AG Graanul Invest: Waiting for General Winter
Dear All,
Please find our initiation and financial model on AG Graanul Invest here.
Due to variables that are beyond its control (pellet pricing, raw material availability, weather and the pace of inventory de-stocking by its utility clients), the company is sweating its assets and running the business for cash hence cash generation remains robust but leverage remains elevated due negative dynamics on the revenue and cost side. The company also needs demand to pick up from a harsher winter which should also benefit its revenues from electricity sales, an increase in demand from UK power generation and raw material pricing declining further. There could also be a supply overhang in the pellet market from the filing and emergence of Enviva from its Chapter 11 restructuring (the largest global player in the industry).
Investment Considerations
- We are staying on the sidelines as the increased execution risk associated with increasing EBITDA to €120 million at the time of the refinancing needs to be priced into the bonds before we get constructive on the situation. If the company can't reach €120 million of EBITDA, there is a high probability that bond holders will rely on shareholder support to support an A&E which is not priced in yet. The bond documentation is weak which implies note holders have limited negotiating power in a restructuring. LTM EBITDA remains at half of its 2022 peak and bond holders will need to wait until at least Q1 2025 (after the upcoming winter) to get more visibility on a par refinancing.
Current Trading - waiting for General Winter
-The company generated €166 million in revenues (+9.2%) with EBITDA at €26.9 million (€21.6 million in Q1 2023). Most of the increase in sales volume resulted from contracted sales to present and new clients and offset by lower spot
prices.
-The company reported gross margins of 25% - 30% in line with comparable quarters in 2020 and 2021 as raw material costs remain above historical averages.
-The company was suffering from loss-making contracts due to a spike in raw material costs in 2023 which have since been re-negotiated including the contract with Drax (which allows cost price-through at lower margins).
- Q1 2024 LTM EBITDA was €69 million with net leverage at 9.0x due to the above factors.
Collateral Damage in Russia / Ukraine War
- The company had some bad luck in 2022 when the Russia - Ukraine war started. Russia and Belarus are the primary source of raw materials for Graanul and due to the imposition of sanctions supply from that region caused a spike in raw material pricing.
Business more volatile than advertised to investors
- The company per se is well run and has well maintained facilities in the Baltics (which is a low-cost production area for pellets) with easy proximity to clients in Western and Northern Europe. Under the right conditions (rising pellet prices, more sales contracts, access to reliable and cheap feedstock, normal winter seasons), it has abundant cash flow with 90% cash conversion which de-levers the capital structure very quickly. There is also a long-term structural tailwind for taking market share from coal’s share of the power generation market.
- Graanul is still reliant on price movements regarding pellets and its associated raw materials and the “spread” or difference between the two variables to generate positive EBITDA and free cash flow.
Housekeeping
- The next catalyst on this name will be the Q2 2024 financial results in August 2024. The questions that investors would like clarity on is when do they expect pellet and raw material pricing to positively impact Graanul’s financials?
Happy to discuss
Saahil
T: +44 203 192 0200
www.sarria.co.uk