Commodity price collapse points to Unigel restructuring

Declan Hanlon | June 9, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Unigel’s recent decision to engage Moelis & Company as its financial advisor and Felsberg Advogados as legal advisor does not come as a surprise following disappointing first quarter 2023 results and a price collapse in agricultural commodities ammonia and urea. The announcement has shifted the market’s attention towards the potential risks of a recuperação judicial, or judicial recovery for the company, in Brazil, or at the very least, an out-of-course restructuring.

In the first quarter this year, Unigel reported weaker-than-expected performance, reflecting continued deterioration in operations in the second half of 2022. Both end prices and volumes declined compared to the previous year in both chemicals and agro. Consequently, EBITDA plummeted by 82% year-on-year to R$104 million, resulting in net leverage rising from 1.1x in the previous quarter to 2.2x. The company had to address cash burn, while the last-12-month EBITDA calculation declined significantly.

The agro business saw a substantial decline in the prices of its main products during the quarter, with ammonia dropping 33.4% and urea 35.6%. The decline has persisted into the current quarter, with ammonia prices falling from approximately $750 a ton in the first quarter to around $400 per ton. Similarly, urea prices have dropped to approximately $300 a ton from $375 a ton in the first quarter of 2023 and $727 a ton in the first quarter of 2022. These price fluctuations have led to a potential 50% decrease in production for granular urea, a more standardized product, as the operating costs at the Sergipe facility become less viable. The facility has been offline since April. Additionally, the linkages to Brent, a benchmark for the industry, have impacted margins, with the effects of higher raw material costs expected to squeeze spreads throughout 2023.

In chemicals, pricing for main products like acrylonitrile and polystyrene has shown less volatility. However, the domestic market, particularly in the styrenics footprint, has faced significant price pressures despite stable order volumes. Acrylics, which primarily exports to Asia, has experienced challenges in both pricing and demand. Although some signs of recovery have emerged in the current quarter, a substantial uplift is not anticipated until at least the second half of 2023.

While the firsts quarter 2023 may have marked the trough of the chemicals segment, prices have further deteriorated in the agro segment during the second quarter. This suggests a very weak financial report for the second quarter, with negative EBITDA expected for agro. Management acknowledged the challenges of rising net leverage during the earnings call but seemed to understate the anticipated impact on credit metrics given the current market pricing.

It seems evident that Unigel will breach its covenants in the second quarter this year, necessitating a waiver from local debenture holders, which is expected to occur but possibly requiring collateral. This breach will also hinder the company’s ability to incur additional debt, as per the 3.5x incurrence covenant in the 2026 bonds. This restriction is crucial to fund cash burn and the scaled-back capital expenditure program, which initially aimed for approximately $40 million USD of deployment throughout the year. The planned expenditure includes projects such as the sulphuric acid project, the Green Hydrogen project, and maintenance spending. Given the anticipated sustained pressure on EBITDA, it is likely that both expansionary projects will be delayed to preserve capital expenditure. Additional credit line drawdowns may be required for the Sulphuric project.

As of the end of March, Unigel reported approximately R$1 billion in unused credit lines. However, much of this amount is uncommitted and no longer serves as a potential source of liquidity due to current operating conditions. Presently, the company has an estimated R$200 million in potential availability, with R$100 million of that amount with BNB, specifically for the sulphuric plant. In April, the company also structured and drew on a R$150 million ECA with Caixa to bolster liquidity ahead of anticipated cash burn and covenant-related constraints in the third quarter.

Looking ahead, as the market sentiment remains highly negative, ratings downgrades are imminent. However, the current bond prices are not relevant to the trade theses. Unigel has begun exploring asset sales to generate cash, with a Mexican acrylic sheets plant being a likely source of liquidity. Nonetheless, divesting this plant, which generates over $12 million in annual EBITDA, would worsen credit ratios. Considering Unigel is a forced seller, it is unlikely to achieve a multiple of over 8x in the current market.

Typically, at this stage of the liquidity cycle, companies turn to shareholders for potential support. Although Unigel’s founder and owner, Henri Slezynger, has indicated the availability of capital if needed, there have been no substantial discussions regarding equity injections, and thus no positive near-term headlines are anticipated. As a result, while bond prices briefly hit a low of 24 cents on the dollar before settling in the low $30s, the transition of bond holdings from long-only investors to the alternative or distressed investor set is still in its early stages, and further price volatility seems likley. This includes the anticipated release of the very weak second quarter 2023 earnings report and the possibility of ceasing interest payments as the company conserves cash and proceeds with a restructuring.