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 Q2 2021 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 Rohit Bhardwaj, Chief Financial Officer. Thank you. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us today. We also have Scott Rook, our Chief Executive Officer with us on the call this morning. And similar to the last few earnings calls, we're in different location. To start, we have a change to the structure of the call that I would like to highlight. There will be a slide presentation to accompany our earnings result discussions today. You should be able to view the presentation of the webcast link provided, and the slides are also available for download on our website. To begin, I will review the Q2 '21 results, after which, I will provide an update to our '21 full year earnings guidance and assumptions and key sensitivities, after which Scott will follow with some remarks on the current state and outlook for the business. Following that, there will be a Q&A session. Before I start on the results, I would like to 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 disclosure documents filed by Chemtrade, the securities regulatory authorities available at sedar.com. One of the non-IFRS measures that you will refer to in this call is adjusted EBITDA, which is EBITDA modified to exclude only non-cash items such as unrealized foreign exchange gains and losses. For simplicity, we will just refer to it as EBITDA as opposed to adjusted EBITDA. Both of these terms are fully defined in our MD&A. Starting with the aggregate results for the second quarter of '21. Revenue was $37.3 million, a decrease of $10.3 million in 2020. The stronger Canadian dollar relative to the U.S. dollar had a negative impact on reported revenues of $29.4 million. The Canadian dollar relative to the U.S. dollar was significantly stronger during the second quarter at USD1 equaling CAD 1.23 compared with the same period of 2020 when USD1 equals CAD 1.39. This had a negative impact on the financial results in all of our operating segments during the second quarter. In addition, lower selling prices for sodium chlorate and caustic soda in the Electrochem segment resulted in lower revenues for the period, but this was partially offset by higher sales volumes of all chlor-alkali products in the EC segment and higher sales volume of Regen acid in the SPPC segment. Consolidated EBITDA of $65.2 million was $10.4 million lower than Q2 2020 with a stronger Canadian dollar responsible for $7.5 million of the decrease. Distributable cash of $21.2 million was $10.5 million lower than the same period in 2020 with a stronger Canadian dollar representing $4.3 million of the decrease. As a reminder, every $0.01 of increase in the Canadian dollar per U.S. dollar is expected to reduce annual EBITDA by roughly $1.8 million and distributable cash by $1 million and vice versa. Shifting now to the individual segment results for the quarter, Sulphur Products and Performance Chemicals or SPPC generated revenue of $105.2 million during the second quarter of '21, which was higher than the $104 million generated in the same quarter of 2020, despite $10.2 million of headwinds attributable to the stronger Canadian dollar. The increase in revenue is attributed to higher sales volume of Regen due to refineries running at higher rates and higher selling prices for Regen and merchant acid. We're pleased to see a rebound in Regen acid demand as COVID restrictions were listed in North America, and the miles driven have started to get back to pre-pandemic levels. In addition, we have been able to capture higher pricing in Regen and merchant acid driven by the higher sulphur index numbers and strong demand. This was partially offset by lower sales volumes of Ultrapure acid, resulting from the previously disclosed large end-use customer that decided to obtain acid from an ultimate source. EBITDA for the period was $30.3 million, which was $1.1 million lower than 2020. The stronger Canadian dollars negatively affected EBITDA by $3.3 million. Better results in Regen acid more than offset the foreign exchange impact and the lower Ultrapure sulphuric acid results. Also of note, during the quarter, SPPC's largest byproduct sulphuric acid supplier, Vale, experienced a work stoppage that started on June 1, '21. They recently announced their plans to restart their operations in the first week of August '21. This event did not have a significant impact on results for the second quarter, but will have a more significant impact on third quarter results. Our Water Solutions and Specialty Chemicals or WSSC segment reported second quarter revenue of $108.6 million compared with $113.5 million in 2020. The decrease in revenue is attributed to the stronger Canadian dollar, which had a negative impact of $10.7 million. This was partially offset by higher selling prices and volumes for water solutions products. EBITDA for the period was $22.3 million, which was $3.7 million lower in the same period in 2020. Higher raw material costs and water solutions products, in addition to the stronger Canadian dollar, offset the higher pricing and volumes that we were able to achieve during the quarter. As a reminder, the water solutions business is generally a contract business that typically requires 1 year commitments on pricing. As a result, our ability to recoup raw material cost increases typically lags as we renew our contracts when they come due. This represents a headwind when raw materials are rising and a tailwind when raw materials are declining. The EC segment reported second quarter revenue of $123.5 million compared with $130.1 million in 2020. The lower revenue was primarily due to the impact of the stronger Canadian dollar, which had a negative impact on revenue of $8.5 million. Lower sales volume and selling prices for sodium chlorate and lower caustic soda pricing was more than offset by a 38% increase in hydrochloric acid sales volumes and a 26% increase in sales volumes of chlorine. EBITDA for the period was $23.8 million compared with $34.7 million in 2020, a decrease of 10.9 and $4.2 million of a decrease attributable to the stronger Canadian dollar. Lower sales volumes and prices for sodium chlorate and lower selling prices for caustic soda were the other reason for reduced EBITDA. And corporate costs in the period were $12.6 million compared with $18 million in the same period of 2020. Excluding unrealized foreign exchange gains, corporate costs was $5.4 million lower than the same period of 2020. The decrease in corporate costs was primarily due to a realized foreign exchange gain of $4.1 million in the second quarter of '21 compared to a loss of $2.1 million in the same period of 2020. In addition, the company benefited from a $1 million government grant recognized in relation to pandemic relief programs in the second quarter of '21. This was partially offset by $2.9 million in higher long-term incentive plan costs in the same period compared to 2020. Turning to our balance sheet. We maintain senior credit facilities that consist of USD325 million term loan and a USD525 million revolving credit line, which in total represents an aggregate credit facility of USD850 million. We continue to maintain ample liquidity with USD246 million undrawn on the facility. As of June 30, '21, Chemtrade was compliant with all debt covenants contained in our credit agreement and a senior debt-to-EBITDA ratio of approximately 3.8%. Chemtrade has no debt maturities until August '23. As a reminder, our decision to borrow mainly in U.S. dollars provides a long-term hedge against currency fluctuations. I will now shift to our financial outlook. We have decided to reinstate our guidance of '21 as we now have more certainty in the key drivers for our business. For the full year of '21, we expect EBITDA to be in the range of $245 million to $260 million, maintenance CapEx to be in the range of $72 million to $77 million. Lease expense is expected to be between 50 and $55 million. Cash interest is expected to be between 65 and $70 million. Cash taxes, the forecast to be between 4 and $8 million. There are a few significant factors to be considered when comparing '21's EBITDA range and actual EBITDA achieved in 2020. First, the stronger Canadian dollar relative to the U.S. dollar. During 2020, the average exchange rate was USD1 equals CAD 1.34 trillion, whereas we are assuming an average rate of CAD 1.23 during '21. This has a negative impact on '21 EBITDA of approximately $20 million. As we know, the first quarter of 2020 was unaffected by the COVID-19 pandemic, and EBITDA for the first quarter of '21 was $25.5 million below the first quarter of 2020. As partial offsets to be above 2 points, 2020 had the biennial turnaround at our North Van facility as well as a major customer turnaround that's affected one of our large Regen plants. The key assumptions driving the outlook are in our MD&A and shown on the slide. I will not read this out for you, but we'll remind you that our caustic soda price generally lags the Northeast Asia spot index by a quarter. The key sensitivities that will have an annual impact on our EBITDA are shown on the slide. Again, I will not read this out for you, and you can access them on the presentation. I'll now hand the call over to Scott for some comments on the longer-term outlook for Chemtrade's business. Scott?

Thank you, Rohit. Good morning, everyone, and thank you for joining us on today's call. I hope you're all doing well. As you all have noticed, effective this quarter, we have decided to include a PowerPoint presentation to accompany this call. This has also been posted to our website. We believe that you will find this additional disclosure helpful. Even though the effects of the pandemic linger on, there is volatility in our business, we decided to reintroduce earnings guidance. Turning now to our outlook. As Rohit just reviewed, our 2021 forecast, I will now spend some time reviewing our longer-term outlook and strategy. But before I do that, I would like to mention 1 item that will have an impact on third quarter results. As most of you probably know, Vale's Sudbury operation experienced a work stoppage from June 1st until last week. Thankfully, the strike is over, and although it only lasted roughly 2 months, there will be additional costs incurred during the third quarter. As given the uncertainty regarding the duration of the strike, we had to make alternate sourcing decisions. Since before the strike, the sulphuric acid market was in tight supply, the alternate supply was difficult to obtain and was very expensive. The situation is quite fluid, but we estimate that this could have a negative impact of between 5 and $10 million in 2021. Now moving to our long-term outlook. As I've highlighted before, our strategy is to deliver sustained earnings growth, which will result in an improved balance sheet and reward investors. Additionally, Chemtrade will focus on being a leading example for corporate environmental, social and governance responsibility. This is ingrained in our culture, and we will continue to strive towards making a positive impact for our employees, customers, shareholders and the society we operate in. There are 3 components to our strategy. The first component is being positioned to benefit from a market recovery as the COVID-19 vaccine gets rolled out and the economy returns to more normal levels. The second, we are diligently pursuing organic growth opportunities that will deliver increased size, scale and diversity of earnings. In the near term, we're focused on organic growth opportunities that we find attractive and in several years, as our balance sheet strengthens, we may consider acquisitions again. And finally, a key area of focus in our -- is our operational excellence. We are passionate about improving our productivity, assets and people to drive sustainable earnings. We see our business and balance sheet improving with time. As mentioned, our EBITDA is sensitive to the U.S. Canadian exchange rate, although the impact is reduced at distributable cash level. Shifting now to our focus on market recovery from a post COVID-19 economy, starting with the EC business, which includes our chlor-alkali product line. As a reminder, this business has been dramatically impacted over the past 2 years from near record low caustic soda prices combined with low fracking activity at North America. In the second quarter, we continue to see signs of improvement, particularly in the caustic soda market, and we believe the trough is behind us. Demand for caustic soda and end-use applications for aluminum and lithium-ion battery production continued to look strong with increased spending on infrastructure, housing and growing consumer demand for electric vehicles and other battery-powered devices. Taiwan contract pricing, which historically has been a leading indicator for Northeast Asia spot pricing has continued to move higher and market analysts are bullish on the mid to long term. As a reminder, for every $50 per ton increase in caustic pricing, the business generates about $10.5 billion in higher margin. For perspective, even if the current Northeast Asia spot price for caustic, which is $350 per ton stayed flat through 2022, it would mean a roughly $20 million improvement in margin for us over 2021. Hydrochloric acid demand and pricing should continue to improve as well with oil prices recovering and fracking activity picking up. This is particularly true for Western Canada, where our chlor-alkali production is based. Chlorine demand and pricing has also benefited from strong demand for PVC and bleach products combined with the capacity in the U.S. that was rationalized. We expect pricing to continue to remain strong, driven by demand. We also expect some modest improvement in demand for sodium chlorate as offices and schools reopen and demand for printing paper recovers. In the SPPC business, Regen, sulphuric acid will continue to depend on higher North American refinery utilization and industrial activity. In the second quarter, we had a strong rebound in demand from refineries as the COVID restrictions in North America was lifted. Also in the second quarter, U.S. highway traffic data climbed above pre-pandemic levels for the first time since the start of the pandemic. We expect this to continue as COVID vaccinations are increasingly administered across the world and borders fully reopen. We expect that driving miles in 2022 should be back to 2019 levels. Next, I'll discuss a few areas where we have significant potential for growth. We see a significant opportunity for our Ultrapure sulphuric acid that mainly supplies the semiconductor industry. The long-term fundamentals for the semiconductor industry are strong with leading global semiconductor manufacturers such as TSMC, Samsung and Intel, recently announcing U.S. expansion plans. In addition, the U.S. administration recently committed $50 billion to support domestic chip manufacturing capacity. We think there are very strong fundamentals for this business with current U.S. demand for Ultrapure sulphuric acid exceeding domestic capacity. Although there are short-term headwinds with this business due to the loss of a key customer, we have already made good strides toward replacing that lost business, and we expect to return to 2020 sales levels next year in 2022. Going forward, we intend to add capacity and meet the growing needs of our key customers. The water solutions business continues to be an appealing segment for us with long-term organic growth opportunities, driven by tighter government regulations that are creating a need for more specialized products. As Rohit mentioned, in the short term, margins have been squeezed with higher raw material costs and the timing on how quickly we can pass those costs through to end customers. But margins are recovering as we renew and update contract customers. So we continue to remain focused on organic growth opportunities for new specialized water treatment coagulants, and will look to expand our existing PAC and ACH production in regions where that makes sense. And in the future, as we improve our balance sheet, we could also consider smaller acquisitions in this space. The third area of growth is tied to our co-production of hydrogen that is part of the sodium chlorate process, and to a lesser extent are chlor-alkali. We are pursuing several opportunities in the hydrogen market that will allow us to fully monetize those hydrogen streams. Our plant manufacturing sites use hydroelectric power, so we are generating green hydrogen, which is important from a GSG perspective and financial return. In Q1, we announced a deal for our small chlorate plant in Prince George that requires no capital investment from Chemtrade and will start to have significant returns in 5 years. The big opportunity for hydrogen is at our Brandon, Manitoba facility, and that's about 5x the size of Prince George. I'll now spend a few minutes talking about the operational excellence initiatives we have been working on. In 2020, we launched a productivity and reliability initiative that's focused on achieving $10 million in savings each year. These initiatives are critical to generating sustainable earnings and will help offset inflationary cost increases going forward. To support these projects, we have been assigning Black Belt and Green Belt leaders, and we have also been training our staff in these proven 6 Sigma methodologies. Our goal is to create a culture of continuous improvement that leverages the best practices and technology to drive improved performance. I would now like to discuss our ESG approach and how we will be implementing systems company-wide to help us track our performance. Targets will be set and integrated into our long-term strategic planning, which will include environmental, such as greenhouse gas, waste and energy management, social, workforce and operational safety, emergency preparedness and employee diversity and inclusion and governance, focusing on ethical with -- and doing the right thing, management of our legal and regulatory environment and proactively governing with our environmental and social issues. Some of the recent ESG highlights include, our focus on renewable energy, where 96% of the electricity used at our 17 largest sites was generated from renewable hydroelectric sources in 2020. We talked about the financial benefit of the sale of hydrogen to Hydro Energy, which will generate $5 million in margins in 5 years, but will also reduce our carbon dioxide equivalent emissions by 10% of our total CO2 emissions. That's equivalent to the emissions from North Vancouver, our largest Canadian site. From a waste generation, over 75% of our industrial waste is high clay alumina. In 2020, we repurposed 27% and reduced our landfill costs. We are pursuing projects to repurpose an additional 30% and most importantly, on safety in 2020, employee injury frequency was at a 7-year low. This has created a culture where employee retention rate in 2020 was almost 87%. In summary, our earnings growth will be well positioned to benefit from the COVID-19 recovery. Commercially, we will continue to pursue organic growth opportunities and Ultrapure acid, water and hydrogen. Operationally, we will continue to focus on improved productivity and reliability. Additionally, we will be a leading example for corporate ES&G responsibility. We think these initiatives will be critical as we continue to strive to be a great chemical company. Thank you. Rohit and I will now be happy to take questions.

[Operator Instructions] Your first question is from Jacob Bout of CIBC.

I want to start with the sodium chlorate and the decline of volumes that you've seen so far this year. Maybe talk a bit about how you're thinking about that? Is it -- how much is structural versus pandemic related?

All right. Well, so there are 2 parts to it. Let's start with the pandemic part. We have seen in North America, there has been approximately a 50% reduction, and office paper reduction since COVID-19 has started. So that's the white paper. It's bleach paper, which uses chlorate. We do believe that as schools and offices reopen, we expect office paper to pick up. We do not expect it to pick up to the pre-pandemic levels, but we are forecasting that that's going to -- that we will see a pickup from that. That being said, there are some structural changes happening in this market. We have a number of our customers that have closed, that they've shut down their production lines for the bleached paper. Those lines that have been shut down can reopen. It's hard to say right now though. Well, we do expect a pickup in volume, but we don't expect it to pick back up to pre-pandemic levels.

So on a normalized basis, what would you think the decline in structural volumes is going to be on a go-forward basis?

So I would say, I think that from where we were, we saw a 10% drop, I'll say, in our chlorate demand, and I think we'll -- I'll hope for a pickup of half of that is going to come back.

Okay. And then moving to the WSSC business, it sounds like the biggest driver of lower margins was sulphur acid. With the new contracts being negotiated, have -- is it -- are you able to tie the selling price to the Canadian dollar or are you thinking about changes in how you're hedging your FX?

So let me take a look at that. So you were asking about the water business for you or?

Yes, on the water business, yes.

So our water business is really not -- it's not -- the Canadian dollar is not relevant to our water business because we don't really export water. It's produced close to the customers. So our U.S. customers get product from our U.S. plants, our Canadian customers get product from the Canadian plants. So the big headwind there has been raw material increases. And so, we cannot tie our contracts, most of the contracts are municipal, so you have to give a fixed price. But what happens is when they come up for renewal, which is all the time, we are able to pass-through the raw material costs generally without an issue. And typically, if you look at historically, whenever raw materials have been rising, and as these contracts roll over, we actually expand margins because once the -- on the other side of it when raw materials stabilize and start to decline, prices take a longer time coming down. So in that business, the exchange is not as big of a factor.

Okay. And then what do the contract renewals look like for the next 12 to 18 months?

It's normal. So we don't have any peak contracting seasons. They're spread out. So our municipal business is not -- is very, very dispersed, so it's not -- so they're basically hundreds of contracts that come up every week basically. So you can -- all intents and purposes assume they're evenly spread.

So kind of renewals, what kind of a 3-year process or would it be less than that?

No, no, no, no, typically they are annual contracts. So you said -- it takes about 6 months on average, they're annual contract.

Your next question is from Joel Jackson of BMO Capital Markets.

I had a few questions. I'm going to ask them one by one. So typically, Q3 earnings are higher for you than the fourth quarter for both the company and for all the segments. For some of the reasons you stated, it looks like they are reversibly true for both the company and for probably Electrochem and past SPPC. Can you please elaborate on that?

So let me start out, Joel, with that, and then I'll have Rohit. So yes, we do see that's going to be the case with -- certainly, with Electrochem, I think, as you know, the caustic soda for us is price roughly on the average of the prior quarter's caustic soda price and so, as -- we are seeing caustic soda continue to move up. And so, what we shared with the comment that I made earlier a few minutes ago was that, even if caustic soda stayed flat with where it is right now for us next year, that's a $20 million gain. Just on this, as you look at, again, the prior caustic price in the quarter. So I think that's the most significant change.

Sorry Joel, can I just -- I just want to make sure I understood your question. Were you saying that you're thinking that our back half of '21 is going to be weaker than the first half of now?

No, no, I'm talking about Q3, Q4 mix in the second half of '21. So typically, Q3, you earn more money, more EBITDA in Q3 than a Q4. But this year, it looks like you're going to earn more in Q4 than Q3. Is that correct?

So let me just -- we didn't give you the quarterly split. So I just want to understand, is that assumption you're making or you're inferring that from something that we may have told you?

I'm asking you the question.

So you are asking a question. So could we...

I am looking at lag caustic prices, I am looking at the Vale corporate cliff issue in Q3 and other factors?

Yes. So I think -- yes, I would say that the Vale is definitely unique to Q3 and the caustic lag is correct. So yes, so on that basis, you can make that assumption. I just want to make sure we are getting to the right fact and you're asking the question as opposed to...

Yes, yes. Okay. And you gave -- I appreciate the color on actually if caustic holds flat here, you get $20 million more margin in 2022. Can we expand on that a little bit, if chlorine and hydrochloric acid prices hold flat, what would be the impact on 2022? And then what will the offset from the biennial turnaround at North Van?

So the turnaround, we've, in the past, said it's $5 million to $7 million. Some of it depends on -- in fact, when caustic prices are higher, it will move a little bit higher because we still use production at a higher margin. But anyway, in that ballpark. And I think with HCL and chlorine, there is some -- we've already -- we are already experiencing a bunch of that this year. So I think when you compare '22 to '21, there might be a slight lift, but not as much because we've already got -- we're already getting a good pricing there as opposed to caustic, which we had a trajectory that is just starting to ramp up. And so that's why the impact in '22 is more than '21.

And finally, you talked about normalized our Regen business, $300 million to $350 million. How many years under that range, it's been now a couple, how many years under that range would it take you to start considering that you may have to reset and lower the distribution?

So Joel, we are -- I'll say, we have no -- we don't have any plans to adjust the distribution as it is right now. And I will remind you that the exchange rate has a more pronounced impact on earnings than it does on cash. And so, as -- even though our earnings are impacted by the strong Canadian dollar, at the cash level, it's half of that because our debt is based in U.S. dollars. So the stronger the Canadian dollar in effect our debt is going down. But look, we see this business, I'll say, we don't have any plans to change the distribution. We think we're going to be fine. Our organic growth projects are on track, and so I think we're -- as the market recovers, and we're -- we see that the market recovery happening in region, we see the market recovery happening in caustic soda. We're still looking for more recovery in chlorate, but for the most part, I think the market recovery is on track for what we're looking for. And organic growth is going to be kicking in and so we think will be high.

And I want to add just one thing to that, Joel. Just so we again set the stage there. So when we released our guidance in 2020 of $300 million to $350 million, but actually our distribution was $1.20. We -- when these -- when the COVID pandemic hit a couple of months later is when we pulled our guidance, and that's when we cut our distributions. So in the context of the $300 million, $350 million, we actually were comfortable with the previous distribution rate. So I don't think we have to -- so at the half rate, I don't think there's a concern if they're below the $300 million.

Your next question is from David Newman of Desjardins.

So just following on Joel's question on -- just looking at -- certainly looking at caustic and hydrochloric acid and chlorine. If you're going into the second half here in your guidance, it already looks like the caustic soda price is above your guidance for the full year. So as you look into the second half versus the first half, any sense on what cost it could deliver in the second half in chlorine in hydrochloric acid in the second half versus the first half?

I think, David, the third quarter caustic was already established in our guidance, so the Q3 is locked. You're right that Q4, if you do the math on kind of -- if you do the math on our assumptions, you'll see that we are assuming that the index for Q2 and Q3 because that's the back half of '21 is a $315 index level. So today we're above that. If today's price hangs in there till the end of the third quarter, we get the lift in Q4. So the Q4 lift could be about a $50 per ton higher, which we've quantified for you as a sensitivity being in that $10 million, $10.5 million annual. So that could be a couple of million dollars in Q4. But again, we have to see how it hangs in there and what are the puts and takes are there. But in terms of chlorine and HCL, we have been seeing those increases already, and we've been factoring them into our guidance.

Okay. And also too, that's a U.S. dollar index, and the Canadian dollar is starting to recover here a little bit, thank God. I mean the other way, Rohit? It would see -- so what's the impact here in terms of -- you said the sensitivity is $0.01 is equal to, again, sorry?

It's $1.7 million on EBITDA and about $0.7 million on distributable cash.

Okay. But that's an EBITDA impact. How does that play into the actual realized pricing that you get in Vancouver, Northwest part of the country?