Making the case for Hulamin

Cheap at the price.

As a relatively small industrial company living off the bounty of cheap energy supplied to BHP Billiton’s aluminium smelters in Richards Bay, the writing was on the wall for Hulamin a few years ago when BHP made plain its intention to close the Bayside smelter. But the management team moved quickly to secure the feedstock vital to its operations, as well as position the company for a seismic shift in the way alcoholic beverages are packaged. What follows is an in-depth look at the investment case of a company that appears to be extremely cheap.

For the last two years, the number one priority for CEO Richard Jacob and his team was to find a sustainable way to source the shortfall of rolling slab that is a necessary feedstock for Hulamin’s plant. Rolling slab is produced from liquid metal aluminium that is cast into a rectangular shape when it solidifies. “We have come to a meeting of minds with BHP and independent BEE party Bingelela. The Isizinda Aluminium consortium will acquire and operate the Bayside cast house with our support as a minority strategic partner,” says Jacob.

Hulamin has a 40% interest in Isizinda Aluminium with Bingelela holding 60%. “Isizinda has a contract with BHP for the supply of liquid metal from Hillside to the Bayside cast house. Hulamin in turn has a contract with Isizinda for the slab offtake that removes uncertainty about our rolling slab supply,” says Jacob. The transaction is currently pending approval from the Competition Commission and should be completed by the end of June.

Besides supplying rolling slab to Hulamin’s plant in Pietermaritzburg, the Bayside cast house is suitable to manufacture a range of aluminium products. These include extrusion billet, aluminium rods (for power cables), window frames and other smaller product lines for sale directly to industrial clients. “The cast house is suitably capitalised to cast rolling slab from day one. Isizinda will assess further capital investment to broaden its product range in due course as circumstances dictate, so it will be ready to go once the transaction is approved,” says Jacob.

New aluminium recycling plant

But what will really get investors tickling their wallets, is the aluminium recycling plant being constructed in Pietermaritzburg, which is expected to be commissioned in the third quarter of 2015. “It will provide an additional supply of feedstock,” says Jacob. The plant will recycle used aluminium material that will be reprocessed into rolling slab. “So it will run entirely on recycled material that we source from the market, adding to our existing reprocessing of metal”, says Jacob.

The nameplate capacity of the recycling plant is 65 000 tons/year and comes at a cost of around R300 million which will be funded with debt. By the end of last year, half the amount had already been spent. The other half will follow in the current financial year.

The recycling plant will begin to ramp-up in the second quarter of this year, with commercial operations starting in the third quarter. “We expect it to be running at full capacity in 12-18 months from now, using trusted technology that’s being used around the world,” says Jacob. The plant will be a first of its kind in SA from a technology and metal recycling point of view.

So where will all the recycled material come from? “We’re targeting about 25 000 tons/year from the purchase of used beverage cans; 10 000 – 15 000 tons/year from other forms of purchased scrap (from the likes of Nampak), and the balance will be processed scrap from internal operations,” says Jacob.

Hulamin supplies Nampak with aluminium sheet from which to make beverage cans. Nampak in turn “stamps out” the cans and Hulamin buys back the skeletons from the used sheets. Aside from the balance of the recycling plant, Hulamin has no immediate additional expansionary capital expenditure planned.

Gas conversion

Hulamin is a large consumer of energy, so it is always looking for ways in which to reduce its energy bills, which currently runs to about R500 million a year. Of this, 60% (about R300 million) goes towards purchasing liquefied petroleum gas (LPG). “We are SA’s biggest consumer of LPG. However, we are investigating converting our plants to natural gas. We plan to initially procure compressed natural gas (CNG) which would be trucked to us. In the longer term, we would like to convert the Durban Johannesburg Pipeline that carries liquid fuels, to run natural gas to our plant,” says Jacob.

Doing this would lower logistics costs and address supply issues. “LPG is not intended to be an industrial gas, and the infrastructure is a bit old and unreliable. So we will benefit from better cost control as well as reducing supply risk.”

Rand hedge

Hulamin is predominantly an exporter with around 70% of its sales destined for foreign markets. “25% of our product goes to the US, 25% to South and Southern Africa, and 20% to Europe. The rest of the world accounts for the balance,” says Jacob.

“In terms of demand, the US has been relatively firm, Europe is tentative – stable at a relatively low level. Local demand is growing strongly, largely on the back of demand from Nampak. Aside from that, non-packaging material demand is at an all-time low,” says Jacob.

The big shift

The growing demand from Nampak follows the conversion of beverage can body stock in South Africa from steel to aluminium. “In the rest of the world aluminium makes up 90% of all beverage packaging, so we appreciate that Nampak has decided to convert their plants. While the conversion has taken place in soft drinks, beverage cans as a packaging material are still under-represented in alcoholic drinks packaging. This is changing as supermarket retailers distribute ever greater amounts of alcoholic beverages. They tend to prefer cans because they are lighter, stack better, use space more effectively and get colder quicker,” says Jacob.

While the company is staying mum on the financial benefits of its new recycling plant, investment managers have been taking a stab at what the investment will mean for the company’s bottom line. “When you take a serious look at the company, you realise that its largest client is Tesla (run by Elon Musk) and will shortly become SA Breweries as the aluminium can substitution continues,” says Brendon Hubbard, portfolio manager at Clucas Grey. “Those are not bad clients to have.”

In order to determine what impact the plant could have on profits, Hubbard has estimated the difference in price between sourcing new material or buying recycled. The assumptions can be seen in the table below:

 

ECONOMICS OF THE RECYCLING PLANT  
Cost of New Aluminium (Not recycled)  
LME Metals Price (US$/t) $1 800
Plus: Regional premium (US$/t) $180
Total price per tonne (US$/t) $1 980
Current Rand dollar exchange rate R12.00
Total cost per “new” tonne (R/t) R23 760
   
Cost of Recycled Aluminium  
Recycled material ‘bought in’ (R/t) R15 000
Plus: Gas energy cost per tonne (R/t) R1 000
Plus waste factor of 15% (R/t) R2 250
Plus: collection/shredding/electricity (R/t) R2 000
Total cost per recycled tonne (R/t) R20 250
Savings between new and recycled material (R/t) R3 510
Nameplate capacity of recycling plant (t) 65 000
Total savings (Rands) R228 150 000

Source: Authors calculations, Clucas Grey

“So we think the plant can potentially increase the Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) by R228m,” says Hubbard. For the financial year ending December 2014, the company reported operating profit of R585 million. So at full capacity, the new plant can potentially increase this by 39% – at the least.

“We are trying to be very conservative as management are guiding us to the buy-in price of R15/kg (R15 000/tonne) but their website talks about scrap available at R5/kg (R5 000/tonne). As you can imagine, the spare R10/kg can make an enormous difference to the numbers,” says Hubbard.

Ignoring the earnings prospects of the new plant, the company as it stands is looking extremely cheap. But at least some of this discount can be attributed to the interruptions the business faces from Eskom. The current situation allows Eskom to impose “load curtailment” quotas on Hulamin, which require it to reduce energy consumption.

Due to the intricate nature of the company’s manufacturing processes, temperatures in the plant have to be kept in a very tight band. Because the timing of load curtailment cannot be foreseen, it disproportionately affects volumes at the plant as the temperatures take time to return to optimum levels. For this reason, the company provided a trading update on the 23rd of March advising HEPS for the six month period ending 30 June would be 20% lower than the previous corresponding period (June 2014).

The current price-earnings ratio of 7.32 makes it one of the few companies on the JSE in single digits. And in the last financial year, the company generated far more cash (R518m) than it declared in profits (R385m). It also paid a dividend.

While the company suffers in the short-term from interruptions to its power supply, over the medium term it appears to be a cheap rand hedge with the ability to easily increase profits.

This article was first published in Moneyweb’s monthly investment magazine, The Investor. See the whole magazine here.

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