Norsk Hydro: Commodity Price Beneficiary

Buy-recommended Norsk Hydro (NHY) offers 14% appreciation potential to our estimate of net present value of $31 a share, that presumes a long-term oil price of $60 a barrel. The estimate was revised from $26 a share on June 6 when we revised our oil price from $50 a barrel.

The current quote for six-year oil futures is $73. Reported results in oil, natural gas and aluminum in the second quarter of 2006 released on July 25 confirm the simple expectation that cash flow and earnings should track commodity price. Though an extraordinarily high marginal tax rate of 78% on oil and gas production in Norway gives the government more than enough of incremental revenue, energy price gains still work out to be incrementally positive for NHY profits and stock price. Most of the remaining 37% of value in the company is in aluminum where cash flow has also been rising with aluminum price. The relationship is not as straight forward because high cost facilities that have turned unprofitable have been shut down.