Norsk Hydro Delivered Slightly Better Results In Q2

seekingalpha08-15

Q2 financial results show revenue up 7% from Q1 but down 5% Y-o-Y, with adjusted net income improving by 12%.Norsk Hydro ASA's share price dropped 21% since our bearish call in May.NHYDY's net debt ...

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Monty Rakusen  Norsk Hydro logo (Norsk Hydro presentation) Investment Thesis We continued our Sell stance on Norsk Hydro ASA (OTCQX:NHYDY) in May this year, as we pointed out that the share price had not priced in the drop in earnings. It has now dropped 21% since our bearish call. On the 23rd of July, NHYDY came out with their Q2 and FH 2024 results. It is a good time to revisit the thesis to see if our stance remains, or if we are turning more positive on this aluminum giant. Financial Results NHYDY often measures its results in terms of EBITDA. We seldom use EBITDA because, as Charlie Munger and Warren Buffett often pointed out, it is arguably meaningless. We prefer to look at the trends of revenue, adjusted net operating profit, and free cash flow. When there are deviations, on either a yearly or quarterly basis, we try to assess the reason for the deviation. The revenue in Q2 was up 7% from Q1 at NOK50.9 billion, but when we look at it on a Y-o-Y basis it was down 5% from NOK53.6 billion. The adjusted net income improved by 12% from NOK1.50 billion in Q1 this year to NOK1.68 billion in Q2. But to keep things in context, the net income was 51% lower on a Y-o-Y basis. Adjusted EPS was NOK 0.97 per share. Here is the trend of the quarterly adjusted EPS.   Norsk Hydro EPS development (Data from Norsk Hydro. Graph by author) Although the adjusted EPS is a far cry from the levels seen in 2022, it is at least on a positive trend. Investors and shareholders need to accept that this industry is highly cyclical, as are many other commodity-related businesses. To drive home that point, NHYDY pointed out in their conference call with analysts that raw material cost increase in Q2 ended NOK 450 million higher than what they had guided back in Q1. They also communicated that they expect further increases in raw material costs. On to the balance sheet and cash flow. We have applauded NHYDY in the past, as we do like companies that hold low levels of debt. This has changed over the last few quarters. Their net debt increased by NOK 2.3 billion since Q1. Adjusted net debt as of 30th June 2024 was NOK26.13 billion. However, on a Y-o-Y basis, the net debt has increased 64% from just NOK15.89 billion. In terms of cash flow, the free cash flow in Q1 was roughly NOK2.8 billion. NHYDY only pays dividends once a year, so when they do pay out the dividend, the cash flow takes a rather big hit in that particular quarter. There was a cash outflow of NOK 5 billion in Q1 related to 2023 dividends. In addition to dividends, the good news is that they have also been busy buying back and canceling their shares. Throughout 2023, Hydro bought back 21.16 million shares from the Norwegian government. These were canceled on 25th of June this year. During the AGM in May this year, the Board of Directors received authorization for a similar program to acquire up to 100 million shares in Norsk Hydro ASA to cancel the shares. The authorization is valid until June the 30th, 2025. As of June 30th, 2024, no shares had been acquired under this program. Business development NHYDY's President and CEO, Eivind Kallevik pointed out in the presentation to analysts that: Our market is, whether we like it or not, in an environment where we are heavily influenced by external factors, all of which we cannot control. So we really can't control what happens in the world around us. But for me, it is paramount that we understand what's going on around us so that we can adapt swiftly Norsk Hydro's electric energy prices and commodity prices (Norsk Hydro Q2 Financial Results Presentation) To make aluminum, you need alumina, which is the intermediary commodity made from bauxite ore. To do this and also produce the finished product aluminum, you need a lot of electricity. Norway has been blessed with plenty of cheap hydropower. But it was certainly not cheap in 2022 when Europe faced massive shortages of gas. Norway assisted by selling electricity to the E.U., which caused a huge increase in electricity costs for both industry and private consumption. This situation has normalized somewhat. Platts PAX development is the average price set by Platts for alumina. Since Q1 of this year, the price shot up from $367 to $433 per ton. One reason for this spike has been Alcoa's (AA) decision to curtail the production of alumina from Kwinana in Australia. This refinery has an annual production capacity of up to 2.2 million tons and was in 2023 running at 80% capacity. As we stated earlier, the aluminum price and cost of the material required to make it is expected to stay elevated for some time. NHYDY actively hedges both currencies and commodity prices. Risk to Thesis and Conclusion We chose to use as the main picture for this article, bales of aluminum scrap for recycling. This is a part of the business that NHYDY has invested heavily in. However, at this moment they are facing pressure from low recycling margins. There is a low availability of aluminum scrap resulting in several recyclers running on reduced capacity. Our concern is that NHYDY potentially is putting too much focus on ESG at the cost of reduced profitability. We did notice that when they talked about stakeholders, of which there are many, shareholders came last. Perhaps that is just a coincidence. There is a market for selling \"green\" aluminum at a premium price to brands like the large German luxury car manufacturers. When we look at the positive trend in the slight improvements in the adjusted EPS, it also begs us to ask the question if NHYDY's share price could be bottoming out at present levels. When we compare the share price with two other large peers, one in the U.S. and one in China, we can see that NHYDY's share price is the one that has done the worst. Norsk Hydro share price versus Alcoa and Chalco (Yahoo Finance) Overall, we conclude that NHYDY should be able to continue to grow adjusted EPS at low single-digit clips in the next few quarters. As such, we upgrade it to a Hold 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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