Graanul - slow burn but winter is here
Dear All,
Please find our updated analysis post the Q2 2024 results on Graanul here.
We remain on the sidelines (post our Initiation Note) as Graanul is still suffering from transitory issues (inventory de-stocking and demand weakness for its pellets which will dissipate though timing on this is uncertain). Q2 2024 was reflected by rising revenues and EBITDA which was boosted by falling raw material prices and higher contracted ASPs. The business is also being run for cash as capex remains low while net leverage remains elevated at 8.2x.
Investment Rationale:
-Senior Secured Notes: The execution risk associated with scaling 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 and the completion of contract negotiations in Q3 2O24) to get more visibility on a par refinancing.
Fundamentals bumping along the bottom but improvements may be around the corner
-As detailed in our Initiation Note dated 22nd July 2024, we have always viewed Graanul as a seasonal credit where the first and fourth quarters are key to cash generation and deleveraging therefore, we view the second and third quarters as non-pivotal to the thesis.
-The positives for Q2 include a reduction in raw material pricing and revenue growth (albeit from depressed levels in the same quarter last year), strong liquidity and free cashflow breakeven.
-Short term catalyst: We expect progress in their negotiations on several pending contracts which should represent 75% of production capacity at (potentially) higher prices as well as a strong winter in H2 (leading to stronger demand for heating pellets) and a subsequent improvement in financials.
Recent results - decent but need more
-Growing topline: Q2 revenues grew to €89 million (+14.6%) with adjusted EBITDA at €18 million (20% margin) - both were higher than our estimates of revenues of €75 million and EBITDA of €12 million. The outperformance was driven by higher pellet prices on contracted volumes.
-EBITDA outperformance was also driven by improving cost per tonne to €93 however that was still higher than the historical average of €60 - €70 as the supply of fibre comes from Russia & the Belarus which remains constrained and pricing elevated.
-Capex remained at maintenance levels of €2 million (which was slightly below our estimate of €3 million) for Q2 2024.
-Cashflow from operations was strong at €32 million with free cash flow break even with strong liquidity at €131 million. An inflow of €14 million from working capital also helped (which was in line with our expectations)
-As net leverage improved to 8.2x and is now below the RCF springing covenant level at 8.73x, Graanul has regained access to 100% of its RCF.
-Management aims to start preliminary preparatory work around a refinancing by the end of the year however our view is Graanul will need to demonstrate accelerating growth and cash generation as well as give a rosy outlook before launching a transaction.
Raising estimates
-In Q2 2024, ASP per pellet was €214 (which was higher than our estimate at €170). As a result, we are raising our estimates for ASP per pellet (€ per ton) for H2 2024 to 200. We believe that the pricing will remain close to the current level from current contract renewals as well as a more robust winter season. We have also increased our medium-term view on ASPs to €180 (in 2025 and 2026) from €164 price context.
-We are increasing our revenue estimates by 11% in 2024 to €519 million, 5% in 2025 to €452 million and 7% in 2026 to €461 million.
-We are also increasing our EBITDA estimates by 18% in 2024 to €91 million, 5% in 2025 to €84 million and 8% in 2026 to €91 million.
-Based on our change in estimates, net leverage is expected to end at 5.8x by Q3 2026 which will still be too high for a par refinancing and hence require an A&E solution.
Current trading level of the bonds fully anticipate an improvement
While we acknowledge that with improving demand and pellet ASPs as well as cost controls, the business can be very cash generative and de-lever quickly, the trading price of the notes at 90% is baking in plenty of positive news going forward, hence our current view and stance.
Happy to discuss
Saahil
T: +44 203 192 0200
www.sarria.co.uk