Vallourec - Good to be boring
All,
Please find our updated model here.
The equity market reaction to this morning’s Q3 financials is negative but credit inventors should look past that and focus on the continued momentum in FCF before Working Capital and the lowering restructuring charges. We see the increasing inventory and increasing investment in Working Capital as an overall positive as the business continues to see positive momentum in its operations. We have not adjusted our projections this morning, although mid point of Company guidance is slightly higher than we anticipate. We are happy to maintain our position.
Equity Reaction:
- Firstly, we should put the negative 6% equity price into context. Vallourec continues to trade at c. 5.9x FY22 EBITDA and is up both on a YTD and 1m basis. It appears the annoyance of the equity market is due to Vallourec maintaining their EBITDA guidance and not increasing it or at the very least, narrowing the range.
- This is partially due to Vallourec having some product ready to ship at the port, but not yet delivered to the end customer and therefore unable to book the revenue.
New Debt Facility:
- Vallourec has arranged a new $210m asset-backed loan with 5yr maturity in November, and used the proceeds to repay the utilised portion of the Revolving Credit Facility. The borrower for the ABL facility are US entities and it is backed by both inventory and receivables.
- We are a little surprised that the Company has arranged this facility as they have a €462m RCF maturing in June 2026 that was only €50m utilised as at Sept-22. We were unable to clarify with the Company but price might be the driving force (RCF is at € + 500bps).
- Either way, we don’t see it as a reason for bond investors to worry. There is limited debt ahead of the bonds. Note the RCF is pari-passu, which is currently undrawn, but the ABL and the ACC ACE facilities, combined total c. €500m are likely to be structurally senior. Combined this is less than 1.0x Gross leverage.
Q3 Numbers:
- Revenue per tonne has continued to increase: 30% up from Q321 and 5% up from Q222. Volumes were also up, increasing top line revenue by 7% versus Q2 (18% v Q321). EBITDA has also continued to grow versus historics despite the mine operations being curtailed.
- North America and Middle East remains favourable for both margins and volumes.
- Normal FCF definition (post Working Capital) remained negative, at €81m but this is after a further €135m investment in Working Capital. This is expected to reverse in Q4, with the Company guiding a positive FCF in H2 driven by restocking and strong Q4 revenue numbers.
Working Capital:
- Movement in Working Capital is dominated by raw material and finished goods price inflation. On average, receivables less payables is relatively flat.
- We do not envisage a continuous outflow and our model shows an inflow in Q422. This is inline with Company's guidance. When the mine ramps up prodcution in FY23, we would expect a further marginal outflow.
- We note Vallourec produces tubes to order and operate under long-term contracts. In the quarter, Vallourec have reconfirmed its long-term agreement with Petrobras, and won new contracts with ADNOC and Aramco.
The Mine:
- No change in guidance for the mine, with production to remain restricted until Q2 2022. This is due to entering the rainy season in Brazil (for Q4 and Q1) where production normally has a seasonal decline. Utilisation will remain at c.55% of production capacity for Q4 and Q123.
- Vallourec has completed the restoration work to Cachoeirinha waste pile and is in discussions to start using this waste pile for future production.
Positioning:
- Vallourec continue to rationalise their operations, putting “New Vallourec” on track in respect of redundancies agreed in Germany, France and UK. With no upcoming maturities until June 2026, Vallourec credit remains a stable boring credit.
- We maintain our 5% long position in Vallourec bonds which we took in early October at 94%. At the time we acknowledged the limited upside. At current levels, 97.75%, the upside is more limited but with the business deleveraging and relatively high cash coupon of 8.5%, we are comfortable with the risk in the name.
- Downside is protected with limited super senior debt (the ABL and other subsidiary debt) ahead of the bonds, and the strong macro environment in the Oil & Gas segment.
- There is a disparity between the equity markets and credit markets concerning the outlook for Vallourec, with the current EV at 5.9x at (€10.80 per share). Leverage is currently 2.2x.
Happy to discuss.
Tomás