Following the completion of a successful bond exchange offer, Grupo Idesa finally released its 4Q22 earnings earlier this month. The results were very poor, with EBITDA falling to a mere USD 1m in the quarter, down from USD 10m in 3Q22 (See Table 1). While costs of sales fell 6.4% quarter-over-quarter (QoQ) to USD 131m in 4Q22 from USD 160m in 3Q22, revenue decreased by a larger 13% over the same period, to USD 137m from USD 173m. This resulted in an operating income of USD -1m in 4Q22. For the full year, the company highlighted higher raw material prices and lower sale volumes, which were offset by higher sale prices.

The low EBITDA, alongside higher capex, negative working capital (WC), and the payment of the semi-annual bond coupon on the 2026 notes in November, led to a free cash flow (FCF) of USD -29m in 4Q22, bringing the FY22 FCF to USD -40m.

We had warned in previous reports that Idesa’s strategy of turning to its suppliers to finance itself during 2021 didn’t seem sustainable in the long term, and a worsening of the operating cycle already started to be perceived in 2Q22 and 3Q22. The operating cycle deteriorated further in 4Q22, marking its worst level since 2Q20 (See Table 2). Nevertheless, it now remains at the pre-pandemic levels.

Debt capitalization also complete

However, with almost five and a half months already into the new year, and the conclusion of partial debt capitalization that ran in parallel with the bond exchange, the most interesting thing with the earnings release was getting a peek at how the capital structure looks now. As such, the company provided pro-forma numbers of its debt as of 2 May (See the indebtedness composition table at the beginning of this report).

As the company had previously disclosed the results of the exchange offer, we already knew the size of the new 2028 notes, as well as the 2026 holdouts. Therefore, the attention was on how exactly the capitalization of Inbursa debt for up to USD 310m would affect the different facilities provided by the Mexican bank. The surprise here is that, in addition to the term-loan (USD 263m outstanding as of 31 December 2022, although we estimate that it amounted to around USD 280m by the end of April, thanks to the PIK interest) and the loan granted by the bank to cover the November coupon (USD 14m), Inbursa also capitalized a portion of the facility for the expansion of Idesa’s maritime terminal. As such, the outstanding size of this facility, which has the payments of a client of the storage business as collateral, moved from USD 29m as of the end of 2022 to USD 10m by 2 May 2023. Idesa didn’t specify, however, whether the partial capitalization of the maritime terminal facility changed the final maturity of this debt (originally, a 68.5% final amortization of the USD 33.5m granted was due in September 2024).

The company also indicated that, in early January, it paid down the USD 3m in debt with BBVA that it had left (therefore, also releasing the USD 1m in restricted cash that was linked to that facility), while in the period between the end of 2022 and 2 May 2023 it increased the size of a new WC facility with Inbursa (used to pay down more expensive factoring lines) to USD 41m from USD 26m.

FCF still negative despite LM

At 6.5%, the new 2028 notes and the Inbursa loan used to fund the cash portion of the exchange offer bear an annual interest rate that is much lower than the coupon (cash and PIK) of the 2026s. Meanwhile, beyond the clear benefit of improving the leverage by getting rid of a large portion of debt, the Inbursa capitalization also comes as a relief in terms of interest payments.

However, those benefits mostly affect what would have otherwise been a heavy debt service going forward, but don’t involve extreme changes with respect to the interest payments made over the last few quarters, as the old Inbursa term-loan was still within a period that allowed Idesa for a full PIK payment, and the cash portion of the 2026 notes’ coupon didn’t reach its maximum until November 2022.

On the other hand, the scheduled principal amortizations of the Northgate facility started in September 2022.

Under the new pro-forma capital structure, we estimate that Idesa faces USD 18m in interest payments and USD 7m in principal amortizations in the eight-month period between May and December of this year. Meanwhile, for the next 12 months (NTM) from May we estimate USD 28m and USD 10m, respectively.

During the 4Q22 earnings call, Idesa’s management guided an FY23 EBITDA of USD 35m, with capex and tax payments more or less in line with last year.

Against that backdrop, we expect the company to continue burning cash this year, with an FCF estimate of USD -27m for FY23 and of USD -24m for the post-liability management (LM) period between May and December (See Table 3). In our estimates, we have preferred to err on the cautious side by not including any cash contribution from the joint venture Braskem-Idesa (BAKIDE), as Idesa’s management indicated during the 4Q22 call that it doesn’t expect material contributions from the JV this year.

As such, until the cash distributions from BAKIDE improve – and assuming steady capex, WC contribution and taxes paid, Idesa would need to record a 12-month EBITDA of at least USD 72m to cover the estimated USD 28m in NTM interest payments, and thus break even in terms of FCF (EBITDA of USD 82m would be required in order to also cover the USD 10m in NTM debt

Your main lender and shareholder will always be there for you

Therefore, with a cash position that amounted to only USD 6m as of the end of 2022 (down from USD 12m three months earlier), we expect the company to require additional financing in the upcoming quarters.

In fact, while making a further debt reduction a priority going forward, the Idesa management acknowledged during the earnings call that some additional WC financing may be needed during the year.

In that sense, we have no doubt that Inbursa will again be there for Idesa when needed. As we noted in our Idesa 3Q22 Credit Report, with the debt capitalization the company was set to become Inbursa risk (an investment-grade financial group controlled by one of the richest people in the world). Together with its previous 25.01% stake in Idesa, the capitalization was slated to give Inbursa a controlling position in the company. However, as the capitalization was closed in April, Inbursa’s increased stake in Idesa wasn’t included yet in its 1Q23 earnings, but we will pay attention to the next quarters’ reports to see how the bank consolidates and reports its presence in the petrochemical company (while the capitalization was formally carried out by Capital Inbursa and Promotora Inbursa, the previous 25.01% stake was held by Sinca, the vehicle used by Inbursa for its equity investments).

Also, asked during the 4Q22 earnings call about the possibility of replacing the existing Northgate debt with additional debt from Inbursa, the Idesa management indicated that this is an option the company is reviewing. To us, this is something that makes total sense, since the Northgate debt is expensive and we are sure Inbursa would be able to provide cheaper financing (even acknowledging that Inbursa is a public company and thus it should be an arm’s length transaction).

While the consent solicitation that ran hand-in-hand with the exchange offer involved the removal of all the collateral that previously guaranteed the 2026 notes, we are not sure whether the cash sweep feature is still there (before, if its cash balance exceeded USD 20m at each of the year-end annual test dates, Idesa had to devote 80% of the surplus to repaying the notes). In any case, Idesa has become a master of navigating through very tight liquidity situations, and therefore we don’t expect the company to hold cash positions greater than USD 10m-USD 15m at any time going forward.

As a side note, the FY22 audited financials showed that Idesa sold its 50% stake in Tonalli in August. The transaction didn’t involve a significant cash flow, according to the company. Also, given that this JV (created for the exploration and production of oil in a Mexican block) wasn’t yet contributing to Idesa’s results, we don’t foresee any impact at all on the company’s earnings in the future.