2023-03-29 01:53:04 ET
Summary
- Umicore posted decent earnings in 2022 but was not able to impress investors.
- The stock has declined after a massive €5Bn investment program aimed at growing the Rechargeable Battery Material business was announced last year.
- To fund the investment, not only debt will be raised, but earnings will most likely be reinvested rather than returned to shareholders.
- Moreover, the investments are not expected to contribute meaningfully to earnings until at least 2026.
- Patience is advised as a better entry point will present itself.
Umicore SA ([[UMICF]], [[UMICY]]) posted decent earnings in 2022 but was not able to impress investors and the stock lagged after management announced a massive €5Bn investment program to prop up the division ‘Rechargeable Battery Materials’. As current earnings will be diverted towards growth rather than shareholders, and the fact the current investments will only make a significant contribution to earnings several years down the road, the stock is a ‘hold’.
Results
On February 16 th Umicore updated shareholders on 2022 performance. Although revenues grew by 10 percent, actual earnings came in lower, see figure 1.
It was noted before earnings would reduce as the Precious Metal price effect, i.e. inflated commodity prices, would diminish and negatively affect results. More important than the €70 million PM effect however, were inflation costs at negative €184 million. Even so, these costs were partially offset by increased performance.
Figure 1 - 2022 Key figures, FY22 results presentation (umicore.com)
Assessing the results over a longer term, a slightly different picture emerges, see figure 2. The Catalysis division has shown modest, although steady growth in revenues. Stricter emission regulations play a role here and will continue to do so throughout this decade. After 2020 earnings from this division grew and are now well above €300 million.
The Recycling division shows a clear link to commodity pricing. On aggregate these prices bumped and are now coming down gradually. Even so, scarcity of (rare earth) metals and increasingly strained geopolitical relations may serve as a backstop. Therefore, the Recycling division will likely remain a significant contributor to earnings.
Clearly the worst performance is accounted for by the Energy & Surface Technologies (E&ST) division. Although revenue has been quite constant, it is especially the profitability of this division that is lagging, continuing a trend that started in 2019.
Figure 2 - Umicore revenue and earnings since 2017 (umicore.com; chart by author)
Summarizing, the deteriorating share price does not reflect the performance of Umicore. Alas, investing is about the future rather than the past. What the share price does reflect, is the expectation for the Rechargeable Battery Materials (RBM) segment, currently still part of the E&ST division.
Capex conundrum
During the 2022 Capital Markets Day Umicore stock plunged after the company shared the intention to invest €5Bn between 2022 and 2026, see figure 3. Given the company has a revenue of approximately €4Bn, and an EBITDA of about €1Bn, the question is how the company will finance its ambitions.
Figure 3 - Capex ramp-up, Capital Markets Day 2022 (umicore.com)
First of all, reading the small print, the company will not shoulder these costs alone and expects co-financing. Unfortunately, so far little has been shared by management about potential investors. It is known however Volkswagen and Umicore set up a joint venture, which will invest a combined €3Bn, while equally sharing costs and investments. Also known is this JV intends to achieve an initial production capacity of 40GWh in 2026. For this reason I estimate the share of Volkswagen at €1.5Bn to be spend before 2026. This reduces the total investment of Umicore to €3.5Bn for the coming years.
Current capex amounts to €0.5Bn per year, implying the company will spend €2Bn per year over the mentioned timespan of 2022-2026 already. Deducting this from the estimated €3.5Bn in investment, Umicore intends to spend an additional €1.5Bn until 2026.
At the latest earnings call CFO Wannes Peferoen indicated capex would be stepped up in 2023. Evenly spreading this out means the company will spend an additional €0.5Bn in capex every year until 2026, or an annual total of €1Bn.
Financing
Financing of this additional capex can be done in several ways. To get a grip on this, the current cash-flow bridge is assessed first, see figure 4.
Figure 4 - Leverage and cash flow, results presentation FY22 (umicore.com)
The bridge shows the company took on additional debt in 2022 essentially to fund dividends and buybacks. Although it would make sense for the company to cancel these returns, it may also choose to reduce the dividend.
Even eliminating buybacks and dividend, the company can hardly fund current capex, let alone when it will be increased to a value of €1Bn per year. For this reason, CEO Mathias Miedreich indicated it sees an upper limit to leverage at 2.5x adjusted EBITDA to maintain its credit rating. This limit would conveniently allow Umicore to take on approximately €1.5Bn in debt, exactly the amount of capex that is not yet vouched for.
So, the company has the ability to raise funds single-handedly, but still has the option to attract external capital through other means, especially as Umicore stated the ‘intention to group RBM activities within one legal entity within Umicore’.
Given this information, issuance of shares to raise capital seems unlikely. It is evident however Umicore will increase debt and most likely cancel share buybacks. Given the growth agenda, it would be sensible to reduce or eliminate the dividend as well, especially as it forms a cumulative cash outflow of nearly €0.6Bn until 2026.
Battery still charging
At the FY22 presentation the company gave an outlook for 2023 indicating margins would be lower ‘in line with current market conditions’. While this is hardly satisfying, the real problem was the outlook for the E&ST division. Last year, Umicore surprised shareholders when it announced a JV with Volkswagen ( OTCPK:VWAGY ), but simultaneously lowered the outlook for the battery materials division. One year later, the outlook for this division remains subdued, just like the overall outlook. From the results presentation:
… It is expected that the earnings of the Rechargeable Battery Materials business unit will be in line with the 2022 level’. (…) Overall, adjusted EBIT and EBITDA for the Group are expected to be below the levels of 2022, in line with current market expectations.
Looking beyond 2023 it can be seen RBM production will ramp-up in 2024 and 2025, see figure 5. This implies any significant contribution to earnings will not materialize in the short term. Actually, in an interview CEO Miedreich shared the expectation the investments in battery factories will earn more than the cost of capital from 2026-2027.
Figure 5 - RBM plan, Capital Markets Day 2022 (umicore.com)
To drive the point home, investors hoping for a meaningful contribution from the Rechargeable Battery Materials division to earnings after the new factory in Nysa was brought online have not only been disappointed, they are now aware patience is required for at least 3 more years.
Risks
The risks are multiple, such as uncertainty about the growth trajectory and future earnings estimates. Obviously, debating actual figures implies one is already onboard with the electrification and recycling narrative. The risk here is that the energy transition will not pan out as expected. As the debate on fossils versus sustainable fuels is very much alive, it will not be treated in more depth.
A connected, yet more interesting risk is that Umicore is betting heavily on the battery technology. The majority of capex is allocated to grow the battery division. If anything, the results in figure 2 show the benefit of diversification. In 2020 when the pandemic hit and results for the E&ST and Catalysis division diminished, the Recycling division saved the day. In other words, with Umicore betting heavily on batteries, the risk profile of the company is changing. Even though returns are generally higher when more risk is taken, Umicore is increasing leverage while reducing diversification. Based on current policy tailwinds it seems little can go wrong, but these are the times one should be wary.
In this respect an analogy is made to Koninklijke Philips ( PHG ). This company was a well-diversified multinational until it decided to exclusively focus on healthcare to boost returns. Long story short, problems with respiratory devices wiped out a decade of stock price appreciation. It’s anything but certain Umicore will experience the same, but one must consider the bear case before making an investment.
Conclusion
Umicore posted decent results in 2022, but the market did not reward this performance. The main issue is a massive investment program to grow the Rechargeable Battery Materials division. Although the company has the ability to finance the expansion, debt is expected to more than double. On top of this, an accretive effect on earnings is not expected before 2026 according the CEO.
As the energy transition is taking shape, policy tailwinds support the thesis of Umicore management. One should be aware however, the current investment plan reduces diversification at a time leverage is increased.
All in all, patience is advised as a better entry point will present itself in the intermediate period till 2026.
For further details see:
Umicore: Testing Shareholder Patience