Vallourec - worth another look - Positioning

All,

Please find our updated model here.

We are taking a 5% long position in Vallourec bonds at 94%. We acknowledge there is limited upside in the current environment, but with the business deleveraging and relatively high cash coupon of 8.5%, we are comfortable with the risk in the name.

Vallourec posted decent H1 numbers in July, but since then, the bonds have traded off with the market weakness, leaving a 10%+ yield for a name that is likely to end FY22 with less than 1.5x leverage. The market has focused recently on refinancing risk for HY issuers, especially those that are subject to a significant increase in their weighted average cost of debt. This is not a concern for Vallourec, with the current cash coupon at 8.5%. The business will be FCF positive for FY22 even allowing for the increase in working capital over the period. Unless subject to further raw material price pressures, the investment in Working Capital will be a one-off ensuring increased cashflow in subsequent years.

Tubes business:

- Vallourec are benefitting from the increase in the global rig count (higher than FY20 and FY21, but still lower than the 2017-2019 era) which, coupled with the inflationary environment has pushed up OCTG prices across all regions. This has added both volumes and margin and is evident from the equity performance of Tenaris amongst others.

- With the financial restructuring behind them, coupled with new management driving further cost-cutting measures, namely the closure of German assets and transfer of O&G activities to Brazil, the business has a stronger balance sheet and aiming for a cost structure that can adapt to its cyclical nature.

- The business has closed its unprofitable rolling capacity in Europe and focusing its production in low-cost regions of South America and China. All of these measures are likely to improve recurring EBITDA by €200-250m.

Mine:

- Following the landslide in early January, production was halted and only recommenced at lower volumes in May. Normal operations are not expected until Q2 2023, but in the meantime, 1.5m tonnes are expected to be mined in H2 2022. This is versus 8.7m tonnes for a full year, implying 35% of capacity.

- Iron ore prices, in Euros, have stayed relatively stable around €100/t supporting the business.

- Vallourec continue to work on additional measures including drainage system reinforcement and the stabilisation of the waste pile, to resume normal operations. Normal operations are expected not before Q2 2023.

Guidance:

- Vallourec has guided FY22 EBITDA in the range of €650-750m, with Free Cashflow post €200m CAPEX to be positive. This is sufficient to lower leverage to 1.5x (we model a slightly worse FCF on unfavourable working capital movements).

- The closure of the German operations and associated headcount reduction has further reduced Vallourec’s fixed cost base. The business is subject to cyclicality in the industry, but current expectations for rig count and OCTG pricing give Vallourec a solid base to further de-lever.

Positioning:

- We are taking a 5% long position in Vallourec bonds at 94%. We acknowledge there is limited upside in the current environment, 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 no super senior 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 5.5x at (€10.50 per share). Leverage is currently 2.0x with an expectation to reduce to c.1.5x by year-end.

Happy to discuss.

Tomás

E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk