(Debtwire) KME adjusted leverage elevated but potential extra liquidity and encouraging outlook provide boost

23 December 2020 | 11:16 GMT

KME’s adjusted net leverage is a whopping 10x including letter of credit draws and pension deficit. Its cash balance also reduced sequentially to just EUR 67m in the 3Q20 results released in mid-December. But the Germany-headquartered copper alloy group could benefit from an extension of its borrowing base facility and a government loan while earnings should recover, leaving its EUR 300m 6.75% senior secured 2023s with short-term momentum, according to three buysiders.

The company’s 3Q20 results showed a reduction in LTM adjusted EBITDA to EUR 84m, versus EUR 88m 2Q20 LTM adjusted EBITDA as 9M20 reclassified EBITDA fell 4.8% YoY to EUR 56.6m. Yet, the 3Q earnings were somewhat resilient given the company on its 2Q20 earnings call had guided for 3Q order intake to be down around 10%-17%.

Management noted in its 3Q20 investor presentation material that its Special division, comprising engineered products and special semis, has had no significant impact from COVID despite the mandatory closure of Spanish and Italian operations, with the order book supporting its annual EBITDA target for FY20.

The company Special division outlook for future quarters was buoyant with a comfortable Europe Steel order book going into 1Q21 and good prospects for maritime defence for 2021. Extruded and drawn product demand also increased in 4Q20.

The KME Copper division on its part benefitted from demand picking up post-quarter since October, with the trend expected to continue into 1Q21. Order intakes have also developed positively since 4Q20.

The impact guided in 2Q20 was an expected fall in orders in 3Q20 and this is exactly what happened. In this context, 3Q20 was unusually good as there was a stronger EBITDA and better than expected results against a 10%-17% guided order intake decline, special opportunities firm Sarria said. “The order intake has already [gone] to normal levels and 4Q20 should return to previous EBITDA and revenue levels,” they added.

“The KME numbers were decent,” the second buysider said. “They were not super strong with no real change in the story but the bonds in the low 80s are still cheap even if they are not so liquid.”

Mansfield manoeuvre room

Earnings could pick-up in the coming year. KME can benefit from large synergies from its KME Mansfield integration; the group was boosted by EUR 18m–EUR 20m of synergies in its 2020 P&L and EUR 4m more to flow through in the 2021 P&L, with an annualized realised impact of EUR 30m–EUR 31m from the Mansfield synergies.

The group can also generate free cashflow and keep its 3.4x net leverage in check though reported metrics climbed versus 3.0x at 2Q20. With a 3Q20 LTM adjusted EBITDA of EUR 84m, it could face a similar EUR 24m LTM capex, around EUR 40m interest and around EUR 5m cash taxes meaning EUR 15m of free cashflow or 0.2x deleveraging per year ahead of working capital swings and exceptional items.

Adjusted metrics are still double-digit when including the company letter of credit draws on its borrowing base facility and pension deficit. KME had used EUR 392.7m letters of credit on its EUR 395m borrowing base facility, which would push adjusted net leverage up above 8x. It also has a EUR 199m pension deficit that would bring adjusted metrics above 10x.

Additionally, liquidity could require a boost given the company was left with just EUR 67m cash on balance sheet at 3Q20, down from EUR 75m at 2Q20. KME could however decide to extend its borrowing base facility and increase the size of the facility, which matures in February 2021 with a two-year extension option. It could also benefit from an Italian state-backed government loan.

Such liquidity enhancement may be needed given the working capital volatility inherent in the business. KME had a EUR 53m working capital release in FY18 and EUR 87m in FY19, which boosted its cash balance but may not repeat. KME had a EUR 41m working capital outflow for 9M20.

“I expect [an] announcement soon on the borrowing base extension and a new government loan,” the third buysider pointed out.

The positive is the capex, which had kept going up since 2017, has now reduced, suggesting that they have not simply been capitalizing costs, Sarria said. “Capex [moving] below EUR 20m means the company has a decent path to cashflow generation even excluding working capital swings.”

“The exceptional items line has also reduced over the past three quarters which is good news,” Sarria continued. “They have been better at explaining what is exceptional versus permitted stock movements and fair value of derivatives with a better breakdown.”

Positive Intek-hnical

Shareholder support and M&A disposals offer some extra comfort, as reported. KME’s 99% shareholder, listed Italian company Intek (EUR 162m market cap) issued warrants of EUR 115m on 9 October. The separation of the Special and Copper division legal entities announced at 2Q20 could also mean potential disposals are upcoming.

KME’s EUR 300m 6.75% senior secured 2023s are indicated steady at 78/80.5 yielding 19.3%, according to Markit. The bonds had rallied from around 73-mid in mid-October when it reported 2Q20 results; they were as low as in the 40s back in mid-May.

It’s been a difficult story to frame, and they are a small company that previously didn’t communicate so well, the second buysider noted. “It is hard to argue to jump into the bonds now, but it could trade in the high 80s.”

The business is performing in line with other manufacturing businesses, Sarria pointed out. Manufacturing PMIs have improved and the company’s copper chain has been especially strong this year, taking advantage of electric cars and renewable energy. Structural tailwinds have benefitted them unlike steel names for example, and KME has positive technicals with people willing to pay for it.

“The equity cushion is positive and it is not complete fiction,” Sarria continued. Intek approved their HoldCo bond refinancing and the warrant issue while the company has a path to refinancing and has made progress with its financial reporting, they added. “Bond investors care about cash, not reverse accruals and high yield companies should report differently to listed ones.”

KME declined to comment.

by Adam Samoon