Description
SXC fair value is +40-100% and the catalysts to make it happen have already been announced: (0) Expiration of restrictions from Sunoco spin-off; (1) sale of coal mining division; (2) drop down of Haverhill and Middletown; and subsequent dropdown of Indiana Harbor, Granite City, and Jewell; (3) Indiana Harbor getting back to full function in 2H14.
Notes:
Geronimo wrote up SXCP over a year ago. This thesis played out well. SXCP is up over 75% (including dividends) since that write-up in a climate where MLP/REIT income stocks did not do well. We have recently exited our SXCP position, but we believe there is lots of value and catalyst in SXC.
As a caveat, this idea has tail risk to a China/commodity implosion. Because it has long-term pass-through contracts, it has very little quarter-to-quarter exposure, but if its North American steel customers were to go bankrupt and close plants, it could hurt SXC/SXCP.
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Background
SXC was IPO'd from Sunoco in July 2011. It was then spun-off in January 2012. They had a two-year tax-sharing agreement that restricted SXC. This Agreement expired a month ago.
SXCP was IPO'd in January 2013 as a classic MLP for dropdown of SXC assets.
SXC is in the business of coke production. They have an adjacent business in coal logistics. They are selling their adjacent business in coal mining. And they have discussed acquiring or building other adjacent businesses.
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SXCP
I will start with SXCP analysis
- 32.1mm units (including GP units (2%) but NOT including the IDRs)
- 13.5mm LP units held by public; rest held by SXC
- net debt = $143mm -- all at SXCP -- not at project level
- With SXCP @ $30.00 --> Mkt Cap = $963mm; TEV = $1,106mm (not including IDR)
- the IDR is a standard IDR structure. The IDR gets nothing up to 47 cents of qtly dvd; it gets 50% (less GP 2%) over 62 cents. At present, the recently announced dividend is 50 cents, and the DCF is 60 cents per shr. So, the IDR is "at-the-money" at present.
SXCP owns 5 assets:
- 65% of Haverhill (HH) #1
- 65% of Haverhill #2
- 65% of MiddleTown (MT)
These are each new coking plants with 550 kT/year of capacity.
- 100% of Lake Terminal -- acquired for $29mm recently
- 100% of Kanawha Terminal -- acquired for $85mm recently
Pro- Forma for owning Coal Handling assets all year:
EBITDA from Coal Handling = $15mm
EBITDA from three Coke Plants = $157mm * 65% = $102mm
EBITDA from Corporate = ($7mm)
Total EBITDA = $110mm
Pro Forma Maint Capex = $20mm (this is about 3.5% of replacement cost -- it seems a bit light to me but probably not as bad as other MLPs)
Pro Forma Interest = $12mm
So, DCF = $78mm (8.1% yield)
Dividend last announced of 50 cents; so implies dvd yld of 6.7%
In terms of valuation with present assets, I think SXCP is still a tad cheap. The customer-concentration risk is over-stated, but there is commodity tail risk, especially at contract renewal time. However, these contracts run a decade, and they are fairly iron-clad. I think $34 is fair value, but the current price is close enough, and I will treat it as fair the rest of the way.
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SXC Analysis
69.9 mm shrs @ $21.68 --> $1,515mm
Net Debt at ParentCo = $311mm (Note: Technically, all the debt sits ar SXC, but SXCP is responsible for principal and interest on $190mm)
TEV = $1,826mm
Simply using the valuation implied by SXCP share price, we get:
Units held by SXC (including GP but not IDR) = 18.5mm --> $555mm
The 35% holdings in HH and MT --> 35%/65% * ($1,106-113) = $535mm; The $113mm is cost of Terminals; You can do EBITDA analysis and get same answer.
This means that we are paying $736mm for SXC less SXCP/HH/MT.
For this $736mm, we get three domestic coke plants:
- Indiana Harbor (1,220 KT) -- it has been undergoing extensive refurbishment and there is still $20mm of capex and 6 months of work left
- Granite City (650 KT) -- this is the same vintage as HH and MT
- Jewell (720 KT) -- this is a very old plant that has been more recently refurbished.
Including their share of corporate overhead, these three plants will produce $130mm of EBITDA (starting in Q4 2014) as compared to the $145mm of HH and Middletown.
On this basis, these three plants (IH + GC + J) alone should be worth $1.37bn. You can run more complex analyses, but in short I get a value of $1.2-1.4bn once dropped down.
But wait! We get more:
- VISA Sun Coke (India) -- 49% of a 440 KT coke plant. They invested $68mm for the stake. It has gotten off to a rocky start.
- Brazil Coke -- SXC has an operating agreement and a preferred equity stake that gets paid upon meeting certain volume -- This produced $16mm EBITDA in 2013 and they expect improvement on this number in 2014. I am trying to find out more about the longevity of this earnings stream, but management is quite positive in discussing it.
- Coal Mines -- They are selling, but they need the coal production to operate the nearby Jewell plant. I think there would be a buyer at a price above zero if this requirment were not in place. As it is, I have it valued at zero. I do not think it is a huge negative as it has been profitable depending on met coal prices.
- Future growth -- this can be a positive or a negative, but I am cautiously optimisitc that management will deploy capital on low-risk cash flow streams to drive growth. This mgmt team has said and done the right things thus far.
- I think SXCP is still a bit cheap, and should rise 10%. This would add 10% to below valaution. Perhaps some leverage at SXCP might help as well.
- And finally, the IDR. Given that we are "at-the-money," the valaution of the IDR is highly sensisitve to whatever model being used. I have a range of $100mm to $500mm.
So, the sum-of-parts using low ends:
SXCP holdings (not incl IDR) : $555mm
IDR: $100mm
35% holdings in HH and MT: $535mm
IH+GC+J: $1,200mm
VISA Sun Coke: $50mm
Brazil Coke: $125mm
Coal Mines: $0
Taxation
A positive take-away from the recent Investor Day was that management is very tax conscious at the SXC level. I had feared that my analysis above would be somewhat bogus because of the possible tax inefficiency of holding LP units in a C corp. However, management has committed to tax efficiency, and I expect less than 10% tax leakage. Further, due to federal tax incentives, these assets would not be paying a 35% tax rate even if held in a straight C Corp vehicle. I am still learning the details on this matter, but I believe that the discount for holding these assets in a C corp is going to be about 5%.
Valuation
Total : $2,565mm --> less debt of $311mm -->$2,254mm pre-tax penalty --> $2,141mm mkt cap or $30.63. I, of course, think this is quite conservative.
Risks:
- The biggest macro risk is North American steel making shutting down. Even if a customer went bankrupt but stayed in business, the economics would not change much.
- But the biggest risk is management growth plans. They could add a lot of value, especially via the IDR, but they could also destroy value.
Catalysts:
-- Selling Coal Mine
-- 35% stake drop-downs (HH and MT)
-- IH + GC + J drop-downs
-- Indiana Harbor getting back up to speed
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
-- Selling Coal Mine
-- 35% stake drop-downs (HH and MT)
-- IH + GC + J drop-downs
-- Indiana Harbor getting back up to speed