Norsk Hydro is a Killer Pick in an Energy Tight Environment (OTCMKTS :NHYDY).

Posted on Value Lab 22/2/2022

IAt this point, t is becoming quite officialThe language used by Russia to address Ukraine is being called an “invasion” Sanctions are coming, and that will mean higher energy prices all around the world as Russia’s supply of oil to the west is at risk. Who is benefiting? Surprisingly, one company is Norsk Hydro (OTCQX:NHYDY)(OTCQX:NHYKF)Despite being an aluminum producer that is energy intensive, their multiple is low. Their multiple is low, and their position in the current market environment makes them attractive. We rate them a buy.

Norsk Hydro’s Positioning

Norsk Hydro’s vertical integration is the key to understanding. Their name does not imply that they are an aluminum producer. They are major producers hydropowerThey use this energy to produce their products. Vertical integration is essential to reduce the gap between high aluminum prices, and the input costs.

Aluminum prices are very high because of high energy prices. Many producers don’t have the resources to produce below breakeven. Lower production has resulted in higher aluminum prices for those remaining players. Low cost bases are a competitive advantage for industrial companies. This has resulted in a very noticeable increase in input costs, and a substantial increase in realized aluminum prices. This has led to a wide spread and excellent EBITDA growth.

We have another reason to expect the current commodities climate to remain despite the deteriorating situation in Ukraine. Other aluminum producers should continue to have a problem with curbed production. Norsk Hydro is a viable player. Their proven resilience to rising input costs should also help to sustain their wedge while other players take a break.

Conclusions and Valuation

The business currently has 7 billion NOK in cash and a market capital of approximately 160 billion NOK. This gives it an EV of around 150 billion NOK. 28 billion NOK has already been added to the EBITDA for 2021. This is the year that commodities really took off in March. This number could rise slightly in 2022 if there is a whole year of tighter prices, instead of just 9 in 2021. The current multiple is just slightly above 5x. Although an environment like this doesn’t lend itself to building capacity, which would allow for high reinvestment rate to justify very high multiples (which would be impossible in a company with a healthy net cash balance) a 5x multiple is quite low. Even optimistic assumptions point to a winddown in supply side issues that are driving up prices starting in 2024. This means that already 2 of the 5 years of EBITDA payback based upon the multiple. Given the geopolitical factors, it is reasonable to expect a longer period at high commodity prices. Furthermore, dividends are not the goal of reinvesting.

Due to the strong financials, Hydro shareholders will receive a cash dividend of NOK 11.1billion or 80% of adjusted net profit from continuing operations. This is the highest end of our 70%-80% guidance that we gave at our December Capital Markets Day.

Pal Kildemo, Norsk Hydro’s Chief Financial Officer

This yield is more than a 6% yield, which can be trusted. With the capital return opportunity being clear due to a dividend, and a margin for safety, we rate Norsk Hydro an buy. The most important risks to worry about are the hydrology risks and, frankly, inflation. Norsk Hydro is a great hedge against inflation.

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