Norsk Hydro (OTCMKTS:NHYDY) stock valuation is looking better – looking for alpha | Candle Made Easy

D Lentz

In my last article on Norsk Hydro (OTCQX:NHYDY), I made it clear that while the company is one of my favorite Scandinavian investments and companies, there is a problem with such an overvalued company Situation marked by a lot of headwind. Headwinds in the form of macro, cost, energy pressures and the raw cyclicality of business and massive slowdown in China.

Because of this and this article I have been on hold and am now changing my stance to a cautious “BUY”.

Let me show you why.

Norsk Hydro – Latest information on the business

While the valuation for the company has improved, by which I mean it has come down, there are reasons for the fall that confound the near-term/2022E forecasts. Macro and energy pressures are becoming “real” and Ukraine, of course, isn’t making it any easier either.

Well, it’s still fair to say that Norsk Hydro is one of the better prepared companies to handle this pressure. We saw that very clearly. The company has its own power generation, which partially insulates its aluminum production from the problems of other companies. Many capacities are also located in South America, which further differentiates the company from Europe and the potential here.

Weaker demand for aluminum

Norsk Hydro IR (Norsk Hydro IR)

We reported 2Q22 on that date. Strong markets make for good profits, but uncertainty is heightened, meaning visibility is actually lower. There is an interesting dichotomy that Hydro reports on recording results, but the stock price can fall by over 20% in a very short period of time. The company is also seeing record volumes and overall momentum for its green products as the world becomes more focused on such ventures.

Hydro is making excellent progress on overall decarbonization and is ahead of its previously mentioned roadmap. In addition, in accordance with its dividend policy, Hydro proposes an additional distribution to shareholders in the form of special dividends. That’s something I expected — but since the stock price has plummeted since I sold my shares, I’m not exactly mad that I missed out on what ended up being less of a reward than reaping the gains on my original investment.

A few updates here.

The current situation for Hydro is essentially a play on the current energy trends as well as the volatile supply/demand situation. I contend that visibility has very rarely been lower in the last 15 years that I’ve set my sights on Hydro.

world economic climate

Norsk Hydro IR (Norsk Hydro IR)

The company has slightly updated its capital structure, remains focused on a rating of BBB or higher from major financial institutions and operates with an adjusted net debt to EBITDA of less than 2X, reflecting the current interest rate environment we are entering. However, Hydro has one of the strongest cash positions in the entire sector. Its dividend policy remains attractive, with a minimum floor of NOK 1.25/share, although the company has to take on debt to pay it, with an otherwise targeted target of 50% (adjusted net income), with the potential for additional dividends or buybacks as Supplement Compensation for Shareholders.

Therefore, NHYDY shareholders are well protected with their investment if they buy the company at a good price. The company proposes to pay an additional NOK 1.45/share, equivalent to NOK 3 billion, as well as implement its NOK 2 billion share buyback program in the coming months, all subject to the approval of an extraordinary general meeting.

The company simply delivered improved EBITDA for the quarter even compared to very strong comps. However, these advantages were based almost exclusively on margins and prices, which the company was able to enforce due to the very tight supply. Headwinds were indeed very visible as raw material costs rose, costs rose and energy prices rose. Hydro is not immune to this.

If global trends in bauxite/alumina pricing begin to shift, it will provide negative trends for the company and things should fall fairly quickly. The company also benefits from alunorte’s ability to finally deliver on time.

The current global situation and prices for metals and commodities are also acting as tailwinds for the company’s inventory valuations, which are being re-priced at higher prices and can distort business results if we are unaware. In the metals markets sector, the company delivered higher premium and positive revaluation results despite lower commercial results for the sector.

While NA growth rates for demand for extrusion remain at the same level, Europe has been updated and now expects negative growth for the coming quarters as well as negative growth for the full year 2022.

Norsk Hydro – European extrusion market estimates revised by CRU

Norsk Hydro IR (Norsk Hydro IR)

The company had net cash (no net debt) into Q2 22 but the dividend payment caused this to go negative so the company’s adjusted net cash/debt is now NOK 6.3 billion in debt, say about $600 million. For a company of this size, this is anything but worrying.

The company is also working on a possible M&A of Alumetal, a Polish recycler listed on the Warsaw Stock Exchange. This is a relatively small M&A with a total offer value of around €232 million, but it will significantly strengthen the company’s already growing share of European scrap metal recycling and reduce its carbon footprint.

Alumetal is the second largest producer of cast aluminum alloys in Europe with a production capacity of 275,000 tons per year with three plants in Poland and one in Hungary. The company sells its products mainly within Europe and to the automotive industry, which is the largest customer group. Alumetal also has experience in sorting post-consumer scrap (PCS) and is currently building a new, state-of-the-art sorting line.

So it’s worth considering as a significant benefit for the company.

Because of all these positive trends, I see a share price below NOK 60 as much more attractive than it was a few months ago. Remember that my initial position at Hydro had a cost base of less than NOK 24/share and was an incredible overall investment considering the returns I was able to generate. I am excited to return fully to Norsk Hydro and bring it back to a 3-5% portfolio position – but I will not do so at a price that could hurt my returns in the coming years as the cycles reverse and we look at years of underperformance.

This would not be out of the character of Hydro at all.

Norsk Hydro share price

NHYDY stock price (search alpha)

When you look at these trends, you can see very clearly how an investment in hydro can and should be made.

Norsk Hydro review

And while we’re off its highs, I don’t think we’re close enough to the potential bottom or bottom just yet. Flying high with a market tailwind doesn’t make a great company — or at least not a great investment. Good investments are made when undervalued companies are bought at cheap prices.

The volatility in Hydro’s forecast is very evident when looking at analysts’ accuracy here – as analysts typically miss (50%+) their forecasts for the company negatively. That doesn’t help, and current projections are for a 3-year EPS growth rate of essentially 0% on average.

Currently, S&P Global views Hydro as ‘BUY’ with an average price target of NOK 55 on the low side to NOK 100 on the high side. Given the NAV target for this company, where it is trading close to 0.9x at this price, I would seriously question the targets and details of this NOK 100 share price target. The average is around NOK 78/share, which is still too high for me in terms of its multiples.

Analysts hated this stock when it was rated at 25-35 NOK/share. I bought it because I knew the basics and the substance of this company. Yet now that the price is still more than double the price I paid, analysts are suddenly loving the company, with 8 out of 13 analysts here still rating it as either a “BUY” or an “Outperform.”

However, there are also advantages here – that is why I am writing this article.

NHYDY is not the same company I bought years ago at rock bottom valuations. It now has more capacity and other benefits. I think the earnings forecast for 2022E is at least reasonably accurate, assuming we don’t see any significant deterioration in some fundamentals. Once 2022E is over I believe and forecast that earnings levels will normalize but I think they will settle at significantly higher levels than we do due to the attractiveness of CIRCAL and similar green initiatives that put NHYDY on top Have seen it in the past up the food chain in terms of long-term appeal. Taxes on non-EU aluminum and cheap raw materials will go further to isolate the company from competition here.

In short, I do see upside potential here — even if it’s long-term. Also, you can’t look at this year’s dividend as a guide to the future, but must look at the company’s floor and normalized earnings payout ratio as more of what you “will get.”

Ultimately, I am not ready to go beyond an average weighted P/E ratio of 10X for the company at this point, which brings us to a target for 2024E of around NOK 75/share and upside potential of around 18.5% per year. or 51% overall. But there is a lot the volatility in that forecast and a lot of things that frankly could go wrong or go down that we can’t predict here.

It is clear that the The company is currently undervalued into 2022E. But I want more than 2022E when I return to Hydro — because it’s not hard to find high-yield companies with collateral in this market.

I like how much the company has fallen and how quickly it has done so. My previous target for Hydro was 68 NOK – and I’m sticking with this PT here. That makes the company a “BUY” for me, but a volatile one, and I’m not going back just yet.

I might regret that, but I also see better alternatives out there at the moment. Still, on its own, and in the context of the market and its forecasts, there is enough upside at Hydro now to make this an interesting prospect.

thesis

My current position on Norsk Hydro is this:

  • Norsk Hydro is currently fairly valued compared to normalized future earnings. While current trends are cyclical and will eventually reverse, there is enough value at the company to turn positive here.
  • The potential returns from today’s levels are now acceptable compared to what other investment alternatives on the market are offering us.
  • At current valuation, Norsk Hydro is a BUY with at least the beginnings of what I see as attractive upside potential.

Thank you for reading.

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