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

Good day, and thank you for standing by. Welcome to the Chemtrade Logistics Quarter 3 Earnings Call. [Operator Instructions] Please be advised that today's conference call is being recorded. [Operator Instructions] I would like to hand the conference over to your speaker today, Mr. Rohit Bhardwaj, Chief Financial Officer. Please go ahead.

Thank you, Sarah. Good morning, everyone, and thank you for joining us today. We also have Scott Rook, our CEO, on the call this morning. And like the last few calls, both of us are in different locations. I'd like to highlight that we will have a slide presentation to accompany our earnings results discussion today. You should be able to view the presentation on the webcast link provided and the slides will also be available for download from our website. I will begin by reviewing results for the third quarter of '21, and then I will provide an update to our 2021 full year's earnings guidance and underlying assumptions and key sensitivities, after which Scott will follow his remarks on the current state and outlook for the business, and then following that we will have a Q&A session. Before I start on the Q3 results, I'd 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 we will refer to in this call is adjusted EBITDA, which is EBITDA modified to exclude only certain non-cash items such as unrealized foreign exchange gains and losses. For ease, while our accompanying presentation will refer to adjusted EBITDA, we will just refer to it as EBITDA in our remarks as opposed to adjusted EBITDA. Both these terms are fully defined in our MD&A. Starting with aggregate results for the third quarter of 2021, revenue was $365 million, an increase of $19.2 million from the third quarter of 2020. The increase in revenue for the third quarter is mainly due to higher volumes and pricing for chlor-alkali products. The higher volume was due to higher demand for chlorine and hydrochloric acid or HCL, which allowed us for higher operating rates at our North Vancouver facility. The higher volumes combined with higher pricing for HCL and chlorine gave a lift to revenue for the period. This was partially offset by the continued strength of the Canadian dollar relative to the U.S. dollar, which had a negative impact on revenues of $15.2 million. The Canadian dollar relative to the U.S. dollar was significantly stronger during the third quarter at USD 1 equaling CAD 1.26 compared to the same period of 2021 when USD 1 equal CAD 1.33. Consolidated EBITDA of $67.3 million was $2.6 million higher than the third quarter of 2020. Higher corporate costs due to higher long-term incentive plan or LTIP accruals and the stronger Canadian dollar partially offset the stronger business performance. Distributable cash of $19.3 million was $7.2 million higher than the same period of 2020. As a reminder, every $0.01 of increase in the Canadian dollar per U.S. dollar is expected to reduce annual EBITDA by roughly $2.1 million and distributable cash by $1.1 million and vice versa. Shifting now to the individual segment results for the quarter, Sulphur Products and Performance Chemicals or SPPC generated revenue of $109.2 million in the third quarter of '21, which was $3.9 million higher than the third quarter of 2020 despite the negative $5.1 million impact of the stronger Canadian dollar. The increase in revenue is due to higher selling prices for sulphur products, regen and merchant acid, partially offset by lower sales volumes of acid products. We are pleased to see the SPPC segment continue to rebound as COVID-19 restrictions were lifted in North America and miles driven returned to pre-pandemic levels. As a reminder, our regen business serves gasoline refineries. We also benefited from higher pricing in regen and merchant acid due to improved demand and higher sulphur costs. In ultrapure acids we have made good progress replacing sales volume that was lost from the previously disclosed large end-use customer. EBITDA for the period was $33.5 million, of which $2.5 million -- which was $2.5 million higher than 2020. The labor disruption at our large by-product supplier, Vale had a negative impact of roughly $6 million in EBITDA. The stronger Canadian dollar had a negative impact of $1.5 million. Our Water Solutions and Specialty Chemicals or WSSC segment reported third quarter revenue of $119.4 million, which was similar to the third quarter of 2020. The stronger Canadian dollar had a negative impact on revenue of $5.7 million. However, higher prices for water products offset the foreign exchange impact and lower sales volumes of water products. The EBITDA for the period was $25.7 million, which was $3.5 million lower than the same period in 2020. As previously disclosed, escalating raw material costs, especially for sulphuric acid and aluminum have caused a reduction to margins. While selling prices are being adjusted to pass-through cost increases, given the upward trajectory of raw material costs, it will take additional time before selling prices fully offset raw material increases. As a reminder, the water products business is generally a contract business with municipal customers that typically requires annual commitments on pricing. As a result, our ability to recoup raw material cost increases typically lags because they're unable to adjust selling prices until contracts come up for renewal. This is creating a short-term headwind for the business as raw materials are rising, but there should be a tailwind benefit when raw materials are declining. Electrochemical or EC segment reported third quarter revenue of $136.4 million, a $15.7 million increase over the third quarter of 2020. The higher revenue was primarily due to higher sales volumes and selling prices for chlor-alkali products and higher sales volumes for sodium chlorate. Sales volume for caustic soda, HCL and chlorine increased by 20%, 22% and 24%, respectively, compared to the same period of 2020. Selling prices for HCL and chlorine increased by 27% and 26%, respectively. This was partially offset by lower selling prices for sodium chlorate and a negative impact of $4.4 million due to the stronger Canadian dollar. EBITDA for the period was $33.7 million compared to $24.5 million in 2020, an increase of $9.2 million. The factors that benefited revenue also benefited EBITDA and more than offset the impact of the stronger Canadian dollar of $2.3 million. Corporate costs for third quarter of '21 were $25.7 million compared with $20.1 million in the same period in 2020. Excluding unrealized foreign exchange gains, corporate costs were $5.6 million higher than the same period of 2020. The increase in corporate costs was primarily due to a $6.7 million increase in LTIP accruals. The higher LTIP expenses were partially offset by lower discretionary spending during the period compared with 2020. Turning now to our balance sheet. We maintain senior credit facilities that consist of a USD 325 million term loan and a USD 525 million revolving credit line, which in total represents an aggregate credit facility of USD 850 million. We continue to maintain ample liquidity with USD 271.2 million undrawn on the credit facility at the end of the quarter. As of September 30, 2021, Chemtrade was compliant with all debt covenants contained in its credit agreement with a senior debt to EBITDA ratio of approximately 3.5. Chemtrade has no debt maturities until August 23. Also, as a reminder, our decision to borrow mainly in U.S. dollars, provides a long-term hedge against currency fluctuations. I'd also like to highlight the recent completion of the sale of the acids relating to the 2 specialty chemicals within the WSSC business, potassium chloride and vaccine adjuvants. The sale to Vertellus LLC closed on November 2 and generated USD 155 million in gross proceeds, which were used to pay down debt in our credit facility. Based upon the midpoint of guidance for '21 and after making a pro forma adjustment for the loss of the full year EBITDA of the disposed business, this repayment will reduce Chemtrade's senior debt to EBITDA ratio by approximately 0.7x. So this will have or this has had a significant impact on delevering the balance sheet and positioning Chemtrade to focus its resources on its core business. The earnings from these businesses will be included in our earnings until the closing of the sale which occurred on November 2. Subsequent to the end of the third quarter of '21, Chemtrade settled a lawsuit relating to Canexus Corporation's North American terminal operations or NATO assets for $21 million. A net benefit of approximately $17.6 million will be recorded in corporate costs during the fourth quarter of '21. I'll now shift to our financial outlook. We reinstate our guidance for '21 last quarter. And I'd like to take a few minutes to provide an update to that forecast and revised assumptions. For the full year 2021, we reiterate our prior guidance but now expect to be at the higher end of the range. This does consider the loss of earnings from the assets sold on November 2, but excludes the benefit of the lawsuit settlement during the fourth quarter of '21. The guidance is detailed on the slide, so I won't read it out. There are a few significant factors to be considered when comparing 21's EBITDA range and actual EBITDA achieved in 2020, and these are shown on the slide. The key assumptions driving that outlook are in our MD&A and shown on the slide. I won't read these 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 La that have an annual impact on our EBITDA are shown in the slide. Again, I won't read this out. I'd 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 third quarter earnings call. I hope all of you are doing well. As you heard from Rohit's update on the third quarter, we now have 2 solid quarters of positive momentum and are really excited about the outlook for our earnings. I'll now spend some time updating you on our view of longer-term outlook strategy. One of the primary goals of 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 or ESG 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 vaccines get rolled out and the economy returns to more normal levels. The second is that we are diligently pursuing organic growth opportunities that will deliver increased size, scale and diversity of our 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 will consider acquisitions again. And finally, a key area of focus for us is our operational excellence. We are passionate about improving our productivity, assets and people to drive sustainable earnings. We see our business and our balance sheet improving with time. The market recovery component of our strategy is clearly starting to materialize. First, beginning with the EC business, which includes our chlor-alkali product line, in the third quarter, we saw significant improvement in the caustic soda market. As you may know, the caustic market price for our North Vancouver production is closely tied to the Northeast Asia spot price. In the third quarter, China curtailed caustic production as part of their national policy to reduce energy consumption. And IHS report in October indicated production was capped at 50% to 70% of capacity. China also reduced production rates on alumina, which requires caustic as a key feedstock. This has required alumina producers outside of China to run at higher rates to meet global demand. The resulting impact is an increase in demand for exports of caustic soda from China coupled with lower supply that's driving the higher Northeast Asia spot. We expect this trend to continue, providing a nice lift to caustic soda pricing. In the last few weeks, we saw dramatic increases in the Northeast Asia caustic price, with prices hitting over $900 per ton, an all-time high. The industry production IHS reported at the average price for the month of October was $777, which is a dramatic increase from earlier this year. As a reminder, every $50 per ton increase in caustic pricing, the business generates about USD 10.5 million in greater margin. For perspective, even if the Northeast Asia spot price was $400 per ton, which it was prior to the recent dramatic runup, and if it stayed flat at that level for 3 quarters of next year, that would mean roughly a $25 million improvement over our outlook this year. HCL demand and pricing also continued to improve with oil prices moving higher and fracking activity picking up. This is particularly true for Western Canada, where our chlor-alkali production is based. Chlorine demand and pricing also continued to benefit from strong demand for PVC and bleach products combined with the capacity in the U.S. that was rationalized earlier this year. Additionally, there have been multiple weather-related events in 2021 that reduced production, particularly in the U.S. Gulf Coast. We expect pricing will remain at these levels, driven by strong demand. Improved fundamentals for chlor products, chlorine and HCL had the added benefit of allowing us to maintain high operating rates at the North Vancouver facility, thereby, selling more caustic soda. We are seeing some modest improvement in demand for sodium chlorate as offices and schools reopen and demand for printing paper recovers. In the WSSC business, as Rohit mentioned, we are seeing higher raw material costs, particularly with our largest product line, aluminum sulphate. As I mentioned in my comments on the caustic soda market, the curtailments that China has made in alumina production are impacting global supply dynamics and driving pricing higher. Alumina is a key feedstock for our aluminum sulphate product. So the higher pricing is negatively impacting our water business. We are also seeing higher pricing for sulphuric acid, which is the other key raw material used to make aluminum sulphate. So these raw material increases in the water business will offset some of the gains that we are expecting in the caustic soda market in the EC business. However, we will look to pass the higher costs on to our end customers as the contracts embeds are renewed. This has been an ongoing process that will provide a tailwind to the business when the raw materials revert to historical levels. In the SPPC business, regen sulphuric acid has maintained its momentum on improved volume led by higher North American refinery utilization. In the third quarter, schools across North America reopened, signifying another milestone in the post-COVID-19 return to normalcy. U.S. highway traffic data has returned to pre-pandemic levels, further confirming that we are seeing around our daily lives. We expect that driving miles in 2022 will be back to pre-pandemic levels. The merchant acid market is also benefiting from the recovery in industrial production. This market was very tight in the third quarter, resulting in strong demand for our product and higher pricing. The key raw material in sulphuric acid sulphur has also commanded higher pricing, but the merchant acid business has been able to pass the majority of these costs through to end users. The ultrapure acid business has made good progress offsetting the reduction in demand at one of our customers that was previously disclosed. We have been working closely with a number of customers to grow our share of their business and we expect our ultrapure business to be back to near sold-out levels in 2022. So, this is a nice transition point to discuss the organic growth opportunities. We remain focused on the significant potential for growth that we are seeing in our current businesses. As we have previously mentioned, the single largest opportunity for organic growth is our ultrapure sulphuric acid that mainly supplies the semiconductor industry. The long-term fundamentals for semiconductor industry remains strong, with leading global semiconductor manufacturers announcing U.S. expansion plans coupled with the U.S. government's commitment to supply domestic chip manufacturing capacity as a matter of national security. As I mentioned, we have seen a strong recovery in demand for ultra pure acid and expect to return to 2020 sales level next year. We have been evaluating options to add capacity to meet the growing needs of our key customers. I am pleased to announce that our Board has approved an expansion of approximately 60% of our ultrapure acid capacity at our Cairo, Ohio facility. In addition to adding capacity at our site, we will also improve the quality capability of the site. We expect that the Cairo facility will be the first site in the United States capable of producing ultrapure acid at the quality level needed for the new fabrication plants in the U.S. The estimated cost of our expansion is approximately CAD 50 million with a targeted return rate of 25% and an expected start-up in 2024. We are also making solid progress in developing our co-production of hydrogen that's part of the sodium chlorate process. We have been pursuing several opportunities in the hydrogen market that will allow us to fully monetize these hydrogen streams. Our plants manufacturing sites use hydroelectric power, so we are generating green hydrogen, which is important from an ESG perspective and financial return. We are excited to leverage this unique position to help us reduce the global carbon footprint, while also creating a sustainable earnings stream. I'll now spend a few minutes talking about the operational excellence initiatives we have been working on. Starting with productivity and reliability initiatives that we initiated in 2020, we are making progress on a number of projects that will help us reduce waste in our business. You can read some of these projects on the slide, the projects are critical to generating sustainable earnings and will help offset from some of the inflationary cost increases going forward. These projects have become even more important as inflation has picked up in the last quarter. We remain committed to supporting these initiatives with the ultimate goal to develop 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, governance, a focus on business ethics, the management of our legal and regulatory environment and proactively governing our environmental and social issues. Some of our recent ESG highlights include our focus on renewable energy, where 96% of electricity used at our 17 largest facilities was generated from renewable hydroelectric sources in 2020. From a waste generation standpoint, over 75% of our industrial waste is high clay alumina or HCA. In 2020, we repurposed 27% and reduced landfill costs. Our target for next year is to reprocess an additional 30% of our HCA waste. And most importantly, on safety in 2020, employee injury frequency, excluding COVID, was at a 7-year low. This has created a culture where our employee retention rate in 2020 was 86.6%. So, in summary, we are excited about the momentum we are seeing in the post COVID-19 recovery. Our earnings growth remains well positioned to benefit from the recovery. Commercially, we will continue to pursue organic growth opportunities in ultrapure and hydrogen. Operationally, we will continue to focus on driving productivity and reliability to reduce cost. Additionally, we will be a leading example for corporate ESG responsibility. These initiatives are critical to our business performance and we remain committed to seeing them come to fruition. In conclusion, we see a strong recovery in many parts of our business as we enter into 2022 with strong momentum and an improved balance sheet. Thank you. Rohit and I will now be happy to take questions.

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

I have a few questions. I'm going to ask them one by one. I appreciate the reiterated color on the upside of the caustic pricing. When caustic prices go up double in a couple of months, do you capture pricing that quickly? Look, I know you'll get into discussions in November, early December. Is that work where you can capture the benchmark or would you have such a high rate of increases over a short period of time? You get demand disruption, you get much more intense discussions, how does it work?

So, right now, demand is very strong. And so we do capture those price increases. But remember that our pricing on caustic is generally set on last quarters, the average for last quarter's caustic price. So, there are...

No, sorry, I'm asking for Q1 pricing, sorry, exactly. Sorry to interrupt. I'm asking for November and December, early December, IHS benchmarks, doubling in a couple of months. Can you capture that for Q1 or will the discussions be more intent?

I believe we can capture that.

And then you raised that MECU production this year to the 190,000 tons. It's been higher than seen for the last few years. What will MECU production being next year? Can you keep that 190,000 rate going until the turnaround at North Van? And then what would production be between'22 you think?

So, on '22, Joel, we do have the turnaround at not North Van, right? So we lose some production there. So I think we should still be able to be in that 190-ish range, because we'll run the plant harder for the rest of the year and just take the down time for probably in Q2 when we do our turnaround.

And what will corporate costs is like in 2022?

So, we should be back, I mean, there's been a lot of noise. So, I'll qualify my response just that the update is one that is hard for us to give an accurate response. So I would say that generally our normal run rate is between 65 and $70 million. And then we'll have to see where the LTIP next year and that will depend on our performance. And so it could be a bit higher than that based on how we perform.

And just finally, if I understand your color on WSSC, so we should expect some margin contraction and then as, these annual contracts for alumina keep rolling, then you should get margin expansion across '22 later in the year, does that make sense?

Yes. And that's really -- if you look back at 2020, that's really what happened in that year.

Your next question comes from the line of Steve Hansen from Raymond James.

Just a question on the ultrapure side to start. It sounds like you've been able to fill that book a little bit sooner or faster than expected. Has there been 1 or 2 customers that have stepped up for that production volume or what's changed there that drive you to get back to fill the wholesale seat?

So, yes, we have filled up our business faster. If you remember, at the beginning of this year, I said it might take 18 months or more. And we've done that in, actually, in a little under 12 months. So, what's driving that, I think, is just the strong demand for chips. So, number one, it's the strong demand for chips. And there's, well, there's a shortage of acid in the U.S. So imports have to come in, in order to meet the full demand. Imports coming in have been infected or affected by the supply chain disruptions that we've all seen. Number two, Chemtrade made improvements in our quality. We invested capital during 2020 to upgrade our quality. And I think it took time to get that approved by our customers, including new customers. But we've seen -- we have -- the customers have approved the material after we made quality improvements and we're seeing the benefit of stronger volumes. So we have new customers that we've brought on, that we've gotten qualified. And so we have increased both that existing customers as well as new.

And if I'm thinking about the margin profile for the new volume or the new customers, the ultrapure market is pretty opaque, I think, for most of us. So, has there been a tightening in that market? And should the new volumes that you're recovering with here should they be at better margins than prior or is it just the recovery of the volume or the earnings you had lost earlier? I'm trying to understand if there's any differential to the new customer volumes and the margin perspective.

So, I would say, right now, equal to the margins that we had, let's say, in '19 and '20. We are seeing competition coming in imports. So there's 2 things going on. There's competition coming in with imports, but there's also improvements that we are making in quality. And so I think we are -- we feel that products that have improved quality should have higher prices. So, the market is bought that out.

I can just add one thing to that, Steve. So, what's going to be actually interesting is when you look a couple of years out, we know there's going to be additional capacity required in the U.S. and that's -- what's going to be interesting is, as you look at pricing based on that reinvestment economics, logically, pricing should go up once we get that new capacity coming in, because people have -- we're now competing with older assets, by and large. And then there'll be -- should be a pricing we set 3 years out, let's say.

And Rohit, can you just remind us what the hit was? I think you had stated it back at the time when the customer wait opened up. But what was the rough math is for?

So, we didn't actually quantify it. What we had said was that if you look at SPPC, 80% of SPPC is the 3 types of acids. And within that, about a quarter of it was ultrapure and this was a very significant customer. So I think that's where we left with. And I think we didn't really go much deeper than that.

And just one last one, if I may, as you referenced some modest uptick on the chlorate side as demand is recovering. I mean, how are you thinking about sort of the opportunity there from a recovery standpoint and any pricing benefits that you might be seeing?

We are seeing a modest uptick in volume. I mean, it's a couple of percent uptick in volume. But I'll also say that raw material prices are going up and so pricing should at least follow that.

So, a flat margin profile at best with some of the cost inflation but better volumes on the margin.

Yes.

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

Just looking at the ultrapure, again. I think initially when you're sort of thinking about this, you're contemplating perhaps bringing on a partner to get you down to sort of 5-nanometer capability and that sort of thing. So, how does that fold in? What is the capability that you're going to have out of Cairo to kind of get to the smaller scale overall? And maybe just kind of give us the spread of the timing of the CapEx over the next couple of years.

So, we have been considering -- we have considered a partner. And -- but we chose not to go with a partner for the Cairo expansion. Our team has been working on the design of a plant for over 18 months. And as I previously mentioned, we made improvements to our production process in 2020 and even some in '21. And we've seen good results from that, that gave us confidence that we could -- that we can design at this facility to meet the demands of customers for the new fab plants. We have been working very closely with those fab plants. And again that's why we have the confidence that we can do that. Now, that being said, the expansion in Cairo is the first expansion of more expected to come. And so we are certainly not precluding or excluding working with a partner on, let's say, the next expansion project, which could be quite sizable.

And to be clear, so this -- when you talk about the new fabs come in, so you can get down to 5-nanometer and below?

Yes.

Okay, very good. Go ahead, Scott.

No, that's exactly what -- that's what this plant is targeted for.

And the spread of CapEx, Rohit?

Yes. So, I think we'll be starting this up in, let's say, middle of '22-ish, and then we expect to get online by '24. So, you can kind of put kind of take it from there. And as we get closer to the plans, we will give you a little bit more granularity on the actual spend of the CapEx.

And then I look -- you updated your guidance a bit for this year. It looks like you about $5 million came from caustic and about $2 million, a bit of a recovery on FX here. But as you sort of contemplate, I don't know when you think about -- you're going to be thinking about putting a 2022 guidance, but you're in a bit of a conundrum here because, obviously, with the blazing hot prices that we're seeing in chemical space, a little bit of rollover recently, how do you think about that in terms of setting your guidance for next year, timing, and you've got obviously caustic chlorine, hydrochloric, merchant, regen, ultra pure all working now a chlorate recovery. So other than water and just chlorate pricing and a few other just small areas, things seem to be firing on all cylinders. And maybe just talk about how -- what we should be thinking of, I mean, can you get to those numbers that we talked about in the past, like $340, $350 in EBITDA.

So, I'll start with that out and then I'll ask Rohit to add some color on that. The -- simply the biggest unknown that I feel that we have right now is what's going to happen to caustic soda. Caustic soda has gone basically in 10 months from $190 up to $900. But I was right and so it was just an explosive run up. However, last week, it fell from $900 down to price in the $500s, I think in good spot. So, where it's going to settle out, we don't know. We certainly don't know. And so we're going to give ourselves some time and continue to study this market and that's the biggest unknown. Everything else, I think we feel like we have a good handle, is as good as we can on what's going to happen next year. But caustic, it's a very difficult commodity to forecast.

And when do you -- when are you putting up the 2022 guidance? I mean, I'm sure it's probably going to be 4Q, you're going to think about this or how are you going to?

We might do it a bit earlier than that. We might actually do that this in January and maybe middle to late January is when we'll probably put it out. So we won't wait until the annual results.

And congratulations on the sale of specialty chemicals. And I think, Rohit, that you sort of mentioned in the past that you might be able to get improved terms with respect to rates, term and covenant and as your debt load eases, maybe you can talk about that and just a set up on the balance sheet.

So, when the pandemic started, we went out and got a modified covenant package just to be safe. And so clearly, we don't need that now that we've paid down the debt using the group proceeds, even removing the earnings from that -- from the specialty chemicals business. So, we will be most likely talking to our lenders to modify the covenants to a more traditional covenant package. And in that -- so when we did -- when we got the relief, our borrowing costs went up by 50 basis points across the grid. So we fully expect to roll that back and go back to traditional covenant package. And we're also looking at -- we've got 3 years left on the term. The Canadian lending market is pretty -- back to being pretty normal. So, 5-year tenures are pretty common. So we look at whether we -- what extensions we do there. And finally, we'll look at the size of the facility too because the facility is quite large. And now we'll have a very large undrawn revolving facility. And so we will look at whether that makes sense or not to save some standby fee, etc. So there will be a few things going there. But all in all I think the balance sheet is still -- is definitely in a lot better shape. We still would like to get debt down -- total debt down a little bit. And as -- we do have these organic growth opportunities. So. clearly, we want to maintain the flexibility so we can fund these organic growth opportunities, too.

And last one for me, just -- and I'll hand the line over. Scott, maybe if you think about the chlorine prices have started to check back as well. And any sense on the demand supply factors at play there in the market. And does that -- when you look at the equation of chlorine versus hydrochloric acid, does that make you consider burning more hydrochloric acid because the chlorine market has been very robust as well. So how do you think about the balance of converting that into hydrochloric acid?

So, historically, there's been a very clear winner for us, and that's HCL in the fracking industry in Western Canada. That was by far our preferred outlet for the chlorine molecule. During the past year, as the chlorine market has tightened up, chlorine prices have come up nicely. And so the, I'll say, the clear advantage of HCL has not been as strong. So that's not been as strong. Right now, we see -- certainly as we look out for the next 6 months, it appears to us that the chlorine market is going to stay pretty tight. So that's what it looks like. And we'll see how that plays out. But we also see right now, with high oil prices, we are beginning to see fracking activity, not beginning, we've seen that franking activity and fracking demand is picking up. And so -- and that's also pushing up our HCL prices. So that I expect to continue as well. And so we might find ourselves, well, I think we'll still find ourselves where the -- where our preferred outlet is HCL into the fracking industry in Western Canada.

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

I wanted to go back to the ultrapure market and just any commentary you have on supply dynamics over the next, say, 3 to 5 years, what are the capacity is being built.

So, the capacity is being built. The demand over the next 3 to 5 years should increase by more than 75% I'd say, a 75% increase in total demand, which is very, very strong. So that would be in line or maybe even slightly conservative relative to the announced fabrication expansions coming from the major players here in the U.S., and that would include TSMC, Intel, Samsung and others. So, if you look at their -- if they bring the fabs on or as they bring the fabs on for their announcement, the market should have -- well the market demand will grow by 75% or more. Now, in terms of expansions, there are -- there's -- our expansion in Cairo, but clearly the market is going to need more significant expansions. And so my comment was that this is our first fabs expansion, and I expect to have more coming out before now.

Sorry, and a 75% increase in total demand, how many tons of that?

So that's going to be an increase of, let's say, 75,000 tons.

And maybe just turning to the chlorate market. I know the complaint historically has been lack of rational behavior within the industry. What are the current dynamics right now?

So, I think we're still -- so the uncertainty that was there was the 2 sales that took place of the 2 businesses, ERCO and then Canexus, obviously. And during those sale processes the way there was some irrational behavior. So I think we'll get a better sense of this, I mean, too, when there are a few -- we're going to see some contract renewals and we see how people are going to deal with the increase in energy cost principally. And because people are being rationally, they should definitely be passed through. And so I think it's a bit early for us to tell because one of the sales concluded midway through this year. So, we really see next year and we have a good sense.

So, expect clarity at beginning of next year?

I'd say by the middle of next year because these are not -- these contracts are not calendar contract. They do come up at different times.

Last question here is just on alumina prices. And I know you talked about it reverting back to historic levels. When do you think that will be?

So, it will depend on the trajectory of the -- because you're playing a catch-up game, right? So, if raw materials keep escalating, then you keep falling, you don't catch up. So really, it will depend on when raw material costs stabilize. And once they stabilized, probably, I'd say, a few months after that, a couple of quarters after that was going to start to actually see benefit of the higher prices and the lower cost.

So, a couple of years of lower margins or how do you think about that?

Well, so let's see, we'll have to see what happens. If raw material, let's say, raw materials stabilize in the middle of next year. Then by end of next year, we should be kind of starting to see the recovery in our selling price. But again if raw materials keep going up, then we keep deferring the catch-up by, let's say, 6 months.

Your next question comes from the line of Endri Leno from National Bank.

Congrats on the good quarter. Question for me. I'll start on the ultrapure extended capacity. I just wanted to clarify that 60% increase at the Cairo facility, how much does that represent an increase on your overall production of ultrapure?

So, we have not shared, let's say, our total capacity, let's say, our total capacity nor the capacity of our individual sites. And so I don't plan to share that right now, but again we're -- what we are sharing is that the investment is going to be $50 million and we're expecting or targeting a 25% return on that.

And if I may a follow-up on that, Scott, have you had any preliminary discussions to sell that capacity or is it too early at this point?

No, we are, I'll say, we are well into the discussions to sell the capacity.

And next couple of questions for Rohit, actually. If you can please remind that, what is your target debt level that you'd be targeting?

So, our, yes, so we'd like our total debt, which includes convertible debentures to be below 4x EBITDA and our senior debt to be 2.5% or below. So senior debt, we're -- once we've paid off the proceeds of the sale, we are pretty close to that or we'll be pretty close to that. And total debt, we've still got a bit of a bit of ways to go, but there's no upcoming maturities. So this is really more kind of longer-term targets for us.

And the last one for me with everything I did and actually going up for most of your products. How are you thinking about the dividend for next year or distribution, I should say?

So, I mean, clearly, our Board looks at that all the time, and we have our views on it as well. But I think given our -- so that -- given our debt, given that we have organic growth opportunities, we believe that for now, the distribution that was set is a good level and there are better uses of capital. But on time, of course, our Board, and we will look at it. But I think at this stage, the better use of capital is to reduce debt to have flexibility because we do have some interesting organic growth opportunities, which is kind of different from the historic view.

[Operator Instructions] Your next question comes from the line of Ben Isaacson from Scotiabank.

Congrats on the good quarter. Just 2 questions for you. Number one, the company is clearly moving out of recovery move into slowly growth mode. And you've committed to this $50 million project right now, which is great. I guess my question is, as we look forward, if you had a bigger war chest, where would you be putting that money right now? Where are there low-hanging fruit opportunities to get returns similar to that 25% that you just mentioned? Can you maybe just talk about the segments or the products or maybe even the time in terms of where you'd like to see those investments being made?

So, the number one is ultrapure. So expansion that we're doing in Cairo is the first expansion. But given the expected total demand in the market, the North American market for ultrapure, the market is going to need a sizable expansion. And so that is a project that we are looking at very closely and thinking about what's the right way to meet the needs of the market, so the path there. Number two would be our hydrogen. So we previously announced our first commercial deal, if you will, for hydrogen at our facility in British Columbia. So we have that. Our -- the hydrogen that we produce in Brandon is 5x the amount of the hydrogen that's in BC. And so there are a number of options that we are looking at for hydrogen that all of which would require some capital and we're renting that to the marketplace. But again, as we said, it's green hydrogen, which should command a premium in the market, and there are nice opportunities. But we're evaluating those opportunities as well and thinking about what's the right time to try to bring that to the marketplace and do that in a way that we can balance our growth in the company with our leverage. And then number three would be some of the specialty products that we have in our water treatment business. So we have nice opportunities in the PAC and ACH market. We have other specialty products that we're developing. Our capacity is -- our production is -- the demand right now is very close to our capacity with some of those products, and we have opportunities, we think, that we're looking at to add capacity and so add significant capacity in water treatment. So those are 3 main areas that we are thinking about, all of which would need capital, but would be nice growth projects for the company.

And before I get to my second question, just a follow-up on this. Are the returns that you're projecting similar to the 25% or are they more kind of mid-teens or how do you think about, I mean you said number 1, 2 and 3, do you want to just put a little bit into everything to diversify or is it really you want to finish number 1 first and ultrapure before moving on to hydrogen, etc.

Right now, it's a little early to say. I would say that in ultrapure, we -- that I think 25% is a reasonable number there. And then the others, I think that's a good number. It's a good number for us to strive towards -- strive to meet. Like but -- so that's all else. That's -- I think that's enough for now.

Let me just move on quickly to my last question, which is when we're thinking about kind of mid-cycle run rate margins or EBITDA margins for the 3 segments, when I look at the SPPC, you guys have done a great job being consistent in that 30% area, plus or minus a little bit over quite a long time. Do you expect that to continue in the water treatment segment? Again, same thing, you've been in the kind of low 20s, and that's a step change higher than what we've seen in the past few years, sorry, going back -- going '19, '18, '17. How do you expect that to be in the long run? Obviously, I'll leave the EC segment because that's a little bit more volatile. But can you talk about the water and the sulphur segments?

I think those are fair. I think in the water segment, the thing to keep in mind, although it won't be a huge factor, though, is the specialty chem business was at a higher margin, as you'd expect that out of it. But I'm not going to make compute difference. But the water business, I think, once we get back to raw materials being stable, then I think there's no reason why we shouldn't be back to those kind of margin levels. And again, in the sulphur and the SPPC segment, there's nothing structurally that's different that should not allow us to be back at those mid-cycle margins.

So, then just on EC, like roughly 30% is kind of the run rate that we should be thinking about when everything is back to normal?

So, you're talking about EC?

Yes, yes, sorry, just asking on EC.

EC is a tough one, right, because we have to see what does a mid-cycle look like.

You have a follow-up question, comes from the line of Steve Hansen from Raymond James.

So, just one follow-up on the ultrapure opportunity. Are you able to provide us with any context as to how these new contract discussions might be structured? Are they going to be multiyear agreements and will pricing be resets on a regular basis? I'm just trying to understand how the margin profile is going to vary with some of this new business, if at all, or how consistent you think it might be relative to where you've been in the past?

So, what I can share right now is that is that what I see is a longer-term commitment, which is different than what we've had before. And so by longer term, I'll say, a multiyear agreement, coupled with stable demand, I'll say, a growing demand profile, not stable, but stable in terms of demand. So we have seen volatility in the past, which -- if we're going to make this investment, we don't -- I don't want to see that volatility if we're going to make this investment. So that's what we're structuring. Our longer-term agreement, of course, what's also tied into that, our future quality requirements. So that's a piece of it as well.

And just so I understand that business a little bit better, like with the merchant business, you're exposed to some degree to sulphur prices. What are the exposures there to think about from the input cost perspective that could push your margins around a little bit, if at all?

I think it's the real input there is -- input sulphur. And typically, in the SPPC segment, we're able to offset that. Maybe it takes a bit of a lag. But generally speaking, that industry is pretty good at passing through sulphur. And of course, we've got the by-product that we do sharing of selling price changes there. The other input cost is, there's a bit of energy that we use for our regen business, but most of the regen contracts are such that you pass-through changes in natural gas. So, the volatility there is not so much driven from the input side. It would really be more from the pricing side.

There are no further questions at this time. I would now like to turn the conference back to Rohit Bhardwaj.

Thank you and -- for your attention. And Scott, do you have any closing remarks?

No. I'd just like to say thanks to everyone for your time, and have a great rest of the day.

Bye.

This concludes today's conference call. Thank you for participating. You may now disconnect.