Graanul - Has anything changed?
All,
Please find our updated analysis here.
We have changed our model substantially, which gives us a better understanding of the business. However, the ultimate issue remains the same: the uncertainty beyond FY26 makes any refinancing near impossible. The true cost of capital for the level of risk beyond FY27 is prohibitively high. The Company attempted a refinancing in spring, but we suspect even with a capital injection, the only way forward is an Amend and Extend exercise.
Investment Considerations:
- We are not taking a position in Graanul’s outstanding bonds. A refinancing of Graanul’s bonds is severely hampered by the lack of contracted sales beyond FY27, due to the regulatory uncertainty and the overall changing dynamics in the wood pellet market.
- Any refinancing would require a double-digit coupon, resulting in poor interest coverage metrics. This further confirms the difficulty of the refinancing.
- We resisted shorting the bonds in February as we market expectations deemed a refinancing was imminent. We had expected the absence of a refinancing would result in the bonds trading below 90.
- At current levels, the bonds are in no-man's land. We expect the only option available to the Company and the sponsor is an Amend and Extend. New equity may be provided to aid the process, but we are unsure at this moment.
- The downside is a protracted negotiation on an Amend and Extend process. An A&E may not be done at an economical level, but with overall enterprise valuation likely to cover the debt, there is limited downside. This is tempting us to invest, but given the uncertainty it is hard to justify an investment currently.
- We are likely to be interested buyers at 75-80%. With a 50% reduction in volume, debt capacity would recover c.50% in new debt, plus c. 25-30% from cash on the balance sheet. We acknowledge there is huge uncertainty for the market beyond FY26, which makes it difficult to invest in this name.
Key Conclusions:
- Graanul is reliant on favourable government action to maintain and increase demand for wood pellets, especially in the energy sector.
- Demand side is primarily driven by government initiatives. Sustainable Aviation Fuel and other industrial processes are having an impact on demand, but are primarily at the exploratory stage. Supply has increased as customers seek to capture the "sustainability" merits in-house. The current production utilisation rate is 78%.
- Europe is a net importer of wood pellets, but the impact of the reduced external demand from Drax could see the market return to equilibrium. (See Demand and Supply)
- Graanul's main customer will reduce its external demand for wood pellets from 7 mt to 1 mt due to a combination of factors. Drax is Graanul's largest customer, c 45%, and Graanul currently provide Drax with 1.2mt or 17% of Drax's requirement. From FY27, Graanul will have to cultivate new customers. A secondary issue is that the demand reduction will put downward pressure on pricing in the European wood pellet market. (See Industry)
- A high level of uncertainty will make it nearly impossible to do a traditional refinancing. Amend and Extend will likely be the preferred option. With maturity not until October 2026, the Company and Apollo (sponsor) are likely to wait until later in the year. However, the increased cost is likely to require an equity injection to achieve a 2.0x ICR ratio. (See Refinancing).
Refinancing Maths:
- Graanul has €630m of debt to refinance, with a new rate of 10-11%. Some have suggested investors in Graanul should be compensated for Baltic risk, which may be warranted, but we will use 10% for ease of purpose. This equates to €63m annual interest, which for 2x interest coverage requires €120m minimum EBITDA.
- This would require €50/t for c.2.5m in volume sold. To put this into context, Graanul only achieved above €50 in FY22 and potentially in FY24, both with lower volumes.
- The Company reports a low maintenance CAPEX, with some investor meetings raising the sustainability of sub €10m spent. We subscribe to the view that this number is low, but in Graanul’s defence, cash conversion from EBITDA to cash flow is relatively high. There are limited cash taxes, working capital is marginally negative and lease payments are negligible.
- With the uncertainty surrounding the composition of its customer base beyond FY26, it will be very difficult to execute a normal refinancing.
Model & Valuation:
- Graanul have contracted the majority of FY25 & FY26 production, therefore leaving the model relatively easy to construct. However, given the uncertainty surrounding the underlying demand for FY27 and beyond, trading levels are not determined by short-term performance.
- The Company has provided little guidance for FY27 (given the level of uncertainty, not surprising), making any projection effort futile.
- We are using a 10% risk premium for our DCF, which may be a little low given the uncertainty. Rough estimates of valuation imply c.7.0x, but we should state we have limited confidence in our projections. The business was acquired with a c. 8.0x multiple, and given the outlook has deteriorated, coupled with the ban on Russian imports, a reduction of at least 1.0x is merited.
- Current spot prices are €10-20/t lower than ASP. €10/t differential in pricing impacts EBITDA c.€20m.
Next Steps:
- The next set of numbers, Q1, are due by the end of May. We would expect an improvement in both EBITDA and cash flow , quarter over quarter. EBITDA is likely to be boosted by higher production and sales volumes, with cash flow flattered by a reduction in working capital.
- But short-term numbers are incidental. All investors are seeking clarity beyond FY26, but we don’t expect management will be able to offer any comfort.
- There is a possibility that the sponsor may provide some additional cash, but we would not be expecting that anytime soon as now.
- Therefore, the numbers should show a slight improvement, but this won’t have any impact on the trading levels.
Happy to discuss.
Tomás
E: tmannion@sarria.co.uk
T: +44 20 3744 7009
www.sarria.co.uk