By Jonathan Szwarc and Arthur Almeida

After we warned of a challenging environment for Unigel during our 4Q22 Credit Report, management mentioned the possible breaching of the 3.5x net leverage covenant (incurrence with regards to the 2026 bonds and maintenance in the case of the domestic bonds due 2027) last month on its 1Q23 conference call. The price of the 2026 bond went down to the 70s from the 90s.

On 5 June, the Brazilian petrochemical producer said it hired Moelis as financial advisor and Felsberg Advogados as legal advisor. Although Unigel responded to a local press report that banks were worried about a bankruptcy filing by saying “that it does not envision such a possibility,” the market got spooked and the 2026s have since traded anywhere between the mid-20s and low-40s.

On 6 June, Unigel announced an NDA with Petrobras [B3: PTR4] “to analyze joint business involving the development of opportunities in fertilizers, green hydrogen, and low carbon projects.” Of the investors we have spoken with since, the more optimistic say “they are doing a holistic JV regarding agro, so they might be able to renegotiate the natural gas supply contract and obtain lower prices,” while the pessimists say “they’re doing a JV for the green hydrogen project, which is in very early stages, so it’s not really a big deal.”

Ideally, an agreement will encompass both views, but there are some aspects that are easier to get done than others. Therefore, potentially arriving at a holistic solution could take too long, and it might be better to start signing on the things they agree to and move forward. It would be fantastic news if Unigel could give Petrobras a stake in the agro segment (including green hydrogen) in exchange for lower natural gas prices and Petrobras’s commitment to invest the necessary funds to complete the first phase for the green hydrogen project.

Unigel needs to hurry up and start explaining to the market what it wants to achieve and how it plans to achieve it. Prices for their 2026s are at default levels, and the longer the company takes to clarify the situation, the longer it exposes itself to investors potentially amassing a large stake of the bonds and trying to force a default to take control of the company.

Legal and contractual situation

Unigel’s total debt (principal only) as of 1Q23 was USD 711m, with the USD 530m 2026s and the BRL 500m (USD 98m) 2027 debentures accounting for a combined 88% of the total. Then, there are some operating leases (excluding the long-term lease of the agro plants with Petrobras), bank debt and working capital lines amounted a total amount of USD 83m (See Table 1 and Figure 1).

As mentioned above and in our previous report, the major problem lies with the debentures. Clause 6.1.2 establishes that an event of default occurs when the company’s net leverage, measured as net debt dividend by adj. EBITDA, surpasses 3.5x.

However, there is a way to prevent a default from being declared. Clause 6.1.4 of the debentures says that the trustee, within two days of becoming aware that an event of default has occurred, has to schedule a meeting so debenture holders can vote on what to do. To obtain a waiver, the company must get two-thirds support from debenture holders (that is two-thirds of the BRL 500m).

Without doing any math, it is clear that unless a super bullish cycle is starting tomorrow similar to that of 2020 -2021 (which doesn’t seem likely), Unigel will probably need a waiver until late 2024, so it would be great if the company could get a six-month waiver and not have the Sword of Damocles over its head every three months. Ideally the waiver would be for much longer, but from the lenders’ point of view, you may want to have optionality, so giving a 12 or 18-month waiver might be asking a little too much.

Management mentioned other types of debt on the 1Q23 call that are constrained by the same net leverage limitations. As those lenders are probably banks and in small quantities, it is logistically easier to obtain a waiver.

If Unigel fails to obtain a waiver, the 2026s have a cross-default clause in excess of USD 25m. That is, if Unigel is in default for a combined amount in excess of USD 25m, then an event of default automatically triggers for the bonds and they are accelerated. If we arrive at that situation, then it’s Armageddon, as the Brazilian company would open the door for some investors to get a sizeable stake in the 2026s and manage their way into getting a big piece of the pie in the petrochemical producer.

The 2026s are not a problem from a financing point of view. As is typical, Unigel has multiple baskets it can tap, in excess of USD 200m plus “Project Finance Indebtedness, which is not guaranteed by any Restricted Subsidiaries at any time.” Our interpretation is that if a subsidiary were to be labeled unrestricted (ie the sulfuric acid plant), it could basically take as much debt as it wants.

Economic and financial situation

The key to getting a sense of the urgency is whether Unigel will breach the 3.5x net leverage covenant when they release 30 June results or when they release 30 September results. As of 1Q23 total debt was USD 755m, the cash balance was USD 135m (plus USD 23m positive result from the swaps) and LTM adj. EBITDA was USD 276m, resulting in a net leverage of 2.2x. Simply speaking, given than adj. EBITDA for 2Q22 was USD 131m, for the company to be within the 3.5x net leverage ratio, that would give the company time to better elaborate a strategy, would be USD 14m (30% below 1Q23 and 90% below 2Q22).

First of all, we have to answer the question “can Unigel post an adj. EBITDA of USD 14m (assuming neutral changes in net debt) to delay breaching the covenant by 30 June and delaying it to 30 September?”

As a reminder, Unigel’s 1Q23 adj. EBITDA was USD 20m, USD 9m coming from agro and the rest from chemicals. From the agro segment, the company mentioned during the 1Q23 conference call (that occurred on 17 May) that it was doing maintenance work in the Sergipe agro plant and also that if prices remained as they were, it was possible that the plant was going to be shut down for all of 2Q23. What we’ve seen is that prices (and therefore spreads) are lower during 2Q23 than in 1Q23 and we also know that volumes will be lower (probably will be above half of 1Q23 in case Unigel had some inventory it could sell).

Now for the chemicals segment. After what appeared to be a bottom in 4Q22 when the segment posted a mere USD 3m, it recovered to USD 13m. Since then, spreads for the main four products are lower in 2Q23 relative to 1Q23. If the chemical segment is able to somewhat recover to somewhere in the USD 20m range or even USD 30m in quarterly EBITDA, then we can bet that the covenant will not be breached with the 2Q23 results, and the problem will be when the company announces 3Q23 results (this is of course assuming no changes in net debt QoQ). If not, the deadline for the waiver will be mid-August. As the situation is today, the USD 83m adj. EBITDA recorded during 3Q22 will be replaced by a much lower number during 3Q23 and most likely we’ll be over the threshold for the net leverage covenant.

Now, can net debt remain unchanged on a QoQ basis? On the capex front, Unigel reduced 2023 guidance from USD 120m to USD 80m (and we wouldn’t be surprised if it’s lower). So, after disbursing USD 40m in 1Q23, the average for the remaining quarters would be USD 13m per quarter (so a USD 27m improvement from 1Q23). On the interest expense front, both the 2026s and the debentures pay coupons during 2Q and 4Q (USD 23m for the 2026s and USD 7m for the debentures). This incremental interest expense more than compensated for the probable improvement in the capex front.

Looking at working capital is a good way to elicit a smile. During 1Q23 Unigel had USD 19m in incremental working capital needs. It is more complicated to manipulate payables (your suppliers will complain you aren’t paying) and receivables (they are going to tell you “I’m not paying cash, so chill out!). However, what is interesting is that the days of inventories, at 61, is the highest ever recorded. If we consider that the agro segment is not producing at full speed, we can very well assume that part of the USD 234m in inventories belong to the agro segment and will be sold during 2Q23 to generate cash and push the date Unigel will have to deal with getting waiver on their debentures (See Figures 2 and 3).

Path to sustainability

Assuming Unigel can obtain as many waivers as needed from debenture holders (and other lenders), then we should turn to the question of sustainability. Let’s first focus on the cash outflows, which amount to at least USD 140m per year:

• Interest expense, of USD 75m-USD 80m (USD 46m for the 2026s, USD 16m for the debentures, and the rest corresponds to the interest in the remaining indebtedness the company had as of 1Q23 and the new BRL 200m in took during April)
• Capex. The company repeatedly said maintenance capex is USD 40m per year
• Leases for the agro plants amount to USD 25m a year

For the chemicals segment (styrenics plus acrylics) we have a little more history to evaluate trends based on historical figures. Between 1Q18 and 1Q23, the average quarterly adj. EBITDA was USD 33m, making a yearly run-rate of USD ~120m. The best four consecutive quarters were 3Q20 to 2Q21, in which the amount during the 12-month period was USD 219m, and the weakest four consecutive quarters were 3Q19 to 2Q20, when the amount was USD 82m, followed by 4Q19 to 3Q20 with USD 87m, and followed by 2Q22 to 1Q23 with USD 97m. As a result, based solely on these five-plus years of data, we believe that we are closer to the bottom of the cycle than from the highs. As such, it wouldn’t be too crazy to think that we should be trending upwards from where we are (See Figure 4).

For the agro segment, as we’ve said multiple times, the key is the price the company is paying for its natural gas supply. The problem is the low domestic supply of natural gas that makes “the market” in Brazil operate based on brent prices. We can clearly see that on the way up between early 2020 and end of 2022 the price of the Henry Hub index and brent oil prices had a high correlation, but on the way down since then, they hzve not. From its peak during mid-2022 to today, brent declined 44%, while from its peak in September 2022, the Henry Hub has dropped 58% until today. Because Unigel has its natural gas supply tied to brent, it is experiencing very high production costs versus peers that can use natural gas prices that more closely follow the price of natural gas. The “good” news is that Unigel’s current contracts run until the end of 2024, but the situation as it is right now, with bond prices in the 20s is unsustainable for another 18 months (See Figure 5).

When looking at a 10-year series, it doesn’t seem that prices of ammonia and urea are particularly at low levels, so the problem here is clearly on the cost side. The company itself revealed that it considers itself to be in the third or fourth quartile in terms of competitiveness, implying it is not very competitive.

Overall, with USD 120m from chemicals and USD 30m from the sulfuric acid would be sufficient to break even in terms of cash flows, with whatever can come from agro (ammonia, urea and green hydrogen in the future) be a plus. This by no means would be enough to delever the company, nor creating positive buzz for a potential IPO (which was on deck not so long ago), but at least can provide some rough idea of what would be enough to survive.

Conclusion: Focus on what's urgent, work towards what’s important

If Unigel wants to continue to be a performing company a few months from now, it needs to get a waiver from the debenture holders as soon as possible. Without this, there isn’t much to discuss. After obtaining the waiver, we think the petrochemical producer must focus on getting the funds for the completion of the sulfuric acid plant, as the incremental USD 30m-USD 40m will count towards the total EBITDA and improve the long-term sustainability of the company. Something of similar importance would be to try to get Petrobras to amend the natural gas contract, but that is probably not easy. Finally, once all these necessary conditions for survival occur, the company should see how it can continue with the green hydrogen project.

So far, there is a lot of execution uncertainty, which is reflected by the bond trading in the high 30s. If the company is able to execute (and hopefully their advisors are working towards that), the fair value of the 2026s would be twice what it is today.