Vallourec - opportunity in an ill-fitted balance sheet?
All,
Please find our updated model on Vallourec here.
Vallourec’s balance sheet is typical of a post restructured Company - an ill-fitted debt structure. Vallourec’s main bond has a coupon of 8.5%, which, for a business that is less than 2.0x leverage is wholly inappropriate. We continue to have concerns about the cash generative nature of Vallourec, especially away from its iron ore operations, but with 2.0x leveraged FY21 EBITDA, the YTW on the senior Notes is attractive at 7.3% for 18-month paper.
Recent Results:
- The release of the Q4 numbers heralded the return of the "tubes" business, with revenue in North America Oil & Gas more than double thanks to both higher prices and higher volumes. Additionally, South American revenue also increased driven by higher activity in Oil & Gas segment. Vallourec are able to absorb the higher raw material costs (partially due to their own mining operations) and higher energy costs, by pushing through price increases.
Reliance on Iron Ore mine:
- it needs to be highlighted the Group's significant EBITDA contribution from their iron ore mine and the volatility of that commodity. Making some assumptions on the margins of the mine and its contribution to EBITDA and cashflow, highlights the fact that the underlying tubular pipes business has a poor record of creating cashflow. Momentum is with Vallourec at the moment, and we expect the 'Tubes" segment to show continued growth.
Mine Closure:
- In early January, following heavy rainfall, some material from a waste pile associated with Valourec's Pau Branco mine slid into a rainwater dam, causing it to overflow, and resulting in damage to a local highway. Thankfully, no structural damage was done to the dam, and there were no casualties. However, operations were temporarily suspended.
- Vallourec expect operations to restart in the coming weeks without using the waste pile, with full capacity reached during Q2, subject to receiving the necessary consents.
Guidance:
- The Oil & Gas segment is seeing strong demand, and the favourable market conditions should continue and even improve in H122, especially in North America. EMEA volumes will increase in FY22, however, energy and logistic costs are likely to reduce margin, especially in H122.
- Iron ore operations are impacted by the mine closure in January, but expectations are that the necessary consents will be received in order to bring back to full capacity in Q2.
- FY22 EBITDA is likely to exceed FY21 levels of €492m. This is based of iron ore prices of $110/t which appears conservative versus current market price of $140/t. Q1 has the potential to be weaker due to the mining issue and some inflationary pressures, but Vallourec's volumes should ensure FY numbers easily beat FY21.
Investment Considerations:
- In the current environment, a safe 7% yield to take out in June 2023 is attractive. Vallourec has benefitted substantially from its iron ore business, and with its main “tubes” business gaining momentum, a refinancing of these bonds at the earliest callable date (June 2023) is highly likely.
- We are not taking a position at this time. A refinancing is our base case assumption, but the bond is call constraint with no upside. We fully expect the mine to resume production this month but the risk remains. The other main risk is the lack of cash deleveraging in our and the Company’s model. The “tubes” business does not generate positive free cashflow in the medium term.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
M:+44 7786 705 806
www.sarria.co.uk