Tuesday, October 22, 2013

An Update on Emeco Holdings

Some news from Emeco this evening/morning:

"Emeco Holdings Limited (ASX: EHL) ('Emeco' or 'the Company') today announced the amendment of two financial covenants under the A$450m Senior Debt Facility, (the "Bank Debt Facility").

Emeco remains in full compliance with its current covenants. Amendments to the Gearing Ratio (Gross Debt: EBITDA) and Interest Cover Ratio (EBITDA: Net Interest) covenants were sought to provide the Company with additional flexibility and headroom and to provide balance sheet certainty while it pursues the debt reduction strategy in FY14.

Amendments will apply for the period to 30 June 2014 at which point the covenants will revert to current levels under the Bank Debt Facility. As previously announced to market, Emeco will not pay dividends or pursue other capital management initiatives prior to 30 June 2014, and has extended this commitment to providers of the Bank Debt Facility during the period to 30 June 2014.
Current and amended ratios are as follows:
Current CovenantsAmended Covenants3
Gearing (Gross Debt : EBITDA1)<3.0x<3.5x
Interest Cover (EBITDA : Net Interest Expense2)>4.0x>3.5x
1 - Rolling 12 month trailing Operating EBITDA
2 - Rolling 12 month trailing Net Interest Expense
3 - Amended Covenants apply to the USPP Notes

Other key terms of the Bank Debt Facility, including pricing, remain unchanged and Emeco retains full access to the Bank Debt Facility. Emeco did not incur any fees or charges from providers of the Bank Debt Facility in connection with the amendment.
Emeco is focused on reducing debt and continues to generate strong cash flow with net debt reducing by
$25m in the first quarter from $415m at 30 June 2013 to $390m at quarter end. Through the combination
of further cash flow generation, working capital release, asset disposals and lower capex, Emeco will deliver further reductions in debt through FY14.
Stephen Gobby, Chief Financial Officer, said "We have been pleased with the cash flow performance of the business this year despite the tough operating environment. Our focus remains on maintaining strong cash flow over the balance of FY14 in order to further reduce debt and ensure that the balance sheet of the Company remains robust."

-----

This is a cash flow story: a bad business environment means Emeco sells off its inventory to generate cash flows; a good business environment means it rents out its inventory to generate cash flows. Emeco's rental fleet is best understood as inventory, which means that Emeco is, among other things, a "net-net".

Addendum November 20th:

An update and clarification of sorts. There's a post on this name at Alpha Vulture and the company has very recently guided between $90 and $105 million in EBITDA for FY 2014. Given that Chile and Canada account for $45 to $50 million of EBITDA, $90m in consolidated EBITDA means that Australian utilization rates have fallen off a cliff, to a third of 2012's figures and a sixth of 2011 figures. 

Alright, so this is where margin of safety comes in to play. 
--> Emeco needs to keep debt below 3.5x trailing consolidated EBITDA.
--> 90 million in EBITDA implies 40% to 45% utilization of its 813 machines
--> which means that it can sell off some of those machines 
--> so the question is, at what discount to book it will offload them.

Here's a sensitivity table relating cash flows from operations, net disposals, and discounts to carrying value on the one hand, to Debt/EBITDA ratios on the other:

Projected DEBT/EBITDA Ratios:
assumptions: operating cash flows = $90m EBITDA minus $30m capex mins $29m interest.

Can Emeco sell 2 machines a week at 40% discount to book? I think it can. And if it can, then you may consider that at the end of 2014 liquidation value will look like this:


That's why I'm long the stock. This is not Caterpillar. I should say that I'm a true believer at this point and I suspect that the conversation at Alpha Vulture would be more nuanced than anything I have to add.

Disclosure: I own shares in Emeco



27 comments:

  1. Thoughts on 1H report? With lower guidance, looks like the company will be cutting it close on the debt covenant:

    88m EBITDA - 30m capex - 20m interest - 9.5m cash taxes = 28.5m in FCF + 28.2m in 1H disposals + $35m in 2H disposals (estimate) = ~92m available for debt repayment

    Which leads to YE '14 debt of 318m or 3.6x EBITDA.

    Also, looks like the company had to write down some rental PP&E (6.132m) prior to sale?

    ReplyDelete
  2. They've adopted a relaxed attitude toward net asset disposals which i don't like.

    Given their inability to accurately forecast revenue and ebitda 6 months out, one would have thought that they'd be more proactive.

    On the flipside, the bankers seem willing to give them more covenant headroom. And one would have thought that they will have used their own judgment after having looked at the company's order book.

    ReplyDelete
  3. Did you note the bullet point on p. 18 in the results presentation:

    "Exploring a range of options which may provide a more flexible debt structure"

    Their credit facility is comprised of three tranches maturing in 2015, 16 and 17...with nothing drawn on the later maturity tranches...

    My guess is they go to the banks to redo the facility into, perhaps one smaller facility due in 2016 with (i) somewhat more relaxed maintenance convenants and (ii) rigid amortization requirements. Will probably have to pay something upfront for this...as well as a scaled pricing grid tied to leverage/coverage...but this is a deal that could get done given the "liquidity" of the collateral.

    Can't see any reason why the banks would pull the plug on Emeco if they do more than 85MM of EBITDA...

    Great blog, BTW...congrats on the Enterprise trade...

    ReplyDelete
  4. I did nnote that. Here's how I see it overall:
    1) Safety: (a) need to dispose of rental assets at >40% of book value in order for the equity to recover its current market value. (b) sold the Indonesia rental assets at 86% of book in an environment where local thermal coal extraction activity is severely depressed, so (c) we can be confident that the remaining rental assets in the other territories will sell at lower discounts to book.

    2)Upside: either an increase in utilization rates or a relaxation of the covenant terms will see the market value of the company double to 1/2 NTAV.

    The reasonable thing to do is to pursue both ends of that equation and to front load the asset disposals.

    Doing that allows for better terms in the renegotiation of the loans/covenants. That they didn't do that, choosing only to dispose of the rental assets in Indonesia and some excess real estate, is bothersome. If, halfway through H2, the PP lenders say no to another covenant modification, the co is faced with having to sell >$40m in rental assets in a couple of months which would mean severe discounts.

    Let's hope that the new fella sees his million dollar options grant as an incentive to act sensibly from here on out.

    ReplyDelete
  5. Revised math after listening to the conference call:


    FY14 EBITDA Guidance 88.0
    1H EBITDA 25.5
    Implied 2H EBITDA 62.5
    Capex (20.0)
    Interest Expense (6.0)
    Cash Taxes (@ 25%) (9.1)
    Profit 27.3
    2H Disposals (through Feb.) 30.0
    2H14 FCF 57.3

    Without Add'l Disposals
    1H'14 Debt 348.1
    Repayment (= FCF) 57.3
    2014 YE Debt 290.8
    Debt to EBITDA 3.30x


    Incremental Disposals so Debt-to-EBITDA <3x 26.8
    Adj. 2014 YE Debt 264.0
    Revised Debt to EBITDA 3.00x

    First, thoughts on math?

    27m in the next 4 months seems manageable. However, if they come in below guidance (say 80m for full year), then required disposals jump to 57m in the next 4 months...

    In the call, they also said that the assets were sold for 21m after impairment of 6m, so w/ BV of 27m = 22% discount to book. They also said that add'l asset sales in Jan & Feb were done at even higher discounts, in the 27-28% range. This is worrisome if they have to pick-up asset sales markedly because utilization does not come through.

    Thoughts?

    ReplyDelete
  6. Thanks for the notes.

    I'm with you on the math.

    And I'm not shocked or disheartened by the discount on the disposals: would have taken time to ship and sell the Indonesian assets to/in some other place so they probably sold them in situ (as I think they had to if they were determined not to sell some Australian assets too).

    If EBITDA comes in 10% under guidance then yes, it gets uncomfortable: another round of steep discounts on the incremental 30m in disposals, so another $10m wasted for no particular reason.. etc

    I'm kvetching but it's still an intelligent investment and I'll add more if price comes down some.

    And I'll be watching the for sale page on their website to keep track of the pace of disposals

    ReplyDelete
  7. Looks like the company is floating a bond offering.
    Serious effort? or creating leverage for renegotiating their current debt?

    ReplyDelete
  8. I think it's a serious effort. The important thing is that they get it done early..

    ReplyDelete
  9. Emeco Holdings Limited (ASX:EHL) (‘the Company’) today announced that it has been assigned the credit ratings as follows from the principal rating agencies:
    • Standard & Poor’s assigned Emeco a corporate rating of B+ with a stable outlook;
    • Moody’s Investor Services assigned Emeco a corporate rating of B1 with a stable outlook; and
    • Fitch Ratings assigned Emeco a corporate rating of B+ with a stable outlook.

    ReplyDelete
  10. Looks like a bit of rough sledding in high yield land for our Aussie issuer:

    (i) Deal downsized from $360MM to $335MM

    (ii) N/C 3 instead of 2 years

    (iii) Expected to price @ a discount to yield 10.25-10.5%

    Though judging by the equity market's reaction, it looks like expectations were that they wouldn't be able to get anything done.

    Will be interesting to see the terms on the revolver...

    ReplyDelete
  11. And they're still going ahead with it. Real head scratcher.

    ReplyDelete
  12. Well, if the indenture on the new bonds is relatively toothless, they might not have any maintenance convenants at all...so they will buy themselves solid financing with no amortizations for the next 5 years regardless of the depth of the downswing...of course, we'll have to see what the terms on the new revolver are..

    Probably will give mgmt plenty of breathing room so they, unfortunately, will not focus on further deleveraging...

    ReplyDelete
  13. Better covenants.. Gearing not tied to ebitda.
    Allows for orderly liquidation.

    ReplyDelete
  14. Looks like the CEO just bought more shares yesterday in open market. About $25k AUS worth.
    Not sure if this is for show.. doesn't seem like material amount, but always happy to see.

    Link: http://www.emecoequipment.com/upload/pages/140331_ehl_changeofdirectorsinterestnotice/140331_ehl_changeofinterestnotice.pdf?1396254715

    ReplyDelete
  15. What is your opinion on the Indonesia wind-down? This seems to be done at rock bottom prices..

    I'm starting to have some doubts about this company, especially the fast shrinking margin of safety..

    ReplyDelete
  16. Getting out of Indonesia altogether is the reasonable thing to do and it speaks well of new management that it came so early in its tenure.

    re: MOS -- Are you applying the Indonesia disposal haircut to the entire fleet? If so, why?



    ReplyDelete
  17. Sorry for the late response.

    The main concern for me was the fire sale of the equipment. They could have gotten a way better price with some time or creativity. Instead, they wasted 40+ million in equity.

    Yes, they did the right thing because the Indonesian mining sector (and especially coal) are not recovering anytime soon, but this somewhat wasteful attitude is not particularly shareholder friendly. It cost them just 3.5 million to have it there, which is peanuts compared to the total write-down.

    This combined with the bond makes me somewhat uncomfortable. Why didn't they take a 250-275 million bond with a 75 million CL? I found this pretty puzzling, considering the fact that they won't have to do any cap ex investments anytime soon..

    Then they could at least have some use for the 40 million of sold equipment, namely pay of the CL. Now it is just standing there on the balance sheet earning pennies.

    That aside, I do not have any reason for them to take the same markdown on their other assets.

    But these moves by management combined with the possible "China exposure" makes me somewhat less comfortable with this company than 5 months ago.

    It might have been the safer move, but these moves have cost shareholders at least 10% of the equity.

    ReplyDelete
  18. Well, I agree with your concerns. Prior management's lackadaisical attitude to disposals was irritating and that it ended up being expensive to the equity was entirely predictable.

    Still, now that covenants are not an issue, we are a long way away from testing the MOS on this stock.

    And if it's safe and materially cash generative something will have to give. It's just a matter of waiting.

    ReplyDelete
  19. Red,

    With lower price of crude, driving reduced oil sands development, and about 30% of Emeco revenue coming from Canadian oil sands, this would seem to change the investment hypothesis.

    Your thoughts?

    John

    ReplyDelete
  20. Well I think the thesis remains all about fcf.

    So at current utilization rates:
    120 in annualized EBITDA. Less 45 from Canada if you think oil sands go to zero = 75 in EBITDA.

    75 EBITDA means 315m in excess gear. Sell that at half book and net debt goes to 150 or 2x EBITDA.

    At 150 net debt, EV = 260 and FCF with no further net disposals disposals = 42.
    2015 42/260 = 16% FCF/EV
    2016 44/208 = 21%
    2017 46/162 = 27%
    2018 48/114 = 36%

    2019 FCF = 7c per share; dividend = 4c, 5% yield ==> 80c

    If this sounds like a plausible worst case scenario, the annualized return from now to 2019 is 35%.

    ReplyDelete
  21. Red,

    Looks like you exited Emeco a few months ago... change in the thesis?

    -John

    ReplyDelete
  22. I did and yes, the thesis changed.

    The thesis was that Emeco would liquidate its gear as necessary to keep FCF steady at $100MM. That was what was promised at the time.

    Old CEO booted, new CEO in, and his "strategy" was to go for utikization instead, at lower margins. That makes it nothing more than a levered play on mining recovery That's not really my cup of tea so I took my lumps and moved on.

    ReplyDelete
  23. Hear ya.. I'm going to wait to see their earnings on Aug 27.
    Does look like they are continuing to liquidate their equipment, but cant tell you how much - it is an uncertain situation.
    Thanks!

    ReplyDelete
  24. And now, the new CEO is booted too..

    ReplyDelete
  25. He was clearly in over his head. Having missed the window for the orderly liquidation of excess gear it would now take a brave soul to bet that the equity isn't done for.

    ReplyDelete
  26. Interesting.. you say the equity is likely done for - however the financing is better (no gearing)which should enable an orderly sale. What is your thinking?

    ReplyDelete