Chemtrade Logistics Income Fund (CHEUN) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Chemtrade Logistics Income Fund Q4 and Annual 2019 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mark Davis, President and CEO. Thank you. Please go ahead, sir.

Thank you, operator, and good morning, ladies and gentlemen. Thank you for joining us for our conference call and webcast today. As usual, joining me is Rohit Bhardwaj, our Chief Financial Officer. Before I commence the review, I would remind you that our presentation contains certain forward-looking statements that are based on current expectations and are subject to a number of uncertainties and risks, and actual results may differ materially. Further information identifying risks, uncertainties and assumptions and additional information on certain non-IFRS measures referred to in this call can be found in the disclosed documents filed by Chemtrade with the securities regulatory authorities available at sedar.com. One of the non-IFRS measures we'll refer to in this call is adjusted EBITDA, which is EBITDA modified to exclude only noncash items such as unrealized foreign exchange gains and losses. For simplicity, we'll refer to it as EBITDA as opposed to adjusted EBITDA. Both of these terms are fully defined in our MD&A. Now in general terms, we're pleased with the way we executed our business activities and operations in 2019. The initiatives we undertook in 2018 and '19 to adjust to changes in market conditions and improve day-to-day execution bore substantial benefits in 2019. While there's always room for improvement, our plants operated well and the supply chain and logistics movements were executed well. Despite this improvement in execution, our aggregate financial results were lower than we had expected at the beginning of the year. This was due almost entirely to the prices received for our chlor-alkali products, and in particular, the prolonged weakness in caustic soda prices. I'll have more to say about our latest outlook for these -- for pricing in my closing remarks. Despite the CN rail strike in the fourth quarter, which had a negative EBITDA impact of approximately $3 million, our results for the year are in line with the guidance we provided. Ignoring the impact of IFRS 16, which Rohit will outline shortly, in aggregate, our operating business generated EBITDA in 2019 that was similar to 2018. We achieved this result despite significantly lower results in the Electrochemicals, or EC segment. In that business, the low caustic soda prices throughout the year and lower netbacks realized from hydrochloric acid resulted in EBITDA that was $50.5 million lower than in 2018. This significant decrease, primarily due to the market price of caustic, was more than offset by strong operating results in our Sulphur Products & Performance Chemicals, or SPPC segment. SPPC reported significantly higher results in each quarter in 2019 than in 2018. For the full year, EBITDA was $52.1 million higher than in 2018. A number of factors contributed to the increase, including higher realized selling prices, reduced logistics costs and fewer maintenance turnarounds in 2019 relative to 2018. While all segments benefited from improved execution this year, the results were most obvious in SPPC. Our Water Solutions and Specialty Chemicals or WSSC segment posted steady year-over-year EBITDA. Contract renewals for water treatment products during the year were generally made at higher prices, more than offsetting raw material cost increases and weaknesses in some of the specialty chemicals. So in general, our business has executed well in 2019. But in aggregate, successful execution was counteracted by the decrease in the market price for caustic soda. We are pleased with how the reconfigured SPPC business has adjusted to structural changes in the merchant acid market, and how our water chemicals business gained strength throughout the year as new contracts came into force. Caustic prices started weakening about a year ago, and the weakness has continued longer than we or the industry experts had expected. However, the long-term forecast continues to call for higher prices for a number of years. We remain confident that the results for EC will improve over time. And that our focus on execution will continue to deliver benefits. Rohit will now provide you with some details on the fourth quarter results before I provide some further information on our outlook. Go ahead.

Thanks, Mark. Good morning. As Mark indicated, our plants and supply chain continued to operate well in the fourth quarter of 2019 and results also reflect higher realized selling prices for sulfuric acid. Before I review the financial results for the fourth quarter and the year, there are a couple of items to note. The application of IFRS 16 on leases at January 1, 2019, means that Chemtrade now recognizes depreciation and interest expense instead of operating lease expense for leases that were previously classified as operating leases. This results in increase in EBITDA, but it does not affect distributable cash. Also comparative information for 2018 has not been restated. In 2018 and 2019, litigation reserves of $100 million and $40 million, respectively, negatively affected both EBITDA and distributable cash. Loan repayment costs of $7.4 million in 2018 affected distributable cash. I will exclude this in my comments this morning about full year results to better compare the actual operating performance of our businesses. These items did not affect fourth quarter results in both 2019 and 2018. Looking first at the aggregate results for the fourth quarter of 2019. Revenue was $355.2 million, a decrease of $35.6 million from 2018. The decrease was primarily due to lower prices for caustic soda and hydrochloric acid in the EC segment. These decreases more than offset higher selling prices for sulfuric acid. Aggregate EBITDA for the fourth quarter of 2019 was $70.3 million compared with $65 million in the fourth quarter of 2018. Excluding the $14.4 million benefit of IFRS 16, EBITDA for the fourth quarter of 2019 was lower than 2018 by $9.1 million. Strong results in the SPPC and WSSC segments more than offset by the EC segment where EBITDA was $19.2 million lower than 2018. Distributable cash after maintenance CapEx for the fourth quarter was $1.4 million or $0.02 per unit. This reflected the lower level of EBITDA generated during the quarter and the heavy maintenance CapEx incurred in the fourth quarter. For the full year 2019, distributable cash from continuing operations after maintenance CapEx was $122.1 million or $1.32 per unit compared with $149 million or $1.61 per unit in 2018. Consolidated revenue for 2019 was $1.5 billion, which was $62.9 million lower than 2018. The decrease was due primarily to lower selling prices for caustic soda and HCL, partially offset by higher selling prices and higher sales volumes for water products and WSSC and higher selling prices for sulfuric acid. Aggregate EBITDA for 2019 was $335.6 million compared with $296.2 million in the previous year. 2018 EBITDA included lease expenses of $56.2 million. Ignoring the effect of IFRS 16, 2019 EBITDA was $16.9 million lower than 2018. SPPC generated strong results in 2019 relative to 2018, with EBITDA improving by $52.1 million. This was, however, almost entirely offset by the EC segment where 2019 EBITDA was $50.5 million lower than 2018. Now turning to segmented results for the quarter. SPPC generated revenue of $117.3 million compared with $129.1 million in 2018. EBITDA for the quarter was $34.2 million, which was $17 million higher than 2018. While IFRS 16 contributed $5.8 million to the improvement, the majority of the increased EBITDA came from improvements in the business itself. Despite sales volumes being lower than last year due to reduced by-product supply, higher selling prices for sulfuric acid combined with better operations resulted in significantly higher margins. There was also a lower-than-normal level of maintenance turnout activity in 2019 relative to 2018. Our WSSC segment reported fourth quarter revenue of $101.8 million compared with $102.4 million in 2018. EBITDA improved to $14.6 million, including the positive IFRS 16 impact of $1 million compared with $11.9 million generated in 2018. Selling prices for water products increased and raw material costs stabilized, resulting in expanded margins. This was partially offset by lower results for specialty chemicals. Our EC segment reported revenue of $136.1 million for the fourth quarter of 2019, which was $23.2 million lower than the same period of 2018. The lower revenue was due to lower selling prices for caustic soda and for HCL. For the fourth quarter of 2019, caustic soda prices were 15% lower than the fourth quarter of 2018. HCL selling prices and netbacks were lower by 21% and 27%, respectively. From an EBITDA perspective, excluding the $7.2 million benefit from IFRS 16, EBITDA for the fourth quarter of 2019 was $19.2 million lower than the same period of 2018. This was primarily due to lower selling prices for both caustic soda and HCL. The week-long CN rail strike in November also had a negative impact on EBITDA of roughly $3 million. Maintenance CapEx in the fourth quarter was $36.9 million, bringing total maintenance CapEx in 2019 to $82.7 million. We expect maintenance CapEx in 2020 to range between $80 million and $90 million. Excluding unrealized foreign exchange gains, corporate costs during the fourth quarter of 2019 were $12.7 million, including a positive IFRS 16 impact of $400,000, compared with $10.4 million in the fourth quarter of 2018. This increase is due primarily to higher compensation accruals. We maintain ample liquidity with USD 265.4 million undrawn on our USD 850 million credit facility and are in compliance with all our bank covenants. In October, we amended certain terms of our senior credit facility as well as extended the term. The facility now matures in October 2024. On October 1, we completed the issuance of $100 million principal amount of 6.5% convertible unsecured subordinated debentures. The net proceeds of the offering were used to pay down senior debt. During the fourth quarter, we announced the redemption of the outstanding Chemtrade Electrochem, formerly Canexus, Series VI, 6.5% debentures. The debentures were redeemed at par on January 3, 2020, for a total of $74.6 million. I'll now hand the call back to Mark.

Thanks, Rohit. Overall, we're pleased with our execution across all businesses and operations in 2019. For the most part, all of our plants operated well. We also were successful in reducing logistics costs, including rightsizing of our rail fleet. We remain focused on improving execution every year and expect further improvements in 2020. We continue to manage all the things that are within our control and ensure that the business is prepared to realize on opportunities especially increased caustic soda prices and HCL demand and pricing when they occur. I do want to touch on a couple of recent developments that are affecting our business. First is the disruption to rail service caused by the recent blockades in various parts of Canada. We, like most chemical companies, are heavily dependent upon the rail as that's often the only viable mode of transportation for raw materials and finished goods. The rail network is very complex and interconnected. Therefore, disruptions in one area can affect other parts of the network. The situation is fluid and it's difficult for us to estimate the financial impact of reduced rail service. What we can say is that to date, the costs have not been material, but many of our plants and our customers' facilities only have a small margin of operating safety. Second issue is the effect of the COVID-19 virus on economic activity, particularly in the Asian chlor-alkali industry. Recent reports show that the industry operating rates have dropped as there is reduced demand for both chlorine and caustic soda. As a reminder, the most important factor for us is the imbalance between demand for chlorine and caustic soda. As a general statement, if demand for chlorine exceeds demand for caustic in Asia, the price of caustic soda drops and that hurts us and vice versa. Very recent indications are that the Northeast Asia spot price for caustic soda may be rising by more than USD 50 per ton. Currently, the COVID-19 virus has reduced Asian chlor-alkali operating rates from about 80% to 65% or lower, and has other serious effects on Asian and worldwide economic activity. We can't predict how the virus will ultimately affect economic activity and caustic pricing for the balance of the year, but our second quarter pricing will be strongly influenced by the index value that we see over the next several weeks. I'll provide some comments on our recently issued 2020 guidance in a minute. First, like last year, I want to provide you with some high-level comments on the market dynamics for certain key products. Generally, other than caustic soda and HCL, the market conditions for our main products remain positive. Starting with SPPC and sulfuric acid. Supply-demand and pricing for each of ultra-pure, regen and merchant are positive. Ultra-pure continues to be sold out and we've been able to achieve higher pricing over the last few years. We expect that North American demand for ultra-pure acid will continue to grow, and we are contemplating how we can best meet this growth. Regen demand based on refinery production of alkylate also shows growth. Regen contracts are multiyear, but as they come due, they are being renewed at higher base pricing. Finally, merchant acid price has improved and continues to improve. Pricing continues to move up, although we do not capture all this increase as we share improvements with our by-product suppliers under our risk-sharing arrangements. Turning to water. As we've previously noted, alum price is also increasing as the market has stabilized and raw material costs are no longer increasing. We expect improved margins in 2020, although a more modest improvement than we saw in 2019. Finally, I want to provide some color on sodium chlorate. The North American sodium chlorate industry is expected to operate at utilization rates of close to 95%. We have a significant portion of our chlorate pricing contracted for 2020, and we're able to achieve price increases in excess of cost increases. Now we don't talk a lot about our EC, electrochemical, business in Brazil, but there have been some developments that are worth mentioning. Our key customer there is the world's largest pulp producer, Suzano. During 2019, in response to reduced demand from China, Suzano reduced the output at the pulp mill that we supply as this mill is not the low-cost mill in Suzano's network. Suzano recently announced substantial investments in this mill to reduce its cost structure. We believe that until these investments are concluded over the next couple of years, they will continue running at reduced rates. Once those investments are completed, we expect the mill to run at high rates. As a reminder, we have a long-term fixed U.S. dollar margin contract with Suzano. But while our margin per ton is fixed, we do bear volume risks. Given the nature of the Brazilian electrochemical industry, we have a limited ability to sell products into the open market. So while we expect an earnings drag from Brazil in 2021 and '22, the long-term prospects for this business are bright. Switching gears to 2020. We expect that our businesses will continue to execute well on aspects within our control. However, there are several aspects that will affect EBITDA this year. We listed these issues in our 2020 guidance released at the end of January. But here's a quick summary. First, in 2019, there were fewer plant turnarounds for our plants and those of key customers that affected us than there were in 2018. That won't be quite as favorable in 2020. The key additional turnarounds are the biannual turnaround at our North Vancouver chlor-alkali facility and a major turnaround of about 60 days at a key refinery customer that takes place once every 5 years. While that refinery is shut down, our associated regen plant is also shut down. As you've been hearing all year, lower cost prices in HCL and netbacks have had a negative impact on the EBITDA we generate. We are still bullish on these markets, but not anticipate any immediate improvement. Our guidance for 2020 lists a number of assumptions. A key assumption is that our 2020 average caustic soda price will be lower than the 2019 average. Our assumption is that 2020 average IHS Northeast Asia caustic price index will be $15 per ton lower than the 2019 average caustic price index. This index value, while not directly linked, is a key variable in establishing Chemtrade's selling price for caustic soda. While we've assumed lower average caustic price in 2020, this would still be higher than the prices at the end of 2019. The market continues to forecast that there should be a modest improvement in caustic pricing during the second half of 2020. As I said, we remain bullish on the medium- to long-term dynamics for caustic pricing. And the most recent update for IHS for Taiwan contract caustic pricing predicts increasing pricing every year from 2021 through 2024, which is far -- which is as far as they predict. For perspective, the forecast pricing for 2024 is roughly $240 per ton higher than the forecast of this year. Obviously, these comments are caveated by the comments I made earlier about the effect of the virus, which is having, so far, unquantifiable effects on what people's predictions or assumptions are. Finally, in this business, we're assuming there will be -- there will not be a recovery in HCL demand from higher netback -- from the higher netback fracking industry. The amount of realized netback revenue is typically higher from the fracking industry than from the industrial market. However, the industrial market is less cyclical. To increase demand stability, Chemtrade added more industrial customers partway through 2019. Thus, the 2020 guidance includes a full year of lower realized netback revenues as compared to 2019. If fracking industry demand does increase, we can realize on this upside, but we are not assuming that will happen this year. We want to end our call with a comment on our distributions, as we've received a number of questions on our distribution policy, particularly in light of our 2020 guidance and current yield. As you know, at our current unit price, our yield is in the double digits. We have a history of not decreasing distributions based solely on a high yield. On the other hand, if we believe that the underlying business cannot sustain our distributions, we make the appropriate capital decision and reduce distributions to a sustainable rate. We last took that step in 2007. Following the release of our 2020 guidance, our unit price decreased, and accordingly, our yield increased. Simplistically, if you take the midpoint of our EBITDA and other cost guidance, you will see that our distributable cash roughly equals our annual distributions of $1.20 per unit. We believe that 2020 represents a trough for our business. We are currently enduring a low point for caustic soda pricing and HCL demand from the fracking industry and a higher-than-average level of turnaround activity. Despite that, as outlined, we believe there's considerable upside in our earnings potential in the future. In other words, we believe that the business will generate sufficient funds to sustain our distribution as it has for the last 13 years. Additionally, we maintain ample liquidity and have no covenants or other restrictions that hamper our ability to maintain our distributions. We'd like to thank you for your attention. And operator, Rohit and I will now be pleased to answer any questions.

[Operator Instructions] Your first question comes from the line of Joel Jackson from BMO Capital Markets.

I have a few questions a few at a time. First, I just want to reconcile some of your commentary between SPPC and WSSC. So you see sulfuric acid prices rising across the complex, if I heard that right. But then in water, do you think that raw material costs aren't rising, although I thought acid is one of the means to water treatment. Can you just reconcile that?

Yes. The short long story, right, is, is as you know is acid is a regional market. And there's markets that are by-product supplied and markets that are sulfur burner supplied. Sulfur price has actually decreased and the acid that we source in our water business is a combination of by-product and sulfur burned. So the acid that's actually linked to sulfur prices likely cheaper than in other regions? But I think you take it all in aggregate is from a big aggregate view, raw material costs have stabilized in the water business.

Okay, that's helpful. Then my second question would be, you've called out generally risks on the CN strike and coronavirus here in the first quarter. Can you help size a bit, I mean, I understand sizing coronavirus impact is impossible, but I'm asking anyways. Can you give some order of magnitude of what that could mean in Q1 and Q2? What your best guess is right now on the 2 issues?

I won't give you a number because I can't, right? I'll tell you 2 things, okay. First, on the rail blockade because that's one of the things we called out is, as I've said is to date, okay, the extra costs, and there have been extra costs, are not yet material. But if the blockades truly actually stop our ability to move product be as material as the other CN things that we talked about. And again, it depends on duration, overall effect on the supply chain and, frankly, where, right. Is -- probably our worst-case scenario is if somehow we couldn't ship in and out of our Vancouver facility, since actually that facility in and of itself makes a lot of money. But that's probably the lowest probability effect of the rail. So a nonanswer for you is I can't quantify it because I don't know how to, right? Let me just finish the coronavirus and then we can circle back, right, is the coronavirus, again, is -- there's people that have actually abandoned guidance based on the coronavirus to be able to quantify the coronavirus effects. I think from our perspective, why we can't quantify it. And I -- we've said that in our remarks. We think the biggest effect on us is what happened to caustic soda pricing that moves on that index that's actually instructive on our pricing in Western Canada. And the question that I can't answer is will the virus and the effect of the virus affect which side of the chlor-alkali business more in Asia, as we said during the terms. So I don't know if chlorine demand goes up or down vis-à-vis caustic demand. And that's why we can call it out as a risk, but we just can't quantify it.

Okay. And then -- that's helpful, I guess. And my last question...

I'd be happy for you to quantify it.

Yes. Well, if I qualify then no one can. Just my last question is, again, on the dividend and the payout ratio. So if we assume over the next few years, little to -- little or modest commodity price improvements across the complex. What would kind of be the average payout ratio? Because you -- obviously, you have turnaround ebb and flow be at North Van, be at customers. So are we talking about low growth -- low commodity price growth scenario of an average payout ratio of 90%, 85%, 80% to 90%. How would you quantify it?

So if you're assuming no commodity price increase or material including our chlor-alkali business, it's -- we haven't done the numbers, but I'm going to say it's 90%, all right?

And if that was the case, it's 90%, that's enough to sustain the dividend in your mind?

Well, 90 is less than 100.

So I'll take that as a yes.

Your next question comes from the line of Jacob Bout from CIBC.

I just wanted to go back to the impact of the rail strike. What is this meant for the chlorine market? Because we've been hearing about chlorine shortages...

So the -- so is -- we're the wrong guys to actually comment on that. I only can say that -- is -- there are Eastern and Central Canada chlorine producers that the blockades have had an effect on. And simplistically speaking, most of our chlorine wheels out of our gate in Vancouver and head south. So it hasn't really -- so we really haven't been affected. But if you want the Canadian nationalistic perspective is the effect on these rail blockades on the availability for people to get chlorine to purify their drinking water, I got to believe it's awfully hand to mouth, which I don't know.

Okay. And then on the -- I think I heard you say Northeast Asia spot prices for caustic up $50 a ton?

Well, let me clarify that in a minute, is that this is what we've heard. The indexes do not yet represent it. We've heard it for good reasons because partially, every so often, we do import caustic. So we have a pretty good handle on the price of imported caustic. So the actual index publications haven't shown it yet, but we believe that's what's happening.

So if this is implemented on -- in contract pricing, then how should we think about the impact on EBITDA?

So you have to -- I would suggest you need to -- if it's up $50 in the first 2 weeks of March, which actually is informative for us for our Q2 pricing, then we should be up some from what -- where Q1 was.

Yes. But I think that will get us close to the midpoint of our guidance because it did drop off early in 2020. And so this would just -- would bring it to where we expect the Q2 pricing to be.

Okay. Even though you were originally talking about a second half versus a second quarter uptick?

Yes. So second half -- so what happened is -- so this $50 we're talking about is from where it was in, let's say, January. And that was lower than where it was in November. So it dipped down, and this will bring it up to where we expect it to be. The uptick you're looking at is really getting it beyond where it was even at the end of the year.

Or maybe this helps is, if what happens -- if what we're seeing now is what happens is the assumptions in our guidance remain valid -- remain pretty much bang on. If it's higher than that, is -- that's good. If it's lower than that, it depends how much lower, may or may not be material, right?

Okay. Going to the WSSC division. You talked about alum and PAC price increasing and volumes growing. Can you just help us, order of magnitude, is it like a GDP-type growth on the pricing and on the volumes? Or it's something better than that?

No, I think the pricing should be better than GDP, but we took most of the price improvement in 2019. So we do expect -- as we have opportunities in 2020 to reprice contracts, we do expect some pricing going up. But as raw materials stabilize, it is harder to get a lot of price increase. In fact, frankly, we'll be comfortable maintaining pricing, because we actually expect raw materials are dropping. They stabilized and now the indications are they will likely be going down. So there should be some margin expansion above GDP but not the way it was in -- nothing of the magnitude of 2019.

And then volumes?

Volumes are just GDP. I mean the volume is not that significant.

Okay. And then in the specialty products in that division, we've seen some weakness? How long does that continue for?

So what we had said was they are 2 -- couple of chemicals we had called out. One was P2S5 or phosphorus pentasulfide, which has already shown recovery in Q4 -- in our numbers in Q4. But the other one we had mentioned, the other big one was potassium chloride or KCl. And we had said that because of the particular situation there with a customer who had overbought, it's really more like a '21 -- 2021 improvement. 2020, we don't really expect any uptick there.

Okay. So what we saw in fourth kind of through 2020 then?

For that product. Now we don't break it out in that level of detail, but it's not a bad -- the P2S5 improvement is there, and there wouldn't be much more improvement in the rest of spec.

Your next question comes from the line of Paul Bilenki from TD Securities.

I'd just like to start out on the large turnarounds that you have upcoming in Q2 and Q4. Are you able to sort of put any numbers around the potential impact of those financially? I think last time in 2015, you had that large regen turnaround, I think you quantified at about $5.5 million. Is that sort of the right range?

Yes, that's right.

Okay. And the North Van is -- would it be something similar? Sort of similar to...

Yes. Because I think last time what we said was when we had the outage, it was closer to $12 million, but that was at a very high caustic price. And so now we expect about half of that.

Okay. And I guess, just sort of hypothetically, and following on all these rail blockade questions. If there is a blockade that impacts the North Van facility, are you able to move forward the timing of that maintenance turnaround at all?

No.

No.

No? Okay. That's the set.

It's very hard to get contractors and everything lined up to -- it's pretty hard to move.

It's not just our guys turning cranks here. We bring in people and you have to preorder equipment you're replacing. And it's...

It's a big production.

Yes. Fair enough. And I guess you've done a lot of work on operational improvements in the last couple of years. What are your areas of focus on that front in 2020?

Well, is -- we focus on all of it. But I mean -- but to give you the 2 big things we're looking at, is actually, we're going to look at additional production efficiencies and whether or not that's actually utilization of raw materials or increased reliability, anything that actually helps us reduce cost per ton produced. And secondly, we're going to be looking for additional logistics chain efficiencies in cost savings.

And how far along are you through the shedding of the railcars at this point?

We're -- we've shed the majority of them. Now actually, we are fine-tuning and affect -- and expect to be able to actually realize additional cost savings in 2020, whether that's by shedding additional cars or using those cars more efficiently is, it's going to depend on how we line out our supply chain. But the big step change was made during the year. But we're going to find other cost-saving opportunities going forward as well.

Your next question comes from the line of David Newman from Desjardins.