Vallourec - watch out for the mine
All,
Please find our Vallourec model here. We will update the model further when Vallourec post their full H1 numbers in August.
Can Vallourec do a refinancing prior to completion of the cost savings? Vallourec’s Q1 results came with a large asterisk attached and Q2 is similar. However, alongside the fact that Vallourec has failed to get both business segments operating at their potential, the “tubes” business has more than compensated and reiterates that the fundamental positive story at Vallourec. The financial restructuring is in the past and it is now apparent the new management team are taking control and changing the global production footprint into lower-cost regions. More importantly, Vallourec are implementing further restructuring, implementing “new Vallourec” over FY22 and FY23. Management are taking control via a “new Vallourec” restructuring of the business, and investors will want to know if this is complimented by the anticipated refinancing.
Q2/H1 numbers:
- Vallourec reports a strong set of numbers in Q2, secured mainly from the positive trajectory in the “tubes” business. Volume has increased by 13% versus Q2 2021, but more importantly, price has increased by 20%. The numbers are in line with our numbers, with EBITDA coming in at €160m versus €148m in Q2 2021. The mine contributed €34m in Q2 (Q1 was negligible as the mine was closed). If the mine was operating at full capacity, Q2 EBITDA for the mine would have been in the €120-130m range.
- The free cashflow remains negative, but the driving force of the outflow is the large Working capital outflow due to higher volume expectations in the coming quarters which is impacted by the increased raw material prices. The expectation is for cashflow to be positive as Working Capital stabilises at current levels.
Guidance:
- Vallourec did not provide any guidance at their Q1 numbers due to the uncertainty in the market, but management currently feel comfortable giving a guidance for remainder of FY22. FY22 EBITDA guidance of €650 to €750 million assumes conservative iron ore mine production.
- H1 EBITDA is €205m, with “tubes” generating c.€170m. EBITDA in H2 is guided to €480-580m and as the Company have guided to low single digit contribution from the mine at the EBITDA level, the majority of the EBITDA is from the “tubes” business. This is underpinned by the strong operating environment including strong pricing dynamics.
New Vallourec:
- Essentially, the “New Vallourec” restructuring is the near closure of their European operations and transfer of production to lower-cost countries where Vallourec are present. Importantly, the plan is cashflow neutral with the expectation of positive cashflow in Q123 from the sale of sites funding the cash outflow in Q124 for severance and other closure costs.
- 700kt of rolling capacity will be lost to the Group from their European operations. However, the majority of this is loss making and refocuses Vallourec and value instead of volume business.
- The restructuring involves the closure of their German operations and moving all European production for the Oil and Gas sector to Brazil. In addition, Vallourec will rationalise the remaining European business closing lines in Scotland and France and some divestment of small businesses. Vallourec plan to reduce the workforce by 2,950 as part of the restructuring.
- The plans expects to be cashflow neutral with asset and site sales funding the severance packages. EBITDA is expected to increase by €230m by end of Q124.
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 2.0x leverage is expensive even in the current environment. The coupon was set in a post-restructuring environment, but we fully expect it to be refinanced at cheaper levels. One of the equity analysts asked about the potential for refinancing when callable next June and this optionality was acknowledged by management.
- 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.
- The main driver of any refinancing will be management’s desire to “right size” the balance sheet prior to any changes to fundamentals, especially in the Oil & Gas sector. Although coy about the potential early call of the bond when asked, the general tone of the new management is have a balance sheet appropriate for all stages of the cycle.
Risks to Refinancing:
- Given the tightness and pricing mechanism in the “tubes” market, the short-term horizon for Revenue and EBITDA remains bullish. All operators are able to pass through inventory and energy costs and demand remains strong. However, the risk is that the oil & gas industry outlook changes, given the volatile nature of the industry, and Vallourec miss the window to refinance. Management are aware of this and are keen to “right size” the Company prior to any change. This is the main driving force behind the “New Vallourec” restructuring as management attempt to lower breakeven and increase efficiency.
- The second risk to a refinancing is Vallourec’s mine operations. In January there was a mudslide and as a result, operations were temporarily suspended. Vallourec recommenced operations in early May and produced 1.1mt in H122. Guidance for H2 is 1.5mt primarily in Q3, as Vallourec continues discussions with the authorities regarding the use of other alternative waste piles to continue production. Vallourec does not expect full production to recommence until H223. There is a doubt that the Company could refinance prior to full capacity (8.7mt).
- The ratings on Vallourec bonds are single B, so in the current environment, it will prove difficult to refinance. However, given expected leverage at the time of refinancing there is definitely potential for ratings upgrade, subject to mine operations returning to normal.
Investment Considerations:
- As part of the restructuring in 2021, creditors received an 8.5% 2026 bond as partial reinstatement 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.
- At current levels, the bond trades at 10% to maturity, however, an early call boosts yields to above 15% if called at the earliest date. Downside risk is limited, given the low leverage and the significant equity cushion beneath the bonds.
- At this moment in time we are not taking a position, 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
M:+44 7786 705 806
www.sarria.co.uk