FERROGLOBE PLC GSM
November 29, 2016 - 3:56pm EST by
nychrg
2016 2017
Price: 11.27 EPS n/a n/a
Shares Out. (in M): 172 P/E n/a n/a
Market Cap (in $M): 1,938 P/FCF n/a 11.2
Net Debt (in $M): 430 EBIT 0 200
TEV ($): 2,368 TEV/EBIT n/a 11.8

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  • Commodity exposure

Description

 

Investment Thesis

 

Ferroglobe PLC (NASDAQ: GSM) is a specialty metals company trading just off multi-year lows despite increasing evidence that management, through recent self-help initiatives, has begun to drive a pricing cycle, soon to be followed by a restocking cycle. A number of upcoming catalysts (including higher pricing, a non-core asset sale, debt pay down, and debt refinancing) should propel cash flow and the stock significantly higher. Silicon metal, responsible for 50% of the company's revenue, recently hit 10- year lows in pricing at $0.85 per pound (well below break-even for most competitors) but has bounced off the bottom and is now poised to inflect higher. A recent trade publication article highlighted that inventories across the supply chain are low, supply is tight, and pricing has ticked off the bottom. Ferroglobe is highly levered to silicon metal pricing and will benefit greatly as pricing rebounds. The crux of our thesis is premised on our conviction that the company, based on its historical behavior and recent M&A activity, will drive a pricing rebound in the near term. We expect this to be followed by a significant restocking cycle, neither of which we believe is priced into the stock. The downside is mitigated by a strong balance sheet, vertical integration, low cost production, and a stock trading at a significant discount to the company’s replacement cost.

 

Ferroglobe acquired its largest competitor, Grupo FerroAtlantica SA (“FerroAtlantica”), in December 2015, but remains saddled with below market legacy contracts through the end of 2016, hurting recent results. In 2H:2016, Ferroglobe mothballed two large facilities to ensure that supply would tighten into 2017 negotiations. Despite the trough of the cycle, Ferroglobe has managed to generate free cash flow in 2016 due to its low cost position. Ferroglobe is currently negotiating contracts for the first time as a consolidated entity and is taking an aggressive stance in both pricing (more detail on this below) and term (by refusing to sign annual contracts due to its constructive outlook on pricing). Additionally, the company remains particularly levered to impending price increases.

 

While many similar commodity companies (metals, steel-cos, and steel raw material producers) have generated triple-digit returns in 2016 (see Exhibits 12 & 13 below), silicon metal and Ferroglobe are slightly above flat year to date after a tough 2015. This is due in large part to the fact that silicon metal is not an exchange traded commodity, thereby inhibiting investors' ability to express bullish forward views. As such, the commodity and the company have lagged significantly and are poised to catch-up as the calendar rolls into 2017. In previous cycles, the current management team has consistently demonstrated its acumen in managing supply to drive pricing. In its current iteration, even a small increase in pricing will lead to significant earnings momentum for Ferroglobe. Additionally, the company is close to divesting a non-core power asset for $200-250mm. We expect proceeds to be used for debt reduction and possibly for share buybacks or additional M&A.

 

In the coming months, we expect further silicon metal price increases and numerous other catalysts to play out (see catalysts section below), followed by improving results in 2017. Our estimates do not assume any acceleration of global growth, however if Trumponomics or other global stimulus measures prove effective, an upside case for silicon metal and Ferroglobe would likely ensue. The company sports a 2.8% dividend, reflecting management's confidence in the company’s earnings power through the cycle and its commitment to returning cash to shareholders. Finally management has a history of well-timed, value enhancing acquisitions and is well-positioned to execute further on M&A given that pricing remains near multi-year lows and numerous small competitors are suffering financially.

 

At 7x our mid-cycle EBITDA estimate, the stock would trade at $22.47, or 97% above yesterday’s closing price of $11.42.

 

Description

 

Ferroglobe PLC is the new entity created by the December 2015 merger of Globe Specialty Metals and FerroAtlantica. The deal was executed as an all-stock transaction with the new entity led by Globe Specialty Metal's highly regarded founder, Alan Kestenbaum. Ferroglobe is the dominant Western world producer of metal alloys and other metallic products, key ingredients in many industrial and consumer products. While nearly half of the company’s business is silicon-based alloy production, Ferroglobe also produces manganese, ferrosilicon alloys, and silica fume. In addition, Ferroglobe generates hydro-electrical power and operates quartz and coking coal mining businesses, consistent with the company's proclivity toward vertical integration.

 

Over many years, Globe Specialty Metals and FerroAtlantica separately consolidated and integrated smaller companies to achieve operational synergies. Globe Specialty Metals focused on North America, while FerroAtlantica focused on Europe. Today, Ferroglobe is a globally diversified company with 26 facilities on five continents. Legacy Ferroglobe's capacity was overwhelmingly concentrated in North America, while the new entity’s capacity is approximately half European and a fifth North American. The benefits of the combination are multi-faceted. Most importantly, the company now controls 35% of Western world capacity and is well-positioned to manage supply and drive pricing, actions that it has successfully executed upon in the past. Ferroglobe's market position is more dominant than it appears because much of the Western world's capacity is consumed internally. Much less is produced for merchant sales, making the company a giant in the tradable market for silicon metal. For example, Dow Chemical, the second largest Western world producer at 18% share of silicon metal production capacity, internally consumes its entire silicon metal output. The merger provided Alan Kestenbaum, chairman, largest individual shareholder, and founder of Ferroglobe's predecessor company with a global platform to execute his growth strategy. The deal provides the company with significant synergies (some still to be realized), diversification across geographies, currencies, and customers, and significant optionality in its commercial and operations strategies.

 

Exhibit 1: Old GSM vs. Ferroglobe (“New GSM”)

 

 
 

Source: Ferroglobe presentation

 

Market Overview

 

Ferroglobe is the largest producer of silicon metal in the Western world. Silicon is a basic chemical element with symbol Si. High-purity silicon metal is utilized by many industries. For example, silicon metal is an essential ingredient in polysilicon wafers for use in photovoltaic solar cells and electronic semiconductors. Other key consumers of silicon metals includes the silicones industry, which produces an intermediate material used in hundreds of household items such as lipstick and bike helmets, as well as the aluminum industry, which relies on silicon metal to improve castability, hardness, and strength. Consumption of silicon metal is expected to grow globally at a 6% CAGR during the next five years, with significant growth in China. Silicon metal accounted for 50% of Ferroglobe’s 2015 revenue.

 

Exhibit 2: Expected Growth in Silicon Metal Consumption

 

 

Source: CRU, Ferroglobe presentation

 

With respect to end markets, the silicones industry consumes 50% of global silicon metal production. Silicones are polymers that are heat-resistant and rubber-like, with many practical uses and widely distributed end markets. As a result, silicones are a rapidly growing segment. Some current applications include auto components used for weather stripping, dashboards, tires, coatings, and cables. There is also growing demand for silicones in applications such as cosmetics, as well as in the construction industry for grout, paint, and sealants. Historically silicones demand has grown at or slightly above the rate of global GDP, with silicon metal being a critical input without substitutes. Dow Chemical, a large silicones producer, has remained vertically integrated in silicon metal to ensure its access to this critical input.

 

The aluminum industry, which uses silicon metal as a critical alloying agent, consumes 40% of global production. There are no known substitutes for silicon metal within the aluminum making process. Secular trends for aluminum, particularly its growth within the automotive sector, bode well for future silicon metal demand growth. Auto aluminum extrusions and like-parts require higher silicon metal content per pound than does commodity grade aluminum. Government fuel efficiency mandates are driving auto companies to light-weight by increasing aluminum content in vehicles. As Exhibit 3 below illustrates, by 2020, aluminum is expected to comprise 13% of light curb weight for light vehicles in North America. The silicon metal required in aluminum is utilized as a strengthener and alloying agent to improve castability and minimize shrinking and cracking. It is important to note that even if auto sales are at the peak, aluminum demand from the auto industry is poised to grow rapidly from market share gains driven by more stringent CAFE standards and from the advent of electric vehicles which require lighter weight vehicles. In addition, the trucking industry is also increasingly using silicon-intensive aluminum wheels to meet EPA regulations.

 

Exhibit 3: Expected Growth in Aluminum Content per Light Vehicle (North America)

 

 

Source: Ducker Worldwide, Ferroglobe presentation

 

The global solar industry consumes 10% of silicon metal production. Demand from the solar industry is growing rapidly, driven in part by the rapidly falling costs for solar wafers and module prices, allowing solar to approach grid parity in many parts of the world. The five year US ITC credit extension in late 2015 bodes well for explosive solar growth going forward. While Trump's renewable energy policies are uncertain, Moore's Law ensures that the solar cost curve will continue to fall irrespective of the direction of renewable energy policy. Meanwhile, solar is a key pillar of China's environmental policy and is expected to experience significant growth going forward. While currently silicon metal's third largest end market, solar is the fastest-growing. As depicted in Exhibit 4 below, solar consumption is expected to double (approximate 19% CAGR) between 2016 and 2020, reaching approximately 1,000,000 silicon tons.

 

Overall, end markets for silicon metal are expected to enjoy both cyclical and secular tailwinds in the coming year and beyond.

 

Exhibit 4: Expected Growth in Solar Installations

 

Source: GTM Research, Ferroglobe presentation

 

Ferroglobe Market Summary

 

Exhibit 5: GSM Product Mix by Revenue (2015)

 

 

Silicon alloys represented 28% of the Company’s 2015 revenue. Steel and foundry products are driving demand for silicon alloys. Ferroglobe is strategically positioned in this space, given the combined technical expertise from legacy Ferroglobe and FerroAtlantica, as well as the company’s just-in-time delivery operations. Silicon alloys are used in steel. Calcium silicon is utilized for manufacturing high grade steel, including lump, powder, and cored wire forms. In addition, Ferrosilicon has both commodity and specialty grades. Commodity grade is used for carbon steel, stainless steel, and other steel alloys, whereas specialty grade is for high grade specifications, such as electrical steel and auto laminates. In addition, magnesium ferrosilicon is used for foundry products, such as ductile iron castings, such as for automobile components, and ductile iron pipes.

 

Manganese alloys represent the remaining 22% of Ferroglobe’s 2015 revenue. Ferroalloys are alloys of iron that contain a significant amount of one or more other non-ferrous elements, such as manganese, silicon and chromium. Manganese ferroalloys are used to increase the strength and elasticity of steel, with more than 90% of global manganese ferroalloy production used for steel production. End products include consumer appliances, automotive body sheets, standard steel pipes, and specialty steel ductile iron.

 

As discussed above, while pricing of steel and its commodity inputs (i.e. iron ore and coking coal) have moved dramatically higher in 2016, the pricing of ferroalloys, another key input in steelmaking, has significantly lagged. We believe that ferroalloy pricing will catch up, as legacy contracts reset to current market dynamics. Because ferroalloys are not exchange traded they tend to lag their like exchange traded commodity peers. Additionally, Ferroglobe's suite of alloys and the company itself is poised to benefit as pricing is reset and current fundamentals become more transparent to the market and investors.

 

Exhibit 6: Summary Balance Sheet

 

* Notes

·         Multi-currency credit facility has five-year duration and terminates on August 20, 2018. Interest rates   

       are tied to Eurocurrency Rate plus a margin ranging from 1.50% to 2.50%.

·         Various borrowings to finance investments have maturities ranging from 2016 to 2026.

·         As of December 31, 2015, the debt was comprised of the following bank borrowings               

      ($, mm):

o    $268 multi-currency credit facility

o    $108 borrowings to finance investments

o    $ 29  other

o    $   1  discounted bills and notes

·         The average interest rate on all debt in 2015 (up until the merger) was 5.44%. Now, the rate is    

       approximately 6.00%

o    We expect the company will re-negotiate its credit facility to simplify and term out the structure, and lower the interest rate

·         Ferroglobe is currently negotiating an asset sale to divest non-core facilities, which we expect will    

       reduce debt by approximately $75 mm and increase balance sheet cash by $125 mm.

·         For additional information about the debt, you can access Ferroglobe’s most recent annual filing

       (20-F, for foreign private issuers) with this link: Ferroglobe 20-F. The relevant pages are F-46 through      

       F-49.   

 

Why this opportunity exists

 

Weak silicon metals market has left prices near 10-year lows

Silicon metal prices in the spot market bottomed at roughly $0.85/lb in October of 2016, below levels experienced during the Great Recession. This level was unsustainable, as numerous higher cost industry players were operating below break-even, even while Ferroglobe (by virtue of its low cost facilities) was able to generate positive free cash flow.

 

Nevertheless, depressed industry pricing, poor legacy FerroAtlantica contracts and generally weak sentiment for commodity investments led investors to punish Ferroglobe’s share price from $20 in April 2015 to below $10. Currently, the stock trades at $11.42.

 

As depicted in Exhibit 7 below, silicon metal prices in the U.S. fell from $1.45 to $0.85 between early 2015 and early 2016. There were several factors that contributed to this cyclical decline and the subsequent slow recovery, which finally appears to have reached an upward inflection in November 2016. Firstly, there was no major producer large and disciplined enough to lead on supply management and pricing. In a market with a fairly balanced supply / demand dynamic and sluggish global growth, some competitors, including FerroAtlantica, chased market share over profitability. As prices starting falling consumers slowed their buying leading to an extended destocking cycle that ended in October 2016. Further, many silicon metal producers (including FerroAtlantica) settled annual contracts pegged to indices that were thinly traded and inaccurate (i.e. small spot volumes selling below general market rates), leading to large quantities of contracted material priced in 2016 at levels well below break-even. We expect Ferroglobe to abandon contracts pegged to such indices and to instead opt to sell contracts on a fixed-price basis.

 

As mentioned previously, the company has already moved to reduce production to ensure that supply demand dynamics remain favorable going forward. In fact, the downdraft in pricing from $1.45 to $0.85 over the past 20 months occurred in a relatively balanced market whereby a few undisciplined producers badly damaged pricing needlessly. However, demand for silicon metal remains robust with aluminum and solar end markets poised to grow briskly and stable industry capacity. Silicon metal plants remains expensive to build and can take upwards of 3-5 years to bring on stream in many Western economies including those in the US and Europe where GSM primarily competes. New plants require a proximate source of key raw materials (quartz, coking coal, charcoal), cheap power, transportation infrastructure, land, and ability to garner various permits. As such, even if prices reach our upside case, numerous barriers to entry exist for new capacity to be added. In China, government regulations and a desire to reduce blast furnace capacity acts as a potential mitigant against new capacity additions. As such, the forward outlook for silicon metal remains favorable even without the disciplined leadership behavior we expect to see from Ferroglobe.

 

Exhibit 7: U.S. Silicon Metal Prices January 2009 to January 2016

   Source: CRU, B. Riley

 

Early signs of an inflection point in silicon-related commodities

According to recent news articles, including one published in early November 2016, U.S. silicon prices have begun to rebound. Inexpensive silicon metal supplies in the spot market have diminished. We continue to expect a rebound in prices in 2017. We anticipate a reversal of the downward spiral de-stocking effect, with an upward spiral re-stocking effect. With inventories low across the supply chain, rising prices will incent buyers to build inventories ahead of rising prices, further tightening supply. However, realizing that prices are rebounding, sellers are hesitant to ink year long fixed priced contracts at today's depressed levels. We expect Ferroglobe will reduce term lengths in their contracts so that the company can benefit from rising prices in 2017.

 

As Exhibit 8 depicts, U.S. silicon metal prices began increasing in late October/early November and are now listed above $1.00/lb.

 

Exhibit 8: U.S. Silicon Metal Prices January 2016 to November 2016

  Source: CRU, B. Riley

 

As Exhibit 9 illustrates, U.S. ferrosilicon prices have rebounded from $0.70 in recent weeks.

 

Exhibit 9: U.S. Ferrosilicon Prices January 2016 to November 2016

 

    Source: CRU, B. Riley

 

As shown in Exhibit 10, U.S. silicomanganese prices have gained strength recently, reaching nearly $0.56.

 

Exhibit 10: U.S. Silicomanganese Prices January 2016 to November 2016

 

  

    Source: CRU, B. Riley

 

An article published in mid-November indicated that U.S. spot prices for high-carbon ferromanganese are now $1,050 to $1,125 per gross ton, up 26% since November 1st, with silicomanganese at 52 to 56 cents per pound, up 23% in the same time period. Since the start of November, U.S. spot prices for high-carbon ferrochrome are up 16% to the $1.00 to $1.07 per pound range, while ferrosilicon is up 4% to $0.73 to $0.76 per pound range.

 

Merger of Globe Specialty Metals and FerroAtlantica

The merger of Globe Specialty Metals and FerroAtlantica created an industry behemoth in Ferroglobe. Whereas last year, both of these separate entities were essentially competing against each other for contracts with customers, now as a merged company, management is able to wield its power for more favorable negotiating terms. Further, the combination with FerroAtlantica removed a bad actor.

 

Ferroglobe is now the leader in the silicon metal industry, with a dominant 35% market share (excluding China capacity). China’s current capacity is approximately 1,500 ktpa, resulting in global capacity of approximately 2,634 ktpa. China’s capacity is excluded, because there are major headwinds for China to sell its capacity to North America and to a lesser extent Europe. These factors include: (a) shipping costs; (b) a 5% regular duty; and (c) an approximate 130% anti-dumping and countervailing duty. The combined market share of Western world capacity of Ferroglobe, Dow Corning, and Elkem is 67%.

 

Exhibit 11: Global Silicon Capacity

 

Source: CRU, Ferroglobe presentation

 

A Uniquely Favorable Risk-Reward Profile

We see Ferroglobe's recent move off the bottom as the beginning of a longer term reversal after an oversold period. Moreover, this upside rests with the major operational leverage that comprises Ferroglobe’s business model, whereby at current utilization, every $0.01 increase in total average portfolio pricing yields approximately $24mm in incremental EBITDA (see Exhibit 16 below). While industry structure post-merger is significantly better, and global growth is improving, the company can generate significant free cash flow even at prices well below those of the $1.45 that we saw in early 2015. That said, we have no reason to believe prices cannot return to or exceed those levels, however Ferroglobe will likely be a good investment at prices well below those reached in 2015.

 

Best-In-Class Management Team

The merger that formed Ferroglobe also united two industry veterans in Alan Kestenbaum (Executive

Chairman) and Pedro Larrea Paguaga (CEO). Both of these leaders have decades of experience in metals and energy sectors, including successfully navigating industry cycles, as well as integrating acquisitions. Mr. Kestenbaum manages contract negotiations and other commercial responsibilities, while Mr. Paguaga manages day-to-day operations. As a result, the Kestenbaum-Paguaga team is well-positioned to navigate the impending upcycle.

 

The Low-Cost Producer

The company is vertically integrated with ownership of all major raw materials (quartz, charcoal, coking coal, electrodes) and enjoys low cost, long term power contracts. The company's geographic diversification acts as an internal currency hedge, currently protecting against the strong dollar. The company runs its plants efficiently and was able to generate free cash flow at the trough of the cycle. With some raw materials prices recently spiking (i.e. coking coal prices more than tripling from <$100/tn to $300/tn), Ferroglobe is poised to extend its cost advantage over non-vertically integrated competitors. If an inflationary environment ensues (not our base case) the company would be uniquely well-positioned to benefit.

 

Our Perspective

 

Recent volatility in the global silicon metal industry pushed pricing below Great Recession levels during 2016, raising investor uncertainty, and thereby creating a compelling long investment opportunity in the equity of Ferroglobe. There was significant investor misperception of market dynamics, which unjustifiably sent Ferroglobe shares to six year lows, below $9 per share. In the past few weeks, signs of a recovery in silicon metal have begun to emerge as low-cost silicon inventories have dried up, marking a potential inflection point and sending the stock above $11. We expect to see a reversal of the multi-year downturn in the industry and see significant upside for GSM shares.

 

As Exhibit 12 below illustrates, the silicon metal recovery has lagged other major commodities year-to- date. As a result, we think the recent inflection in silicon metal prices is well-justified.

 

Exhibit 12: Percentage Change in Commodity Prices Year-To-Date through Mid-November

 

Source: CRU, Bloomberg, estimates

 

Exhibit 13: Select Commodity Stocks Year-To-date Performance (through November 28, 2016)

 

 

Ferroglobe is a best-in-class industrial metals and mining producer with significant leverage to ferroalloys such as silicon metal, benefits from its low-cost producer status as a vertically-integrated company, and is led by a superior management team, including Alan Kestenbaum, its executive chairman who has more than 30 years experience in the industry. The Company’s vertical integration includes ownership of raw material sources for quartz, woodchips, low-ash coal, and energy.

 

Across the world, Ferroglobe operates 26 facilities on 5 continents (North America, South America, Europe, Africa, and Asia. With a dominant 35% global market share, Ferroglobe has the ability to set the pace for the industry, including heavily influence silicon metal pricing by adjusting its capacity utilization (i.e. temporarily shutting down operations) to reach a more favorable supply-demand dynamic for price equilibrium.

 

Therefore, if necessary, we expect that Ferroglobe will exercise its industry clout to drive up silicon metal pricing in 2017 and 2018 by selectively shutting down plants where market conditions are unfavorable, such as in North America where silicon metal production is unprofitable (spot price is less than the cost of production). North America production costs are now $0.95, compared to $0.75 in Europe owing to the strong dollar.

 

Thus, the current dynamic is near the market trough. Spot prices were recently below levels experienced during the Great Recession, with many small unprofitable players forced to curtail production or default. With unsustainably low pricing, these small players will leave the market or be bought by larger players like GSM.

 

Moreover, we think Ferroglobe is uniquely positioned to reap the rewards of the market turnaround (not a “if” but a “when” issue), given its diversification in products (silicon metal, silicon alloys, manganese alloys), markets (Europe and North America, thanks to Globe Specialty Metals and FerroAtlantica combining forces), operational base (five continents reduces risk of local cost fluctuations), and vertical integration (ownership of raw materials).

Further, the company has stated that replacement cost of its asset portfolio exceeds $6B, suggesting that the company is trading at 1/3rd of replacement cost.

 

Turning to the Numbers

 

As depicted in Exhibit 14, Ferroglobe currently operates at 82% capacity utilization, with silicon metal utilization at 81%. Total capacity is 2.9mm pounds, of which 2.4mm are currently utilized.

 

Exhibit 14: Capacity and Current Utilization

 

Source: Ferroglobe

 

Exhibit 15 illustrates ferroalloy prices from 2009 to 2015.

 

Exhibit 15: Historical Ferroalloy Prices

 

Source: Statista, CRU

 

As discussed earlier, at current utilization, Ferroglobe generates an incremental $24mm in EBITDA for every $0.01 increase in company-wide average pricing. Exhibit 16 illustrates a sensitivity analysis with three scenarios, each of which assumes various pricing averages for 2016. The spot case is what we estimate is current "spot" pricing in the market. The base case assumes an aggregate $0.20 average price increase across the company's products (including silicon metal pricing of $1.24), while the upside case assumes an aggregate $0.30 average increase (including silicon metal pricing of $1.40). Our base case projects $585mm of EBITDA, generating $301mm of free cash flow (15.3% FCF yield to the equity and 13.3% to the enterprise). At our base case, the company would be 0.5x net levered and would enjoy significant debt capacity to execute on further value enhancing M&A.

 

Exhibit 16: EBITDA and FCF Scenarios with Current Utilization

 

Valuation*

Ferroglobe currently trades at attractive EV/EBITDA multiples, when considering the historical multiple of 8x and current inflection point to the upside in silicon metal prices, which are currently still trading near multi-year lows. Exhibits 17-19, depict our EBITDA and share price sensitivity analyses based on the total portfolio price increase above the 2016 average. In summary, assuming a total $0.20 per pound increase, which would yield $585mm in EBITDA, and applying a 7x EV/EBITDA multiple (one less turn than the historical average), we derive a price of $22.47 for GSM shares, 97% above yesterday’s closing price.

 

Exhibit 17: EBITDA Sensitivity to Total Portfolio Prices

 

Exhibit 18: Share Price Sensitivity to Total Portfolio Prices Increases and EV/EBITDA Multiples

 

 

Exhibit 19: Share Price Return Sensitivity to Total Portfolio Prices and EV/EBITDA Multiples

 

 

* Valuation section based on 3Q:16 pro-forma balance sheet and assumes asset sale gross proceeds of $250mm, net proceeds of $175mm (with $75mm debt assumed by buyer). Tax rate estimated at 28%. Results in pro-forma net debt of $230mm inclusive of a $125mm increase in cash.

** The above sensitivity tables assume current capacity utilization of 82% across products. At 95% capacity utilization we estimate EBITDA would increase by an additional $75-125mm based on various pricing assumptions. While increasing capacity utilization is likely should global economic growth accelerate, we view this as a free call option on a further upside case and have excluded it from all of our estimates.

 

Risks

Global recession -- A financial crisis, major global conflict or any event that would materially depress global commercial activity would be negative for GSM. The offset to this risk is the fact that pricing and valuation are now near trough levels. In addition, the company's diverse asset portfolio and strong balance sheet enable it to manage supply.

Elimination of ITC solar tax credits  -- As discussed earlier, while the elimination of solar ITC solar tax credits could slow US solar demand growth, global demand will remain robust and domestic solar will still benefit from falling costs and from state mandates.

Minority ownership structure -- The December 2015 merger of FerroAtlantica and Globe Specialty Metals was executed as an all-stock transaction with FerroAtlantica receiving 57% of the new shares. These shares are controlled by the family of industrialist Juan-Miguel Villar Mir, who was formerly the sole of owner of FerroAtlantica. Being minority shareholders is a clear negative as the board could initiative a take-under, fire Alan Kestenbaum, or undertake a sub-optimal strategy at the expense of minority shareholders. We are comfortable underwriting this risk given that Alan Kestenbaum has his life savings invested in the new company and bears essentially the same risks shareholders do. He is the executive chairman of the board and runs commercial operations and M&A for the company. As such, we see the majority holder as willing to take a more passive approach to its investment, but we will monitor this issue carefully.

Key man loss -- Alan Kestenbaum, the company’s chairman, is a key to this story but has held his stock and remains as engaged as ever to run and grow the business.

New Western capacity -- Undisciplined capacity additions would damage fundamentals. As stated above, new capacity is expensive, hard to permit and takes years to build. Further after the recent downturn, capital for such projects would be hard to acquire and any project would not come online for some time.

 

Conclusion

Ferroglobe is at the dawn of an upcycle at a time when its valuation is undemanding, it possesses numerous self help levers that are already being pulled, global growth seems poised to accelerate, sentiment for metals names is improving, and the benefits of its industry consolidation are about to be harvested. Evidence of a sharp metals commodity rebound off the 2015-2016 lows are evident everywhere but in the non-exchange traded commodities which have lagged significantly. Ferroglobe is poised to play catch up in 2017 as the numerous catalysts described above play out.

 

Downside is mitigated by a strong balance sheet, a low cost asset base and a 2.8% dividend.

 



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Increases in silicon metals and alloy pricing (1H:2017) -- Would lead to earnings momentum and a virtuous restocking cycle

Non-core asset sale (1H:2017) -- We expect the company to realize approximately $250mm of proceeds of which $75mm will be used to reduce debt, and the remainder (net of taxes) to be used for either share buybacks or M&A

Refinancing of credit facilities (1H:2017) -- The company is paying above market rates for its debt and intends to consolidate its debt and reduce its interest costs

M&A -- GSM is well-capitalized at a time when many competitors are under financial stress and is therefore well-positioned to make additional value creating acquisitions

Tariff protections -- The company is already well-protected from China, however further restrictions on imports in both the US and Europe are likely given the current protectionist climate

Share buyback -- The company has engaged in buybacks from time to time and could utilize funds from the non-core asset sale to buyback the stock at its currently depressed price

Restart of mothballed facilities -- This would improve currently depressed sentiment and would represent a substantial step up in earnings power for the company


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