Q1 2008 Results Conference Call
Mark Davis
Good morning, ladies and gentlemen. Thank you for joining us for our conference call and webcast this morning.
Joining me today is Rohit Bhardwaj, our Chief Financial Officer. We will review the first quarter results, after which we’ll answer any questions you may have.
Before I commence the review, I would remind you that our presentation contains forward-looking statements that are based on current expectations, and are subject to a number of uncertainties and risks, and actual results may differ materially. Further information identifying risks, uncertainties and assumptions, and additional information on certain non-GAAP measures referred to in this call can be found in the disclosure documents filed by the Fund with the securities regulatory authorities, available at www.sedar.com.
Chemtrade had a very strong first quarter. The actions we have taken over the past few years to stabilize and improve our business both operationally and financially continued to positively impact our results. The key 2007 initiatives to improve the quality of our plants, reposition our SHS products and actively pursue market opportunities all positioned us to succeed in the first quarter.
The main reason for the significant increases in revenue and earnings was the historically high prices for sulphuric acid and an associated increase in the margin we realize on the acid we sell. In fact, all of our businesses performed well, not just those that benefit from higher sulphuric acid prices.
The beneficiaries of the escalating margins for sulphuric acid were, of course, our Sulphur Products & Performance Chemicals and International segments. Our SHS business, also a part of SPPC, also performed better than last year. Finally, Pulp Chemicals reported higher sales and margins than last year, which added to the excellent first quarter results.
Distributable Cash after Maintenance Capex in the first quarter was 53 cents per unit, while our distribution rate was 30 cents for the quarter. Clearly, it was a good quarter for Chemtrade.
The unprecedented conditions in the sulphuric acid market are expected to continue for some time, and have significant impact on our results. After Rohit finishes his review I will give a more detailed outline of how the sulphuric acid market can be expected to affect Chemtrade over the next several years.
Before I hand over to Rohit, I do want to mention two other significant events that took place in the first quarter.
In early March we announced the renewal of the long-term contract between Chemtrade and Vale Inco. Vale Inco provides Chemtrade with the majority of the acid we sell to the merchant market. The new agreement has a 10-year term and continues the philosophy of mitigating typical commodity risks.
The concept of sharing price movements between Vale Inco and Chemtrade is continued under the renewed agreement. Further, since Vale provides Chemtrade with by-product acid, our cost of obtaining this product is not affected by the price of sulphur. I will have more to say about this later and how this agreement interacts with the market dynamics of the sulphuric acid market.
Later in March we announced our investment in Buenos Aires-based Meranol, a leading Argentine producer of sulphuric acid and other sulphur products. This is a small initial investment - US$2.5 million in notes, which are convertible into 10% equity of the company, and an option to increase our equity investment to up to 45%. The most important aspect of the investment is that it extends the international scope of our business and enhances our ability to participate in markets with expanding demand for our products.
It was a busy, and profitable first quarter for Chemtrade. We were able to and will continue to capitalize on the current buoyant market for sulphuric acid. We also renewed a core long-term customer agreement and obtained a valuable foothold and visibility into the vibrant South American market.
Rohit will now review the financial results, after which I will have some remarks on the sulphur and sulphuric acid markets.
Rohit Bhardwaj
Thank you, Mark and good morning everyone.
As Mark said, it was an exceptional first quarter for Chemtrade. In addition to the higher price for sulphuric acid, which was the main driver for the increases in revenue and earnings, there were some other items that affected the results that I will summarize before looking at the consolidated results and the segments.
In the first quarter of last year we had charges in SPPC of $1.5 million related to the cessation of powder SHS production at Leeds, and this year we had a recovery of restructuring costs of $1.2 million. Also, in the first quarter of 2007 our two largest regen plants took maintenance turnarounds, whereas this year one turnaround was completed in the first quarter and the second commenced in the quarter and was completed early in the second quarter. And finally, there were a number of items in Corporate that resulted in higher costs this year, primarily accruals related to the Long-Term incentive plan and incentive compensation.
For the three months ended March 31, 2008, Distributable Cash after Maintenance Capital Expenditures was $17.9 million, or 53 cents per unit compared with $6.6 million, or 20 cents per unit in 2007.
EBITDA for the first quarter of 2008 was $22.2 million compared with $11 million in the first quarter of 2007. Revenue was $217.8 million, an increase of $89 million over 2007. Most of the Fund’s products generated higher revenues, however it was the significantly higher prices for sulphuric acid that accounted for the majority of the increase. This more than offset the impact of the stronger Canadian dollar on our U.S. dollar denominated revenues.
The corporate cost increases relative to 2007 were mainly due to costs associated with the Fund’s LTIP, which totalled $4 million, and unrealized losses on natural gas and foreign exchange hedges totaling $2 million. Also, the first quarter of 2007 included a recovery of $0.8 million related to an insurance claim with respect to Hurricane Rita.
Net earnings for the first quarter were $9.5 million, compared with a loss of half a million in 2007.
Turning to the segmented results for the quarter, SPPC generated revenue of $98.9 million and EBITDA of $19.9 million compared with $72.9 million and $7.5 million, respectively, in 2007. The higher revenue reflected higher prices for merchant acid and sulphur, as well as higher volumes of SHS, the latter including sales to customers acquired through the Olin asset acquisition. These were partially offset by the effect of the stronger Canadian dollar.
The higher EBITDA was due primarily to improved margins on sulphuric acid and SHS. The higher acid prices more than offset higher sulphur costs and foreign exchange impact and as I mentioned earlier, this year we didn’t have both our major regen plants take maintenance turnarounds in the first quarter, as we did last year. And finally, SHS results benefited from lower net zinc costs and higher realized selling prices for SHS products. As reported in previous quarters when zinc has been quite volatile, this business likes zinc costs to be stable at low levels and this is exactly what happened in Q1.
Pulp Chemicals reported first quarter revenue of $14.8 million compared with $14 million in 2007, reflecting higher volumes of sodium chlorate. EBITDA was $5.2 million compared with $4.7 million. Costs were lower this year due mainly to lower costs for salt which last year were high due to the transition to a new supplier.
International reported revenue of $104.1 million for the first quarter, compared with $41.7 million in 2007. This was a result of significantly higher prices and volume for sulphuric acid, and significantly higher prices for sulphur. The continuing tightness in global markets enabled International to generate EBITDA for the quarter of $6.2 million compared with $1.4 million last year.
Maintenance capital expenditures in the first quarter were $2.1 million compared with $1.5 million in 2007.
As we noted on previous calls, the high demand for skilled labour and materials has led to increased costs for most capital projects and we expect, therefore, that our annual maintenance capex spending will be higher this year. Accordingly, we expect 2008 maintenance capex to be about $11 million. We expect these expenditures will continue to improve our plants’ reliability.
I’ll now hand the call back to Mark.
Mark Davis
Thank you, Rohit.
The first quarter clearly demonstrated Chemtrade’s capacity and ability to generate significant earnings. This result was a combination of various initiatives which permitted us to benefit from very robust markets for our products, particularly sulphuric acid.
The market dynamics are very beneficial for Chemtrade's products, especially for sulphuric acid. As we've discussed before, there are a number of factors that are positively affecting the acid market, and we see no signs that these factors should change. These dynamics are having, and will continue to have a significant impact on our results for the balance of this year and next year. I want to provide you with additional information that helps you understand how the market dynamics for these products affects Chemtrade. To do that I have to talk about both the market dynamics and how Chemtrade is structured.
As I said on our last call, there are really two factors at play in the acid market. First are acid supply/demand characteristics, and second is the price of sulphur.
In short, a reduction of North American acid supply over the last number of years and a substantial increase in demand has led to material increases in the price of acid. As we discussed last time, demand has increased worldwide due to demand from the fertilizer, metals and biofuels industries. Demand characteristics have also drastically increased the demand for sulphur. There is no meaningful increase in acid supply projected, especially within our North American market over the foreseeable future. Growth in sulphur supply is expected to be evident starting about 18 months from now.
The tight supply/demand situation has led to substantial price increases for both acid and sulphur. Based on industry publications, acid pricing in the US Gulf region was about $80 a tonne a year ago. Now that price is listed at about $270 for spot sales. Similarly the acid price in the industrial US south was about $70 per tonne a year ago; but is now about $200.
While the pricing for acid can vary region by region based on the region’s supply/demand balance and our contract positions, these two pricing indications are consistent with our previous statements about the strength of the acid market, and our recent success in the market
These market dynamics need to be understood in the context of Chemtrade’s business structure.
The first structural element is how we source our sulphuric acid. We essentially have two sources of sulphuric acid. The first, which accounts for roughly 2/3rds of our merchant acid volume, is by-product acid that we receive from base metal smelters. The other 1/3 of our product is obtained from our own manufacturing facilities and these facilities must bear the increased cost of sulphur to produce acid.
For manufactured acid, price increases achieved are first needed to cover the price increase of our sulphur raw material. Sulphur pricing has increased to a new high of about $450 per tonne from about $60 per tonne a year ago. Since it takes about 1 tonne of sulphur to make 3 tonnes of acid, pricing for acid produced from sulphur needed to increase by over $130 per tonne just to maintain margins.
The second structural element has been the basis of our business model since our IPO. The by-product acid we market is obtained through risk sharing contracts. These contracts, and particularly the Vale Inco contract, attempt to mitigate but not eliminate typical commodity risks. While these agreements protect us from downward movements in pricing they also require us to share increasing pricing with our suppliers.
Taking the market dynamics together with Chemtrade’s business structure, our results demonstrate that we have been able to expand our margins on the acid we market for each of the last two quarters. While our margins have expanded materially they have not expanded at the same rate as the price of acid itself since we needed to cover the increased input cost of sulphur, and our risk sharing agreements pass on some of the pricing benefits to the suppliers of the product.
One final structural comment. As a general statement Chemtrade does not seek to sell a large amount of product on the spot market. There are a number of reasons for this. First, we think that continuing and consistent customer relationships are beneficial in the long term. Secondly, is the nature of our relationship with Vale Inco. This relationship is based on two fundamental premises. One is that we obtain the maximum value for their product in the market. But, the other premise is that the product they produce must always be removed and sold so that there is no interference with their core smelting operations. As part of this relationship it is important to both Vale Inco and Chemtrade that we maintain the logical customer base in certain target geographies to ensure reliability of removal. Due to this second premise, Chemtrade by design does not sell a large quantity of product on a spot basis.
Accordingly, although we have been able to increase pricing and recover our increased sulphur costs, we are not able to increase all our prices immediately. As we have said, we expect that over time our average prices will continue to climb and our margins continue to expand.
Taking all this together, as stated in our MD&A, a $1 per tonne price increase would positively affect our EBITDA by between $0.5 million and $0.6 million taking our contractual sharing into account. The benefit would be decreased by the amount of any sulphur input costs we incur.
Having said all that, this strong acid market has and will continue to be a strong benefit for Chemtrade. We expect the market to remain buoyant at least through all 2008 and 2009. Despite our increased capex spend which we've mentioned, we now expect that the next 12 months will generate higher distributable cash after maintenance capital expenditure than the 12 months just ended.
Before I hand the call back to the operator for the Q&A, I would like to remind you about our annual meeting which will take place this morning at 10 a.m. at the TSX Broadcast Centre. I hope everyone will be able to join us there.
Thank you for your attention. Rohit and I would now be pleased to answer any questions you have.
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