Eco Friendly: Making Money As Oil Falls
Summary Introduction: auto makers and the aluminum industry. Symmetry between oil costs and lower aluminum. Overview of last year’s pick: Norsk Hydro. Looking to the Future and Growth. Conclusions. Making more of our vehicles out of aluminum equates to continually lower demand for oil. Existing regulations in Europe and America require that each new generation of automobiles be more fuel efficient than the last. Car manufacturers around the globe are switching to aluminum in an effort to reduce gross vehicle weight and by doing so reduce fuel consumption. Yesterday Clark Schultz , SA News Editor released a note about Ford (NYSE: F ) and the closed loop recycling program that has been put in place at the company’s facilities. The system allows Ford to recycle every piece of scrap aluminum that is created during the production of the new F-150. This is helping to reduce the higher production cost of the new more fuel efficient truck . The trend is here to stay and in large part has been responsible for the increase in the price of aluminum over the last few years. Currently, orders by automobile manufacturers show more growth than any other sector of the aluminum market, but we will come back to that later. Although price appreciation may appear slight, it was achieved while working through an excess in warehouse inventories. Inventories are now near historical lows and supply can only be described as tight. Neat Synergy Savings Aluminum production is particularly energy intensive. This makes large producers like Alcoa (NYSE: AA ) particularly sensitive to oil price. There is a nice symmetry to the reduction in fuel consumption and demand for aluminum. As oil prices decline, the cost of aluminum could also decline. It would seem more likely, given the tightness in supply that margins will increase for producers like Alcoa before the price of aluminum declines substantially. In addition, increased recycling of aluminum is also reducing energy demand. It takes about 10% lees energy to produce recycled aluminum than it does by normal production. I covered this topic last year in the first eco friendly article that covered Norsk Hydro (OTCQX: NHYDY ). Like Alcoa, Norsk Hydro is a large aluminum producer and will certainly benefit from these savings and increased demand. I would like to take a look at what separates Hydro from the rest of the crowd. What gives them that extra competitive edge? Norsk Hydro It is almost exactly 1 year since I released my first article about Norsk Hydro. At that time I had a price target of $10.50 for December 2014 and $15.25 for December 2015. I guess we should have a look at performance then and see if we are on track. NHYDY data by YCharts 34% increase for the year is not bad especially given recent market action. The stock did trade 3% higher yesterday on a down day for the markets but at $5.32 we are still a long way from the $10 price target. Even the highs in July and November were just over $6, so what happened? All Values NOK Q1 2014 Q2 2014 Q3 2014 Q4 2014 Revenue 18.28B 18.27B 19.7B EPS (Diluted) 0.19 0.09 0.29 EBITDA 1.72B 1.45B 2.63B EBITDA Growth -3.43% -15.73% 81.48% Gross Income 2.85B 2.62B 3.67B Some of the highlights:- Revenues were stable throughout the year. ESP grew 222% from Q2 to Q3 based of higher aluminum prices Gross Margins expanded to 18.6% in Q3 before the largest decline in oil price. The company did have some real currency headwinds this year which muted performance. The strong US dollar and Euro both had an effect against the NOK. I do not anticipate a repeat of this in 2015. There is much talk in the Eurozone about another round of stimulus next year. In the US, the FOMC appears to be more dovish and many say we will not see a rate hike soon. Either of these two outcomes will positively impact Norsk Hydro. If both happen then it is even better. Trust in Management to deliver So far, these have all been external factors that the company has little control over. Good management does not just sit around and wait for things to improve; so what has the company been doing over the last year. In my first article, I covered some of the improvement efforts that the company had planned. 2009 was the last time that aluminum prices were at these levels and at that time Hydro was still losing money. The company set forth the $300 plan which aimed to reduce the cost of production of aluminum by $300 USD per metric ton. They successfully completed that program last year, a 35% reduction in CapEx. The program was so successful that they expanded it to cover smelters also looking to reduce costs by a further $100 USD per metric ton. That program has been successfully achieved this year. They then decided to expand this operating principal to the B to A division of the company. At the last earnings call, the CEO Svein Richard Brandtzaeg said: “I’m very pleased to announce that the effects From B to A improvement program in Bauxite & Alumina are coming true. The bottom line as maintenance costs following the power outages are coming down. And we can observe a reduction in cost in our reported third quarter a continuation of the B to A program was a high priority and you should continue to expect positive developments even in this business setting.” So it would seem that the margin improvements in the 3rd quarter are here to stay. The company is the most efficient producer of aluminum in the world. They have been so aggressive in conserving energy costs that the goal is now to be carbon-neutral by 2020. Continued expansion of recycling will be important in achieving this, and as we said earlier recycling adds to the bottom line. The zero footprint target over the next 5 years may initially appear unachievable but the company has consistently delivered on all of their promises so far. CO2 emissions have been reduced by 70% since 1990 and the company views this as a competitive advantage. As the world looks to industry for the answers to climate change, Norsk Hydro is very well positioned to answer. So, here is a list of other developments for the last year, all of which will add to Hydro’s bottom line in the future: February 25th EUR 130 million automotive investment in Germany to lift BiW capacity to 200,000 t/year from current 50,000 t/year April 30th EUR 45 million recycling investment in Germany to reach 100,000 t/year UBC capacity May 8th Permanent closure of 180,000 t/year Kurri Kurri smelter in Australia. Old and inefficient June 13th Enova supports planned technology pilot at Karmøy with NOK 1.5 billion June 23rd New long-term power contracts of a total 2.7 TWh for Norwegian smelters July 3rd Announcement to take control of Søral aluminium plant in Norway September 9th Sunndal production optimized by replacing remelt volumes with SU3 production September 12th Included on Dow Jones Sustainability Indices for 15th time October Alumina production at Alunorte increased to 6.0 million t/year All of which have positive implications for the company going forward. So what does this mean for earnings? Realized improvement efforts from 2011 to 2014 amounts to 3.7 billion NOK ($0.5B USD approx.). Anticipated further improvements would add another 1.5 billion NOK ($0.2B USD) over 2015-16. This does not include the synergy saving expected from the Sapa joint venture. I guess it is time to take a look at that. Is the extruded aluminum division of the company and is run as a joint venture with Orkla ASA (OTCPK: ORKLY ) ADR. There is a nice press release about the formation of the company if you would like to read it. Sept. 12, 2013 press release. For now I will just tell you what they do. They are the global leader in this area. They make building systems and aluminum tubing primarily. In terms of what the goal is, I am going to borrow directly from Hydro’s Capital Markets Day Presentation. •Continue improvement efforts and realization of annual synergies through rightsizing portfolio •Maintain No. 1 position in North America and Europe through unique network, R&D expertise, process capacity and strong customer focus •Develop attractive positions in high-growth markets •Capitalize on expectations of a continued strong US market, and respond to more challenging outlook for Europe and South America A further 1 billion NOK in synergy savings is anticipated over the next 2 years. Once you combine that with the previously-mentioned 1.5 billion for 2015-16, you get 2.5 billion NOK permanent savings over the next 2 years. It is another large reduction in expenditures. In October Hydro was spending about $550 USD per mt of aluminum on oil. How much has that come down? We have looked at all these highlights and have not even talked about growth. I guess it is time to go back to the automobiles as promised. Growth The company expects to see 6% CAGR in transportation between now and 2024. The largest component of which will come from the automobile manufacturers. For each 10% reduction in vehicle weight, manufacturers gain 5-7% in fuel economy. The table below illustrates emission targets from around the world, which will be a key driver behind demand and growth. (click to enlarge) We are already starting to see this shift occurring as outlined earlier by Ford. The economy in Europe is still a concern at the moment, but the headlines yesterday are very encouraging. Mitsubishi November European car registrations: +12.8% (OTCPK: MMTOF ) Jaguar Land Rover November European car registrations: +4.2% (NYSE: TTM ) Mazda November European car registrations: +7.1% (OTCPK: MZDAY ) Volvo November European car registrations: +11.0% (OTCPK: GELYF ) Nissan November European car registrations: +20.4% (OTCPK: NSANY ) BMW November European car registrations: +9.7% (OTCPK: BAMXY ) These headlines are just confirming the data from the prior month, and October sales. Mitsubishi had seen a rise of 68%, Mazda 25% and Nissan again near 20%. It is not all about Transports for Norsk Hydro as outlined in the Capital Markets presentation; the company sees 4% CAGR in Construction and 5% CAGR in Electrical and Electronics by 2024. Conclusion This is a long-term shift in the attitudes of consumers, manufacturers and governments. I can find no other company as well positioned as Norsk Hydro to meet this demand in the aluminum industry. In my opinion the proactive steps taken by management puts Norsk Hydro 5 to 10 years ahead of their competitors. I say that in relation to the ability to leverage the environment, sustainability and corporate responsibility as a competitive advantage. The company’s tag line for the Capital Markets presentation was “Better, Bigger, Greener” and could be seen as a working outline for all industry looking to the future. The fact that the company is going to be even more profitable while achieving this should be a lesson to every manufacturer and producer out there. You do not need to rape the planet in order to make money. The company has too much going on for me to cover it all here. I highly recommend that you do your own research and read the Capital Markets Day Presentation in full. Currency fluctuations bring another complexity to this stock, so make sure that you also take those into account before making your own decisions. I do not view this as a short-term investment, although I do believe money can be made with a shorter time horizon. I view this as a multi-year or decade-long investment opportunity. I am happy to maintain a price target of $15-$16 over the next year or two. Management has faith in the company which has been illustrated by insider buying as recently as last month. I will finish by saying that I also forgot to mention the 3% dividend, which I expect the company to maintain going forward. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Additional disclosure: This article may contain certain forward-looking statements. I have tried, whenever possible, to identify these forward-looking statements using words such as “anticipates,” “believes,” “estimates,” “expects,” “plans,” “intends,” “potential” and similar expressions. These statements reflect my current beliefs and are based on information currently available. Accordingly, such forward-looking statements involve known and unknown risks, uncertainties and other factors which could cause actual results, performance or achievements to differ materially from those expressed in or implied by such statements. I undertake no obligation to update or provide advice in the event of any change, addition or alteration to the information contained in this article including such forward-looking statements.