Hulamin (HLM) is a business that has been in existence for 80 years, forms a mainstay of the KZN economy, employs just over 2000 people and has grown to become the largest semi-fabricator of aluminium in the world. The company takes molten aluminium from the Hillside and Bayside smelters in Richard’s Bay and converts this basic aluminium into saleable products at its facilities in Pietermaritzburg and Midrand. The products include packaging such as cans and rigid aluminium foil containers as used by caterers and in take away packaging; extrusion products such as windows and door frames, which are sold to the construction industry and developers such as Balwin; and rolled products such as sheets, coil and plates sold to the auto industry and exported to industrial customers globally.
The company has faced severe headwinds recently, which has seen its market cap reduced to R600m, with the share price of R1.80/share near 5-year lows, having been trading at almost R10 half a decade ago.
Hulamin sells products on every continent, with 59% exported, 25% of sales go North America, mostly the USA. With increasing protectionism in the USA, South Africa has been reclassified as a developed country by the US Department of Trade, leading to additional tariffs on SA products and putting Hulamin’s exports to this destination at risk.
Generally speaking, this is not a great business for the following reasons:
- Over 50% of aluminium fabrication capacity is located in China, from where dumping to international markets occurs. The group is therefore constantly working against anti-dumping tariffs in its export destinations (see the USA example currently playing out above) and has to lobby its home government to forestall dumping at home.
- Fabricated aluminium is a commodity and they are price takers in a bigger market. Margins are very low at 4% and ROE is 7%. This is with the scale affects of being the largest company in the business and extreme proximity to the smelters. The group has little control over these metrics.
- The business is both directly energy intensive and is fully exposed to a single supplier, South32’s smelters, who is even more exposed to the price of electricity. In an environment of rising energy prices and ongoing load shedding in the medium term, this does not bode well for the group.
However, given the very depressed share price, these poor fundamentals may be priced into the business and the share may present an incredible value play at this level. In fact, this is exactly what Investec’s John Biccard believes and he is putting his money where his mouth is. The various funds that he manages have upped their stake in the business to 11%. In addition, he purchased almost 7% (or R50m) of the company in his personal capacity. Hulamin directors agree and the company has also repurchased 3% of its shares in the last few months, at an average price that is 30% higher than the current share price.
The thesis is that the company will return to historic profitability. Revenue of R11bn in the 2017 and 2018 financial years produced, HEPS of 95c and 91c in respectively. Free cash flow was R300m in 2017 and still R90m in 2018. Even with a poor 4% margin, operating profits on R11bn revenues could be R440m, almost 70% of the current market cap. Despite an impairment of R1.1bn in 2018 the group paid an 18c dividend and reported record sales and revenue.
The thesis changes though when looking at the interim results for H1 2019 where the group reported a loss of 23c. The loss included once off costs such as right sizing and retrenchments costs and losses incurred due to metal price lag, which will reverse in the long run. The price lag is likely to continue this year as the aluminium price has fallen further, but will eventually taper off. More worryingly, is a drop off in sales, in particular in North America. This led to a R400m build up of inventories, which are now R2.6bn and make up half of assets. We are likely to see more poor sales in H2, with the coronavirus annihilating Asian demand.
The build up of inventory has led to negative operating cash flow of R170m and suggests a scrapping of the dividend is on the cards, in fact it is surprising that the group strained cash resources with a share repurchase programme.
Management concludes the poor H1 2019 results with:
“Hulamin expects the turnaround actions to gain momentum in the second half, and these are forecast to start yielding ongoing benefits from 2020. “
This is precisely the bet made by Biccard. If earnings revert to R1/share, then shares could easily increase 5 fold for an exit PE multiple of 9. This is premised on a long term vision that an increased focus on recycling and the move away from plastics will underpin aluminium fundamentals. The business is also trading at less than 20% of NAV. The bet, however, needs two key outcomes:
- The group remains liquid with sufficient working capital whilst the US protectionism, coronavirus and Chinese dumping reduce sales and right sizing and further price lag increase costs. This will play out in the next 12-18 months.
- The Bayside and Hillside smelters remain in business. They are currently running on the last years of their notoriously beneficial supply contract with Eskom. Whether South32 (or a new owner) will be able to negotiate a power supply agreement that can keep an old fleet of smelters operating on expensive and dirty electricity remains to be observed in the next 3-5 years. The Industrial Development Corporation is a 30% shareholder in Hulamin and may target the preservation of jobs by getting directly involved in these smelters in the future.
If these two trends play out, they will certainly generate significant value for people willing to take a bet at these prices. However, I chose to pass on this bet because:
- As per my Investment Philosophy, I don’t trade or bet, but choose to invest in long term, boring, cash generative businesses. This Hulamin bet is simply not boring enough.
- Aluminium has strong fundamentals and prospects, but I am unconvinced that South Africa is the right location to process it. Iceland, Canada, Norway have abundant geothermal and hydro-electric energy sources and should be global sites for aluminium smelting, while Guinea and Australia are hosts to excellent bauxite deposits. Dirty, expensive coal power and no good local sources of bauxite make SA uniquely unattractive for this business.
- I find I have a better play into South African packaging through boring old Bowcalf.