Craig Martin: Why I think you could get at least 25% out of Hulamin in the next year

By Craig Martin*

Hulamin Ltd (HLM) is a mid-stream aluminium semi-fabricator. It is also one of those companies that fits the Peter Lynch model of “boring name, doing boring things.” Hulamin does not own smelters, but rather it purchases primary aluminium and then adds high value by creating niche rolled products and complex extrusions to manufacturers of finished products in South Africa and around 60 other countries. Aluminium rolling contributes more than 80% to Hulamin’s revenue, with the balance comprising extruded products, casting and other downstream products.

While it is a significant seller into the South African market, it still exports more than 70% of its rolled products, which in a sense makes it a bit of a Rand play. The only problem is that Hulamin is a price-taker, not a price-maker, in that both its input costs and the selling price of its products are linked the price of aluminium. Fortunately though, the rand price of aluminium has been on a nice rise since around May this year (as can be seen from the table) which means that Hulamin can charge more for its value-added products.

Hulamin has struggled to gain traction ever since it was unbundled from the Tongaat Hullet on 25 June 2007. On that first day of trading, the company traded at a high of 4200c and a low of 2900c and then finally closed the day at 3200c.  The listing really came at the wrong time as aluminium prices had been on a great rise from 2005, but then came under pressure as the world enter a recession in late 2008. While demand for aluminium was slowing, increased production from new global competitors meant that the market was left with increased supply for most of 2009-2011.

Although demand for aluminium has picked-up slightly due to increased applications for the product, there is still an oversupply globally. China, Brazil and the Middle East still continue to bring new capacity on line. South African has no import duties for aluminium, meaning Hulamin has to continually contend with global competitors operating on their doorstep. Ironically Hulamin export some product to China and Brazil, where they levy import tariffs.

The share price of Hulamin has actually been a reverse ten bagger – if measured since its unbundling. It started 2013 at just 310c and opened this year’s trading at 506c and went on to climb to a high of 890c and has now settled at around 685cps. Certainly this recent performance in the share shows that there is renewed interest from investors in the company.

Most of this share price appreciation has been on the back of a turn to profitability in the group. For example, in the first-half of 2013, the group achieved R91m in profit, second-half of 2013, the profit climbed to R110m, the first-half of this year profit amount to R130m. The company has guided that both EPS and HEPS will definitely exceed 70cps, but I anticipate profit of at least R148m for the six months to end of December, which implies HEPS of around 85cps for the year.

Rolled Products sales volumes for the first six months of this year increased by 5% over the corresponding period last year and by 9% when compared to the lower sales volumes achieved in the second half of 2013. The fact is that the company is supplying over 200 000 tons of rolled product each year. This is despite the fact that there is a lot of competition around.

In my view, the consistent earnings increases are testament to management’s efforts at restructuring and cost control initiatives, including the retrenching of around 130 staff. In addition, there has been an increase in real application of rolled and extruded aluminium products. It is used in household items, such as foil and foil trays for cooking, it is used in window and door frames and other construction items. Aluminium is used in solar heating panels, shopfitting, bicycle frames, and more recently in beverage cans and in automobile construction.

Debt levels have reduced from around 18% debt to equity to 10,9% in the first half of this year. Cash inflows in the first half were used to repay borrowings which, effectively brought debt down from R612m at the start of the period of R387m at the end of June 2014. I believe that management will continue to apply their cash flows to paying down debt, although they are negotiating a R275m term loan for a new recycling plant in Pietermaritzburg.  Management also noted about a year back that they had negotiated a R1,65 billion funding solution with Nedbank. These facilities were intended to assist with providing liquidity and allowing Hulamin to hedge its foreign currency exposures.

Hulamin did source approximately a third of its rolling slab from the BHP Billiton’s Bayside smelter and casthouse. At the end of June, BHP Billiton closed the 43-year old Bayside smelter and a few months ago it was clear that Bayside would not open again. BHP Billiton has contracted to continue to supply Hulamin with rolling slab from Bayside until 31 December 2014.  The other two-thirds of Hulamin’s required supply came from their own casthouse in Pietermaritzburg – however if Hulamin does not manage to negotiate replacement supply within decent proximity then essentially its production capacity will be capped. In mid-2015 the new recycling plant in Pietermaritzburg is expected to come on line which should assist in filling a large part of the gap left from the Bayside closure – but we expect that demand for Hulamin’s products, especially for beverage cans, will continue.

For a number of months now, Hulamin has been supplying aluminium slugs to Nampak Bevcan who in turn print and provide a large chunk of the cans for SAB Miller and Coca-Cola on the African continent. These cans also make their way back to Hulamin through their waste collection initiatives and are used as scrap at a far reduced rate to what they would have otherwise cost.

There may also be potential for Hulamin to supply to the automobile market, as we have seen that demand for aluminium bodies for vehicles has begun to grow.  Overall, we think that there is a lot more certainty to Hulamin’s earnings going forward, provided that they can close the gap left by the Bayside closure.

The company net asset value is at around 1092cps, which means that it currently trades at a 38% discount to NAV. Based on my estimates for 2014 of 85cps, the share is trading on a forward PE of just 8. We do think that the share deserves to trade at a discount to the market due to the uncertainty issues, but I think that it could easily rerate to a multiple of 11. This implies a share price of 935c, which is around 37% higher than the current trading price.  A more likely scenario is that it finds the 850c that it was at earlier this year which implies a PE of 10 on my estimates, or a PE of 12 based on the 70c that we know is a certainty. That is a nice lift of 25% from the current price.

* Craig Martin is an entrepreneur with investments in information technology and financial services. He has experience as a discretionary Portfolio Manager, and has worked for ABN-Amro, Aurica Asset Management and Guardbank in the past. He currently investments for his own account and operates as an independent equity analyst.