Norsk Hydro: Evaluating Old NHY, New NHY And Statoil

Buy-rated Norsk Hydro (NHY), reporting first quarter 2007 results on May 31, also becomes Hold-rated new Norsk Hydro and Buy-rated Statoil (STO). By October 1, each share of Norsk Hydro is expected to spawn 0.8622 share of Statoil. Accordingly, we split our analysis of one stock into two parts.

We calculate the stock price for the continuing NHY as the price quoted today minus 0.8622 times the price quoted for STO. Offering Net Present Value [NPV] of $35 a share, STO has strong appeal with other oil and gas buy recommendations. New NHY appears to have a promising outlook as a pure play in aluminum, but our experience in analyzing that industry is limited.

Two More Quarters of Transition
On the quarterly conference call on May 30, Statoil Chief Financial Officer Eldar Saetre explained that after shareholders of both companies vote on July 5, another 60 day waiting period is required, meaning that the transaction would likely close by October 1. In the earnings press release on May 31, NHY Chief Executive Eivind Reiten confirms, “'New Hydro' will start trading as an aluminum and power share from 1 October.” Notwithstanding that likelihood, we have - for convenience in making consistent valuation projections for the next twelve months [NTM] - included all of Norsk Hydro’s oil and gas production with that of Statoil beginning July 1. Similarly we project only non-oil and gas results for Norsk Hydro for the same period.

Raise Industry Present Value Estimates Ten Percent
On May 29 we raised our long-term price assumptions for estimating present value to $66 a barrel for oil from $60, to $11 a million btu for natural gas from $10 and to $11 a barrel for the refining margin from $10. As a result, estimated NPV for Statoil increased to $35 a share from $32. NPV for new Norsk Hydro increased to $11 a share from $8 though it will be an aluminum company, not an oil and gas company.

The Statoil estimate fits our correlation with reserve life and cash flow for some thirty producers. From its dominant position offshore Norway, the company has expanded to offshore Africa and the U.S. Gulf of Mexico among other areas.

Results exceeding expectations reported on May 31 point to a modest NTM unlevered cash flow multiple (EV/Ebitda) of about 7 times for new Hydro. The valuation looks lower than that for industry competitors Alcoa (AA) and Alcan (AL), but we have not done a complete independent analysis of those stocks. Moreover, the connection between reported results as part of old Hydro and the actual results that new Hydro will eventually report is complicated and subject to different interpretation.

Changing Ratings and Weights
We keep a Buy rating on old NHY, the existing stock priced at $35.03 at the close on May 30, as a reflection of the combination of Buy for the two-thirds of current stock price that relates to Buy-rated Statoil and Hold for the one third of current stock price that relates to Hold-rated new NHY. Also on May 29 when we increased long-term oil price in present value, we lowered the unlevered weighting of old NHY in the illustrative McDep Energy Portfolio to half from full. The main reason was favorable price performance.

Looking ahead, we replace old NHY with STO at a half weighting in the illustrative portfolio. Investors who had a full weighting in old NHY and reduce that by a fourth would have a half weighting in STO and a residual of new NHY for equity exposure outside oil and gas.

Originally published on May 31, 2007.