KME - Of Financing, Volume and Time, Positioning.
All,
Please find our updated analysis here.
KME’s decision regarding the use of proceeds from the sale of the Specials business is at odds with a business looking to rebuild volumes in its copper business. With insufficient cash to finance its working capital, KME has been forced to sacrifice volume throughout 2021. So we were surprised at the decision to pay €190m of the €200m net sale proceeds to bondholders. With hedges running off, the inventory finance challenge is still growing. On our model, KME does not have the liquidity to redeem such a balance unless it drops volumes further. Whether the €110m will be rolled into a larger bond as part of a wider refinancing or whether KME will turn to its banks remains to be seen.
Is €75m enough?
- Our model shows volumes falling from 115kt per quarter in Q220 to 89kt in Q321, partially due to the deconsolidation of the specials business, and partially reflecting the company's struggle to finance its exposure to a rising copper price. Our modelling also shows that volumes will have to fall further to balance the reduction in cash available to fund Inventory.
- The company needs an additional €75m to replace the recent reduction in bank LC facilities from €398m to €320m. Without the additional facility, further volume cuts would be necessary. KME said the signing of a new facility was imminent last week. We have not seen any confirmation that it has been signed or the terms (the bank LC lines expire in November 2022), but clearly, it must be coming. It also does not look sufficient to return to full volume.
Lower volumes to buy time:
- The proceeds of the sale of the Specials business offered an opportunity to rebuild volumes. By choosing instead, to distribute €190m of the €200m net proceeds to bondholders via buybacks KME has put funding its inventory financing problems on the long finger.
- Reduced volumes will buy time to await a fall in the cost of inventory but fixed costs will hurt free cash flow generation which is already marginal.
- KME has mentioned an increase in tolling as a possibility, but with KME’s banks reducing LC lines (albeit excluding the specials business), we don’t see clients rushing to increase their exposure to KME via increased tolling agreements.
- Intek might be able to support KME via an equity raise, however, we have heard this one for over 2-years and nothing has materialised.
Positioning:
- We are closing our short of 5% of NAV. The bonds rose a few points on the back of the partial redemption albeit they are still below par. We no longer see our thesis as having a chance to play out, so exiting now is the best course. Also, we have to assume the lender wants his bonds back...
- We had expected that the company would offer bondholders around €50m and seek an amend and extend operation. We are struggling to understand the rationale behind this redemption.
I look forward to discussing this with you all,
Aengus