Zinc Miners to Benefit from Dell Battery Recall?

by: Paul DeMartino

After Dell Inc. (DELL) recalled laptop batteries made by Sony Corp. (NYSE:SNE) on Aug. 16, our first reaction was to slam Sony. After all, $400 million is a lot of money even by multi-national standards. But rather than cursing the darkness, we thought that we'd light a candle instead. What companies stand to benefit from faulty laptop batteries? Companies that mine the only thing that all future battery technology must contain: metal.

Sony's battery woes aren't going to sink the company but, leaving aside the short-term impact of what may be a very material earnings hit, Sony's growth rate may be negatively affected if its relationship with customers including Dell, Apple Computer Inc. (NASDAQ:AAPL) and Hewlett-Packard Co. (NYSE:HPQ) sours.

However, as Morgan Stanley analyst Masahiro Ono told Reuters on Tuesday: "Realistically speaking, it would be hard for Dell to find another supplier that can provide a large number of batteries as stably as Sony." Not to quibble, but such companies as Sanyo Electric Co., Sharp Corp., and Matsushita Electric Industrial Co. would probably give it a good try. Alas, though, from an American investment perspective, there is no ADR available for these companies, and it's unclear, in any case, which if any would profit from Sony's misfortune.

Furthermore, the names that the American consumer thinks of first for batteries, Duracell (a division of Proctor & Gamble Co. (NYSE:PG)) and Energizer Holdings Inc., (NYSE:ENR) don't make laptop batteries.

With that in mind, we turned to the idea of the future. Unfortunately, the development of batteries is not as fast-paced as that of, say, semiconductors. The big future technology seems to be "fuel cell" tech. Fuel cells are similar to batteries, but run off of a fuel that can be replenished in an ongoing manner. Advances in the field seem to be geared around use in battery-powered and hybrid vehicles and using water as a fuel source, which is mostly theoretical right now. Wikipedia, though, notes that there is one type of fuel cell in mass production: zinc-air batteries, which are disposed of rather than refilled.

Zinc-air batteries run on, well, zinc, air and catalysts. The specifics can be found here. Currently, they're used in hearing aids and electric vehicles. Between those two extremes is laptop-battery size, obviously, but so far as we know no one is developing zinc-air laptop batteries specifically.

There seem to be two reasons for that. First, zinc-air fuel cells, because they work by depleting a fuel of zinc, can't be recharged. This seems relatively minor to us. A necessity to load your laptop with a fuel cartridge may be annoying, but from a business perspective that's another way of saying "recurring revenue stream." Second, and far more importantly, there has been overwhelming competitive pressure from lithium-ion battery manufacturers. We sense that there might be a chink in that armor.

So let's imagine a world in which zinc-air batteries fuel the next generation of laptops. One would imagine the demand for zinc increasing, naturally. Fundamental Metals Monthly said in an Aug. 17 report that "According to the International Lead and Zinc Study Group, global consumption of zinc is increasing, while production of the metal is decreasing." (The most recent information at the International Lead and Zinc Study Group is subscriber only, but the reader is invited to check it out anyway.) The research report also states that the price of zinc is up 80.2 percent so far this year.

At this point, one could imagine that futures contracts on zinc might be the way to go. Not so fast. Zinc-air is one of several competing technologies; we've merely concentrated on it because it's the best tested. Betting on a winner in a standards war, particularly when there's another tech that dominates now, is a high-risk strategy. Furthermore, zinc's price is cyclical, reflecting its importance in industrial materials; zinc is the coating that galvanizes galvanized steel. Given recent economic uncertainty, now might not be the time to go into a financial instrument tied to a cyclical material and that carries an expiration date.

That said, all battery technology has one thing in common: metal. Lithium, zinc, nickel, even potassium or barium are used in current or potential battery technology. If this is the case, then we might want to turn to the suppliers of metals in general for investment ideas, since a significant increase in demand for any metal would likely be good for a profit boost. The first idea, then, is the SPDR Metals & Mining ETF, (NYSEARCA:XME) which would simply be exposure to the industry in general.

Our analysis of zinc, however, suggests that perhaps we can do better with an equity investment in some company that mines the metal specifically. We turned to the Reuters Select screens for company ideas. There were six metal mining companies on the screens recently. A visit to the Web sites of those companies revealed two with zinc mining operations: Australian miner BHP Billiton Ltd. (NYSE:BHP) is on the Lesser Known Stocks screen and Canadian miner Teck Cominco Ltd. (TCK) is on Relative Growth, Rising Expectations, Industry Leaders, and Strong Operating Margins.

We performed valuation analyses on these companies. BHP Billiton carries a 1.65 percent dividend yield, so we looked at the shares from the perspective of future dividends. A new investment in the stock at recent prices seems to require an 8.6 percent per-share annualized dividend growth rate over the next six years to break even. Three analysts provide long-term earnings growth rate projections. The average is 28.4 percent, the high is 44.0 percent, and the low is 14.0 percent. Using the lowest projection and an assumed future payout ratio of 30 percent, below the five-year average of 35.9 percent given the trailing 12-month payout of 14.7 percent, our analysis projects possible dividend growth of 13.7 percent. Since that's above 8.6, BHP is probably worth further review by interested investors, though some of that "undervaluation" is likely a result of ongoing labor unrest at a copper mine in Chile.

As for Teck Cominco, it operates the Red Dog mine in Alaska, which is the "world's largest producer of zinc concentrate." A recent bid to acquire fellow Canadian miner Inco Ltd. (NYSE:N) fell through, and the market reacted favorably, pushing the share price just under its 52-week high. A new investment in Teck Cominco at recent prices seems to require an 8.7 percent annualized per-share earnings growth rate over the next five years to break even. The two analysts who provide long-term earnings growth rate projections differ widely: 21 percent and 5 percent. The mean of 13 percent is well above our requirement, but the spread suggests that only those who side with the bulls should continue their zinc exploration with Teck Cominco.

At the time of publication, Paul DeMartino did not directly own puts or calls or shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.