash flow (organic
growth investments and NCIB), and sustainable dividend (yield of ~7%).
Key Points
Raising 2024 Guidance; Potential Canadian Rail Strike In Focus: Given
the solid H1/24 results, CHE.UN now expects 2024 adjusted EBITDA to be
$430MM-$460MM (consensus: $430MM) vs. the high end of
$395MM-$435MM previously. CHE.UN stated that while the low end and
middle of the range do account for some impact from a rail strike, the high
end does not. We note that while much of the Q2/24 adjusted EBITDA beat
(~$20MM ahead of consensus) stemmed from the SWC segment (solid
margins), part was due to EC segment customers building inventory ahead
of a potential Canadian rail strike. This inventory build should unwind in
H2/24, with CHE.UN noting it is already incorporated into current guidance.
Solid SWC/Improved EC Segment Fundamentals: SWC’s Q2/24 EBITDA
margin was >300 bps higher Y/Y (primarily water products); this was the
result of CHE.UN focusing on improved reliability in recent years, specialty
water capacity expansions of late, and some moderation in raw material
costs. Within the EC segment, hydrochloric acid and chlorine continue to
perform well. Caustic prices have moved through trough levels (CHE.UN
raised its 2024 Northeast Asia caustic price assumption to $385/t vs. $375/t
previously). Chlorate pricing should remain higher Y/Y in H2/24. CHE.UN will
cease production at its smaller Prince George facility, moving production to
its larger Brandon facility. While this should lead to a modest volume
reduction in 2025, cost economics should improve.
Capital Allocation Focus On Dividend, NCIB And Organic Growth
Projects: We continue to view CHE.UN’s dividend as safe with a FCF-based
payout ratio (excluding growth capex) of <50% in each of 2024 and 2025.
Following the completion of the SIB on July 31, CHE.UN notes that it intends
to execute on its previously announced NCIB (best use of capital given the
depressed valuation), helping to offset the conversion impact of the
remaining amount of 8.5% debentures. CHE.UN will continue to invest in
organic growth projects ($70MM-$100MM in 2024, with ~$38MM spent in
H1/24), including the Ohio ultrapure brownfield expansion (on track for
commercial ramp in 2025), PAC/ACH and a new water chemical line at
Augusta. The balance sheet remains in good shape (2x net debt/EBITDA).