Norsk Hydro: Good Returns On A Fairly Highly Valued Aluminum Play

seekingalpha09-25

Norsk Hydro has seen an 11.11% RoR since my last update, outperforming the index return of 10.94%, despite significant market volatility.The company's focus on green initiatives, like Hydro Rein and ...

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RelaxFoto.de/E+ via Getty ImagesDear readers/followers, In this article, I'm going to look at the returns for Norsk Hydro (OTCQX:NHYDY) (OTCQX:NHYKF) and the company's performance since my last update, which was now almost 6-7 months ago. We're now looking at a significant upswing, which could have been even higher if I acted on what I saw as overvaluation only a few months ago. Unfortunately, I didn't act and what we have here is 11.11% RoR, compared to an index-return of 10.94% RoR for me since then.   Seeking Alpha Norsk Hydro RoR (Seeking Alpha Norsk Hydro RoR)My last article on the company can be found here. The company is currently extremely volatile due to trends in the commodity sector, with trends from Iron and other metals spilling over a little bit on Aluminum. The company also has a whole host of different segments under its control. I have been following this company for a very long time. In my initial pieces, I invested at a price that we can only dream about today, at below 28 NOK for the native ticker (we're now over 60 NOK), and I've made a very good profit by investing in this, and other Norwegian companies, for a triple-digit (or close to it) RoR. I have been hoping for a fundamental decline down to below 40 NOK once again, to where I can invest very cheaply, but the company has not \"obliged\" here. Let's look at what the most recent set of results brings us. Norsk Hydro and its long-term upside When I started reviewing Norsk Hydro, I noticed that it had its share of issues with its Alunorte assets and other parts of its operations. The issues were, at the time, operational and specific to the company. Now we instead have macro issues, which the company doesn't really control all that much. The main trends in metals and especially aluminum at this time is the approach to the sustainable transition and green market and world we're moving towards. Norsk Hydro is an integral part of the European transition here because it's one of the largest aluminum players in this geography. In this quarter, we continued to see echoes and reflections of the rest of the commodity market, with solid upstream or revenue trends, but a more challenging bottom-line market and results. The revenue is also mostly up due to pricing, not demand - because current demand is down, and low recycling margins for not only Norsk Hydro but other companies, are pressuring the industry. Big news for the quarter includes the establishment of a Norsk Hydro JV, which is working to support the decarbonization trends (Hydro Rein). Also, the company's recycling and green pushes - like Hydro CIRCAL - are seeing excellent trends with upscaling necessary to meet the demand for company services. New partnerships are also interesting - and Norsk Hydro recently started a new partnership with Porsche. In the end, though, I would say that Norsk Hydro's near-term impacts are dictated by the degree of punitive measures in terms of customs for imported cheap aluminum from China, and how the demand situation looks. In order for the company's green aluminum push to work, Norsk Hydro needs the market to favor its products, which is more difficult when customs measures are not in place. The company's current ambitions, assuming this \"works\", include investments in recycling and extrusions to lead the market opportunities from the green transition, as well as working on its decarbonization plan and new renewable power generation with even more asses. Also, partnerships, which is a focus that has been lifted even more to the forefront as of the latest quarterly reports.   Norsk Hydro IRIn fact, if you're interested in \"green investing\", I would argue that Norsk Hydro is one of the companies you definitely should be looking at. Some of the company's headwinds include low scrap generation, pushing prices for scrap (and widening the spreads in recycling), but despite this, CIRCAL is set to deliver its longer-term targets.   Norsk Hydro IRAnd the company extrusion segment is positioning itself for long-term growth, but also significantly increasing its flexibility to better meet the demand levels in order to work more efficiently. Hydro Rein deserves special mention here. The company has done this together with Macquarie AM, and the target is 60 renewable projects already under development, coupled with growth projects going forward. The company is targeting 8.4 GW in gross capacity to meet its demand for production. Its target is to become the preferred supplier of renewable energy solutions to industrial customers - and if you've followed my work on Swedish industrial companies in northern Sweden you know that many of these companies are in significant demand of this sort of energy. There's a high focus on the Nordics and the Nordic market specifically, but the company has already established a foothold in the Brazilian market as well. Its current projects and estimates are already fully funded for those that are currently under construction, and the pipeline for the coming few years is to be self-funded, according to current targets and estimates. Here are the company's long-term targets for this segment and for this transaction.   Norsk Hydro IRAlso, Alunorte - there's a reason I mentioned it before. The company's fuel-switching upgrade is nearing completion. This includes 10 boilers and calciners converted to LNG and completely free of oil. This will result in significant savings when fully implemented (about $160M-$190M). Upon full conversion of this, the company will also reduce its Co2 output by over 700k tonnes each year. The company, in addition to this, has switched from a Brent to a Henry index for Oil, reducing volatility here. Here is the forward plan for the company's GHG emission reductions.   Norsk Hydro IRAnd obviously the partnerships are cause for excitement here. Porsche is a big one, with the supply chain under the new partnership able to source aluminum directly from reserved capacities, for which Hydro gets compensated through green premiums here. The company's scope here includes low-carbon and recycled aluminum, which will go into the company's sports cars. This also includes technical collaboration - and could be only the first of many potential cooperations with other companies that Norsk Hydro could do here. On the pricing side, there's a current tightness in alumina. This is driving prices, and if we exclude China from the equation, pricing looks good. If we include China, things look worse - though demand is expected to improve based not only on general demand but from demand on Solar, automotive semi demands, and EV demands. Chinese PHEV demand is, in fact, expected to increase further. In short, Norsk Hydro's future investment thesis is based in no small part on further growth in China.   Norsk Hydro IROn the headwind side, we have some issues with the extrusion demand. The transport and automotive sector is expected to drive significantly lower demand for extrusion products, with sales volumes down 11% in total on a 2Q24 YoY to 2Q23. On the company's results side, for EBITDA, the results are up because the company increased pricing. Due to higher energy prices, volume, raw material costs, extrusion, volumes, and some eliminations, the company saw growth despite all of these due to pricing, upstream volumes, and positive FX. The company also saw a net debt increase - mostly dividends and adjustments are responsible for this, increasing adjusted net debt to 2Q24. So why should you look at Hydro? The company is a major green player until 2030, and it estimates a 2 Billion NOK earnings uplift with a portfolio of solutions for \"green enablers\". The company's zero-aluminum is already working here, and the company has a very resilient shareholder base with government ownership and competitive dividends - and a good track record. Let's look at valuation. Norsk Hydro - The company's valuation is so-so here As I see it, the company's results were better than expected. That is why the company today is, in fact, up a bit, and it's also why I am increasing my PT as of this article. I now believe NHY to be worth around 70 NOK/share, which means that the company continues to be a compelling buy despite trading up several percent today. The company's current yield is a solid 4%, or slightly below, with a BBB rating. The only issue I have is that I believe that Norsk Hydro, along with others, has overestimated the impact of the green transition. I do not believe it will come as clearly or as easily as the company expects it to here, and that is why I am discounting the company somewhat here. I do believe NHY to outperform here for 2024, and for that reason, I say the company is a \"BUY\" here. Even estimating it only at 15-16x P/E, the company has an upside well above 15% annualized here. Forecasting at the analyst consensus brings us triple-digit RoR and an implied share price of well over 100 NOK, at 121 NOK. (Source: Paywalled FAST Graphs link). The company also trades at less than 13.2x P/E today normalized. It should be said that Norsk Hydro has a fairly high rate of forecast inaccuracy on the negative side. That's also one of the things I base my caution on. I'm discounting the growth estimates by as much as 50% here, meaning instead of the 20x P/E average, I'm going at around 16x P/E, and instead of 21.7% annualized growth, I estimate no more than 10%. But still, even with that taken into account, Norsk Hydro is estimated to excel at 16-19% annualized here, with an RoR of over 50% in 3 years. And if you accept the general forecasts here, you can see triple-digit RoR levels for a 16.25x P/E if the 21.7% growth estimates turn out to be correct. What I am saying is that even if you forecast very conservatively, this company is more likely to generate good returns than many other commodity players. Norsk Hydro has had an excellent quarter, building to an excellent overall fiscal, and it is this that I am \"betting\" on here. For that reason, I consider my thesis to be the following here. Thesis  Norsk Hydro is currently attractively valued to normalized future earnings and my new improved price target going into 3Q24, improved again for 2Q24, and now a few NOK above the last one. The potential returns from today's levels are now acceptable compared to what other investment alternatives in the market offer us. I now view the company as more attractive than at the time of my last article, which you can view here for the 1Q24.  At its current valuation, Norsk Hydro is a \"BUY\" with what I consider to be an attractive upside. The price target is 70 NOK, upgraded from my last article.  Here are my criteria and how the company fulfills them (italicized).  This company is overall qualitative. This company is fundamentally safe/conservative & well-run. This company pays a well-covered dividend. This company is currently cheap. This company has a realistic upside based on earnings growth or multiple expansion/reversion.  I can't call Hydro \"cheap\", but I am calling it \"attractive\" here, even after a slight drop after my last articles, and even after the gain we're seeing after today's market action.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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