NHYDY - Norsk Hydro: Why We Expect Lower Earnings From This Aluminum Giant

2023-09-08 10:43:05 ET

Summary

• Norsk Hydro's share price is down 13% YTD, but we believe there is more downward pressure to come.
• Their net profit fell 54% in FH 2023 compared to FH 2022.
• Lower earnings and dividend for 2023 will be the catalyst that will press the share price further down.

Investment Thesis

In our January analysis on Chalco ( ACHHY ), we concluded that we would sell ACHHY and buy the Norwegian aluminum giant Norsk Hydro ( NHYDY ).

At that time, fundamentals greatly favored NHYDY.

Nearly 9 months have gone by, and it is a good time to revisit that thesis. Chalco has since been delisted in the U.S. and is now only trading on the stock exchanges of Hong Kong and Shanghai.

Although fundamentals favoured NHYDY, its share price is down 13% against its peer Chalco, which is up 14% Y-T-D. That is a 27% difference in FH 2023.

With this revisit of the thesis, we want to explore if this is now a good time to buy into NHYDY.

FH 2023 Financials

On the top line , we saw revenue decrease by 8% Y-o-Y to NOK102 billion, which equates to roughly USD9.6 billion.

However, their net profit fell 54% from NOK14.5 billion in FH 2022 to NOK6.7 billion in FH 2023.

EPS was NOK3.47 in FH 2023, compared to NOK6.80 Y-o-Y.

The large reduction in profit Y-o-Y can partly be explained by much lower alumina prices when compared to FH 2022.

The price at the London Metal Exchange for 3 months forward delivery of alumina, which is the raw material required to make aluminum, showed a steady decline from $360 per ton in Q1 to $344 per ton in Q2.

When we look at the price of aluminum, there has been a slight trend reversal in the present quarter, as shown by this 3-month forward delivery graph by LME from 4 September 2023.

However, it is too early to give the economy a "clean bill of health".

Decreased real estate building and industrial activity lowered volumes in their extrusion business in FH 2023. Demand in the Eurozone was down 22% and in North America, it was down 15%. NHYDY expects this lower volume to continue in the short term, with CRU estimating that FY 2023 market demand will be down roughly 8%.

The only bright spot was the automotive industry, where the extrusion business kept growing.

On a positive note, NHYDY does have a good balance sheet, even though there has been some deterioration lately.

Adjusted net debt increased from NOK 6.26 billion at the end of FH 2022 to NOK 15.89 billion at the end of FH 2023.

With regard to its Capex, NHYDY, like so many industrial companies, is investing in renewable energy. This is done through their subsidiary Hydro Rein.

We are positive about ESG initiatives taken by companies. The world desperately and urgently needs to focus on how we can limit damages from environmental pollution.

Their business is a very big user of energy. As a matter of fact, that is why it was established in Norway, to take full advantage of the cheap and everlasting hydropower, hence its name Norsk Hydro.

Its estimated total Capex for FY2023 is now raised to NOK 20.5 billion from its earlier estimate of NOK 16.5 billion. Hydro Rein takes up NOK 3 billion.

Over the last couple of years, we also noticed a large Capex for renewable energy investments by Shell ( SHEL ) where we are invested. At that time, we, and other investors, requested Shell to separate out the investment made in renewable energy and other "green initiatives" so that we could get an idea of what the ROE would be on these investments.

We hope NHYDY will follow suit and start to report separately on the profitability of these investments, much like what Shell is now doing.

Risks to thesis and conclusion

There is a risk that NHYDY could become "cheaper" in a few months' time.

There is always a chance that we are only at the beginning of a downturn in the economy. When we look at a 10-year historical graph of the price of aluminum, and take out the period just after the start of the war in Ukraine, we will see that the price has oscillated between low levels of $1,500 and peaked around the level we now see, which is about $2,200.

Therefore, we believe that there is a high probability that we will see lower aluminum prices in the next 12 months. Despite the recent uptick in the price.

This will bring NHYDY's net profit lower for the year 2023, and most likely 2024. Shareholders will receive less dividend, but in a cyclical industry like this and with a dividend policy that anchors its payout to the earnings, it should be expected that it will fluctuate.

The 10-year average dividend is $0.25 per year, including the special dividend paid out last year. Based on the recent share price for the ADR of $5.75 that is a yield of 4.35% before WHT. Norway's WHT is 15%.

NHYDY has gone through two world wars and several recessions. We are confident that they are ready to deal with whatever comes next.

With a good balance sheet, and the Norwegian government owning roughly 41% of the company, we have no doubt they will be making money for many years to come.

However, due to uncertainty in the economy, we would set our stance as a "Hold" at this moment.

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