We initiate Interpipe’s US$211mn 10.25% notes due 2024 with a Hold. Interpipe is a steel pipe and railway wheels producer with its own steel-making facilities. It recently completed a lengthy debt restructuring, which cleared its balance sheet of excessive debt. At the same time, an outstanding FY 19 performance helped the company accumulate significant liquidity before the recent oil price shock and Covid-19 pandemic hit. INTHOL 24s seem to have outperformed the market on the way down and never felt the full strength of the March-April sell-off. One may argue that the company’s strong financial position supported the bonds, but we tend to think that their illiquidity played a role too. INTHOL 24s are indicated at mid-price of 95 (YTM 11.7%), according to Bloomberg. Because the issue is callable at par at a short notice, the potential upside is limited to 5ppts, while the potential downside is likely to be higher as the worst is yet to come when the pipe producer’s revenues and cash flows take a hit in 2020. This is partially offset by the company’s low leverage (0.3-0.6x), high cash reserves (US$134mn), low maintenance capex (US$32mn) and no debt maturities until 2023. We view Interpipe’s strong financials as protection against the downside risks and assign a Hold to INTHOL 24s.
Strong starting position ahead of a challenging 2020. 2019 was an exceptional year for Interpipe. The company came out of a lengthy restructuring with a sustainable debt level, while a temporary suspension of the 34% anti-dumping duty on railway wheels by the Eurasian Customs Union helped to generate its highest operating cash flow in 7 years. In FY 19, Interpipe’s revenues increased by 4% yoy to U$1,122mn, EBITDA was up an astonishing 64% yoy coming in at US$259mn, and the EBITDA margin increased 8ppts to 23% (Table 1 on page 3, full report). Such an impressive growth in profitability was driven by an almost six-fold increase in EBITDA of the wheels segment, which should not be viewed as a sustainable trend. Debt reduced to US$400mn from US$1.4bn through restructuring and the company accumulated US$256mn in cash. Net leverage came down to 0.6x from 8.1x. After the reporting date, Interpipe repaid US$121mn ahead of schedule, reducing total debt including contingent liabilities (US$84mn) to cUS$295mn (Table 2 on page 3, full report).
Bond structure supports prices, but call at par curbs potential upside. In 2019, as part of the debt restructuring, Interpipe issued US$309mn senior notes secured by stakes in the company’s key production facilities in Ukraine. In 2020, Interpipe redeemed a third of the issue, reducing the outstanding amount to US$211mn. The bonds have an amortising structure with the first instalment of US$150mn due on 31 Dec 2023, 12 months before the final maturity date. After the senior secured loan was repaid in January 2020, the bonds became callable at par at a short (10-60 days) notice. Interpipe has a strong incentive to call the bonds ahead of the first amortisation and final maturity. If the bonds are repaid by 25 October 2023, the company could save US$40mn in exit fees payable to the original bondholders (those who received bonds in the restructuring) and creditors under the senior secured facility. Effectively, this imposes a cap on INTHOL 24s price at par. Debt covenants loosened after the repayment of bank facilities, with total debt/EBITDA threshold set at 3 for debt incurrence test.
Poor visibility of future cash flows. The unprecedented drop in oil prices and Covid-19 related lockdowns around the world are likely to have a severe, but not yet measurable, negative effect on Interpipe’s results in 2020. The key business segments are wheels (c40% of revenues) and pipes (c60% revenues), of which 35-45% comes from the oil and gas industry. Oil and gas producers are beginning to respond to low oil prices by cutting production and capex, and consequently drilling. Wheels are likely to be under pressure too if the anti-dumping tariffs are reinstated by the Eurasian Economic Union after being suspended for a year (since July 2019. But, even if the beneficial import regime is extended, the depreciation of local currencies in the biggest economies of the Eurasian Customs Union (-18% ytd in Russia, -14% ytd in Kazakhstan and -15% ytd in Belarus) will hardly leave capex budgets of Interpipe’s key CIS customers unaffected.
Further early redemption/call is unlikely as cash flows are weakening. Taking into account the debt repayment made at the start of the year, we estimate Interpipe’s pro-forma cash at US$135mn. However, not all of it is available. According to the FY 19 financial results, some US$52mn of cash was used as a cover for the letters of credit and guarantees issued to the company’s suppliers and customers. It is quite likely that Q1 20 (or at least the first two months of the year) was relatively strong in terms of cash generation. But with 2020 looking like a tough year for Interpipe’s customers, it would be prudent to preserve the excess cash, which could be needed pay interest (cUS$22mn), and maintain capex (US$32mn) if the business cannot generate sufficient operating cash flows. Expansionary capex of US$50mn is still on the agenda, but could be scaled back if necessary. We think that in the current circumstances, the company is significantly less likely to call the bonds or make further redemptions in 2020.
Bonds of other steel pipe producers sold off more than INTHOL. There are no industry peers for Interpipe in the Ukrainian market, but there are pipe producers in Russia and the EU with outstanding bonds. None of them are perfect peers due to differences in: 1) the product mix, 2) their anchor markets, 3) financial position (leverage and liquidity) and 4) access to banking systems with high lending capacity. However, it is still worthwhile to see how INTHOL performed relative to the Ukrainian corporate space and bonds of steel pipe producers elsewhere. Figures 1 and 2 (in full report) suggest that INTHOL outperformed both Ukrainian corporates and selected industry peers. In turbulent times like now, indicative prices may be quite far from the levels at which bonds can actually change hands, particularly when it comes to small and illiquid names like INTHOL. However, they are still useful to provide context for the analysis.