Norsk Hydro Earnings Have Fallen, But The Share Price Has Not Yet Dropped

seekingalpha05-22

Norsk Hydro reported lower adjusted EBITDA in Q1, with reduced sales volumes, lower prices, and compressed margins.The company's cash position may be reduced if negative cash flow continues.Its share ...

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Monty Rakusen  Norsk Hydro logo (Norsk Hydro) Investment Thesis In January this year, we decided to downgrade Norsk Hydro ASA (OTCQX:NHYDY) (OTCQX:NHYKF) based on lower earnings, higher expected Capex, and competition from lower-cost producers, such as those in China. When writing our last thesis, the ADR was trading at $5.90 and the share price went down during the first quarter. However, things are starting to look better with increasing aluminum prices. We believe this is the main reason NHYDY's share price is up 7.5% to $6.34. It has also been helped by higher investor confidence in the prospects for equities, in general. NHYDY has published two quarterly results since our previous call. It is therefore a good time to revisit our earlier thesis. Our focus is on their latest financial results. Norsk Hydro’s 2024 Q1 Financial Results  Profit & Loss NHYDY reported an adjusted EBITDA of NOK 5.4 billion in Q1 of 2024. This is lower both on a Q-o-Q basis and on a Y-o-Y basis. The reduction was 28% and 45%.   Norsk Hydro - key performance metrics in Q1 of 2024 (Norsk Hydro - Q1 of 2024 Results Presentation) Sales volumes suffered, margins were compressed, and higher costs caused the drop in EBITDA. This meant that the TTM adjusted return on average capital employed was only 5.6%. After EBITDA, we need to look at the finance costs. Here they had a net foreign exchange loss of NOK 1.63 billion. Fortunately, interest costs were only NOK 597 million. The higher interest rate environment can be both a positive and a negative thing. Due to NHYDY's considerable cash holdings of NOK 19.6 billion, they also had an interest income of NOK 426 million. We all know that Norway, where NHYDY is domiciled, is well known for its high taxes. NHYDY had income tax expenses in Q1 of NOK 720 million. That is 63% of income before taxes. As such, the net profit after taxes for Q1 was only NOK 428 million. That is a net profit margin of only 0.9% of the revenue. Let us look at their adjusted EPS.   Norsk Hydro adjusted EPS (Data from Norsk Hydro. Graph by author) Their TTM EPS was NOK 3.47 at the end of Q1. With a share price on the Oslo Stock Exchange, as of 17th of May 2024, of NOK 67.16, we get a P/E of 19.35 We expect to see a higher EPS in Q2, as the aluminum price has improved by 16%.   Aluminum price improvement taking place in Q2 (SA) The FCF has been negative in every quarter since Q1 last year. Apart from the three quarters shown above, they also had a negative FCF in Q2 of 2023 of NOK 8.42 billion, and in Q3 of NOK 3.348 billion. Balance sheet At the end of Q1, NHYDY’s LTD was NOK 31 billion. This is quite manageable, given their cash position of NOK 19.6 billion. However, as we have shown, due to lower margins and capex going out, the cash position will be reduced if the trend of negative cash flow continues. This is an area we want to monitor going forward. Management continues to guide for a Capex for 2024 to be about NOK 15 billion. Dividend & Share Buyback In 2022, the board of NHYDY decided to reduce the dividend payout ratio. It had been paying out as much as 101% in the year before.   Norsk Hydro - historical shareholder distribution (Norsk Hydro Q1 of 2024 Financial Presentation) It now aims to pay out a minimum of 50% of adjusted net income as ordinary dividends over the cycle to its shareholders. They have also set a floor of a minimum dividend of NOK 1.25 per share. In addition to the dividend, they have also used share buy-back to reward shareholders. The company has been buying back shares. Since they received a mandate in May last year to buy back shares, they have bought back, and canceled 21.16 million shares for NOK 1.32 billion. NHYDY's Valuation We already pointed out that the TTM P/E was 19.35 How does this compare with the general market? NHYDY is part of the Oslo Stock Exchange Index. That index covers the 68 largest companies listed on the Oslo Stock Exchange. NHYDY is the third largest, with an approximately 5% weighting of the index. According to Morningstar, the average P/E for this index is 8,04. Morningstar has a forward P/E of 13.28 for NHYDY. SA’s valuation tool puts NHYDY’s P/Book on a TTM basis at a reasonable 1.29 against a sector median of 1.91 Last, but not least, we do want to assess the dividend yield as a part of the valuation. The main reason for this is that, as value investors, we often find that picking great value propositions gives us little certainty about whether the value will be unlocked and when it is going to happen. It could be within one year, which would be nice, but we often find ourselves holding on to value stocks for many years. We do not mind this waiting time, as long as we get paid fairly while we do the waiting. What is a “fair” payment? This probably means different things to different people. Our assessment is based on what alternatives we have with our money. The principle of an equity risk premium should apply, in our opinion. If the ERP is negative, in other words, your dividend yield is lower than what you can get on risk-free assets, like a Treasury note, you are not being compensated for taking the risk of holding equity. NHYDY’s 3.71% TTM dividend yield delivers a negative ERP of 0.71%. As of the time of writing, the 10-year U.S. Treasury Note yields 4.42% Based on this, we cannot claim that NHYDY presently trades at a price that is offering good value for money. Risks to Thesis We do have some concerns about a global fallout from Chinese factories running overcapacity, flooding global markets with cheaper products. The U.S. President just fired the latest salvo with a rise in duty from 25% to 100% on the import of EVs from China to the U.S. And they have made it clear that this will also include “Chinese cars” assembled in Mexico. This big jump in levy seems to be mostly a political move aimed at voters in the upcoming U.S. election because as the Atlantic Council recently pointed out, only 1% of EVs imported currently come from China. The E.U. has more to be worried about, as the import of Chinese manufactured EVs have had success in increasing their market share in Europe. It has gone from an import value of $1.6 billion in 2020 to a staggering $11.5 billion in 2023. It has now reached a market share of 37% of imported EVs. Perhaps it is because of this development that the U.S. wants to nip this in the bud. The Europeans are supposedly coming out with a decision on 5th June with their decision about potentially increasing duties on import of EVs from China. The risk that the G7 nations may lose their competitiveness in heavy industries such as aluminum is real. Tariffs by one side are going to be met with tariffs from the other side. China has become an important market for luxury European car manufacturers. Their sales could be hit hard if China decides on similar moves to what the U.S. just announced. With stock markets reaching all-time highs, it is easy to become complacent. Recessions? What recession? We recommend all SA readers to make good use of Seeking Alpha's transcripts from companies conference calls. It is the Q&A session that is the most interesting. Presentations are usually done as marketing material, but good analysts will probe and seek answers not already given by management. In NHYDY's latest conference call with analysts, management also raised their concerns about the strong export growth of Chinese EVs and how this could negatively impact their business. Conclusion In our previous article, we concluded that our belief was for NHYDY to deliver lower earnings and return of capital to shareholders. We thought that it would result in a lower share price throughout 2024. So far, the causation, which is lower earnings, has not happened, but the effect, which should be lower share price, has not yet materialized. We still believe that Benjamin Graham’s wise words of the stock market behaving like a voting machine in the short term, and a weighting machine in the long run still make sense. Therefore, we still maintain our stance of a Sell. The risks and rewards do not entice us to change our stance.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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