Hexion bonds strengthen as EBITDA gains YoY; management tightlipped on asset sale progress – Analyst Snapshot

Hexion’s second lien bonds traded up around three points today after the chemical maker reported 1Q18 results showcasing higher sales and segment EBITDA. However, on this morning’s call, management was mum on the progress of its asset sale efforts – which are critical for a successful refinancing of the junior debt.

CEO Craig Rogerson stressed that a “normal timeline” is underway and that the process is “where we expected, everything is moving ahead as planned.” The comments came after several call participants pushed for more details.

“Clearly, deleveraging is a consideration…We’re looking at the maturities we have in 2020 and looking at this as a way to effectively deal with that, while having a company at the end of the day that makes a lot of sense, that’s got growth potential and that’s worth continued investment,” said Rogerson when asked about the big-picture goals for the strategic process.

“The quarter showed growth, but they have more than USD 1bn in debt due 2020, and the asset sale was the one thing that [management] didn’t really address on the call,” said a buysider in an interview following the earnings call.

After the call, Hexion’s USD 1.55bn 6.625% first lien notes due April 2020 traded about a half-point higher to 95.75, yielding 9.1%, while its USD 315m 10% first lien notes due 2020 rose about a point to 101.125 yielding 8.676%, according to MarketAxess. The USD 574m 9% second-priority senior secured notes due 2020 jumped three points to 85 to yield 16.6%, and the USD 225m 13.75% 1.5-lien notes due 2022 traded up to 89 yielding 17.9% from trades around 86.5 last week.

Management stated that EBITDA benefitted from significant improvements in its base epoxy resins and phenolic specialty resins businesses, as well as the positive impact of cost reduction initiatives. Hexion’s formaldehyde and forest product resins business also positively contributed to the quarter’s results. For FY18, Hexion expects improved segment EBITDA as compared to FY17.

The company’s net sales rose 8.7% year-over-year to USD 946m in 1Q18, compared to USD 870m in 1Q17. Excluding net sales of approximately USD 4m related to asset sales in the Forest Products Resins business, 1Q18 net sale rose 9.2%. The increase was driven by pricing initiatives in the base epoxy resins business, and the pass-through of higher raw material costs in the global forest products resins and phenolic specialty resins businesses.

Hexion reported USD 118m (12.5% margin) of segment EBITDA for 1Q18, a 24.2% YoY increase from USD 95m (10.9% margin) in 1Q18, but rose 25.5% when adjusted for divestitures. The improved results reflected cost reductions, and higher margins in the base epoxy resins, phenolic specialty resins, and global forest product resins and formaldehyde businesses. Adjusted segment EBITDA, for the trailing twelve months was reported at USD 430m.

By segment, net sales for Epoxy, Phenolic and Coating Resins in 1Q18 increased by USD 48m, or 9.8% YoY, to USD 540m from USD 492m in 1Q17, due to the pass through of higher raw material costs and price actions in certain businesses, partially offset by a decline in volume. By numbers, the sales increase was the result of YoY change in price/mix (+7%) and currency translation (+8%), offset by volume (-5%).

Segment EBITDA rose USD 18m, or 34.6% YoY, to USD 70m for a 13% margin, which marked a 240bps increase from a segment EBITDA margin of 10.6% in 1Q17. Segment EBITDA benefited from a significant increase in base epoxy resins, driven by strong market fundamentals, YoY improvement in phenolic specialty resins due to the company’s diversified portfolio and recent cost actions. Management stated that there was continued strong volume in the NextGen EpoxyTM Waterborne System. Hexion Management expects the company’s base epoxy business to continue showing strong volumes in 2018 with high prices. Also, Hexion’s waterborne coatings business will become an increasingly significant contributor to its overall specialty epoxy growth in 2018 and 2019.

Forest Products Resins’ net sales increased by USD 28m, or 7.4% YoY, to USD 406m from USD 378m in 1Q17, due to price mix (+7% YoY) and currency translation (+2%), partially offset by weaker volumes (-1% YoY), and the impact of dispositions (-1%). Revenue increased in all geographic areas, and reflected the contractual pass-through of higher raw material costs partially offset by slightly lower volumes due to weather-related customer shutdowns.

Segment EBITDA increased USD 6m, or 9.8% YoY, to USD 67m (16.5% margin) from USD 61m (16.1% margin), reflecting volume gains in Latin America and Europe, partially offset by weather-related weakness in North America. Segment EBITDA also benefitted from cost efficiencies from the new North America formaldehyde facilities.

Hexion had cash usage from operations of USD 83m during 1Q18, compared with net cash usage of USD 118m in 1Q17. With net proceeds from asset sales of USD 50m, and capital expenditures of USD 25m during the quarter, net cash provided from investing activities was USD 25m compared with net cash used in investing activities during 1Q17 of USD 26m.

During 1Q18, Hexion achieved USD 13m of cost savings, and has identified approximately USD 40m of savings related to headcount reductions. At 31 March 2018, the company had USD 39m of annualized in-process cost savings that it expects to realize the full run-rate by 2018 year-end.

Management commented that it expects further structural cost savings in 2018, and for continued growth across most product lines to support 2018 segment EBITDA growth.

Analyst Snapshot: Key Points
Seth Crystall, Senior Analyst, 646-378-3105

  • In January, Hexion announced the sale of its ATG business for approximately USD 49m in proceeds, with the net funds for use in general corporate purposes. The business was sold at a multiple of 12 times LTM EBITDA. Management previously estimated that this business accounted for 2017 sales and EBITDA of USD 40m and USD 4m, respectively.
  • The company has initiated a process for the sale of a portion of its Epoxy, Phenolic and Resins segment. Hexion is pursuing this sale as it represents an attractive opportunity to monetize assets, simplify its portfolio and materially reduce its debt, especially the need to address its 2020 maturities.
  • Hexion stated that it expects epoxy resins supply/demand dynamics to remain favorable for the foreseeable future, supporting continued profitability. There are no significant known planned capacity additions.
  • Management believes that its Forest Products segment will benefit from an ongoing recovery in housing starts driving growth in North American resins, and demand for sustainable product solutions. The company believes that the annual segment EBITDA can eventually hit USD30m-USD35m, but is currently running around USD 20m.
  • Hexion’s wind energy business in China is stabilizing, as lower demand and pricing pressure hurt it. The company believes that this business will recover, but doesn’t expect to see much change in 2018.
  • The company does not expect as quick of a recovery in establish drilling basins for its coated proppants business, as the current cost compared to sand would be 3x-4x the cost of sand.
  • The average prices of Hexion’s major raw material inputs of methanol and urea increased 10% and 3%, respectively, while the price of phenol fell 3% for 1Q18 versus 1Q17. Global raw material pricing increased approximately 9% sequentially in 1Q18 from 4Q17.
  • Capital expenditures for 1Q18 were USD 25m versus USD 30m in 1Q17. Management is estimating a 2018 capex of USD 80m-USD 90m.
  • Hexion continues its focus on managing its working capital. Management expects working capital to increase modestly in FY18 compared to FY17 with an increase in 1H18 and a decrease in 2H18. The increase in FY18 working capital includes the company’s 1Q18 asset sale.
  • The company had USD 282m of liquidity at 1Q18-end, comprising of USD 95m of unrestricted cash, USD 145m of availability under its USD 350m senior secured asset-based revolving credit facility and USD 42m available under international credit facilities.
  • Hexion had USD 3.8bn of total debt at 31 March, compared to USD 3.7bn at 2017-end. We calculated total leverage of 8.7x based on LTM adjusted EBITDA of USD 430m, with a leverage of 8.0x through the company’s second lien notes.
  • The company reported that its adjusted EBITDA-to-fixed charges ratio was 1.37x compared to a secured notes covenant minimum ratio of 2x, which would restrict Hexion from incurring additional indebtedness and making investments. There are exceptions to these restrictions, however, permitted under the ABL facility, which provides USD 145m of availability for borrowing.

Analyst Takeaway –With its 2020 maturity wall on the horizon, management will need to address it at some point in time, but for the moment, it would appear that HXN has some runway to stabilize its business, benefit from improvements in its businesses and make asset sales to pay down debt.

2018 Debtwire

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