Pick of the week: Hulamin

The all-aluminium beer can could become the largest contributor to the group’s earnings long term.

Hulamin’s JSE history has been dire, but change is in the air. The mid-stream aluminium semi-fabricator is enjoying a change of fortunes since its listing seven years ago when it was unbundled from Tongaat Hullet.

The business has struggled to control costs and the share price drifted down to a quarter of the listing price before beginning an upward recovery. Our view is that there is still more in it.

Recent efforts by management to restructure and tame the company’s growing cost base are paying off. Management estimates that the initiatives, which include the retrenching of about 130 employees, have saved more than R200 million since 2010.

Its operating margin, which has been under pressure for the past few years, has started responding. When one-off restructuring costs are excluded from results for the interim period to end-June, the operating margin expanded to 5.2% from about 3% in the comparable half.

We expect the trend to continue when the company releases its annual results this month.

Augmented by increased usage in the market of its rolled products and a relatively weaker rand, its headline earnings per share have grown at an average of 70% over the past three years.

The change in fortunes has been noticed by the market, which pushed the share price up 32% last year, bringing the increase to nearly three-fold over the past two years.

Nevertheless, our discounted cash-flow model shows that the stock is still trailing its intrinsic value. We anticipate its earnings per share for the 2015 financial year to be between 140c-150c and to fully capture that growth, our model shows that the stock is worth 26% more than current prices.

Our positive view on the stock is strengthened by the recent increase in applications of aluminium rolled and extruded products globally and locally, even though there is currently an oversupply of aluminium on the world market. Given that Hulamin is largely a price taker with little control on the buying prices of primary aluminium, its profit is a function of the margin it makes on rolling aluminium slabs into sheet. As such, the increased usage of rolled sheets enables the company to optimise margins.

One such opportunity looms as SA Breweries is switching to an all-aluminium beverage can and Hulamin has been contracted to supply about 15 000 tonnes of body stock this year to Nampak. With this market tipped to consume as much as 60 000 tonnes of beverage cans by 2018, we will not be surprised if the beverage can becomes the single largest contributor to the group’s earnings in the long run. This increases the group’s revenue from the local market and comes with higher margins.

Inputs

We are also encouraged by the stability in the supply of rolling slab – the company’s single largest production input. Hulamin recently sealed a five-year rolling slab supply deal with Isizinda Aluminium. Isizinda, 40% owned by Hulamin, acquired the BHP Billiton’ Bayside casthouse, which supplies Hulamin with a third of its slab requirements.

Hulamin’s core operations involve adding value to primary aluminium to produce rolled and extrusion products, which it supplies to downstream fabricators in a broad range of industries. For it to remain profitable it is imperative that it secures a reliable source of slab.

In another bid to wean itself from partial dependency on external slab supply, the company is expected to start production of its own rolling slab from scrap when a recycling plant, now being constructed, comes online in the second half of this year.

The recycling plant would make Hulamin less dependent on raw materials. It will make use of abundantly available aluminium scrap and we expect the company to inch towards slab self-sufficiency. The process will also consume less electricity – good news given that a third of its operating expenses are energy costs.

However, despite improved prospects, its main weakness remains that it is largely a price taker, with little control on its input costs and the selling prices of its products, which are linked to aluminium prices. Exporting about 70% of its rolled products, its earnings are also influenced by the rand’s value. It is also one the few aluminium manufacturers that does not have tariff protection in its home country.

The numbers

The company’s solid prospects are also bolstered by its strong balance sheet with the net debt-to-interest ratio lower than 10% of equity. This is crucial in a market where materials-pricing volatility is high.

While it is still to declare a maiden dividend, Hulamin offers a good asset underpin as it is trading at a 20% discount to its NAV.

With its normalised earnings for the year to end-December estimated to be as high as 120c/share – 90% up on last year – according to its trading statement posted in December, the stock will be trading at an attractive price: earnings ratio of 7.4. And based on our estimates, the one-year forward multiple should be around 6 times. We think a multiple of 8 captures the growth the company promises after discounting for the risk inherent in its business model.

If you can stomach a bit of earnings volatility due to movements in the exchange rates and aluminium prices, this is a stock which could deliver double-digit growth for your portfolio in 2015.

Analyst: Orin Tambo, CFA; Editor: Colin Anthony, CFA

Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view. For Intellidex’s full disclaimer, please click here.

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