|Shares Out. (in M):||186||P/E||0||0|
|Market Cap (in M):||323||P/FCF||0||0|
|Net Debt (in M):||621||EBIT||0||0|
Canexs Corporation (TSX: CUS)
In our opinion Canexus Corporation represents a very good investment opportunity. The investment thesis is essentially a selling of non-core assets supported by two very stable core assets. CUS’s stable chemicals business is overshadowed by former management’s blunder to expand into an unrelated business with shocking destruction of shareholder value. The company is currently over indebted. The new (July 2014) CEO seems to understand that debt repayment is first priority. To reduce debt, he is attempting to sell the non-core NATO asset and recently also put up an unattractive chemical asset up for sale. Either of these sales would significantly reduce leverage and would be very positive for the share price. Additionally, we believe the convertible debentures present a very rich risk reward opportunity.
CUS is a chemicals business which was carved out of Nexen in June 2005 (the assets were owned by Nexen since 1974). Initially the business was structured as an income trust (a Canadian version of MLP’s) which paid out the majority of its free cash flow as distributions. Nexen sold down its remaining holdings in January 2011. Immediately prior to the IPO, Gary Kubera was appointed President and CEO of CUS. He served in that role until March 2014 when he stepped down due to the unsuccessful implementation of the NATO project. For further background, I suggest reading CUS’s most recent Annual Information Form.
North America Chlorate
CUS’s Brandon, Manitoba plant (one of two core assets) is North America’s lowest cost producer and the largest facility in the world. About 75% of the variable cost of CUS making chlorate is electricity. Because of this, plants are situated in markets that tend to have reliable electricity supply with stable pricing. Manitoba has access to some of the lowest cost hydroelectric power in all of North America giving CUS a low cost advantage over its peers. The pulp and paper industry accounts for almost all (95%+) of the demand for chlorate. The North American Chlorate market is supplied by five producers: Erco (34%), Eka (28%), CUS (22%), Kemira (11%), and Chemtrade (5%). In 2014, North American chlorate accounted for 55% of CUS EBITDA.
The South American operations (the second core asset) produce both sodium chlorate and chlor-alkali products. The facilities are located next to its largest customer, Fibria, who operates the world’s largest eucalyptus pulp mill. Under a 27 year long contract, which expires in 2026, Fibria must purchase 100% of its needed sodium chlorate, caustic soda, and hydrochloric acid from Canexus at fixed US dollar margins with a built-in escalation for key cost components. Only 25% of this division’s revenue has exposure to Brazil’s merchant market which makes the cash flows of the entire segment quite predictable (assuming no impairment to the relationship with Fibria). In 2014, South America accounted for 25% of CUS EBITDA.
North America Chlor-Alkali
This is CUS’s most volatile business in terms of cash flow and is up for sale. The finished products include caustic soda, chlorine and hydrochloric acid. The business is cyclical and given its location on the West Coast of Canada its end markets are prone to dumping by Asian producers. End use markets for this segment include: Pulp & Paper (64%), Oil & Gas (19%), Water Treatment (7%), General Industry (4%), Chemicals (3%), and Metals & Mining (3%). Given the recent decline in business activity in the Oil & Gas sector end demand for those customers has been very weak. Most recently, CUS took a large write down on the North Vancouver plant and as part of its deleveraging strategy decided to put the plant up for sale. In 2014, North American chlor-alkali accounted for 26% of CUS EBITDA.
NATO (North American Terminal Operations)
NATO (North American Terminal Operations), the second asset up for sale, is a fee for service crude by rail loading facility. It is located in Bruderheim Alberta, near the heart of Alberta’s petrochemical’s complex near Fort Saskatchewan. CUS has operated chemical terminal operations in Bruderheim since the early 1990’s. In December 2012, CUS decided to invest $125mm to expand the original facilities to take advantage of the then favourable opportunities in crude by rail as others were also deploying capital in the space – Kinder Morgan, KKR (Torq Energy Logistics), Keyera, Pembina, Gibson, Enbridge. To finance the project, CUS began to issue equity where it had never had a need to issue equity before given is slow growth, mature chemicals businesses. Apart from this new equity, CUS also managed to lever up substantially during this time as it was heavily spending on capex and maintaining its hefty dividend. In 2014, NATO contributed negatively to firm wide EBITDA.
CUS’s site is strategically located close to pipelines and is serviced by both railways, CN and CP. The site also includes two underground salt caverns that can be used as oil storage which should be in demand given the current contango in the market. Because of the heated oil and gas industry in Alberta, renowned for its cost overruns, the NATO expansion did not go as originally planned. All in estimates of the total cost to complete NATO (albeit with slightly increased capacity relative to the initial plan) now stand in the $400mm+ range (estimates vary). In March 2014, the CEO stepped down over the mismanagement of the NATO project. The new CEO, Douglas Wonnacott, was hired in July 2014. He identified the need to sell NATO as it was not strategic to the rest of CUS’s chemicals businesses. The other priority for the new CEO was also the reduction of debt; the financial covenants on CUS’s banking facility have been relaxed twice in the last 6 months, in October 2014 and most recently in March 2015.
In Q3, 2014, CUS announced its intent to sell NATO. Initially, the new CEO was on the record stating that the sale would be completed in the first half of 2015. Since then, the decline in oil prices has significantly reduced interest from E&P buyers. The company has communicated that midstream buyers remain at the table but no transaction has been consummated due to 1) differences in price expectations 2) further due diligence and 3) uncertainty in crude differentials. This last point is worth further mention; the attractiveness of crude by rail economics to end customers is primarily determined by spreads (Bloomberg: USCSWCAS Index) in WCS (essentially oil prices in Alberta) and WTI (Cushing Oklahoma prices). The greater the spread the more incentive for Canadian based producers to ship their product to the US. Currently the spread is ~$13/bbl versus a 5 year average of ~$19.50/bbl. Given this low current spread the attractiveness of shipping crude by rail are diminished relative to 6 months ago.
We believe that conservatively the chemicals business can generate ~$65mm in FCF given current interest payments, management’s newly guided capex estimates and the company’s new business improvement program. Assuming 0% growth and using a 15% discount rate we arrive at a value for the shares of $2.35. Using a 10% discount rate and a 2% growth rate would suggest the shares to be worth close to $4.40. Apart from this valuation, we also believe that if or when (depending on how one views things) NATO or North Vancouver are sold, the shares would significantly appreciate given the debt overhang and management’s view that debt repayment is the first priority. CUS has four different series of converts outstanding trading, all significantly discounted; the 6.5% 2021 yields 12.0%, the 6.0% 2020 yields 11.2%, 5.75% 2018 yields 11.85%, and the 5.75% 2015 yields 8.2%. Although they are not very liquid, if you are able to buy some we believe these are attractive as a 1) we don’t believe the company’s ability to meet its obligations is impaired as the cash flow from the two core chemicals businesses is reliable 2) the liquidation value of all the assets would exceed the debt outstanding 3) Canadian banks have historically been very accommodative to clients and have rarely pushed creditors into bankruptcy/liquidation.
One note about the dividend – CUS recently cut its dividend by 90% (negatively affecting the share price due to dividend loving retail investors) to help repay debt. We believe the cut was not 100% as the largest shareholders (top 2 ~30%) of CUS are dividend oriented funds and require the company to pay a dividend to maintain some ownership of the shares.
·Sale of NATO and/or North Vancouver
·Repayment of debt