Description

Overview

• Ferroglobe PLC (“Ferroglobe” or “GSM”) is a specialty materials company with a very favorable supply/demand outlook. The company has completed a recapitalization which takes liquidity concerns off the table. It is in early stages of turnaround with a new CEO who has a strong reputation. Trades at  just 3x 2023/24 EBITDA.

Introduction

• Woodrow wrote up GSM in May of this year and I would refer you back to his writeup for some excellent context; I believe that it is time to revisit the stock

• Shares have done well subsequent to the writeup on an absolute basis, rising from his writeup price of $4.15 to ~$6/shr; however, this obscures what was an even more impressive interim run to $9.50/shr

• Since the May writeup, there have been a number of favorable developments

• The company has completed its balance sheet restructuring; liquidity risk is off the table

• Cost takeouts have proceeded either in-line with or ahead of management’s original expectations

• Pricing for the company’s products has remained incredibly strong

• Over the past 13 mos (since the company released its projections in conjunction with the proposed financial restructuring), pricing for the company’s products is up anywhere from 80% to 270%, with an average increase of 180%

• Since Woodrow’s May writeup, pricing for the company’s products is up anywhere from 10% to 140%, with an average increase of 85%

• Note that this pricing is based on Bloomberg index pricing, which (per the company) generally understates actual realized market pricing for suppliers

• Despite these developments shares have taken their lumps recently; the primary culprit is market concern over the company’s ability to manage increased input costs, primarily energy, and drive acceptable operating leverage

• I believe that we remain in the early stages of the company’s recovery; management is moving aggressively to leverage its global footprint to address cost inflation and the supply-demand outlook appears favorable over a multi-year period

• Smaller local competitors are highly disadvantaged vs Ferroglobe, with limited/no ability to leverage geographic diversity to minimize cost inflation (i.e. energy) headwinds

• Spain is the company’s most troubled geographic locale w/respect to rising energy prices, as (I believe) it is the only locale where it is 100% exposed to spot energy pricing from external suppliers

• Spanish energy costs have risen ahead of all expectations, from €45/MWh (1Q 2021) to an intra-quarter peak of €189/MWh (3Q 20210)

• Ferroglobe has begun a multi-faceted effort to ameliorate the situation in Spain

• Several furnaces in Spain have been idled, with additional production cutbacks at non-idled furnaces

• Contract negotiations for 2022 are underway, with provisions for pass-thru of energy costs to customers of the Spanish facilities

• Longer-term power supply agreements in Spain are being discussed, to provide a higher degree of predictability and limit exposure to spot energy pricing

• Results in Spain have begun to turn, moving from a loss position in 3Q to (modest) profitability in the early part of 4Q

• Management plans to host an analyst day in 1Q 2022, at which point I expect it to (at a minimum) affirm the existing operating/financial plan or (ideally) increase existing medium-term guidance

• Contract negotiations for 2022 are currently underway, and reflect the company’s advantaged position vis-à-vis customers that are looking to lock in needed supply

 Business

• GSM was formed through the 2015 merger of Spain-based FerroAtlántica, S.A.U. (“FerroAtlántica”) and US-based Globe Specialty Metals, Inc.

• Segments

• Silicon metal (31% TTM volume, 37% TTM revs)

• 242k metric tons capacity (2019); 70% N America mkt shr, 20% global market shr ex-China

• End markets: aluminum (45% 2019), chemicals (43% 2019) serving diversified end markets (personal care, construction, health care, electronics), solar (10% 2019); segment is primary driver of consolidated profitability; required for production of aluminum alloys, reduces shrinkage and cracking

• Silicon-based alloys (31% TTM volume, 28% TTM revs)

• Primary end market is steel (accts for 88% of sales); deoxidizing + alloying agent

• 34% market share in Europe; among top 3 ex-China

• Manganese-based alloys (38% TTM volume, 25% TTM revs)

• 309k metric tons silicomanganese capacity (2019) + 346k metric tons ferromanganese capacity (2019)

• 15% European market share

• Primary end market is steel (accts for 90% of sales); deoxidizing agent

• Overall end markets (per company 2018 presentation): steel (35%), aluminum (23%), silicones (15%), photovoltaic (13%), other (14%)

• Control some raw material assets: metallurgical coal (US), quartz (US, Spain, Canada, S Africa), charcoal (S Africa)

Thesis

• Company is benefiting from a favorable supply-demand outlook

• Strong macro/demand tailwinds for virtually all the company’s primary end markets: steel, aluminum, silicones, photovoltaic/solar

• US International Trade Commission (ITC) has implemented tariffs ranging from ~50-150% for a minimum of five years on US imports from Bosnia/Herzegovina, Iceland, and Kazakhstan; reduces pricing risk

• Energy, one of the primary cost inputs, has been a major P&L headwind for the company recently; however, the silver lining in rising global energy prices is that they will help keep swing capacity in check for high-cost producers

• Significant portion of China capacity linked to coal-fired energy sources so rising Chinese coal prices are a positive in limiting supply

• Growing global focus on environmental impact and sustainability is limiting production in China and Iceland

• Multi-year lead time for new greenfield capacity; 5 years in the West, 3 years in China

• Supply additions from furnace conversions unlikely to add meaningful aggregate capacity

• Company will garner increasing exposure to (favorable) spot pricing as current contracts roll off

• Silicone metal contracts typically ~1 year; other products typically have shorter-term contracts

• Management expects to maintain much higher than normal exposure to spot pricing for 2022; is targeting 25-30% of 2022 silicon metal volumes on fixed price contracts vs 70% historically

• Evidencing the strong demand environment, Ferroglobe customers who are currently under contract have come to the company offering to raise current contract rates in exchange for guaranteed supply over more extended time periods

• Significant low hanging self-help restructuring benefits available

• Since the 2015 FerroAtlántica merger company has had meaningful excess capacity in Europe; legacy mentality was always to maintain this capacity and focus on volume instead of price/profitability; new management team is finally changing ingrained attitudes and managing the business for profitability; permanent capacity reductions will lower fixed overhead + improve global/regional supply/demand dynamics

• Initial restructuring plan has identified $180mm of self-help EBITDA improvement; presupposes no improvement in current pricing/demand environment; major buckets include footprint optimization ($40mm), continuous plant efficiency improvements ($60mm), SG&A reductions ($25mm), centralized procurement ($15mm), and commercial excellence ($40mm)

• Early innings of restructuring under new management team are already beginning to take hold

• EBITDA progression from ($29mm) in 2019 to $33mm in 2020 despite a >30% decline in revenues ($1.6bn → $1.1bn) driven by short-term COVID headwinds

• $116mm cash pulled out of working capital in 2020

• Strong, revamped management team

• Current CEO (and architect of the turnaround plan) is Dr. Marco Levi

• Prior to joining Ferroglobe in early 2020 he spent the bulk of his career (20+ years) at Dow Chemical; his final role was running the $3bn emulsion polymers business Styron (acquired by Bain during his tenure)

• Reputation as turnaround specialist

• Levi has replaced virtually the entire senior management team (CFO, CMO, Chief Legal Officer, entire level of VPs); many worked with him at Dow

• External consultants are reportedly working on a contingency basis, giving them strong incentive to deliver clear, actionable cost saves

• Financing deal, now complete, has removed near-to-medium-term liquidity risk and provided the necessary cash ($100mm) to fully implement restructuring plan

• Successful exchange offer for senior unsecured notes ($350mm) has been completed; maturity now extended to late 2025, 9.375% coupon (unchanged)

• $60mm new super senior notes

• $40mm new equity

• Reasonable quality business: 2008-2020 generated positive FCF in 10 of 13 years

• China risks are manageable

• China has theoretical production capacity that could swamp aggregate global demand; however, multiple headwinds are likely to keep much of this offline

• China is high-cost marginal producer

• Rising energy prices (coal) are further pressuring Chinese capacity

• Removal of ferro subsidies; declining government support for outdated technology

• Raw material bottlenecks: lack of access to supply for both metallurgical quality coal and quartz

• Global supply likely to stay tight for foreseeable future

• China

• Reportedly has 5mm tons of nameplate capacity; theoretical max if they could run all plants

• Much of this is practically unusable b/c no longer has access to power, etc.

• Over past 10 years, 3mm tons of old, small, inefficient plants have been shut down (these are included in the 5mm nameplate figure) and 2mm tons of high efficiency production capacity has been opened in the NW region of the country (inner Mongolia)

• Today, effective capacity is 2mm tons (aforementioned) and 0.5mm tons of capacity in south (driven by hydro power) = 2.5mm tons…represents ~2.1mm tons of effective capacity at max utilization levels

• Internal Chinese demand is 1.4mm tons, growing 10% annually

• So ~600k tons available for export (steady in each of past two years)

• West (global ex-China)

• 850k tons of capacity online today

• Another 500k of offline capacity, only 250k of which has access to competitive power sources

• Of the 250k that could be brought back online today, ~50% is Ferroglobe, so Ferroglobe is in a position to dictate pricing going forward

• So 850k + 250k = 1.1mm tons of theoretical potential capacity today

• Global ex-China supply-demand picture

• Current global supply (ex-China) = 1.4 – 1.5mm tons; West = 850k online today + 600k tons Chinese export

• Current global demand (ex-China) = 1.7mm tons

• So, 250k shortfall

• With full 250k of swing capacity back online supply/demand in West would be balanced at 1.7mm tons

• Swing capacity is high cost, so will only come back online if prices remain high

• Strong long-term demand

• Silicon metal demand has grown 5-6% CAGR over past 30 years; incremental demand driven by semiconductors, polysilicon (solar), etc.

• High-end nano and micro silicone

• Can drive meaningful improvement outcomes in batteries (charging time, capacity, etc.)

• Demand today ~10k tons; projected to increase to 200-300k tons by 2030

• Sells for 3x the commodity grade prices

• Current financing deal projections are arguably conservative

• Business has been running ahead of 2021 plan projections despite energy cost headwinds

• Projections were made when COVID still had demand locked down and talk of mini commodity supercycle had not emerged; management focus was on cash preservation

• As mentioned previously, pricing is running way ahead of original plan by orders of magnitude; for example US ferrosilicon pricing is nearly 4x original plan expectations; silicon metal (the key driver of consolidated profitability) is anywhere from 2.5x to 3x original plan pricing

• The market has grown increasingly concerned lately over lack of perceived operating leverage despite the massive pricing increases; however, 2021 was never expected to demonstrate tremendous operating leverage given the high % of fixed price contracts coming into the year; 2022 should begin showing the expected step function improvement in overall profitability

• Extremely attractive valuation

• EBITDA should begin to meaningfully accelerate in 2022 as contract repricing takes hold; the necessary operating leverage under the current pricing deck in order to exceed the Oct 2020 projections is almost laughably low; by my calculations, the company only needs to convert 5% of incremental revenue to EBITDA in order to meaningfully exceed plan projections

• Business should be debt-free by YE 2023

• Relatively conservative multiples (6-7x EBITDA, 10x FCF) yield upside of 100-200% to the equity

  Management Projections

• These are available in the company’s Investor Update (2/1/2021); see IR section of company website (https://investor.ferroglobe.com/events-presentations)

Upside/Downside

Risks

• Cost inflation

• Chinese data is murky; we have tried to triangulate numbers for the Chinese supply-demand situation, but there are no “official” numbers available
• Restructuring efforts in Europe are difficult/slow

Catalyst

Operating leverage kicks in (2022), Analyst Day (1Q 2022), energy price declines