Buy high, sell low. This strategy has never made a whole lot of sense to me but many people seem to be doing that in today’s market. They listen to all of the “experts” on TV when they call a bottom in the market, and they jump in hoping to get lucky. Of course the market continues to fall, and these people sell out of fear. If your stock picking strategy is based off of luck, I won’t be the only one to tell you that you’ve got yourself a losing strategy. You can continue to do this, and experience little success, or you can find cheap stocks with a large margin of safety. I believe I have found such a stock. This is why I say forget the rabbits’ feet, buy Horsehead.
Horsehead Holdings (ZINC) is one of Benjamin Graham’s net/net stocks that has quite a bit going for it. (A net/net stock is one that sells for less than its net current asset value.) It is the largest producer of high quality zinc oxide and Prime Western (PW) zinc metal in North America. It is also the world's largest recycler of zinc-bearing materials, including electric arc furnace (EAF) dust generated by steel mini-mills during the melting of recycled steel scrap. It also owns and operates on its premises a 110 megawatt coal-fired power plant that provides it with a source of electricity and allows the company to sell approximately one-fifth of its capacity. Its products are used in a variety of applications, including in the galvanizing of fabricated steel products and as components in rubber tires, alkaline batteries, paint, chemicals and pharmaceuticals.
Horsehead operates in the Industrial Metal and Minerals industry, an industry ranked 82 or 99 by the very trustworthy Value Line. Why so low? Commodity prices have plummeted as demand from China, India, and other developing countries has suddenly disappeared. While demand may have slowed, I can promise you that development in these countries is far from done. Commodity based stocks have followed suit as Horsehead Holdings is down 75% in the past 6 months. The severe decrease in commodities has created a wonderful opportunity in Horsehead. Here is a breakdown of the numbers as of 10/31/2008:
- 6 Month Change: -75%
- Price: $3.46
- P/E (trailing): 1.8
- Forward P/E: 4.00
- Percent of NCAV: 79.59%
- Price/Tangible Book: .45
- Price/Sales: 0.22
- Price/Cash Flow: 1.6
- Debt/Equity Ratio: 0.00
- ROIC: 29
- Market Cap: 121.76 Million
- Cash: 68.98 Million
- (Trailing 12 Month) EBITDA: 112.64 Million
- Enterprise Value/EBITDA: 0.47 (I encourage anyone who does not know what this ratio is to look it up. It is considered to be one of the best ratios in determining whether a stock is cheap or expensive. 0.47 is ridiculously low (cheap) by the way.)
- Z-Score: 4.38
- Piotroski F-Score: 5
(The previous 2 figures are simply tests to see if a company is in danger of going bankrupt. A company is considered to be safe from bankruptcy if it has a Z-score of at least 3 and an F-Score of at least 5.)
The numbers say the company is cheap, and this alone would get me excited. However, what gets me even more excited are the institutional holders. There are 5 funds that own at least 5% of the company's stock: Wellington Management (13.3%), Harbinger Capital (9.8%), TPG Axon Capital (7%), Third Point (6.8%), and Cobalt Capital Management (6.7%). There are also 11 other professional institutions invested in this stock.
On August 27, 2008, Cobalt Capital Management filed its first ever 13D filing. It sent a detailed letter to the company discussing the opportunities currently available to stabilize the current earnings and improve the long term prospects of Horsehead. The letter also urged Horsehead to repurchase more than 30% of its common stock over the next 12 to 18 months. Cobalt also suggested that Horsehead assess the standalone economic merit of smelting secondary material, evaluate a purely integrated business model, and reconsider its resistance to taking on debt.
Cobalt Capital is run by Wayne Cooperman, son of legendary Omega Capital founder Leon Cooperman. Wayne Cooperman says he seeks companies benefiting from secular or cyclical trends and that are undervalued for what he considers inaccurate or short-sighted reasons. Cobalt is not an activist investor. Cooperman says he likes to invest with management that "gets it," and is doing what he thinks they should. He claims that he also needs to understand and agree with how management is allocating capital. He says buying cheap stocks with poor management and forcing them to do something different is not how Cobalt tends to do things.
However, two of Horsehead's other large stockholders are Harbinger Capital and Third Point. Both have experience in activist campaigns. Third Point, in particular, has an impressive record of successful activism. If one of these stakeholders becomes more active in this investment, it will likely get the support of the other two, comprising a combined total of 23.3% of the company's common. If the value of the company’s stock continues to remain at these levels, I would not be surprised to see this. With Horsehead’s insanely low EV/EBITDA, it would be an easy sell for much more than it sells for today.
In regards to zinc itself, it appears that due to a declining price many companies are shutting down their zinc operations. Those familiar with the basics of supply and demand can see how this will benefit Horsehead in the years to come. Current prices of $.4949/ lb suggest at least 1.3 million tonnes of production will shut down by 2009, according to Octagon Capital. Strategic Resources Corp (TSE:SRZ) announced earlier this month it would shut down one of its mines and canceled two other zinc mines scheduled to go into production.
Lundin Mining (LMC) announced its zinc mine in Ireland will enter a three-year phased shutdown. Hudbay Minerals (HBMFF.PK) announced it will be shutting down one of its zinc mines in upstate New York. Mining giant Teck Cominco (TCK) said it will be closing down one of its zinc mines in Australia.
That’s just a few of the bigger ones. Five more mining companies have either shut down their zinc mines, scaled back production, or canceled plans to go into production. Already, mining deals for new mines are getting shelved. Not too many investors and financiers are willing to get behind a new project if current producers are getting shut down. It’s history all over again. If commodity prices continue to fall, we’ll be right back in the same position we were five years ago. The mining industry will be underfunded and underdeveloped and the supply side of the equation will be in catch-up mode once again. (This paragraph contains information received from another article on this website, “Zinc Falls Victim to Commodity Boom 2.0.”)
If this stock is of interest to you, I encourage you to read two other articles about ZINC on this website titled, “Got Zinc? The Long Case for Horsehead Holding” and “Horsehead Holding: Compelling Idea with Large Potential.” Both have many points that I chose not to touch on because they already did.
So as you can see, I believe this to be an excellent long-term investment. I would suggest you approach these shares with a bit of caution however. While still well off its 52 week high of $23.51, the price has jumped 40% over the past week or so since I first purchased the stock. This is unfortunate for me as someone who averages down when purchasing stock, but I guess that’s a pretty good problem to have. Most commodity stocks have jumped like ZINC has and I would not be surprised to see them come back down in the near future.
If you want in, put this one on your watch list and when the market has another inevitable big down day, go ahead and start your position then. Buying in 20% increments every 10% it goes down should serve you well. Like I said before, forget any sort of luck you may try to implement in your stock picking process. Go for good companies with a large margin of safety. Go with Horsehead.
Disclosure: Long ZINC.