ZINC - Horsehead Holding Corp

[thelads]

Hi guys, here is the presentation that Monish Pabrai made to Boston college. About 1:11 to 1:13 (may  be a little earlier) he talks pretty openly about why he likes ZINC.

 

http://www.valuewalk.com/2013/12/mohnish-pabrai-boston-college-presentation-video/

 

 

[racemize]

It's strange that he's giving out this information now.  I guess he realized it doesn't matter that much.

[one-foot-hurdles]

http://presciencefunds.com/wp-content/uploads/2013/09/Horsehead-Holding-Corp_Prescience_Final.pdf

 

 

[OracleofCarolina]

Hey guys, what did Pabrai say? The video will not play for me :(

[CorpRaider]

Sez it will generate approx $120 mil - $150 mil in cash flow in a year or two after big capital investment winds down, said market cap is about $700 million is highly levered to zinc which is close to the bottom of its range over recent history…no discussion of enterprise value.

[Guest hellsten]

Hey guys, what did Pabrai say? The video will not play for me :(

 

See:

and

 

He said something like this:

Two facets to their cash flows. One facet is independent of the price of Zinc. If Zinc prices stay where they are today. These guys may produce somewhere between $130-170 million of cash per year.

 

It's a company that has a market cap of $700 million. On the low-end...$130 million, it's like six times cash flow or something.

...

But also the flip side is, for every 10 cent price increase in Zinc, their cash flows increase by $25 million. They are very highly levered to the price of zinc.

 

Zinc is currently at about 80 cents per pound. Historic range is 50 cents to 2 dollars, for example. 50 cents is when the world shuts down. That is unlikely. Unlikely to go below where it is now. It's not outside the realms that zinc prices will be $1.3-2.0.

...

At the extreme high end the cash flow is $280 million. What is a business like that worth? I don't know, but it's worth more than what it is worth now.

...

ZINC is giving you a free option. I'm not paying for zinc prices going to $1.3-2, or whatever. If that would happen almost for sure the stock price would move in a significant way. I like free options where you have upside without downside.

...

In businesses which have high variability of cash flows you can get wider gyrations from intrinsic value which creates the opportunity to do something about it.

 

Price of zinc is over $1 per pound:

http://www.wolframalpha.com/input/?i=price+of+zinc

 

Later in the video he talks about the moat of ZINC and low-cost commodity producers which he compares to Coca Cola and Geico:

It dawned on me that commodity based businesses can have incredible moats. In order for them to have incredible moats they need to be low cost producers, so most commodities they talk about which quartile of cost their in.

 

Lets take not the company with the ticker symbol ZINC, but lets take the commodity zinc for example. If you look at the commodity zinc, the lowest cost producers in the world who have the lowest cost mines, the bottom 25% of production, may have a cost of 40-50 cents per pound.

 

The next quartile the 25-50% producters may have a cost of lets say 60-70 per pound. In the third 70-80. In the fourth close to 90 per pound. If zinc is trading like it is trading now at 80 cents per pound.

...

All those guys who have cost above 80-90 cents per pound, unless their marginal costs are low, they pretty much have shut down production at current prices because the would be losing money at current prices. Their mines are mothballed.

 

If zinc demand increases you know the price might go up to a $1-1.5 and more production may come online. The person who has the greatest moat in that business is that mine that is producing zinc at 40-50 cents. That mine is going to make money day in and day out.

 

Even if production drops, china goes into a tailspin, it's still unlikely you get to less than 50 cents per pound. If you own a commodity business where you are the low cost producer and you have some pretty significant volumes you can bring online at low cost, that is a fantastic business.

A business that has a moat like Coca Cola and Geico, a durable competitive advantage. So when I look at commodity businesses, one of the first things I look for is what quartile are they in in their production. You also have to look at long continuums of where commodity prices are.

 

...

In 2008 when we were making these commodity investments most of the investments we made where in businesses that were first-quartile producers. Prices had come down to the point were they were barely making any money.

It was clear to me that at some point the economies would start functioning again...

 

He also talks about Teck which he calls a blue-chip miner, "the IBM of mining" and how it went from $3 to $30 because of what he just explained

https://www.google.com/finance?q=NYSE%3ATCK

 

He also said he didn't know much about commodity investing before 2008, but that now he has tools that help him understand the dynamics better.

 

To summarize it looks like his thesis is something like this, correct me if I'm wrong:

- ZINC is a free option on the price of zinc

- ZINC's moat is perhaps as wide as Coca Cola and Geico

- zinc prices won't drop much below the lowest quartile's cost of production

[Guest hellsten]

Mohnish postmortem on Teck, "his best ever investment":

http://www.gurufocus.com/news/136687/monish-pabrai-postmortem-on-his-best-ever-investment--teck-cominco-tck

 

The big concern was that if Teck could not handle their debt in a year, they would have to file for bankruptcy. Teck was looking at massive debt coming due. Within a year, all the commodity prices had collapsed. Their cash flow projections were out the window. The stock went from $50 a share to $4 a share in just a few months. That's when we started to first buy the stock.

 

On the balance sheet, Teck had a lot more assets than liabilities. They had a liquidity mismatch. They had enough assets to pay off all the liabilities, but those assets weren't liquid. The markets were concerned that when the debt came due, Teck wouldn't be able to pay the debt, and they would have to file for bankruptcy. When I looked at the whole thing, I thought that even if they filed for bankruptcy and even if they went through a bankruptcy reorganization, the equity would still have value because there was so much more in assets versus debt.

...

A similar situation happened recently with General Growth (GGP). General Growth is a very large mall operator. They have a huge amount of illiquid assets in their very valuable prime properties, but they didn't have the cash flows and the liquidity to service their debt. In General Growth's case, they went bankrupt, but when they came out of bankruptcy, the equity did not get wiped out. I saw the same thing in Teck. Even if they went bankrupt, I didn't see the equity being wiped out.

...

As that overhang lifted, the stock pretty much started to go back to where it was, from under $5 a share to over $40 a share in ten months. The mid-$30 a share approaching $40 a share was pretty close to my assessment of what the business was worth. We held Teck for only 13 months. We held to get long-term gain, and then we were done.

[Guest hellsten]

What if we apply this mental model to gold? Gold's current price is 1227$. Who are the lowest cost producers? What are the quartiles?

 

http://www.bloomberg.com/news/2013-04-16/gold-miners-approaching-1-300-pain-threshold.html

 

Gold miners led by Barrick Gold Corp. (ABX), the world’s largest, will likely accelerate spending cuts and trim high-cost output as the metal’s biggest plunge since 1980 threatens to make about 30 percent of production unprofitable.

 

Gold futures fell 9.3 percent to settle at $1,361.10 in New York yesterday, taking losses to more than 20 percent since the record close in August 2011 and meeting the common definition of a bear market. The average so-called all-in cost of 20 gold producers was about $1,306 an ounce in the fourth quarter, Toronto-based analysts at Dundee Capital Markets said in an April 12 note.

 

“Below $1,300 gold, about 30 to 40 percent of mine production is probably not cash-flow positive,” Joseph Wickwire, the Boston-based manager of Fidelity Investments’ Select Gold Portfolio fund which has about $2.14 billion under management, said yesterday in a telephone interview.

 

So my guess would be that already somewhere between 40 to 60 percent of mine production isn't cash-flow positive if the average is $1,306 per ounce.

 

Barrick Gold:

Today Barrick Gold Corp. is the world’s lowest-cost senior gold producer (all-in sustaining cost basis) and is also the world's largest gold producer.

...

In 2012, Barrick produced 7.4 million ounces of gold at all-in sustaining costs of $918 per ounce and total cash costs of $558 per ounce.

...

These five mines (two are in Nevada) are expected to generate some 60 percent of 2013 production at an average all-in sustaining costs (AISC) of $650-$700 per ounce.

 

http://aheadoftheherd.com/Newsletter/2013/TEN-Out-Of-Ten.htm

 

Barrick is trading at the same level as when gold was at $200-300 between 2000-2005. This sounds very attractive to me.

 

http://seekingalpha.com/article/1883221-barrick-gold-still-offering-more-gold-to-its-shareholders

 

Barrick, the world's leading gold producer, is leading the industry since it is the only miner that has reported a decreasing AISC. Moreover, the company is aggressively putting efforts into reducing its operating costs by an additional $500 million as it is planning to move ahead with job cuts, which will ensure improving efficiency and also streamline production.

 

http://seekingalpha.com/article/1883221-barrick-gold-still-offering-more-gold-to-its-shareholders

 

One problem with applying this mental model to gold is that gold is a currency and many other things, which depends more on Mr. Market's mood than zinc. The average person doesn't buy wedding rings made from zinc and doesn't buy zinc because they think the price will go up.

[Guest hellsten]

http://presciencefunds.com/wp-content/uploads/2013/09/Horsehead-Holding-Corp_Prescience_Final.pdf

 

After watching the video where Mohnish talks about ZINC, zinc and commodities, it's like he gave me a new pair of glasses.

 

In the presentation from Prescience Fund's we see that cash-flow break-even price is estimated to be ~65 cents per pound. After the new plant is operational the break-even price will be ~42 cents per pound.

[yadayada]

what prevents several competitors setting up plants like that tho? Or is that not really relevant here?

[Guest hellsten]

Mohnish seems to share my doubts about gold producers, but I'm probably reading too much into what he said about gold:

 

Q: Would you invest in Gold?

 

A: No. Gold is too hard to value. It has luster value but the intrinsic value is unclear. He has investments in gold through some of the companies he owns. He wants to invest in productive commodities and then find the lowest cost producer. Then he would be interested.

 

http://www.gurufocus.com/news/70886/pabrai-funds-annual-meeting-notes-2009-huntington-beach-california

[racemize]

Mohnish seems to share my doubts about gold producers, but I'm probably reading too much into what he said about gold:

 

Q: Would you invest in Gold?

 

A: No. Gold is too hard to value. It has luster value but the intrinsic value is unclear. He has investments in gold through some of the companies he owns. He wants to invest in productive commodities and then find the lowest cost producer. Then he would be interested.

 

http://www.gurufocus.com/news/70886/pabrai-funds-annual-meeting-notes-2009-huntington-beach-california

 

So I think for a gold miner, he would talk about the cost-curve, but then conclude that even if it is $900 break-even for the lowest cost gold producer, we still cannot be sure that $900 is a reasonable price for gold.  Something like zinc should have much better defined demand and so it is easier to figure out what prices are reasonable and the volatility should be lower (presumably).

[original mungerville]

I understand this idea of being levered to the price of zinc, and therefore there is option value. But to me, its not a "free option" as Monish seems to describe. I say this because, yes, if zinc prices stay where they are now or go up, then that is like a floor plus an option. But why are these the only premises. Why can't zinc prices stay where they are, go up, OR GO DOWN from here. Why is he so sure they won't go down.

 

If they do go down, we may lose the floor, no? ie a $700M market cap now with what cash flow?...what's the cash flow likely to be if zinc prices go down? How far down can they go and stay for a 3-4 years? What's that cash flow? What's that P/E.

 

Once I know that, that's the floor (and the P/E multiple on that floor may indeed be high..which means this option he speaks of is not free, right?)

[Guest hellsten]

The bullish argument is based on the expected closure of a number of large zinc mines – together with a lack of new projects ready to replace them. Unlike copper and iron ore, where a wave of new supply is poised to hit the market after mining companies spent billions on new projects and expansion, years of relatively low zinc prices have disincentivised investment.

 

More than 2m tonnes of new supply is needed by 2016. There is a real shortage of quality projects in the pipeline which are anywhere near ready for production

 

Gayle Berry, analyst at Barclays, describes Chinese output as “the big wild card” for the zinc market. “Chinese mine production has continued to outperform expectations in the last few years,” she says. “When we see this level out, it will be constructive for zinc prices.”

 

http://www.ft.com/intl/cms/s/0/142cd43c-3b2f-11e3-87fa-00144feab7de.html#axzz2mpWd8jn0

 

“There will be a significant number of large mines closing,” says Duncan Hobbs of Macquarie. “On paper there seem to be sufficient projects to replace those closures; but there’s a rising risk that those projects come later than we are expecting.”

Demand is also likely to be supported by construction-intensive growth in emerging markets. In a recent presentation Nyrstar, the zinc producer, noted that only 4 per cent of steel used in China is being galvanised, compared to 18 per cent in the Europe and the US.

Mr Hobbs of Macquarie predicts prices could hit $3,000 in the next three years – up nearly 50 per cent from current levels.

Others are more optimistic still. Graham Deller, head of zinc research at CRU, the consultancy, says he firmly believes “prices will go through the roof”.

“Anything you pick up now is going to look cheap in three or four years’ time. Tripling [from current prices] is conservative,” he says.

 

http://www.ft.com/intl/cms/s/0/295fa830-57eb-11e1-b089-00144feabdc0.html#axzz2mpWd8jn0

 

 

"Chinese output as “the big wild card” for the zinc market", sounds like something similar to what happened with FTP could happen to ZINC if China decides so.

[alertmeipp]

I understand this idea of being levered to the price of zinc, and therefore there is option value. But to me, its not a "free option" as Monish seems to describe. I say this because, yes, if zinc prices stay where they are now or go up, then that is like a floor plus an option. But why are these the only premises. Why can't zinc prices stay where they are, go up, OR GO DOWN from here. Why is he so sure they won't go down.

 

If they do go down, we may lose the floor, no? ie a $700M market cap now with what cash flow?...what's the cash flow likely to be if zinc prices go down? How far down can they go and stay for a 3-4 years? What's that cash flow? What's that P/E.

 

Once I know that, that's the floor (and the P/E multiple on that floor may indeed be high..which means this option he speaks of is not free, right?)

 

You are a wise man. natural gas, dissolving pulp, airline tickets - when management get paid to sell at a loss, they will.

[phil_Buffett]

in the Video mohnish said to value Business without growth at 10-13x cash flow.

and growth companies with 15x

 

for example put this to horsehead

 

low end: 120-130mio cash flow x 10 = 1200-1300mio market cap. almost double from today stock Price

 

middle: 200mio cash flow x 10= 2000mio market cap  almost a tripple

 

high: 280mio cash flow x10= 2800mio market cap -> 4x times

 

this with a low multiple. we can even lower the multiple and take the low end of the cash flow and  have a high margin of safety.

 

 

[alertmeipp]

10x cash flow for commodity business is very very high?

[phil_Buffett]

10x cash flow for commodity business is very very high?

 

right now it is 6x times. i think fair value would be 8-10x times.

[CorpRaider]

It has some real debt now though too since it has been fumbling bumbling and stumbling to this great expansion.

[txlaw]

I understand this idea of being levered to the price of zinc, and therefore there is option value. But to me, its not a "free option" as Monish seems to describe. I say this because, yes, if zinc prices stay where they are now or go up, then that is like a floor plus an option. But why are these the only premises. Why can't zinc prices stay where they are, go up, OR GO DOWN from here. Why is he so sure they won't go down.

 

If they do go down, we may lose the floor, no? ie a $700M market cap now with what cash flow?...what's the cash flow likely to be if zinc prices go down? How far down can they go and stay for a 3-4 years? What's that cash flow? What's that P/E.

 

Once I know that, that's the floor (and the P/E multiple on that floor may indeed be high..which means this option he speaks of is not free, right?)

 

You are a wise man. natural gas, dissolving pulp, airline tickets - when management get paid to sell at a loss, they will.

 

I think his thesis with regards to zinc prices is that, even if prices go down, the market valuation of the company over the zinc commodity cycle is fair, given ZINC's position as a global lowest cost producer after construction of the new plant.  That is, he seems to believe that if zinc prices stay where they're at, ZINC is attractively priced (maybe not super cheap), but if zinc prices collapse, it is likely still trading at fair value, at least over the boom-bust cycle.  And if zinc prices go up substantially, there is huge upside optionality solely from existing manufacturing facilities.

 

Key to his thesis is the notion that ZINC is a low cost provider that will survive over a boom-bust cycle.  Even though Pabrai seems to be skeptical that zinc prices will totally collapse, he must be fairly confident that ZINC really can operate at break-even if zinc prices get crushed (as they say they can). 

 

But, IMO, Pabrai is likely withholding his full thesis on ZINC.  It's such a large portion of his portfolio now that I’m skeptical it simply represents a play on zinc prices and existing capacity.  Instead, I’m willing to bet that he is putting so much into it because he believes in the ZINC growth story.

 

So ZINC consists of multiple business — EAF dust recycling, battery recycling, value added zinc products, etc.  This portfolio of businesses is both sustainable (green, if you will) and low cost.  In fact, you can see that they are trying to implement the Posco strategy.  License a low cost, environmentally friendly industrial technology (in the case of Posco, FINEX; in the case of Horshead, ZINCEX and the EW technology), gain expertise in building the lowest cost zinc producing capacity, and then grow the biz via fully owned capacity, JVs, etc.  And then pair that with having low cost feedstock agreements and recycling facilities.  Hedge out some risk by owning value added product capacity.

 

If everything goes well with the new capacity, and the returns on investment are as good as ZINC seems to indicate they can be, then we’re talking about a long runway growth company.  This is my guess on Pabrai’s thinking. 

 

Now, I think that dilution risk is clearly there (as we saw with the last common offering), and the high debt load could cause problems if they hit more air pockets with construction.  And if some of these plants blow up or whatever, then it’s game over, so it’s probably not as low risk as he might claim.  Certainly not as low risk as if it were already a well diversified conglomerate.  Still, I think I get the thesis.

 

I have owned ZINC in the past and have tended to trade with the position.  I recently dumped my position when they announced the common offering, which I really did not like.  However, I’m back in at this time.

[phil_Buffett]

I understand this idea of being levered to the price of zinc, and therefore there is option value. But to me, its not a "free option" as Monish seems to describe. I say this because, yes, if zinc prices stay where they are now or go up, then that is like a floor plus an option. But why are these the only premises. Why can't zinc prices stay where they are, go up, OR GO DOWN from here. Why is he so sure they won't go down.

 

If they do go down, we may lose the floor, no? ie a $700M market cap now with what cash flow?...what's the cash flow likely to be if zinc prices go down? How far down can they go and stay for a 3-4 years? What's that cash flow? What's that P/E.

 

Once I know that, that's the floor (and the P/E multiple on that floor may indeed be high..which means this option he speaks of is not free, right?)

 

You are a wise man. natural gas, dissolving pulp, airline tickets - when management get paid to sell at a loss, they will.

 

I think his thesis with regards to zinc prices is that, even if prices go down, the market valuation of the company over the zinc commodity cycle is fair, given ZINC's position as a global lowest cost producer after construction of the new plant.  That is, he seems to believe that if zinc prices stay where they're at, ZINC is attractively priced (maybe not super cheap), but if zinc prices collapse, it is likely still trading at fair value, at least over the boom-bust cycle.  And if zinc prices go up substantially, there is huge upside optionality solely from existing manufacturing facilities.

 

Key to his thesis is the notion that ZINC is a low cost provider that will survive over a boom-bust cycle.  Even though Pabrai seems to be skeptical that zinc prices will totally collapse, he must be fairly confident that ZINC really can operate at break-even if zinc prices get crushed (as they say they can). 

 

But, IMO, Pabrai is likely withholding his full thesis on ZINC.  It's such a large portion of his portfolio now that Im skeptical it simply represents a play on zinc prices and existing capacity.  Instead, Im willing to bet that he is putting so much into it because he believes in the ZINC growth story.

 

So ZINC consists of multiple business EAF dust recycling, battery recycling, value added zinc products, etc.  This portfolio of businesses is both sustainable (green, if you will) and low cost.  In fact, you can see that they are trying to implement the Posco strategy.  License a low cost, environmentally friendly industrial technology (in the case of Posco, FINEX; in the case of Horshead, ZINCEX and the EW technology), gain expertise in building the lowest cost zinc producing capacity, and then grow the biz via fully owned capacity, JVs, etc.  And then pair that with having low cost feedstock agreements and recycling facilities.  Hedge out some risk by owning value added product capacity.

 

If everything goes well with the new capacity, and the returns on investment are as good as ZINC seems to indicate they can be, then were talking about a long runway growth company.  This is my guess on Pabrais thinking. 

 

Now, I think that dilution risk is clearly there (as we saw with the last common offering), and the high debt load could cause problems if they hit more air pockets with construction.  And if some of these plants blow up or whatever, then its game over, so its probably not as low risk as he might claim.  Certainly not as low risk as if it were already a well diversified conglomerate.  Still, I think I get the thesis.

 

I have owned ZINC in the past and have tended to trade with the position.  I recently dumped my position when they announced the common offering, which I really did not like.  However, Im back in at this time.

 

txlaw great post and i agree with you. if zinc Prices will rise this stock will appreciate a lot. Mohnish is very confident. i was also dissapointed about the Dilution recently, but all the factors and the Point that horsehead will lower their cost with the new plant from 0,60$ per Pound to 0,4$per Pound is great.

[Guest hellsten]

But, IMO, Pabrai is likely withholding his full thesis on ZINC.  It's such a large portion of his portfolio now that I’m skeptical it simply represents a play on zinc prices and existing capacity.  Instead, I’m willing to bet that he is putting so much into it because he believes in the ZINC growth story.

 

Thanks txlaw. I can understand that there might be more demand for zinc in the future, but the other part of the growth story is something I didn't have the knowledge and experience to identify. Understanding Posco also helps understand ZINC and the demand for zinc. Maybe Mohnish is coattailing Buffett after all :) I need to study Posco...

[wknecht]

But, IMO, Pabrai is likely withholding his full thesis on ZINC.  It's such a large portion of his portfolio now that I’m skeptical it simply represents a play on zinc prices and existing capacity.  Instead, I’m willing to bet that he is putting so much into it because he believes in the ZINC growth story.

 

Thanks txlaw. I can understand that there might be more demand for zinc in the future, but the other part of the growth story is something I didn't have the knowledge and experience to identify. Understanding Posco also helps understand ZINC and the demand for zinc. Maybe Mohnish is coattailing Buffett after all :) I need to study Posco...

Just curious where you're thinking the growth will come from. Low cost growth opportunities seem pretty limited to me, at least in the Zinc part of the business. Not to say there's no growth opportunities, but it's constrained by domestic steel growth / capacity utilization. To grow at a low cost, they need more dust. I don't recall the numbers, but I thought they already control something like 70% of the dust market. Maybe if they replicate the model in other countries (Nucor has ops in Brazil, Columbia, Italy, Switzerland, UAE, and Trinidad) . I liked the Monaca acquisition, the returns look to be pretty large. Maybe they can pull off other similar acquisitions.

 

Edit: by Monaca, I meant Inmetco

[jay21]

So this will be the lowest cost producer because of a new plant?  I can't help but to think about Buffett's anecdotes about BRK here.

 

Is the plant replicable?  Any other type of moat?

[phil_Buffett]

Any other type of moat?

 

Later in the video he talks about the moat of ZINC and low-cost commodity producers which he compares to Coca Cola and Geico:

It dawned on me that commodity based businesses can have incredible moats. In order for them to have incredible moats they need to be low cost producers, so most commodities they talk about which quartile of cost their in.

 

Lets take not the company with the ticker symbol ZINC, but lets take the commodity zinc for example. If you look at the commodity zinc, the lowest cost producers in the world who have the lowest cost mines, the bottom 25% of production, may have a cost of 40-50 cents per pound.

 

The next quartile the 25-50% producters may have a cost of lets say 60-70 per pound. In the third 70-80. In the fourth close to 90 per pound. If zinc is trading like it is trading now at 80 cents per pound.

...

All those guys who have cost above 80-90 cents per pound, unless their marginal costs are low, they pretty much have shut down production at current prices because the would be losing money at current prices. Their mines are mothballed.

 

If zinc demand increases you know the price might go up to a $1-1.5 and more production may come online. The person who has the greatest moat in that business is that mine that is producing zinc at 40-50 cents. That mine is going to make money day in and day out.

 

Even if production drops, china goes into a tailspin, it's still unlikely you get to less than 50 cents per pound. If you own a commodity business where you are the low cost producer and you have some pretty significant volumes you can bring online at low cost, that is a fantastic business.

A business that has a moat like Coca Cola and Geico, a durable competitive advantage. So when I look at commodity businesses, one of the first things I look for is what quartile are they in in their production. You also have to look at long continuums of where commodity prices are.

 

...

In 2008 when we were making these commodity investments most of the investments we made where in businesses that were first-quartile producers. Prices had come down to the point were they were barely making any money.

It was clear to me that at some point the economies would start functioning again...

 

the Quote is from hellsten from page 6 of this thread  :)