After seeing their dividend survive the global financial crisis in 2008-2009, Methanex (MEOH) recently found it appropriate to reduce them by a massive 90%. Even though this now sits in the rear-view mirror, analyzing their situation can still provide insights into the probability of it being reinstated and even more importantly, if this is actually a warning sign of worse pain to come.
When assessing distribution coverage, I prefer to forgo using earnings per share and use free cash flow instead, since distributions are paid from cash and not from “earnings”. The graph included below summarizes their cash flows from the last quarter and previous three years.
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Their operating cash flow has fluctuated over the years, which should be expected for a methanol producer as prices for their underlying commodity fluctuate across time. Following their recent surge in capital expenditure, their free cash flow and thus dividend coverage was weighed down heading into this downturn at only 48.83% in 2019.
Nevertheless, during 2017-2019, their average dividend coverage was still a very strong 379.96%, which indicates that on average their dividend can easily be funded without the use of debt. This provides quite a positive sign for their ability to reinstate their former dividend once operating conditions recover. Especially since their excess dividend coverage provides a margin of safety and thereby means that they are not necessarily reliant on the earnings from their future growth projects, such as their Geismar plant in Louisiana.
When looking at their immediate future, naturally their free cash flow will continue to suffer as this downturn persists, as was evident throughout the first quarter of 2020. Due to the volatility in commodity prices and general uncertainties surrounding when this downturn will end, accurately forecasting their free cash flow is practically impossible. Nonetheless, when releasing the results for the first quarter of 2020 they forecast that demand for methanol will be lower in the second quarter versus the first quarter, so it seems highly likely that their free cash flow will continue suffering for longer.
Since their free cash flow should be adequate once operating conditions recover, the main deciding factor in reinstating their dividend will be their financial position. The three graphs included below summarize their financial position from the last quarter and previous three years.
Image Source: Author
Naturally, many of their financial metrics fluctuate across time along with their earnings, which can partly cloud any judgments regarding their leverage. Overall, they appear to have entered this downturn with moderately high leverage, as evidenced by their gearing ratio of 44.98% and interest coverage of 3.43. Whilst this is not likely to threaten their ability to remain a going concern, since they operate in a capital intensive industry, they will likely be required to deleverage before completely reinstating their dividend, which should not be too surprising since they have also been seeking flexibility from lenders.
Since they have a history of producing ample free cash flow during years of normal operating conditions, once a recovery eventuates, they should be capable of deleveraging quickly. Even if their net debt were to reach approximately $1.5b before operating conditions recover, based on their historical average free cash flow of $394m for 2017-2019, they could deleverage in only two years by approximately halving their net debt. Realistically, they are likely to take longer than this as they continue to progressively increase their dividend, which is not necessarily any worse as it provides shareholders with more income sooner.
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Whilst there have been concerns regarding their liquidity when they reduced their dividend since they have been seeking flexibility on certain covenants, these appear to be overblown. They are a fundamentally viable company, as evidenced by their historical ample free cash flow, and when this is combined with supportive central bank policy, it seems unlikely that they will be facing a liquidity crisis in the foreseeable future. To further help their case, they have always had adequate liquidity throughout the past three years, with an average current ratio of 1.59 for 2017-2019 that was also accompanied by a relatively large cash balance.
Whilst seeing their dividend being reduced by 90% is certainly painful, thankfully it does not appear to be a warning sign of larger problems and it seems likely that they can reinstate it shortly once operating conditions recover. Due to the uncertainties surrounding the timing of any potential recovery and the fact that once reinstating their previous dividend, investors would only see a yield of approximately 6% on cost, I believe that a neutral rating is appropriate.
Notes: Unless specified otherwise, all figures in this article were taken from Methanex’s Quarterly Reports, all calculated figures were performed by the author.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.