Description
Thesis Summary
â– Stable, non-cyclical and highly cash flow generative business that is half of an industry duopoly
â– Today’s bond price is the equivalent to buying the company at 6x EBITDA or receiving the equity in a restructuring at a 25% FCF yield which is far too cheap
Situation Overview
PYX is levered nearly 8x with most of the debt maturing in 2021. The company had planned to monetize a small cannabis business they own to help facilitate refinancing the capital structure. However, over the last 6 months cannabis stocks fell over 50% delaying the monetization process and causing the bonds to trade down from 90 to 55. The core business however continues to perform well and at the current price the bonds are cheap even assuming PXY files bankruptcy and the cannabis business is worth $0.
Core Business Overview
Pyxus (PYX) is the second largest tobacco leaf exporter/importer in the world. The company is the middleman between the farmers that grow the tobacco and product manufacturers (Phillip Morris, British Tobacco, Japan Tobacco, etc). Together with Universal Corporation (UVV) Pyxus is part of a duopoly that controls around 80% of the non-vertically integrated tobacco supply.
There are two reasons this business exists. First is the logistical infrastructure required to buy from small farmers around the world. Globally, Pyxus may buy from over 100,000 farmers many of whom are in remote locations in Africa and South America where infrastructure is lacking. Pyxus offers technical assistance to many of these farmers, often going as far as to provide seeds and fertilizer. Tobacco is also perishable and must be processed shortly after harvest. PYX’s global network of facilities allows for quick local processing and proper storage.
The second reason for this business to exist is that it provides a clearinghouse for different types of tobacco. Every crop will contain various grades and varieties of tobacco, yet product manufactures require specific types to create the right blend for their products. PYX will buy an entire crop from farmers and then allow manufacturers to pick only what they need. The company’s large and diverse customer base ensures that PYX is able to find a buyer for the entire harvest.
PYX’s annual results can fluctuate materially based on harvest conditions. Tobacco demand is highly stable, but weather (and to a lesser extent political conditions and pests or diseases) can cause the volume and quality of tobacco production to vary significantly. Adjusting for these periodic variations it is not hard to underwrite $175mm in normalized EBITDA (vs. LTM EBITDA of $193mm) for the core leaf business.
This is Not a ‘Melting Ice Cube’
In North America smoking rates are falling and have been for many years. However, the U.S. accounts for less than 5% of global cigarette consumption. Global cigarette consumption is likely falling but at a very slow rate. This is at least partially offset by growth is other types of tobacco use. Any decline in global tobacco consumption will be offset by: 1) increasing percentage of volumes outsourced by PYX’s customers, and 2) Increasing market share for the PYX and Universal at the expense of the remaining smaller industry players. For these reasons, PYX has stated they expect volumes to grow slightly over the next several years.
Scenario Analysis
Broadly speaking there are 3 possible outcomes here:
Refinancing – Its still possible that PYX is able to refinance prior to maturity using some combination of cash from asset monetization, a term loan and an ABL facility. While this appears increasing unlikely, in this scenario the bonds would return 100% in less than 18 months.
Fulcrum Security in a Restructuring *most likely outcome*– The most likely outcome is that the 2nd lien creditors receive some combination of new notes, equity and rights in a chapter 11 or out of court restructuring. This scenario will provide a compelling return at current bond prices.
Minimal Compensation in Ch 11 *unlikely* – It is possible that 1st lien lenders could try to effect a restricting that provides minimal recovery to the 2nd lien. This could only be at a valuation of
Restructuring is a Good Outcome
The most likely outcome is a chapter 11 or out of court restructuring where noteholders receive some combination of new notes, equity and rights. The simplest scenario would be that the second lien receives all the equity in the post-reorg company and the other creditors are unimpaired. This would leave the company with a manageable 4.5x leverage ratio with 3x interest coverage. In this scenario (shown below) today’s bond price is equivalent to buying reorg equity at a 26% CF yield. Of course, the actual restructuring will likely be more complex and could involve other transactions such as a rights offering to further reduce debt or some small recovery for equity. However, these variations do not materially change the economics of a reorg.
Figure 1: If Bonds Receive 100% of NewCo Equity
While exactly how a restructuring plays out is unknowable, since the 2nd lien is almost definitely the fulcrum security bondholders should have a good return as long as they are buying the business at a good price. 6x is simply too cheap for a business of this quality. While we don’t generally find it instructive to look at peer EBITDA multiples, in this case UVV is a near perfect comp to PYX. UVV trades at a long-term average multiple of 8.25x implying that if PYX traded at this level post-restructuring there would be at least 70% upside to the current price.
Figure 2: UVV Trading Multiples
Bond Docs and Asset Support Provide Confidence in a Restructuring
In addition to the financial analysis, we feel OK holding these bonds into a bankruptcy because the bond documents look good and there is tangible asset support. We had a specialized lawyer review the documents for this bond and believe we have a good indenture if creditor’s rights are tested in Chapter 11. Additionally, the absolute worst case for any bankruptcy is a full liquidation. Given the long history of strong cash flow for this business, liquidation seems highly unlikely. Even so, as shown below the 2nd lien should recover at a level near the current market price in a liquidation. Most of the company’s inventory is ‘committed inventory’ meaning it is already sold to a major tobacco company. Similarly, most accounts receivable are with high-quality counterparties. As such, PYX’s working capital would be expected to receive a substantial recovery in liquidation.
Figure 3: Liquidation Analysis
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
Debt refi or restructuring