The Long and Short
New Braskem debt prices in key risks
Declan Hanlon | September 8, 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.
Braskem, a global chemical company, somewhat unexpectedly tapped the bond market in the last week to raise $850 million in a 7-year issue. The bonds came with an 8.50% coupon, yielding 8.75% on an issue price of $98.687. The decision to issue US bonds raised questions among market participants about whether it was the best choice compared issuing local debt or tapping into the company’s 2026 credit line. Nevertheless, the new bonds should perform well.
The rationale behind the bond issue appears to be a combination of market opportunism and liquidity enhancement. However, concerns loomed over the company’s negative credit trajectory, with its ratings currently at ‘BBB-‘ with a Negative Outlook. Consequently, market pricing reflected apprehensions about a potential downgrade, leading to a widening of the existing curve. To entice participation, Braskem added a premium to the new 2031 issue.
Despite the initial concerns, the new bond issue garnered substantial interest, resulting in a robust $2.5 billion order book. This success was accompanied by a slight tightening from the initial 9% initial price talk (IPT). Still, analysts believe that the issue level remains below fair value, with a potential downgrade already priced in.
The increased liquidity, following the bond issue, bolsters Braskem’s financial position, providing approximately $5.7 billion in cash and credit line availability. This liquidity is expected to support the company in addressing operational weaknesses, managing the Alagoas contingency, meeting upcoming amortizations, and potentially funding a call of the 2081 hybrid bond with a coupon step-up in 2026.
In the most recent reporting cycle, Braskem’s second-quarter 2023 results fell below already modest expectations. While working capital contributed positively to operating cash flow (OCF) generation, the company faced challenges due to deteriorating LTM EBITDA and ongoing Alagoas-related disbursements. As a result, net leverage increased to nearly 8.0x, including the impact of hybrid bonds. The next anticipated improvement in net leverage metrics may not occur until the release of fourth quarter 2023 results in April.
Despite working capital enabling positive OCF generation, overall free cash flow (FCF) remained close to break-even, considering the disbursements to Alagoas. Braskem’s enhanced liquidity position will be crucial as the company grapples with short-term debt obligations of $388 million and approximately $1.2 billion in debt scheduled to mature by year-end 2026, excluding the potential hybrid bond call. Given expectations of continued sector weakness, further EBITDA pressure and additional or escalated Alagoas payments are likely, potentially resulting in negative FCF-generation in the second half of 2023. These factors, in turn, could exert further pressure on net leverage metrics and credit ratings.
Braskem’s recurring EBITDA during the period was $140 million, marking an 83% decline year-over-year. This decline stemmed from lower volumes across regions, especially in Brazil, combined with ongoing weak spreads. In Brazil, EBITDA reached R$407 million, a 36% quarter-over-quarter decrease, attributed to lower demand and volumes, as well as weaker contribution margins. In the US and Europe, EBITDA was R$119 million, reflecting a 77% quarter-over-quarter decline due to costly inventory of finished goods, limited flexibility in the purchase of propylene in the US, and weaker PP spreads in Europe.
In the near term, the focus on LBO/asset sale headlines may diminish in the face of the fundamental challenges Braskem faces, impacting credit ratings and bond spreads. The possibility of a high-yield rating for Braskem may reduce the urgency of a change-of-control debate for potential new owners. However, the company’s current net leverage trajectory suggests limited tactical advantages for a debt-financed takeover, and market appetite for such an approach appears minimal. As a result, market attention is likely to shift towards fundamental analysis and the potential for negative technicals as more investment-grade investors consider exiting the complex. At current yields, these factors are already priced in, implying strong performance of the new bonds.
Santander US Capital Markets occasionally serves as underwriter for Braskem debt, including issues discussed in this note.