UMICF - Umicore: Significantly Undervalued Materials Technology Leader

2023-10-31 08:43:20 ET

Summary

• Umicore is strategically expanding its cathode and recycling operations to meet the growing demand for critical supplies from carmakers.
• The company benefits from both traditional combustion engine vehicles and electric vehicles, positioning it to capitalize on the shift toward electric mobility.
• Umicore's capital spending is expected to increase significantly, supported by EU regulations promoting local sourcing of materials for EVs.

Umicore SA ( UMICF ) is a global materials technology and recycling group with a strong focus on areas where its expertise in materials science, chemistry, and metallurgy plays a significant role. The company is structured into three business groups: Catalysis, Energy and Surface Technologies, and Recycling. Each of these groups comprises market-focused business units that offer cutting-edge materials and solutions. Umicore is committed to clean technologies, dedicating most of its research and development efforts to areas such as emission control catalysts, materials for rechargeable batteries, and recycling. Headquartered in Brussels, Belgium, Umicore operates worldwide.

Critical Raw Materials

Umicore is strategically expanding its cathode and recycling operations, driven by the growing demand from carmakers for critical supplies. As one of the leading midstream chemical processing and metal refining companies globally, Umicore's operations are tightly linked to the specialized lithium market, where product consistency is paramount, making it more akin to the chemical industry than traditional metal supply chains.

The company takes raw materials like cobalt and lithium early in the supply chain and refines them into materials suitable for use in lithium-ion batteries. Umicore has already established a presence in supplying components for smaller lithium-ion batteries used in consumer electronics and continues to invest in expanding its capacity. Notably, Umicore's early investment in securing its own mine supply gives it an edge over carmakers who are now rushing to secure mine-level resources.

Unlike some competitors, Umicore benefits from both traditional combustion engine vehicles and electric vehicles (EVs). Its automotive catalysts segment caters to conventional vehicles, while its involvement in the EV market positions it to capitalize on the ongoing shift toward electric mobility. Additionally, Umicore has ventured into solid-state batteries, although significant profits from this technology are not expected in the near term.

Investors can find opportunities in Umicore's current situation. Despite challenges in the automotive sector causing a decline in its stock price, the company's profitability remained relatively stable in the first half of the year. Although adjusted cash profits were impacted by weaker precious metal prices and increased capital spending, Umicore's diversified business lines offer optimism.

H1 Earnings

Umicore's earnings are divided among its three main business units: catalysis, energy and surface technologies (including the electric vehicle business), and recycling. While recycling contributed the highest adjusted EBITDA in 2022 at €532 million ($562 million), catalysis and energy generated significant cash profits of €419 million ($441 million) and €290 million ($306 million), respectively. These businesses have historically been influenced by cyclical forces tied to auto sector demand and metals prices.

The current year has presented tougher trading conditions compared to 2022. Recycling - of Precious and Industrial metals - faces challenges due to falling platinum group metal prices, making it unlikely to replicate the strong performance seen in the first half. Despite these challenges, Umicore's management remains optimistic, citing returns from growth investments and anticipating an increase in EBITDA next year thanks to a significant volume increase on the back of several long-term, value-creative customer partnerships with car and battery OEMs for the EV markets around the world.

Umicore's historical returns and margins vary between business units, with recycling boasting the highest adjusted EBITDA margin at nearly 50%, while catalysis and energy maintain 23% each. Achieving similar margins in the battery space is challenging but essential for the company's growth.

The EV market continues to expand, with a 56% increase in EV sales in 2022, reaching 10% of all global vehicle sales. Umicore expects growing demand for its battery-ready metals, especially cathode materials, as EV adoption continues to rise. The company's "rechargeable battery materials" unit aims to achieve cash profit margins of 20% by 2030, requiring substantial capital investments.

Supportive Regulatory and Policy Environment in Europe

Umicore's capital spending is forecasted to increase significantly, supported by the EU regulations promoting local sourcing of materials for EVs under the European Critical Raw Materials Act introduced in March this year.

The Act sets clear benchmarks for domestic capacities along the strategic raw material supply chain and to diversify European Union supply by 2030:

• At least 10% of the EU's annual consumption for extraction,
• At least 40% of the EU's annual consumption for processing,
• At least 15% of the EU's annual consumption for recycling,
• Not more than 65% of the Union's annual consumption of each strategic raw material at any relevant stage of processing from a single third country.

Solar panels, heat pumps, electric cars, chips, pharmaceuticals, ammunition: raw materials are essential to technologies and products of strategic importance. Demand for these precious and scarce resources is increasing sharply, which has led to a global race for the new gas and oil at the heart of our economy. With this Act, the European Union is upping its game in terms of extracting, refining, recycling and diversifying to ensure secure and sustainable access to critical raw materials.

Thierry Breton , Commissioner for Internal Market, March 2023

Umicore's Nysa cathode plant in Poland is ramping up production, adding to the company's capacity for lithium-ion batteries. While Umicore still relies on others to build battery cells, it has secured supply agreements with battery and car manufacturers. An example of this is in October, Umicore and AESC, a global leader in the development and manufacturing of high-performance batteries for EVs and energy storage systems, signed a ten-year agreement whereby Umicore will supply high-nickel battery materials for the production of EV batteries at AESC's US manufacturing facilities.

Despite uncertainties, Umicore's diversified business lines offer stability. The company aims to generate cash flow from combustion engines while focusing on efficiency and operational agility. Its objective is to deliver around €3 billion ($3.2 billion) in cash between 2022 and 2030.

Umicore's share price has declined this year, resulting in a higher prospective yield and lower valuation compared to historical averages. Challenges include reduced free cash flow due to increased spending and concerns about potential negative cash flow in 2023.

However, the company has a safe Altman Z-Score of 3.99, which greatly eases doubts about financial strength.

Conclusion

In short, three factors make Umicore an attractive long-term investment: consistent cash generation from the catalysis business, the growing importance of recycling in the EV supply chain, and the potential benefits of investing in Europe's EV market, supported by state initiatives.

Umicore, with its established supply agreements and upstream deals, is well-positioned to benefit from Europe's efforts to counter China's dominance in the supply chain for electric vehicles.

Umicore's full-year results for 2023 will be published on 16th February 2024.

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