ZINC - Horsehead Holding Corp

[yadayada]

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?

+1, do they have some kind of proprietary equipment? What is other players preventing from doing something similar and keeping the price of zinc down.

[wknecht]

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?

You need dust. If you don't have dust contracts it doesn't make sense to replicate.

 

Maybe it get's replicated in many countries and ultimately lowers the "floor price" at the bottom of the cost curve for zinc which could potentially create the tip-toes at the parade situation. Would need to look at the numbers, but I would expect that mining still dominates the total zinc production and plays a bigger role in setting prices.

[txlaw]

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.

 

According to the company itself, they have the following potential growth/diversification opportunities.

 

Capital investments in existing businesses:

-Completing Zochem expansion to consolidate zinc oxide business

-Expansion of INMETCO’s melting capacity

-An additional Waelz kiln in U.S. for EAF dust processing

 

Acquisition/JV opportunities:

-A bolt-on metals processing business with synergies with INMETCO

-A spent catalyst recycling venture

 

International expansion opportunities:

-EAF dust recycling JV opportunities in Asia

 

These prospects actually seem pretty reasonable.  Market share represents a growth opportunity in NA.  Apparently, 74% of zinc metal is imported in the US.  If ZINC can be the low cost producer domestically (advantaged feedstocks and transport advantages) and take market share, that seems to be a growth opportunity to me. 

 

The battery recycling ops are also pretty intriguing to me, since I think that represents a very interesting growth opportunity not just in NA, but pretty much all over the world.  Obviously, the growth in battery use is going to be pretty outstanding going forward.  And as long as Ni remains a key part of battery technology, that also gives ZINC a possible low cost feedstock for nickel products.

 

 

[txlaw]

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?

You need dust. If you don't have dust contracts it doesn't make sense to replicate.

 

Maybe it get's replicated in many countries and ultimately lowers the "floor price" at the bottom of the cost curve for zinc which could potentially create the tip-toes at the parade situation. Would need to look at the numbers, but I would expect that mining still dominates the total zinc production and plays a bigger role in setting prices.

 

Yeah, the "moat" has to do with their feedstock supply. 

 

The manufacturing processes are not proprietary as to themselves.  They license the technology, and as far as I can tell, they don't have any exclusivity.  Having said that, they likely have know-how that cannot easily be replicated by new entrants.  And that know-how could be invaluable to potential JV partners abroad.

 

WEB sometimes makes things a bit too simplistic. 

[skanjete]

As I said before, I think you need to have some kind of opinion on the direction of the zinc prices for an investment in ZINC. In my view, the stock could be fairly valued if zinc prices stay at around current levels.

 

If you have a firm opinion that zinc prices will be higher in the future, then there is a lot of optionality at the current stock price.

 

However, (for me in any case) it is very difficult to make an informed guess of the future zinc prices. I tried that before around 2004 when I was analysing a zinc mine. For what I remember, a big part of the zinc supply comes on the market as a by-product from copper-lead-silver-nickel mines. Zinc could be the main product in some mines, but not always. So the dynamic on the zinc market is not only dependent of the zinc supply-demand, but also at least partly from copper-lead-silver-nickel market.

 

That makes it (for me) very difficult to make an informed bet of the future of the zinc prices. It's not unimaginable that zinc prices go extremely low for reason that have nothing to do with the zinc supply/demand.

A bit like what is happening with natural gas/oil in recent years. Natural gas is generally speaking not economic to develop at the moment, but is being produced/supplied anyhow, partly as a by-product from (high priced) oil development.

 

 

[txlaw]

As I said before, I think you need to have some kind of opinion on the direction of the zinc prices for an investment in ZINC. In my view, the stock could be fairly valued if zinc prices stay at around current levels.

 

If you have a firm opinion that zinc prices will be higher in the future, then there is a lot of optionality at the current stock price.

 

I agree that zinc prices have a material effect on ZINC's prospects.  And it could certainly be the case that the stock is close to fairly valued (especially, if debt and shares outstanding continue to increase) if zinc prices stabilize at these prices.  But that's not taking into account the potential addition of low cost capacity and the returns associated with that.  And the opportunity to deleverage over time.

 

So, the way that I would approach ZINC is as a potentially great biz trading at a fair price.

 

Zinc prices going up is upside optionality.  But this is also a small company, which means there is downside optionality from some terrible things going wrong with parts of their capacity. 

[original mungerville]

txlaw,

 

Thanks for your reply: "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."

 

I agree with that statement. If he is putting in 20%??? (i think that is right), that's huge. I would only do that if I thought ZINC could make money / pay debt / operate with a reasonable P/E multiple to boot (say 10 times) at low zinc prices. THEN, you get a free option. OR, as you say, if they can do the foregoing but with a higher implied p/e multiple (say 15 times) but where there is this very long-term growth strategy.

 

a) I don't think the thesis can be as simple as what he is saying or b) I think he is making a mistake (overly bullish / not prudent enough on this one clouded by his past - probably successful - experiences in commodities).

 

I am talking out of my ass, but that is my sense. I would have to investigate the weeds on this one.

 

 

 

 

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.

[original mungerville]

txlaw,

 

Why are you back in at this point. Do you mind sharing your (high-level) valuation on ZINC and most key assumptions (or what you think Monish's bullish key reasoning is, with any countervailing bearish arguments) - would be very helpful - just the main points, nothing too detailed.

 

Cheers.

[LC]

Perhaps he is withholding his full idea...but I don't think that just because the thesis as stated is simple means he must of course be holding something back. A large position as a $ of aum does not necessitate a complicated thesis.

[original mungerville]

No of course not, but the uncomplicated thesis seems risky because it seems dependent on zinc prices not declining. It doesn't seem like a slam dunk plus a call option if you consider zinc prices could decline.

 

I guess the third option is Monish thinks zinc prices can't decline materially... this is the only thing that makes his simple thesis make sense to me.

[LC]

No of course not, but the uncomplicated thesis seems risky because it seems dependent on zinc prices not declining. It doesn't seem like a slam dunk plus a call option if you consider zinc prices could decline.

 

I guess the third option is Monish thinks zinc prices can't decline materially... this is the only thing that makes his simple thesis make sense to me.

 

I think his reasoning is sound though...that only during an almost pure economic standstill do zinc prices fall down to around .50/lb. and if horsehead's cost of production is .40-.50/lb, that is still not a complete death-knell for the company. even if zinc prices fall lower, let's say to .30/lb, can anyone produce?

 

take a look at the applications for zinc: http://en.wikipedia.org/wiki/Zinc#Applications

 

-Galvanizing (55%)

-Alloys (21%)

-Brass and bronze (16%)

-Miscellaneous (8%)

 

these are not fly-by-night uses (although they may be dependent on the construction cycle).

 

also take a look at the 5 year zinc price vs the 5 year stock levels (http://www.kitcometals.com/charts/zinc_historical_large.html)

 

price has held relatively stable in the last year despite a steady decline in the stock levels of zinc, which suggests a level of increased demand.

 

but all this comes back to horsehead being that low-cost producer that will operate regardless of the price movement of zinc. so you have that moat (low-cost) plus the asymmetric risk-reward from movement in zinc prices, plus what looks to be a competent or at least conservative management team from a capital allocation standpoint (no debt from 2008-2012).

 

 

[PhatKing]

I just wanted to weigh in my 2 cents on ZINC. Most of you probably know the thesis, and the Pabrai case is laid out in his Boston Q&A session. But let me summarize:

 

1) The moat of the company stems from its contracts for EAF dust. It has long term contracts for about 75% of the all the EAF dust in the US, generated by the steel mini-mills (such as NUCOR), that use scrap steel as the starting point of the steel making.  So if anybody wants to enter this business in the US, they cannot, as no dust is available for processing. The mills pay ZINC to haul away the dust and so the cost of getting raw materials for Horsehead is de-minimus. (NOTE: they still have to process the dust, so COGS is not zero).

 

2) The new solvent extraction process they are going to use at the new plant, is not as energy intensive as the previous smelting process. So cost of production is lower. If you read some of the conf. call transcripts (from 2011 to 2013), you will see that they expect to break-even at prices of 40-50 cents (say 50 cents) per pound.  They will make decent money at today’s prices of 85 cents per pound at the new plant.

 

3) The company has repeatedly stated that they will make $90-$110 million of incremental EBITDA once the plant is fully operational  and functioning for about a year (by 2015).  Average EBITDA over past 3 years has been approx $40million.

 

4) Zinc mines are closing and over the next few years (2015-2018), there is likely to be a supply-demand imbalance, leading to higher Zinc prices (Google it and see various opinions). As auto production across the globe ramps up, galvanized steel demand (which use zinc) is climbing.

 

5) Horsehead also expects to extract lead , and perhaps silver from their zinc extraction process, as by-products. Last week/ or the prior week, Barrons had an article of how lead prices are likely to rise over the next few years, due to a looming shortage.

 

6) They are also making decent money in the Zinc-oxide business – they are opening a warehouse in the South, so that they don’t have to incur large shipping costs from the Brampton, Ontario facility.

 

7) The Nickel recycling business is also decently profitable, as it is mainly a tolling business.

 

In short, there are lots of expected tail-winds for Horsehead that are going to create a lollapalooza effects for the Horsehead business, once the plant is fully operational and start-up issues are all sorted out. There are execution risks, as starting a new plant using a new technology and NEW workers, ina a new geography is not going to be a smooth process. I expect there will be hiccups, and some unforseen problems are inevitably going to crop up. But I expect the company to sort them out by Q1/Q2 2014.

 

Disclosure: I am a holder of a considerable number of shares of Horsehead Holdings, purchased at prices significantly lower than here. I am not expressing a view on today’s prices, but only my expectations of the business.

 

[skanjete]

The company estimates a production cost of 0,40-0,50$/lb with the new facility.

 

Is this production cost an all-in production cost, or a cash cost? According to my understanding, they mean a cash cost (since they focus on EBITDA from the new facility), akin to a mine that talks about its cash costs. However, I suppose a total production cost (incl. depreciation) would be more relevant since depreciation is a real (and generally understated) cost in these types of undertakings.

[skanjete]

I just wanted to weigh in my 2 cents on ZINC. Most of you probably know the thesis, and the Pabrai case is laid out in his Boston Q&A session. But let me summarize:

 

1) The moat of the company stems from its contracts for EAF dust. It has long term contracts for about 75% of the all the EAF dust in the US, generated by the steel mini-mills (such as NUCOR), that use scrap steel as the starting point of the steel making.  So if anybody wants to enter this business in the US, they cannot, as no dust is available for processing. The mills pay ZINC to haul away the dust and so the cost of getting raw materials for Horsehead is de-minimus. (NOTE: they still have to process the dust, so COGS is not zero).

 

Phatking,

are you sure ZINC is being paid for hauling away the dust? I thought I read they had to buy the dust?

[PhatKing]

Yes, skanjete, they are being paid. If you look at the financial statements in the 10k, you wil see a line item of EAF dust receipts, under the revenue line. If you browse thru the Management discussion of the financial statements, you will see some discussion of the EAF dust collection receipts/process. They lay out the whole business in the 10k. It is worth a detailed read. Also worth reading are some of the transcripts of the conf calls from 2010 onwards, when they started serious contemplation of the building of the new plant. They are on Seeking Alpha. The new plant is key towards a ramp up of the EBITDA.

Hope that helps.

[txlaw]

txlaw,

 

Why are you back in at this point. Do you mind sharing your (high-level) valuation on ZINC and most key assumptions (or what you think Monish's bullish key reasoning is, with any countervailing bearish arguments) - would be very helpful - just the main points, nothing too detailed.

 

Cheers.

 

I'm back in (very small position relative to my total portfolio) because I actually think the growth story, as described in my previous posts, is compelling.  I really like the idea of owning a company that is a low cost, sustainable tech commodity producer.  High returns on capital invested, long potential runway for growth.  And there is also that optionality factor on zinc prices. 

 

Let's just say that I think ZINC is trading at a fair price at this time (I don't see it as being cheap unless you think zinc prices are going up, and I don't know whether that's going to happen or not).  I'm not as worried as some about the possibility of zinc prices collapsing because these guys are more than willing to hedge their zinc production by purchasing puts, so unless you get an overnight crash in zinc prices, they will mitigate drops in zinc prices and remain break-even.  But I can't put too much in at this time because of the binary nature of the new capacity's effect on valuation.  And it's only after these guys start up and get ramped up that we will see whether management was right with its EBITDA estimates.  I have to say that I was definitely miffed about the equity sale and that's why I dumped my shares initially.  But Pabrai pulling a DaVita-like buying spree has made me think, well, I'll give these guys a chance -- maybe he's talked to these guys and trusts them.   

 

ZINC is also a way to add more diversity to my portfolio.  Over the last couple of years, I have been heavily concentrated in certain stocks and done quite well.  Now, I find the number of positions in my portfolio growing, simply because the deep value opportunities have gotten a bit less deep value.

[eburnside]

It is my understanding that EAF Dust is a non-value-add in the actual production of steel. For the minimill steel producers, it is strictly a byproduct of their production process. I would think they'd be extremely motivated to find ways to reduce the volume of dust created per ton of steel produced. Doing so would reduce an economic cost that adds no value to their end product. 

 

Has anyone considered this a potential risk to the business model of Horsehead? Is it possible that at some future point minimills actually eliminate EAF dust altogether?

[MYDemaray]

But Pabrai pulling a DaVita-like buying spree has made me think, well, I'll give these guys a chance -- maybe he's talked to these guys and trusts them.   

 

Just a reminder that Pabrai doesn't usually (ever?) talk to management....

[LC]

It is my understanding that EAF Dust is a non-value-add in the actual production of steel. For the minimill steel producers, it is strictly a byproduct of their production process. I would think they'd be extremely motivated to find ways to reduce the volume of dust created per ton of steel produced. Doing so would reduce an economic cost that adds no value to their end product. 

 

Has anyone considered this a potential risk to the business model of Horsehead? Is it possible that at some future point minimills actually eliminate EAF dust altogether?

 

Welcome to the forum!

 

I think the dust is produced regardless as a result of using scrap metals in the EAF process...these scrap metals were previously galvanized and now as they undergo the EAF process, the old zinc is separated, then re-constituted in the dust-collection process into zinc oxide, which is what horsehead etc use to produce zinc.

 

Disclaimer: This opinion came from wikipedia in the last hour, so it is most definitely simplified and may very well be flat out wrong (if so, please someone correct me!)

[phil_Buffett]

But Pabrai pulling a DaVita-like buying spree has made me think, well, I'll give these guys a chance -- maybe he's talked to these guys and trusts them.   

 

Just a reminder that Pabrai doesn't usually (ever?) talk to management....

 

the ceo of horsehead was this year at the annual Meeting from mohnish in California. so in this case he talks to Management  ;D

[PhatKing]

EAF dust is produced when scrap steel is melted using Electric Arc Furnaces. The melting process produces dust that contains many metals, but of value are the zinc, lead, silver and iron metals. This EAF dust is toxic, and has to be disposed off in special ways by waste disposal companies. Horsehead has figured out how to extract the zinc (and lead and silver, eventually) from the EAF dust. So they, over time, purchased the waste disposal contracts from the waste disposal companies, as well as signing new ones with companies such as NUCOR. They have a 10 year contract, I believe starting in 2011 with NUCOR to haul away the EAF dust at almost all their plants (for which they are getting paid). Recycling the EAF dust is also a “green” thing to do. NUCOR’s 2011 sustainability report highlights that they recycle 92% of the EAF dust, up from only 59% in 2007.

 

If steel production from scrap metal declines in the US, then less EAF dust will be produced and so the raw material advantage for Horsehead will indeed decline. That will happen certainly when there is a recession. Currently, I believe that about 60% of steel in the US is made by mini mills, using scrap metal. The rest is made from iron ore.  But the use of mini-mills and using scrap metal to make steel has been steadily increasing over about 15-20 years - witness the growth of NUCOR over the past 2 decades.  And so I don’t expect this trend to reverse anytime soon. Hence  EAF dust will always be available over the long-run.  In the US, Horsehead has no threat of anybody mimicking their business model over the next 6-8 years. They will become the low cost producer of zinc in a commodity industry, after a successful startup of the new plant. And as we all know, the only winner in a commodity industry is the low cost producer. They also have growing revenue streams from Nickel, Zinc oxide and over time, lead and silver. The byproducts of lead and silver will be small quantities, but those revenues are likely to fall entirely to the bottom line.

 

[txlaw]

But Pabrai pulling a DaVita-like buying spree has made me think, well, I'll give these guys a chance -- maybe he's talked to these guys and trusts them.   

 

Just a reminder that Pabrai doesn't usually (ever?) talk to management....

 

the ceo of horsehead was this year at the annual Meeting from mohnish in California. so in this case he talks to Management  ;D

 

That's great to hear!

 

I'm pretty sure that ZINC is the non-cloned position that Pabrai is referring to in his latest presentation.  So I thought it might actually be an exception to his "no talking to management" rule. 

[APG12]

I'm pretty sure that ZINC is the non-cloned position that Pabrai is referring to in his latest presentation.  So I thought it might actually be an exception to his "no talking to management" rule.

 

Hey txlaw, do you happen to know where I could find that presentation? Thanks!

[txlaw]

I'm pretty sure that ZINC is the non-cloned position that Pabrai is referring to in his latest presentation.  So I thought it might actually be an exception to his "no talking to management" rule.

 

Hey txlaw, do you happen to know where I could find that presentation? Thanks!

 

Yes, it's here:

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/mohnish-pabrai-boston-college-presentation/msg144992/#msg144992

[yadayada]

Interesting to note is that zinc prices were only briefly low in 2009 before shooting up again. I dont have those numbers, but I supose if you look at demand from emerging countries in Asia and south america over the last 20 years you can get a pretty clear idea of where the zinc prices are going to be?