(Idea) Genesis Energy
Where is the stock headed after it sold its soda ash business?
By: Jon Costello
On Monday, Genesis Energy, L.P. (GEL) announced the sale of its soda ash business. The deal addresses two issues that have weighed on GEL units in recent months. First, it generates cash to pay down debt and convertible preferred securities. Second, it eliminates exposure to global macro economic forces that have depressed soda ash prices and reduced the segment’s margin contribution to GEL’s financial results.
While those are clearly positives, the negative is that the deal was made at what I consider to be a low price. Had they held out for the soda ash market to inflect higher, they probably could have gotten a better price.
Poor Capital Allocation Continues
GEL bought its soda ash operation for $1.3 billion in 2017 from Tronox and invested billions into growing it and making it more efficient.
To finance the acquisition, GEL made a $750 million private placement of Class A Convertible Preferred Units to Tronox. While the conversion feature remains far out of the money, GEL is currently paying interest of 11.25% on the preferred units.
GEL’s expansion of its Granger trona processing facility, completed in late 2023, added 750,000 tons of soda ash production capacity, or nearly 20% of the capacity at the time. The expansion cost several hundred million dollars, a “portion” of which was funded through the issuance of $250 million of payment-in-kind preferred units in 2019 that paid an implied average interest rate of 11%. Then, in 2022, GEL refinanced the preferreds through a bond offering that featured a 10% overriding royalty interest in the company’s trona mineral interests for a 20-year term. Of course, all these capital investments are unadjusted for inflation.
The investments increased the book value of the soda ash operation to $1.67 billion by the time the Granger facility expansion was completed in late 2023. This book value is above the sale price of $1.4 billion.
It’s clear that the soda ash business was a poor use of capital, followed by investments that failed to yield a return.
This wasn’t the first time GEL’s management bungled capital allocation. I warned about the risk of poor capital allocation in my first GEL article and reiterated it in my article published on September 8, 2021, as follows:
Genesis Energy units are cheap, but our dim view of management’s capital allocation abilities leads us to see risk for unitholders. The risk is unquantifiable but is nevertheless real. It pertains mainly to the potential for management to do something dumb such as a high-priced acquisition or low-returning expansion project. So while the company’s operating prospects may be poised to improve, we’re avoiding GEL units as an investment.
With capital allocation risk in mind, I spoke with GEL management about the soda ash operation before making an investment for the HFIR Energy Income Portfolio. Management was bullish on the operation’s growth prospects, its status as a low-cost global producer, and the long-term demand outlook for soda ash.
As it turns out, this enthusiasm appears to have been misplaced, assuming the sale is indicative of a change in management's outlook on soda ash. Given management's decision to invest large sums in soda ash production since 2017 and its many comments over the years about the operation's bullish prospects, I have little doubt that it views this sale as a disappointment.