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

Ladies and gentlemen, thank you for standing by, and welcome to Chemtrade Logistics Income Fund Q3 2020 Results Webcast and Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Mark Davis, President and Chief Executive Officer. Please go ahead.

Good morning. We thank you for joining us for our call today. I hope all of you are staying safe and well. Before we commence the review, I'd like to remind you 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 disclosure documents filed by Chemtrade with the securities regulatory authorities available at sedar.com. One of the non-IFRS measures we refer to on this call is adjusted EBITDA, which is EBITDA modified to exclude only noncash items. For simplicity, we'll just refer to it as EBITDA, and both of these terms are fully defined in our MD&A. As usual, Rohit Bhardwaj is on the call today, but like last 2 calls, we continue to be in different locations. As a reminder, Chemtrade falls under the essential business classification under U.S. state and Canadian provincial orders. So all of our operations have continued to operate during the COVID-19 pandemic. Our highest priority has been our employees' health and safety. By following the measures we've implemented, our employees have ensured that they can continue to work safely and supply our customers. Given the challenging circumstances created by the pandemic, our measures have been largely effective. I wanted to start this call by again thanking each member of our workforce for their dedication and outstanding performance during these trying times. On this morning's call, Rohit will provide a review of our third quarter results and a number of financing initiatives we took during the quarter. But first, I have a few comments on the general market conditions that prevailed during the quarter. Our third quarter results reflected the various matters we referred to in our second quarter call. Results were affected by continued weak demand for certain products and the deferral of our Vancouver turnaround. I'll briefly discuss the macro conditions that prevailed during the quarter as these provide some context for Rohit's more detailed comments. As mentioned, COVID-19 adversely affected demand for certain of our products. It has not affected our Water Solutions business. However, the ongoing pandemic continues to affect demand for our regen, merchant acid, sodium chlorate, hydrochloric or HCL products. Regen demand rebounded from its trough in the second quarter, but our third quarter demand was still about 10% lower than demand at the same time last year. Secondly, demand for merchant sulfuric acid, which is one of the world's most widely used chemicals, was also lower than last year due to the generally reduced level of economic activity. Thirdly, on our last call, we mentioned a decrease in the demand for printing paper as more people work from home. This affected our sodium chlorate demand, which was weaker in the third quarter than last year and frankly, weaker than we had expected. Finally, fracking activity and thus demand for HCL showed some improvement during the year, but remained well below 2019 levels. Turning to operations. Lack of contractors resulted in our deferring the planned third quarter turnaround of our North Vancouver chlor-alkali facility into the fourth quarter. This turnaround is now complete and the plant is up and operating well. Following Rohit's reviews, I'll have some comments on the future economic environment facing Chemtrade. Rohit?

Thank you, Mark. Good morning. I hope everybody is keeping well. Looking first at the aggregate results for the third quarter of 2020, revenue was $345.9 million, a decrease of $49.8 million from 2019. The decrease in revenue for the third quarter is primarily due to lower selling prices and lower sales volumes for hydrochloric acid and caustic soda in the Electrochemicals, or EC, segment and lower sales volume of regen and merchant sulfuric acid in the Sulfur Products and Performance Chemicals, or SPPC, segment. Aggregate EBITDA for the third quarter of 2020 was $64.7 million compared with $90 million in the third quarter of 2019. For the third quarter this year, EBITDA was $25.4 million lower than last year. As I will outline shortly, this shortfall was attributable to the EC segment due to low caustic soda prices and reduced demand and prices for HCL and lower results in the SPPC segment. This was partially offset by stronger results from the Water Solutions and Specialty Chemicals, or WSSC, segment, driven by our water business. Distributable cash after maintenance CapEx for the third quarter of 2020 was $12.1 million or $0.13 per unit. Distributions declared for the third quarter were $0.15 per unit. Now turning to segmented results for the quarter. SPPC generated revenue of $105.4 million compared with $127.8 million in 2019. The decrease in revenue in the third quarter of 2020 was primarily due to the COVID-19 pandemic, which resulted in lower sales volume for regen and merchant asset and other SPPC products. The most significant factor that negatively affected EBITDA during the third quarter of 2020 was reduced demand for merchant acid and regen services. Merchant acid demand was lower due to the reduced level of economic activity. As Mark noted, sulfuric acid is one of the world's most widely used chemicals. Government orders restricting nonessential travel and people working from home continue to reduce demand for gasoline. Therefore, refineries operated at lower utilization rates, which led to the reduced demand for regen services. EBITDA for the third quarter of 2020 was $31 million, which was $12.6 million lower than 2019. Our WSSC segment reported third quarter revenue of $119.8 million compared with $122.4 million in 2019. The slight decrease is due to lower sales volume of Water Solutions products and lower sales volumes of Specialty Chemical products, partially offset by higher selling prices for Water Solutions products. EBITDA improved to $29.2 million from the $24.3 million generated in 2019. The improvement was due to higher margins for water products, which benefited from higher selling prices and lower raw material costs. Our EC segment reported revenue of $120.7 million for the third quarter of 2020, which was $24.7 million lower than the same period of 2019. The lower revenue in the third quarter of 2020 was primarily due to lower sales volume for hydrochloric acid and caustic soda and decreased selling prices by 30% for HCL and 11% for caustic soda. This was partially offset by a 4% increase in selling prices for chlorine. HCL demand from the fracking industry has been sharply lower during 2020, and this has resulted in our having to operate the North Vancouver facility at reduced freight. As a reminder, we have ample demand for caustic soda as our core region is short of domestic supply of caustic soda and relies upon Asian imports for the balance. We are constrained by our ability to place the chlorine molecule either as chlorine or as HCL. Our core region doesn't have a lot of demand for chlorine, and we typically ship it as far as shipping rates allow. From an EBITDA perspective, EBITDA for the EC segment of $24.6 million for the third quarter of 2020 was $18.2 million lower than the same period of 2019. This was primarily due to lower selling prices for both caustic soda and HCL as well as the effect of operating the North Vancouver facility at reduced rates. Our production rate was constrained by reduced demand for HCL. In the third quarter, netbacks, that is, selling price with less freight for HCL were 43% lower compared to the same period of 2019. Turning to CapEx. Maintenance CapEx in the third quarter was $17.3 million. Maintenance CapEx in 2020 continued to be difficult to predict, primarily because of the uncertainty of being able to find contractors to carry out the work due to the pandemic. If we're able to hire contractors, we estimate maintenance CapEx of between $75 million and $80 million for 2020. Excluding unrealized foreign exchange gains, corporate costs during the third quarter of 2020 were $20.2 million compared with $20.8 million in the third quarter of 2019. The lower costs were primarily due to lower incentive compensation accruals. Turning to our balance sheet. During the third quarter, we took actions to completely redeem the debentures that were set to mature in 2021. To fund the redemption, we completed a public offering of $86.3 million principal amount of convertible unsecured debentures with an interest rate of 8.5% per annum. These funds, plus availability under a trade agreement, were used during and after the quarter ended to complete the redemption of the outstanding 2021 debentures at their face amount plus accrued interest for a total of $128.3 million. With the full redemption of the '21 debentures, we have no debt maturities until 2023. We maintain ample liquidity with USD 227.8 million undrawn on our USD 850 million credit facility. We are in compliance with all our bank covenants. I'll now hand the call back to Mark. Mark?

Thank you, Rohit. The economic uncertainty caused by COVID-19 continues to prevent us from knowledgeably predicting with specificity the key elements necessary to make guidance meaningful. However, we can comment on certain key items that are expected to affect our earnings. We caution that COVID-19 continues to create a very fluid situation. And what we say is going to be based on our current understanding of our customers and our markets, which can and likely will change over time. Accordingly, the following comments should be read with extreme care, and we won't update them until our next MD&A. Turning to comments on certain elements contributing to Chemtrade's 2020 fourth quarter earnings are as follows. Regarding key facilities, as previously advised, we have a significant maintenance turnaround at one of our regen plants. The plant is tied to a once every 5-year major maintenance turnaround at this plant's refinery customer. Secondly is our North Vancouver chlor-alkali facility, also has its biannual turnaround in the fourth quarter instead of the third, due to availability of contractors. But as I mentioned, this has now been completed, and the plant is back online. Some comments on demand for the fourth quarter is that demand for many of our products continues to be weaker than last year due to COVID-19's effect on the economy. A couple of particular comments is that fracking activity and less demand for HCL has shown some improvement during the year and it remains well below 2019 levels. Demand for our regen services, which is dependent on gasoline demand, has been improving, but it's still about 10% below normal levels. Demand for printing paper remains low, as large number of people are working from home, which has led to a reduced demand for sodium chlorate. Finally, on the demand side, demand for our water products is stable. However, as a reminder, our fourth quarter is a seasonally low demand quarter with generally reduced water consumption in the winter months. We could also make a couple of comments on pricing. First, despite lower demand, pricing for most of our products is expected to remain stable in the fourth quarter. The main exception is pricing for caustic soda. The Northeast Asia spot index for caustic soda, which is very influential on our caustic selling price, settled at a very low level towards the end of the third quarter. It was approximately USD 50 per ton below the level relative to the same period in 2019. Turning to 2021, which is a more interest, I assume, we can make some similar comments. First, on key facilities. We expect all of our plants to operate well during 2021 with only normal turnaround activity and no atypical turnarounds like we had in the fourth quarter this year with our regen plant. On the demand side, as a general statement, we've expected that COVID-19 will continue to affect demand for certain of our products in 2021. However, we expect our sales volumes for 2021 will be higher than 2020. Some more specific demand comments are as follows. With respect to WSSC, we expect demand for our Water Solutions business to be similar to 2020 and continue to be largely unaffected by COVID-19. Regarding SPPC, regen and ultra-pure volumes are expected to be higher than 2020, but still below pre-pandemic levels. And on merchant acid, we expect volume to be similar to 2020 levels. Regarding demand for our EC products. Our North Vancouver chlor-alkali plant is expected to operate at a higher level than in 2020 when we had the biannual maintenance turnaround. The plant's operating rates in 2021 are expected to be constrained by HCL demand. If there's increased activity in the fracking industry and our HCL demand increases, we can run the plant at higher utilization rates. Finally, on the demand side, sodium chlorate demand should be higher than in 2020 but still lower than historic levels. Demand will be affected by the extent of work from home during the pandemic reduces paper demand and thus reduces bleach pulp production. And finally, some comments on pricing. Most of our products do not experience a cyclical pricing. However, caustic soda pricing, as most of you know, can move significantly. In 2021, we expect that the Northeast Asia spot index for caustic soda should move higher during the year. The long-term supply demand characteristics still support upward price movements for many years. During 2021, pricing is expected to start increasing and to continue increasing for at least several years. Recall that we generally incur a quarterly lag between our caustic soda price and movements in the index. Due to this lag, unless the price indexes move up soon, the annual index level for 2021 is expected to be lower than 2020 despite the upward movement during the year. Finally, given the reduced demand for sodium chlorate, there could be some pressure around sodium chlorate selling prices during 2021. To summarize, we believe that the severity of COVID-19 in 2020 will result in 2020 being a trough year for Chemtrade. This has been much more than a typical recession. In a typical recession, parts of our business such as regen and chlorate are not as adversely affected as they were in 2020. These businesses were hurt because of the curtailment of nonessential travel and requirement of people to work from home as opposed to just the typical reduction in demand experienced in an economic recession. We expect 2021 to be better than 2020. And as the effects of COVID-19 on the economy dissipates, we are well positioned to take advantage of better economic conditions and generate higher earnings. I would like to add that these comments were all drafted and prepared as was our MDA before the recent announcement of the Pfizer vaccine. We actually have no particular view about how quick and how effective their vaccine will change the effect of the pandemic. But obviously, the quicker people and the economy gets back to normal the quicker we will benefit from it. As a final comment, I'd like to conclude by letting you know that this will be my last conference call. As you will have seen in our news release of yesterday, I've decided to retire on February 28, 2021, at which point I will also be stepping down from the Board. Scott Rook will be appointed to CEO and the Board on March 1, 2021. Scott is well prepared to drive improvements in Chemtrade's performance and he, of course, along with Rohit, will be happy to answer future questions on future calls. Thank you. That concludes our remarks. And operator, Rohit and I will be pleased to answer any questions.

[Operator Instructions] Your first question will come from Joel Jackson from BMO Capital Markets.

A couple of questions. I'll go one by one. Obviously, the fourth quarter is typically your weakest quarter. You called that out this year as well. The last couple of years, we've seen the fourth quarter maybe about $20 million EBITDA lower than the third quarter. So sequentially, this year, you've got some heavy turnarounds, lot of stuff going with COVID. Is that about the right amount is about $20 million? It should be similar sequential decline in the fourth quarter as usual? Or is this year different?

Yes. I mean I don't think we want to really get into that specific about Q4. I think what the right way to look at it is we've pointed to the 2 big turnarounds, Richmond and North Van. In the past, we've said each is about $5 million of an effect. And then, I think, we got to think about the fact that regen is coming back. If you compare to last year Q4, regen is coming back. And to the extent, it's down a bit. The impact is not going to be as severe as normal because we do have the large turnaround in Richmond, and Q4 is a seasonally low quarter. So operating rates will not have as severe an impact. But we are still looking at merchant being down and we -- the other thing you should think about is we now know that the caustic soda index settles for Q4. And as Mark pointed to a USD 50 per ton lower. So I think you have to kind of do that kind of math as opposed to go sequentially. I think you're better off starting with last year Q4 and then kind of modeling in a couple of these things that we've pointed to for Q4.

That's helpful. And then I appreciate the comments on '21. You talked before about kind of normalized Chemtrade earnings being kind of $300 million to $350 million range. If we assume sort of a normal -- sorry, seems like a reasonable caustic recovery across '21, as you talked about, is it reasonable to expect you can get at least to the low point of that range next year? Anything you can provide to be a little more granular would be helpful. Maybe even you could talk about -- you talked about water in '21.

So look, it kind of goes like this. Water is going to be -- going to continue to be good. It was good this year. It's going to be good next year, right? SPPC should see improvement because we shouldn't have that trough in regen in the second quarter, right? How much better depends a little bit. I'm not a little -- how much better depends on how quickly the economy recovers between driving miles and therefore, refinery utilization rates and general industrial activity, which, as we said, hurt us in the third quarter. So it's a question of how quickly. And all that is, I don't want to say knits and bits. That's all important and actually it's all better than this year. But to get to the numbers that you're talking about, I mean, one of the factoids is that the Northeast Asia spot index for caustic is actually at the lowest point it's been in the last 10 years, it's about $210 right now. The 10-year average -- if you want to talk about run rate stuff, the 10-year average for the spot price is $350. So up USD 140, $150 a ton, right? So if you normalize for what caustic pricing should be and if you get some recovery in the HCL markets so you can run Vancouver at full rates, is you put all that stuff together and that's how you get to those numbers.

And your next question will come from Ben Isaacson from Scotiabank.

Maybe just a follow-up to Joel's question. Maybe I'll ask it in a bit of a different way. Fed Chairman Powell came out yesterday and said that any economic recovery will lead to an economy that doesn't -- that won't ever look the same as what it did pre-COVID and work-from-home is here to stay. And so when you think about that and maybe in that context, you could discuss what kind of trough to peak EBITDA is in each of the 3 segments? And if you assume, I don't know what the right number is $60 million of kind of corporate negative EBITDA. If each of the 3 segments are at trough, can you fund your distribution at that level?

Well, the answer to the last question is yes. To the more detailed question, I'm going to answer it differently for you, right, is that if you believe what Powell says, and I don't necessarily agree or disagree, but if you go through our business, again, is the WSSC segment has been largely unaffected by the pandemic, right? In our SPPC segment, okay, you get affected 2 ways. One is driving miles and second is general industry or merchant acid demand, right? Although the world might not return to normal, as Mr. Powell says, I believe that Americans are going to drive historic miles. So I think our regen business will actually come fully back. And if you look at the trend that's been on the last couple of years, it's actually been improving every year and that should continue to do so, right, which actually leaves Powell's comments about what the new world can look like in the EC segment, right? And as you know, we have 2 moving parts in the EC segment. We have the chlor-alkali part and the chlorate part. As far as chlor-alkali is concerned, is and again, we've all talked a lot about chlor-alkali, but the big general statement is that the chlorine derivatives are the vinyls snaps back faster than manufacturing does, and that provides a mismatch of supply and demand between the chlorine side and the caustic side. So once the economic recovery has some duration and some breadth is we're back to, in our view, the supply demand characteristics, which actually should use caustic pricing even though the world looks different. So you take all that and you actually, in our view, you netback to sodium chlorate, right? And in a general statement year-over-year printing paper production is down about 20%, driven by work-at-home, right? So the question is, how much does that reverse, okay? I'm not sure it reverses 100%, right? But there will be some reversal. And when there is some reversal that increases demand for our sodium chlorate and snugs up that market. So a long-winded answer to say is I don't disagree with Powell, that actually, the world is going to look different when actually it comes back to life. But I suspect the biggest effect on Chemtrade is the fleet's pulp production in North America and what that does to sodium chlorate business. Rohit, I don't know if you want to add anything to that or...

I'll just add one thing, which is really drilling a bit down into the Northeast Asia index for caustic. So the other thing that's been happening there is the differential between the spot price in Northeast Asia and the contract price in Taiwan has widened considerably, has gone up to $150 differential. Historically, it's about a $30 differential. So this kind of a dislocation -- these kind of dislocations can occur when there's extreme shocks to the economy like we've had with the pandemic. But really the -- for a contract price to be that far away from a spot price doesn't make sense. And the fundamentals will support kind of the differential getting narrower again. So 2 things at play. One is the, going up just because of the fundamentals of chlorine and caustic molecule getting back into sync, and the other thing is the differential shrinking. So that gives more credence to have recovery in the caustic market.

That's great. And just as a follow-up, looking at your yield at 13% almost, and you're not alone, Enbridge is at 9% right now. When you think about that yield, what do you think the market lacks in terms of confidence and in terms of letting that yield sit there? I mean when you break it into controllables versus noncontrollables, you guys are kind of checking the boxes that you can. And when you talk about a recovery in '21, do you think that's really what investors are doing, is they just nervous about when that recovery starts? Why are investors leading that yield so high?

Well, I can ask you why Scotia's yield is so high, too, but I won't, right?

That was a good point.

Look, I think there's a bunch of reasons. One, I think as a general statement. I think there's great fear everywhere. I guess they went back up again, right? But I think there's a couple of things that are particular to Chemtrade, right? One is we've made no bones about it that we're more highly levered than we'd like to be. And it's our game plan to reduce leverage. So I think actually, we get penalized a little bit for that. And then secondly is, historically, we've been a much more stable business before we actually acquired Canexus. Now we acquired Canexus off chlor-alkali earnings rate, which was substantially below where we are even today. But that has actually introduced a great deal of cyclicality into our earnings. So I think -- my guess is, you take those 2 comments, plus the additional cyclicality for shareholders that weren't used to it. And I think it's a wait-and-see story. And I think that when that index starts to move in the right direction, which we believe it will, I think there'll be a rapid effect on our unit price, but I could be wrong. But that's my best explanation of all that.

And your next question will come from Jacob Bout from CIBC.

And Mark wishing the best in retirement.

Thanks, Jacob.

Wanted to start just with North Van. Did you build enough inventory to offset production for the quarter?

So there's -- I mean we can build some inventory. But frankly, at these -- at where the caustic price is right now because also to build inventory, we got to move the chlorine, right? So we're already constrained with moving chlorine. So it's hard to -- we already are trying to sell out as much as we can. So if we -- the only way you could build inventory of caustic is if you had excess market for chlorine. So we do a little bit. But frankly, it's not really enough because of the constraints we have on the chlorine side.

If your question is directed is, can we keep our customers supplied? Yes. If it's directed at, do you have enough inventory so that you won't see the cost effect of the shutdown in the quarter? The answer is no, you will see it.

Okay. And you said that the plant is fully operational at this point?

Yes.

Yes.

Okay. Any update on the civil lawsuit for General Chemical? And let's -- just remind us again, what's still outstanding there?

Yes. If you recall, and actually, if you're successful in being able to block out this stuff like I try to, the only thing that's left are some of these derivative suits brought by one particular employee in 3 or 4 states. And those things are continuing to slowly wind its way through the various straight courts. Some have been dismissed. Some of -- there's motions on some of them. But the court world has also drastically slowed down in light of COVID. So we remain at the same views that actually is -- there's not a material risk to Chemtrade, but I'd like to tell you that we've put a stake in the heart of all those, but it's just slow going. But again, from a financial perspective, is -- we think we're there.

Okay. And then the $19 million write-down in SPPC. What was the rationale for this write down?

So we are rationalizing some capacity in the Gulf Coast, where we have a plant that we felt we could actually generate additional returns by shutting down that facility completely and moving the production to another facility, we are able to spread our costs out. And frankly, it does have a -- should have a knock-on effect on the market as well.

So this is the last trough of process. If you remember, maybe a year ago, we actually said that we stopped producing regen acid at this facility, right? And this is just winding down the rest of it.

And your next question will come from Paul Bilenki from TD Securities.