Chemtrade Logistics, or yield investors be very careful

If any of you hold units in Chemtrade Logistics (TSX: CHE.UN), it is quite possible in the mid-term future that the current $0.05/unit per month distribution (which was already reduced from $0.10/unit per month during the Covid crisis) will be chopped down by about a half. It’s not a guarantee that this will happen.

Chemtrade’s underlying businesses are profitable, but the amount of financial leverage they have accumulated over the years is impressively high. Back many years ago, they were trading in the upper teens despite having an effective payout ratio higher than their free cash flow generation. Although the business itself is relatively stable (it is a staple commodity producer of industrial chemicals that are foundational in nature for many industries, similar to Methanex (TSX: MX)), the leverage is probably going to be too high for the banks to get comfortable with extending credit. CHE did receive a relaxation on covenants until 2022, which will give them a couple years to get their financial leverage metrics in the right direction.

In September, they did manage to close the deal on some additional unsecured debt financing (TSX: CHE.DB.F), but it came at a higher cost – a coupon of 8.5% and conversion price of $7.35/unit, when previous issues (when the units were trading at $20/unit) were around 5% coupons and $25-30/unit conversion prices. Needless to say these debentures are well out of the money. The proceeds of the new unsecured convertible debt was used to redeem the near maturity unsecured debt that was set to mature in June 2021.

The total debt is about CAD$812 million in senior bank debt, and CAD$531 million in unsecured convertible debentures, for a total of $1.34 billion in debt capitalization. Looking at the first nine months of this year (which is not typical due to Covid, but reflects the existing reality), after interest expenses and lease payments, the company generated roughly $85 million in cash. A good chunk of this (CAD$55 million) went out the door in unitholder distributions. There’s a couple scenarios that are possible, but the easiest route is to slowly reduce debt by reducing or eliminating the distributions. The unit price will most certainly take a short-term hit, but as the company’s credit profile improves, the equity pricing (currently at a market cap of roughly CAD$450 million) looks cheap, although it is this way right now because of the high magnitude of leverage.

If there is another credit crisis (whether it is induced by the company’s actions or not) that comes along in the next year, you can be sure these units will be cratering, even further than they have already.

I remember people pumping this income trust around $15-$20, citing the high distribution yield. Right now, I don’t see a lot of pumping, and if they do cut distributions again to get the bank debt down, I’ll be closely examining the equity. I do have a small position in one of their debentures.