Vallourec - fair wind behind
All,
Please find our updated analysis here.
Although Vallourec’s Q1 results comes with a large asterisk attached it does not change the fundamental story behind the Company. Vallourec has came through a large financial restructuring, and with the recent changes in management further operational restructuring is planned. Headlines post results focused on the issues at their Brazilian mine but we have looked beyond that and focused on the underlying sector dynamics.
Asterisk:
- On January 8, 2022, following the exceptionally heavy rainfall in Brazil, some material from the waste pile associated with the mine slid into a rainwater dam (causing it to overflow. This resulted in the interruption of traffic on the nearby highway. The structure of the dam was not affected, and there were no casualties.
- Operations at the mine were suspended and recommenced in early May, but without the use of the waste pile. Operations are currently at 70% and are expected to reach full capacity by end of the quarter.
- The cessation of operations meant Vallourec’s Q1 EBITDA was significantly lower than “normal”, with the Company estimating the loss of earnings to be c. €85m.
Results:
- Away from the mining problems, Vallourec showed strong numbers in the “tubes” business.
- Volumes were up 10%, revenue up 30% and more importantly margins, adjusted the mine operations was up c.500bps, highlighting that raw material price increases are passed on to the end customers. This is confirmed by analysis of Tenaris, Vallourec’s peer primarily based in North America.
- But more imprtantly is the overall market conditions in the Oil & gas segment. Rig count is up from the trough experienced through Covid, but still only 80% of pre Covid levels.
Guidance:
- Management would not offer any concrete guidance but it should be noted the Company has moved from saying FY22 EBITDA would beat FY21 EBITDA to the now current view of “significantly above FY21”. This is based on the very favourable market conditions in the Oil & gas segment.
- The company sees these conditions should continue and even improve into H2 2022, in both terms of price and volume. This is especially true in Middle East segment, and cost increases are been passed on to customers. Volumes are expected to increase in South America, which will lead to higher margins throughout the year.
- The overall guidance is based on $130/t average price for iron ore, with mining operations returning to normal in H2 2022.
- CAPEX is expected to be slightly above €200m as they proceed with the closure of the German plant and transfer the operations to Brazil.
Bond Refinancing:
- We remain of the view that this capital structure is not optimal for Vallourec. The coupon of 8.5% for a business with 30% debt/70% equity EV is extremely expensive, even in this environment. The coupon was set in a post restructuring environment, but we fully expect it to be refinanced at cheaper levels.
- Historically, Vallourec benefitted from a larger RCF component to its capital structure, which is needed to fund working capital requirements in the increasing volume and pricing environment.
- However, in the environment of increased end-user demand, 8.5% coupon is handsome reward for a business that is reducing leverage to 1.4x at end of FY23.
Investment Rationale:
- As part of the restructuring in 2021, creditors received an 8.5% 2026 bond as partial re-instatement of debt. This bond is callable at par from June 2023.
- We strongly believe the bond will be refinanced at the earliest possible date, namely June 2023. Management talk about ensuring Vallourec is future-proof through the cycle and we envisage a refinancing to take out the existing debt with a lower coupon and possibly lower leverage.
- There is significant equity cushion beneath the bond, and with limited debt ahead of the bond, a straight refinancing is highly likely.
- There is no upside beyond the 8.5% running coupon (trading at par), but we envisage limited downside due to favourable market conditions, lowering overall leverage and the large market capitalisation behind the bonds.
- At this moment in time we are not taking a postion, but we will revisit the name as part of a wider portfolio discussion.
Happy to discuss
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk