In a recent article I briefly covered some of my favorite picks for 2014. Some of them I have written about before where as other I intend to give more detail on going forward. Today I wanted to have a more in-depth look at Norsk Hydro ASA (OTCQX:NHYDY) ADR. In some ways it is easy to compare them to Alcoa Aluminum (NYSE:AA) but there are some key strategic differences. I will focus on what I think makes Hydro different. Much of what separates the two companies has been the focus of development over the last decade. We all know that the last five years has been particularly challenging in the industry. How each company has met this adversity will be central to their success.
"Hydro is a global aluminum company with production, sales and trading activities throughout the value chain, from bauxite, alumina and energy generation to the production of primary aluminum and rolled products as well as recycling. Based in Norway, the company has 13,000 employees involved in activities in more than 50 countries on all continents. Rooted in more than a century of experience in renewable energy production, technology development and progressive partnerships, Hydro is committed to strengthening the viability of the customers and communities we serve." From the corporate website.
The company has a definite focus on conservation. They really do try to be a green giant in modern industry. All too often when we think of green, we are forced to weigh the financial costs against the environmental ones. Hydro believes that conservation reduces the financial cost of doing business. Being green makes you more efficient. I lived in Trondheim, in Norway, for a while and it is an attitude I came across a frequently. For example; it snows so much in Trondheim that they heat the streets. Someone sat down and worked out the cost of owning and operating the snow plows. The cost of gas needed to run them for up to four months a year. The wages of all the operators to drive them, repairs, etc. It turns out that it is just cheaper to heat the streets. This is especially true if you can use waste heat, from public buildings, that you have already paid for. It also solved two huge headaches at the same time. Firstly, you no longer have to work out where to pile all the snow, it just melts away. Second people no longer get up, possibly late for work, and discover they have to spend half an hour digging the car out. They no longer get plowed it.
"By looking beyond where we are today, it's much more possible to build a sustainable future."
As far as I know Hydro had nothing to do with that project in Trondheim. I think it illustrates the idea quite well. In many cases there are additional benefits to doing the right thing. The company has stated that it wants to be "climate neutral" by 2020.
How is Hydro Organized?
The main company can be split into 4 distinct groups; Bauxite & Alumina, Energy, Primary Metals and Rolled products.
Bauxite & Alumina
This segment of the company's operation is primarily located in Brazil.
In 2007 Hydro purchased the Alumina (Aluminum Oxide) producing activities of (NYSE:VALE) SA. By any standards this was a big deal. Hydro now gets the majority of its Bauxite from mining in Brazil. It also refines the raw Bauxite into Alumina at the world's largest Alumina Refinery.
The deal itself was valued at over $5 billion, and included hiring 3600 vale employees. Hydro had never been a miner before and bring the experience from Vale was essential for a smooth transition. They have however secured all the bauxite they could need for decades.
Primary Metal in alphabetical order, some highlights.
- Brazil: - in 2012, 460,000 tons of aluminum metal annually at the Albras plant, which they part own.
- Canada: - 20% interest in the Alumineria Alouette plant. Expansion completed in 2005 which made the plant the largest in N. America. It also has one of the lowest operating costs.
- Germany: - Hydro owns the largest plant in the country
- Norway : - operates the largest primary aluminum plant in Europe.
- Quatar : - Hydro is part-owner in an aluminum production plant
- Qatalum, with an annual capacity of 585,000 tones, is the largest primary aluminum plant ever built in one phase. It is a fully integrated plant consisting of a smelter, casthouse and carbon plant as well as a dedicated gas-fired power plant.
Also included in this segment are the Re-melting and Recycling Plants. Located across Europe they are an important addition to Hydro capabilities. In line with the company's conservation ethos, they have spearheaded recycling initiatives with partners like IKEA, WWF, Green Dot and Syklus. In addition to the European locations, Hydro has two re-melters in the USA. The plants which are located in Kentucky and Texas have a combined capacity of almost 200K metric tons a year; all from scrap metal.
"we aim to bring more metal back to life which is as good for the business and is good for climate. With only 5% of the energy needed to recycle aluminum as it originally takes to produce at first time around, had been no loss of aluminum's many qualities, recycling of aluminum makes perfect sense, especially as more and more customers are seeking greener and usable products from lifecycle perspective"
Essentially they are represented all over the world through important strategic partnerships. I have decided not to go into this now other than to say; they produce products for Auto manufacturers, create building systems, precision tubing etc.
Energy, the non aluminum segment.
They produce 9 terawatt hours of electricity annually and have a total of 17 power plants in Norway. These power stations produce electricity for many of Hydro's aluminum plants there and the excess power is sold. As we learned earlier they also have a gas powered plant in Quatar, but I believe that plant produces power solely for operations there.
At this point we can see that Hydro has positioned itself well with operations at each point along the chain. They have done this while keeping an eye on the environment and also reducing the cost of production for the finished product. An important part of this was the implementation of the $300 plan.
At various times over the last decade, the production costs for aluminum were higher than the spot price on the LME. To put it simply Hydro was losing money, even though they were one of the most efficient producers of aluminum. In 2009 they set themselves to the task, aiming to save $300 per ton from the cost of producing aluminum. By 2012 they had manage $200 per ton and have reported progress to be on track for the last sixteen quarters. On Friday Dec 6th at a Capital Markets presentation they said,
"The ability to foresee a culture means in many ways the ability to write our own history and also write our own future something Primary Metal has done so successfully with $300 programs that is now being completed. By now Primary is $300 program to say equivalent to $300 part one produced aluminum almost needs no introduction. We have been reporting on track on schedule for 16 consecutive quarters, which surely must be some kind of improvement record as the result of the great work by Hilde Aasheim and her 4500 team members in primary metals, everybody from top management to shop floor assistant has been fully on board. And as we have also been able to report for some time, this is a program that has been paying off. Without it, we would be in a very challenging situation, but instead it has lifted our self considerably relative to our competitors and we are running a competitive smelter portfolio. The $300 program has been a great story and Hilde will come back later today and explain the new program for our part owned smelters. We aim to save $180 per pound aluminum produced by end 2060. Showing how primarily it's truly living by the philosophy of continuous improvements."
When Hilde Aasheim spoke we learned a few more specifics.
"Let me then start by the $300 program, I've been talking about the $300 program, I think it's the fourth time on Capital Markets Day and I must say that I'm very happy to say now that we have achieved the $300 program."
"Since 2009 we have reduced fixed cost by roughly NOK650 million which represents a 20% reduction on our fixed cost asset base for these smelters, we have worked on improving operation and roughly 200 million is improved in terms of improved operation, which is also about productivity and the productivity in the same period has improved by 15%."
And then finally
"In this program we have focused a lot on cost discipline but also on cash discipline, and in terms of sustaining CapEx we have reduced sustaining CapEx by 35% since 2009. Without that I would say not jeopardizing the integrity of the assets because that is a fine balance"
So to wrap up this section, the $300 program was so successful in the Primary Metals portion of the business they have continued to expand it to the other parts. The cost reductions to be achieved in the smelters will come in large part from R & D in energy conservation.
"competitiveness in aluminum so closely linked to energy costs it is quite clear that running the most cost efficient smelter technology is a key success factor, overall average in 2012, 13.8 kWh/kg aluminum against the world average of 14.1, and my best guess for this year as that they will be about 13.7 and we do have test cells (NYSE:PH) running at 12.3 and even below 12 kWh/kg Al."
Going forward they have plans to build the world most energy efficient plant.
"Our ambition to be the world leader in smelter technology is illustrated by our recent announcement that we are looking into building a possible pilot plant at Karmoy. If established this plant will contain the next generation electrolysis technology and our goal will be to have the world's most energy efficient plant with the lowest CO2 footprint in the world."
There are two partnerships I would like to focus on.
The future of building is Powerhouse. According to statistics buildings account for 40% of all energy consumption. Powerhouse has an ambitious project underway in Norway, to build an energy positive office building.
An office building that produces more energy than it consumes. Although this is not a new idea, this building will certainly be the furthest north.
The building will generate a lot of its energy from a solar skin and heat pumps, which makes the location surprising. The cold dark days of the Norwegian winter will prove to be a rigorous testing ground. Once complete the building should set new international standards in energy efficiency and prove that they can be built anywhere. Helping to drive demand for Hydro's building systems, now organized under the second partnership, Sapa.
A partnership between Orkla ASA (OTCPK:ORKLY) ADR and Hydro.
"The transaction to combine Norsk Hydro ASA's Extruded Products business area and Orkla ASA's Sapa into a 50/50 joint venture has been completed as planned. Sapa, the new global leader in extruded aluminium solutions, was established on September 1.
Orkla and Hydro agreed in October 2012 to combine their respective profiles, building systems and tubing operations in a joint venture, owned 50/50 by the two companies.
With the last outstanding approval from Chinese competitions authorities on August 19, the transaction was completed on September 1.
Sapa AS, with 23,000 employees, is headquartered in Oslo, Norway, combining local expertise with a global network and R&D capabilities, serving customers from more than 100 production units in 40 countries.
The new joint venture has leading positions in Europe and North America, and strong footholds in emerging markets such as Brazil, China, India and Vietnam."
This joint venture really gives Hydro a huge global infrastructure. We learned from the last earnings release and conference call that Sapa has already begun to contribute to Hydro's bottom line. Going forward, they have identified about NOK 1 million in synergy saving and expect to realize those by the end of 2015. That just makes Sapa a more profitable venture for both companies.
There is a greater value in Hydro than the sum of its parts.
The cost reduction measures already achieved are enough to keep the company on a sound financial footing going forward and sustain the current dividend. The company's track record in this area gives me the utmost confidence in their projections going forward. In particular their ability to deliver on cost reduction while maintaining production capabilities. In addition the synergy savings attributable to Sapa are significant and will add to revenues over the next 2 years. Even without any improvement in the overall aluminum markets we should expect Hydro to outperform many of its competitors.
Current stats: from Yahoo Finance.
|Market Cap (intraday)5:||8.38B|
|Enterprise Value (Dec 8, 2013)3:||8.70B|
|Qtrly Revenue Growth (yoy):||9.90%|
|Gross Profit :||11.69B|
|Total Cash (mrq):||1.72B|
|Total Cash Per Share (mrq):||0.84|
In almost every aspect Hydro is undervalued. The strong balance sheet, with solid cash reserves could add additional upside in the face of dollar weakness long term. The company has hedged most of its exposure to the BRL for 2014.
Recent positive numbers from the auto industry and other sectors have suggested that demand is returning to pre 2009 levels. Hydro is ideally positioned to take full advantage of this.
They continue to expand their horizons and I feel that Hydro could be a great long term play.
Their current price $4.11 is far below where they ought to be even without the benefits coming from Sapa over the next two years. The only reason I do not currently hold a long position is the expectation of political turmoil in the USA during the early part of 2014.
Uncertainty surrounding the next round of debt ceiling debts could add strength to the dollar, effectively putting Hydro on sale. I would certainly buy that dip. As there can be no certainty such an opportunity will exist, I intend to start purchasing shares of Hydro after Christmas at or near current levels as it is already cheap.
- Price target for FY ending Dec 2014 $10.50
- Price target for FY ending Dec 2015 $15.25
Significant upside from here.