Friday Workout - Sell-off running out of gas? Accounts non-receivable; 2x Heide
Chris Haffenden
•15 min read
Over the past couple of weeks, the number of names in European LevFin entering into stressed territory has increased markedly. Most are not directly connected to the Russia/Ukraine conflict but have suffered from second order effects, as oil, gas and other commodities soared earlier this week. We even saw Nickel prices suspended on the LME as a short squeeze saw prices double and hit $100,000 per tonne as a Chinese billionaire (perhaps now just a millionaire) was caught short.
Wednesday saw the sharpest daily reversal since 2008 in commodity prices, but so, far, EHY prices are yet to show real signs of price recovery, with the number of issuers trading below 90 increasing markedly in the past week, now 131 companies, according to 9fin’s screeners, 23% of our European issuers.
The about turn in Government bond yields since mid-week has helped spreads, however. The iTraxx Crossover contracted from Monday’s wides of around 430bps to 387bps at Thursday’s close. But HY cash prices lag the index significantly, the negative basis was exceptionally wide at around 37bps on Thursday morning. This may suggest covering of index hedges, rather than genuine buying. But with many issues widening by 150-200bps in past 3-6 months, will the sell-off in HY eventually run out of gas?
Take a look at Dutch TTF April 2022 Natural Gas Futures chart this week – after more than doubling on Monday, and gapping higher on Tuesday, they are lower on the week at 115. That said, prices are still up over 200% since the start of this year and were at just 19 in January 2021.
On Tuesday, the effects of the spike in natural gas prices became evident, with Pro-Gest, the Italian containerboard, cardboard and packaging firm halting production at its Italian plants as high energy costs made then uneconomic. Their 3.25% 2024 SUNs have dropped even further this morning, sinking 21 points to 67.4-mid at time of writing. Norske Skog has suspended production at its Bruck Paper Mill. Sticking with paper losses, Reno Di Meidici FRNs haven’t provided much downside protection, launched in December, they dipped below 90, this week to 86, this morning. Schoeller Allibert, isn’t plastic fantastic, the containers and pallet box manufacturer saw its bonds dip from 98, to just over 90 (92 currently), as oil surged and the market woke up to its Russian operations.
At the sharp end are the fertiliser producers. Borealis and Nitrogenmuvek are already reducing output due to natural gas costs which make up to 90% of their input costs, which at current levels make production uneconomic. This leads to shortages of fertiliser and raises prices of grains and other food products. Making this worse, is our reliance on Ukraine and Russia for grains and sunflower oil. The more you look into it, the bigger and wider the effects.
Over the past week or so, the market has woken up to how serious this could be.
Despite default expectations of less than 2% for 2022, we now have 49 European issuers whose bonds trading with a spread to worst of over 800 bps, probably the upper bound of a refinancing, 32 are over 1200 bps, a level at which we would view as distressed. So, with 8.7% of our 564 followed European companies indicated as stressed/distressed, does this mean the ratings agencies are behind the curve, or the market is trading cheap? (NB this search was run on Thursday morning, 10 March).
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Bulls would point to the sharp recovery in the market in 2020 after the initial collapse from the Covid pandemic, saying that effects from the war will be temporary, if anything, this will limit the amount of rate rises and quantitative tightening. Issuers were remarkably successful in passing on input cost rises in Q3 and Q4, and bad comps will drop out of H1 22 numbers leading to reductions in leverage, they would argue.
However, with inflation set to hit 8% and perhaps go even higher, with consumers to be hit by higher energy bills and food prices, could we be entering into an era of stagflation?
Barclays Capital analysts in a report released last Friday certainly think so, and on a broad relative value basis, they say that EHY is not pricing in economic risks, trading at its tightest versus Investment Grade on a ratio basis in 12-months.
But US HY has even more room to widen, having significantly outperformed Europe in this year’s widening, notes Barclays. With investors hiding in shorter-duration single B bonds the BB/B spread in Europe has bizarrely contracted to the tightest levels since 2017, leaving little further room for outperformance, they suggest. I would argue that 2023 default rate expectations should rise here, which would typically widen the gap between BB and single-Bs.
Whatever your view, things have started to get interesting, and yes, we are beefing up our distressed capabilities in anticipation (and still hiring btw). Opportunistic refinancing isn’t really possible, we suspect the number of 2022 deals that can still be called is less than €10bn. We would love to listen in to follow-up conversations with bankers that the deal you pitched in September is now 150bps wider and you may pay a higher coupon that your existing bonds.
Meanwhile, the hung LBO pipeline is growing, and cap rates must be close for deals struck late last year. It’s a great time to be a special situations fund, there is value for them in primary, while they wait for distress to arrive. I’m sure they are putting in a lot of calls to underwriters in recent days.
Accounts non-receivable
Corestate had an uncomfortable conference call with investors earlier this week, not helped by the announcement earlier in the day, that their fully audited 2021 accounts would be delayed. The new anchor investor and freshly appointed CEO (just hours earlier) Stavros Efremidis faced a number of questions about the reasons for the delay, as yet again the German Real Estate services firm failed to deliver on its deleveraging targets.
After changes in senior management at Corestate Bank, auditors Ernst & Young want more time to assess the accounts and told Corestate on Monday (7 March) they couldn’t come to a full conclusion. Efremeis added during the presentation that “we couldn’t provide the full information that they asked for.” It has promised to release full audited accounts by 31 March 2022.
Early last year, Corestate bought Aggregate Financial Services, subsequently renamed Corestate Bank from Aggregate Holdings. The aim was to diversify its real estate lending business, to reduce its reliance on the existing debt fund structures. The benefit was immediate, boosting Q2 revenues after it structured the financing of the jumbo Furst project in Berlin for Aggregate, its former owner.
But two key directors, the Chief Debt Financing Offer and Chief Debt Investment Officer left the board after less than a year, with Rene Parmantier, former CEO, taking on these roles in early February.
When asked to comment on the two departures and other senior members of the team during the Q&A, management said that “they couldn’t comment for legal reasons,” adding that there were no economic or business impacts from the departures. On the contrary, said Efremidis, there is a significant pipeline of business for Corestate Bank of over €2bn.
As reported, Corestate disappointed investors in its Q3 release, falling behind in its deleveraging efforts. It set a self-imposed 3x leverage target to start a refinancing process in H1 2022 with upcoming debt maturities in November 2022 (€191m of converts) and April 2023 (€298m SUNs) to address. They failed to hit this target at year-end (discounting €13m of restricted cash in the net debt calculations, it rose on a year earlier) with leverage coming in at 5.8x.
This week Corestate repeated its intention to significantly reduce its financial liabilities and complete the scheduled refinancing of its April 2023 bonds before the summer, with a reduction in net debt to 2-3x, “accompanied by a long-term enhancement of the business model’s risk profile.” The November 2022 convertible bonds will be repaid from the cash position.
With a refinancing efforts likely to start this Spring, it is unlikely all of the planned deleveraging or cash inflows will be in place (see reproduced slide above) before the bond refinancing starts. With LTM EBITDA of €90-100m by this time and net debt of around €350-360m, this results in net leverage of 3.5x to 4x, if they can finally deliver on their promises. This cannot be done in isolation, as it cannot extend maturities without the November 2022 converts being addressed at the same time. However, this leaves liquidity depleted with very little left to regrow AUM this year.
But the new CEO remains bullish, touting the repositioning of the group ‘as a comprehensive and entrepreneurial new start.’ The business will be rebranded in the second half, its dependence on bridge lending will be reduced alongside the number of co-investments. Corestate will have lower warehouses in the future, with Efremidis saying that Corestate wants to rebuild investor trust and realise the preconditions for further profitable growth.
The company is a huge, huge, oil tanker which is slow to turn around - we want to turn it into a speedboat, quipped Efremidis. He promised investors improved corporate governance and the quality of transparency, but this is something the previous management had said too.
Corestate’s 3.5% 2023 SUNs slumped by over five-points after the release to 70-75 but have since crawled back 78-79, according to ICE data. For more, clients can click here. If you are not a client but would like to request a copy please click here.
Accounts non-receivable Part Two
Just as I was enjoying the networking drinks at the Kirkland & Ellis distressed debt symposium drinks with old friends and sources, an announcement landed from Adler in my Slack channel. Their auditors KPMG have yet to conclude their special investigations work, so far unable to refute some of the allegations and will need to close the valuation gap on the development properties.
Regular readers of the Workout will know the story by now. But to recap for newbies, the German Real Estate company was subject to several allegations from Viceroy Research, the short seller in early October. In short, these concerned the over valuation of rental properties, related party transactions, and the acquisition of a development portfolio at inflated values from Aggregate Holdings, which ended up with a 26.6% stake in Adler after a series of transactions.
Adler Group subsequently sold two large rental portfolios in excess of book value, which reduced LTV below 50% which placated investors to some extent. But the next challenge was to reduce the sharp discount to book value, and realise gains from the development portfolio, with concerns over the progress and planning approvals for a few projects, as unveiled by Jack Sidders from Bloomberg.
In a letter released yesterday evening (10 March), Stefan Kirsten, Adler’s chairman said:
Today we have therefore published an ad-hoc statement to formally address the markets, even if the KMPG summary is still preliminary.
As mentioned before the investigation focuses on
Alleged related party transactions
Portfolio valuation
Subsequent loan to value calculations
About the alleged related party transactions KMPG is not able to refute the allegations due to currently available data that need to be further investigated.
About the valuations, the existing CBRE valuation for the rental portfolio is rock solid. With regard to the development portfolio, KPMG has indicated valuation differences, which we are now jointly narrowing down.
All calculations on the LTV do not endanger financial instrument covenants. Even here we will, together with KMPG refine our calculations further.
What are our next steps?
We have asked KMPG to extend the special investigation with data inputs from us until March 25th. We recommended to KPMG to focus on the ongoing email analysis, loose ends with regard to alleged related party transactions and narrowing the valuation gap in our development portfolio.
Due to all the work done so far, we reasonably expect a prompt final report afterwards.
We are in the process of finalizing our year-end and, taking into consideration the special audit report, intend to publish our 2021 group account in the last week of April. Subsidiary groups might issue their accounts earlier on their respective timing.
When this is done, my colleagues and I will reflect on the results and, where necessary, will adjust structure and processes within Adler.
Due to the preliminary status of the investigation, we will as of now not comment any further. With that I remain,
Sincerely yours, Prof. Dr A. Stefan Kirsten
Kirsten, former finance director of Vonovia told journalists in early February his job was stablise Adler after a pervasive loss of confidence, adding the elephant in the room was Wirecard.
Twice as good
As we put together our piece on the non-deal investor update for Raffinerie Heide on Tuesday, one figure jumped out at us. The Kalundborg Danish refiner, recently contributed by sponsor Klesch to the Heide restricted group who paid $48m at closing to Equinor, less than 2x 2021 adjusted EBITDA of €29m.
The combination of the two will nearly double refining capacity to 198 thousand barrels per day (kbpd), split 54%/46% in favour of Kalundborg. The Danish site produces 107 kbps to Heide’s 91 kbps. The product mix, a key driver of refinery margin and therefore value for the refineries, is similar at both sites.
As 9fin’s Ben Hoskin reported, the hedging expertise Heide can offer is a big boost for the combined group, but with energy prices surging due to events in Russia and Ukraine, key question marks for investors will be how quickly an equivalent program for Kalundborg can be implemented. The presentation showed 95% of Kalundborg's margin is hedgeable, versus 85% for Heide. Management said today they have locked in some of the group’s 2022 margin but stopped short as to how much.
We’ve said in the past due to volatility of earnings, and with inventory and other assets pledged to receivables and other asset financings, corporate leverage for refinery businesses should be low. If anything, Kalundborg has seen sharper EBITDA swings in recent years.
One point of contention is the punchy €170m illustrative EBITDA projection for the combined group. This is calculated through multiplying the annual capacity of the group by the utilisation, which is in turn multiplied by the refining margin, before subtracting operating expenses.
As Ben notes, €170m still feels ambitious on assets that produced a €132m combined total for the preceding two years. Nonetheless, €170m of EBITDA would provide a net leverage figure of 0.7x on Heide's net debt of €120m as of September 2021 (assuming no debt at Kalundborg), in line with marketing materials sent out on peer Prax before it was eventually pulled last month.
The bonds have rallied by around six points to 88 this week, but at a 25% yield, it might suggest more support from Klesch, or an A&E, perhaps with some form of cash sweep, to get done.
Amigo 2.0 Scheme unopposed at convening hearing stage
In stark contrast to its first attempt last May, Amigo Loans’ second English Scheme convening hearing on 8 March was less eventful. After all, most of its SSNs were repaid in January via an early redemption, and with the UK-based guarantor lender disclosing on Monday that the FCA would not oppose the latest scheme, most of the remaining uncertainty is removed.
Amigo shares rose 175% in a week to a lofty £38.75m market capitalisation after raised hopes that Amigo 2.0, its new lending platform, may get the go-ahead from the FCA later this year.
There were no formal objections at the convening hearing, and Justice Snowden said that he will take a day or two to submit a written judgement. This is to allow it to be posted on the Scheme website for claimants to see with voting documents to be sent out this week.
Haya Real Estate
Our analysts number crunching skills were tested on adjustments to projects and the cash sweep after the Spanish Real Estate servicer failed to secure the Sareb contract as expected.
The deal mechanics, and the gives and takes between the bondholders and sponsor Cerberus are not that easy to understand. For those looking to get up to speed, our Restructuring QuickTake is a good place to start. If you are not a client but would like to request a copy, please complete your details here.
Kloeckner Q4 update
With its sub notes trading below 70, KP released a Q4 trading update to reassure holders, saying that liquidity is strong at over €260m and while the FY audit is yet to be finalised, EBITDA should be within 2% of guidance. It claims that all 2021 input cost rises were offset in full in January, and will continue to pass through cost inflation in 2022. The results are due on 1 April.
What we are reading this week
Yet more disruption for the automotive sector, with Porsche suspending its Taycan EV production until the end of next week due to shortages of wire harnesses as suppliers in western Ukraine have been shuttered by Russia's invasion. With VW being its largest customer, it is not good news for Standard Profil if this shortage continues for an extended period of time. High energy prices are impacting the Building Materials sector, with a number of smaller producers of bricks and tiles shuttering production, leading to shortages for construction companies. Several building materials companies tapped the leveraged loan market last year.
