Hudson Q2’19 Recap: Earnings in-line with pre-release, negotiations with PNC continue. No change to thesis $HDSN

Hudson’s earnings were in-line with the pre-announcement. Unfortunately, there is no real update with the covenant relief. As stated in my last post, HDSN is in violation with its covenant with PNC. PNC can either bankrupt the company, likely taking a haircut on their debt or owning the re-org equity in a tiny company, or provide relief and continue to collect interest and possibly full payment. These discussion are ongoing, but I have a feeling PNC And the other lenders will choose option 2 over option 1.

As larger refrigerant manufacturer Chemours noted, refrigerant prices were impacted in Q2 by illegal imports into Europe. This pressured prices which eventually bled into US prices. As such, HDSN reported a 19% sales decline to to price, but a 12% increase in volumes. The volume growth is pretty good in the context of unseasonably cool Q2.

Moving to the forward look, the company noted this on its earnings call (my emphasis added):

As we move through the back half of 2019, we draw closer to the end of R-22 production. In June of this year, 3 largest allocation holders notified that customers that they have discontinued the sale of R-22. This information reinforces our belief that stockpiles are dwindling and that possibly, by the end of this cooling season, the industry may have worked through its stockpiles. Upon the elimination of R-22 to stockpiles, we expect that the R-22 market will operate within a traditional supply demand model and that the negative price influence we’ve seen during the past 2 seasons will be alleviated. It’s important to note that the pricing pressures of the last 2 seasons were created by the 3 largest allocation holders, which we believe related to market dynamics, that had nothing to do with R-22 demand in the U.S. rather we believe these pricing pressures were associated with shortfalls in other areas of our businesses.

Given the existing installed base of R-22 equipment and with the elimination of Persian production, we expect to see a shortfall in the supply of R-22, and we believe our ability to reclaim and resell R-22 creates a tremendous opportunity to position Hudson to address the anticipated supply shortage and become the leading producer of R-22. Currently, we’re seeing R-22 pricing of approximately $9 per pound, while this pricing dynamic has negatively impacted our 2019 selling season to date, we expect that the R-22 market will demonstrate more traditional supply-demand behavior once production has stopped, which will result in increased pricing for R-22.

In sum, management’s thesis is unchanged.

As for the debt, the company disclosed it will be getting a $9MM payment from Airgas for a working capital adjustment. That may seem small, but helps with some breathing room. PNC has been getting monthly details on HDSN’s performance so seems like it knew there would be a breach so hopefully conversations end soon.  Can’t help but like this statement:

We didn’t generate cash relative to our increased interest rates and debt services and so forth. So that really [indiscernible] get into what cash we generated, but the we had to have a little bit more borrowings during the period. We’re good at come out of that cycle though. We originally thought we would generate about $20 million of free cash flow. We’re not going to generate that level but certainly, with the cash award that we have with the Airgas, we’ll probably end up being in the mid-teens for the year. So you’ll start to see the dead coming down and the availability increase over the remainder of the year.

Mid-teens FCF on a $20MM market cap company… I’ll take it.

The company also mentioned its looking to tap new lenders in the 2H’19.

Certainly, we should and have publicly said that we will be looking to seek new lenders in this back half of ’19. That is our intention. But we also need to resolve the matter with the current lenders relative to a wavier and amendment to get that behind us

These likely will be more of the “special situation” type lenders, so may come at a price (and possibly new equity or some hybrid type of security that might include PIK interest to help cash flow, but I’m just hypothesizing here). This too is good news. No bankruptcy is good news.

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