Description

Pitch:

AMG Advanced Metallurgical Group is a significantly mispriced security, with ~75% upside (conservatively). Shares have been wrongly caught-up in the commodity complex weakness, when - in fact - business fundamentals have never been stronger. The stock trades at a 13% FCF yield this year, which is completely unlevered (no net debt by year-end). And FCF will continue to grow next year & beyond. It is simply too cheap.

This investment is also timely /compelling, situationally:

• The (somewhat-controversial) emeritus CEO has agreed step down by 1H17, with a succession process underway;

• An activist fund in London recently joined the Board;

• There are a number of compelling tuck-in M&A & reinvestment opportunities;

• Despite the challenging environment, organic trends are positive overall, with a several bright spots (incl. a recovery in Engineering from deeply depressed levels). This has been somewhat obscured YTD by FX translation.

There is also a high probability AMG will be sold over the next 12-18 months. The business has been de-levered & streamlined. Mgmt is buying stock & set to transition. Ultimately, the company is poorly suited for public markets - too small & complex, especially with respect to its market cap & liquidity (<$1m / day).  The rationale for a go-private deal has never looked more compelling.

Background: What is AMG NA?

AMG is a diverse collection of niche, “specialty” (or “critical”) material processing businesses. There is also a high-quality, but cyclical Engineering business (advanced furnaces), which ran into an unusual confluence of problems in 2H14 & is now recovering nicely.

These business are generally unsexy - some are better than others (see below). But they are generally capital-light, highly-specialized & operate in niche products area with very few competitors. Several have secular growth drivers (Li-Ion batteries, smartphone glass, aerospace lightweighting, etc.) &/or potential consolidation opportunities. Commodity price exposure is limited – most are cost-plus processing businesses. Returns on capital are mid-teens & moving higher.

Below is a bullet point on key business lines (feel free to skip this part, for brevity):

• Graphite. High-quality flake graphite is used as a flame retardant in construction & industrial markets. It is also used in electronics & intensively in Li-ion batteries, which may drive one of the few interesting S/D stories in global commodities over the next few years. Bernstein has done good work on the battery supply chain.  This is one of the few areas where AMG has a mining footprint, which it is expanding (internal & third party material is processed in the EU). Earlier this year, AMG sold a ~40% stake in this business to a PE fund at almost ~$100m valuation (10-12x EBITDA), highlighting the potential value here.

• Titanium. This business is driven by alloys for the aerospace industry, a secular growth area. AMG secures material in Asia & processes it in Germany, with a new furnace recently brought online. Largely long-term, fixed-price contracts. 25%+ ROIC.

• Aluminum. AMG is one of just ~3 companies processing/alloying aluminum for casting/rolling/extrusion. Autos are a driver. This is an average, cost-plus business under some pressure in this environment. AMG has been rationalizing its footprint here. Further consolidation would be helpful.

• Silicon Metal. AMG is a captive supplier to Wacker’s poly business in Germany (fixed contracts).

• Vanadium. Used to strengthen structural steel, vanadium demand grows 2-3% faster than global steel demand, as specific consumption increases. Prices are at 10 years lows, given severe turmoil in the global steel industry. But AMG Vanadium (based in OH) continues to be profitable & grow volumes/mkt share, given its unique business model: producing vanadium from spent catalysts from the O&G industry, which it gets paid to recycle. Competitors are heavily cash-burning at current prices (several literally in bankruptcy) & under heavy pressure to cut capacity, which could dramatically improve pricing.

• Engineering. This business primarily sells highly-advanced plasma furnaces. Orders are driven by growing demand for advanced materials in the auto, aerospace, & glass industries. Plans to separate Engineering (which carries a ~$0.1bn German pension deficit) fell through last year, when earnings collapsed precipitously in 2H; we suspect geopolitical factors were to blame (US sanctions, China anti-corruption drive, etc.). This year, mgmt is cutting costs & orders/financials are rebounding nicely. This business has high entry barriers/scarcity value, very limited capex requirements, & we think it could be sold for as much as 75% of AMG’s current market cap in ’16-’17.

• Tantalum/Niobium. This business has processing/mine capacity in Brazil & the materials have a growing role in glass & electronics industries. There may be an opportunity to build a sizable lithium business from AMG’s mine tailing in Brazil.

Why does the opportunity exist?

Each of these businesses has multi-industry exposure & variety of revenue streams. I have not done them justice in the above bullet points; several units I didn’t even mention (chrome, antimony, etc.).  This mishmash of obscure niches can be time-consuming & difficult to analyze. AMG is also small ($230m mkt cap), somewhat illiquid, & listed in Holland (with mgmt in PA & USD financials).

Additionally, there is reputational overhang. The CEO – Heinz Schimmelbusch – has a somewhat checkered past; some of you may be familiar with his controversial tenure at Metallgesellschaft in the early-‘90s or, more recently, AMG’s unsuccessful investments in the solar industry, before the ‘11 crash (Timminco, etc.). Those lines of criticisms are valid, but backwards-looking, in terms of Heinz’s focus today. The business has been signficantly improved over the last few years. Heinz is also in his 70s & slated to step aside. Further, a 20% shareholder & activist fund in London recently joined the Board to focus on comp, corporate governance & capital allocation.

Finally, there is an element of “baby thrown out with the bathwater” here, in terms of perceived commodity price exposure. Financial performance (EBITDA growing 10%+ this year, organically) should validate the argument that this is a largely processing business, & commodity risk is overstated.

Valuation

Bottom line here is the stock is too cheap. On ‘16 numbers: 6-7x EPS, ~16% FCF yield, 4x EBITDA (counting the pension deficit & minority). FCF is not driven by NWC. Most of the improvement in '16 results over '15 is driven by a return of Engineering to historical levels of profitability. And the company is investing in growth (new processing capacity, graphite mine expansion); at maintenance capex levels, the FCF yield is 20%+. Equally, the implied multiples are even lower if the graphite business is worth the big price PE paid for it. The portfolio of assets is under-levered & the valuation offers a significant margin of safety/downside projection.

In terms of catalysts, again, there are multiple ways to win. Organically, consistent execution & strong ’15-’16 results should prove-out the resiliency of the business & drive a rerating. AMG is in a position to reinvest in its most promising businesses (e.g. Lithium) &/or pick-up cheap assets to further consolidate its niches. There is also optionality around a reversal in pricing for certain commodities, especially flake graphite & vanadium, where AMG is long.

Then, there are the structural angles.  CEO succession is a key piece of the story.  AMG is strong candidate for a go-private transaction. The company is likely to revisit selling the Engineering business (with its pension deficit) next year - a potential precursor to an LBO/MBO. New mgmt could relist the company in the US.

Conclusion

These are unsexy, niche businesses with attractive & improving returns on capital. AMG equity offers a low-teens FCF yield that is unlevered & growing, despite the onerous environment. There are multiple ways to win, incl. a reasonably likely near-term go-private transaction. The business is improving & the equity is worth at least eur13 (75% upside), a 9-10% ’16 FCF yield.

Catalyst

- Recovery/sale of Engineering

- Sales of the business

- Strong operating results

- Organic & inorganic investments

- Vanadium supply cuts

- Further capital returns

- Mgmt transition