Graanul - the refinancing debate
All,
Post the investor meetings last week, we have added our thoughts to the potential refinancing debate.
Find our unchanged analysis here.
Ultimately, we don’t believe a refinancing is currently possible given the debate around the name. The uncertainty beyond FY26, with limited contracted sales coupled with public doubts about the “green” credentials of biomass, is juxtaposed with a buoyant new issue market. The feedback from the investor calls was mixed at best with the additional scrutiny doing the Company no favours. The investor update has left some bondholders with more outstanding questions and in our opinion reduced the probability of a refinance in FY25.
Investment Considerations:
- We are not taking a position in Graanul’s outstanding bonds. A refinancing of Graanul’s bonds is severely hampered by the lack of contracted sales beyond FY27, due to the regulatory uncertainty and the overall changing dynamics in the wood pellet market.
- Any refinancing would require a double-digit coupon, resulting in poor interest coverage metrics. This further confirms the difficulty of the refinancing.
- Shorting the bonds at 95%, on the fixed bonds results in 6.2pts of downside (the fixed rate bonds have call protection) plus coupon. Absence a refinancing, the bonds would trade below 90 giving at least 5pts minimum upside.
- However, we are not currently taking a position due to the buoyancy of the high-yield market. In addition, management reportedly told investors that they were close to signing a new deal with Drax extending the relationship. Further, management indicated they were close to signing a new UK utility entity for 0.5mt (25% of FY24 volumes) but we have been unable to verify this.
- We are therefore inclined to wait and see if there is any significant positive catalyst from the above-indicated deal-making in the short term.
- Although the two bonds trade at similar levels, the fixed rate bonds enjoy some call protection which compensates investors for the relatively low coupon versus the floating rate notes. The fixed-rate bond becomes callable in March at 101.16%.
What are the problems?
- Graanul customer base is extremely concentrated with c.80% of its revenue generated from 3 customers, Drax, RWE and Orsted. Longer-term contracts did enable Graanul to invest in its facilities and more importantly its storage capacity. It has generated a virtuous circle with both Graanul and its customers mutually benefiting from the long-standing relationship.
- However, Graanul has minimal contracted sales in FY27 and beyond. Why? Regulatory Change and uncertainty about whether governments will continue to support/subsidise wood pellets for energy production.
- Moreover, as of February 20, 2025, only 17 out of 195 parties to the Paris Agreement have submitted their updated Nationally Determined Contributions (NDCs) for 2025. No EU country has filed. That withdraws a lot of general support for biomass.
- The UK have, but at a price. The UK government has agreed Head of Terms agreement for the continuation of the subsidies offered to Biomass Power plants from their existing renewable schemes to a newer, reduced scheme from 2027. Full terms are yet to be disclosed, but the initial view is that Drax's, Graanul’s largest customer, subsidies will be reduced from 7mt to 3mt, reducing the overall demand by 4mt. This would commence in FY27.
- This regime change is the main factor in Graanul’s contracted volumes reducing from 80-90% in FY25 & FY26 to c.10% or lower thereafter.
Regulation change in the UK:
- It is very apparent from reading the statement from Michael Shanks, the Parliamentary Under-Secretary of State for Energy, that the UK government are questioning the value of biomass as part of a net zero future. The UK government has reluctantly agreed to a revised Head of Terms on the continuation of the biomass subsidy in the UK market.
- The UK government are balancing security of supply issues versus value for money in continuing biomass subsidies. The government have concluded that Drax continues to offer stability to the sector and the industry is not able to reposition itself within this timeframe. Therefore, the Head of Terms agreement is based on the period 2027 to 2031, in which Drax will continue to benefit. However, the government’s aim is for Drax to have a much more limited role in the system, reducing its load factor to 27%, and operating less than half as often as it currently does.
- Secondly, the level of subsidy will be reduced by 50% from 2027.
- There is a mechanism to reduce excess profit at Drax with a clawback mechanism if Drax benefits from price fluctuations.
- Drax is Graanul’s largest customer. Graanul will lose a minimum of 25% of sales to Drax beyond FY26, or 10-15% of Graanul’s overall sales volume.
European Regulation Change?
- EU countries are grappling with the same issues the UK government is facing, namely biomass subsidies to energy producers are required to maintain energy stability but don’t represent value for money.
- There is renewed political pressure to change the “green” credentials of Biomass, with many commentators questioning the sustainability of subsidising wood pellets.
- But apart from sustainability issues, biomass is seen as prolonging the life of coal plants, especially where co-fired with biomass. Solid biomass (wood pellets, etc) accounts for 60% of EU electricity generation from biomass, with a quarter of the plants co-firing alongside coal. This is mostly prevalent in Poland and Denmark.
- We include in this section potential positive regulatory changes. Graanul may benefit from a trade war between Europe and the US if tariffs are imposed on imports of wood pellets from North America.
- Wood pellets are only used for energy production because of government-provided subsidies to existing coal plants to convert and use biomass/wood pellets. Therefore, in a world of lower subsidies and less enthusiasm for wood pellet burning, Graanul loses its main sales segment.
European Market:
- Despite slight contractions in the market, the European Union remains the world’s largest pellet producer and consumer. Europe produces 44% of the world's pellets and consumes 50% leaving it a net importer.
- Global demand is expected to continue to outstrip supply, especially in the Asian market. European growth is expected to be modest, and with some mills under construction, it is expected to be met internally.
- A significant increase in Asian demand is forecasted, which would require substantial scaling in Southeast Asian supply to be satisfied.
- The driving force behind the growth expectations is the phasing out of coal-fired energy plants with biomass taking a greater share. However, we question the regulatory tailwinds that underpin the market growth assumptions. We point to the proposed changes in the UK which would result in demand falling by 50%.
- Graanul is well placed for the Northern European markets, but we would question its ability to export beyond Europe to benefit from the wider global growth.
- Increased demand in other jurisdictions may see less competition in Europe, but given the overall cost of shipping, we would be surprised if there are significant imports into Europe currently.
- The overall uncertainty in the European market is exasperated by increasing supply. Drax who is also a producer of wood pellets in North America is guiding the market it will meet 2/3rd of its lower demand internally, further reducing its external demand.
- All of these combined will put downward pressure on wood pellet pricing, reducing Graanul’s profitability profile.
Refinancing Maths:
Graanul has €630m of debt to refinance, with a new rate of 10-11%. Some have suggested investors in Graanul should be compensated for Baltic risk, which may be warranted, but we will use 10% for ease of purpose. This equates to €63m annual interest, which for 2x interest coverage requires €120m minimum EBITDA.
This would require €50/t for c.2.5m in volume sold. To put this into context, Graanul only achieved above €50 in FY22 and potentially in FY24, both with lower volumes.
- The Company reports a low maintenance CAPEX with some investor meetings raising the sustainability of sub €10m spent. We subscribe to the view that this number is low, but in Graanul’s defence, cash conversion from EBITDA to cash flow is relatively high. There are limited cash taxes, working capital is marginally negative and lease payments are negligible.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk