Description

Overview:

Ferroglobe has been written up numerous times on VIC over the past five years with the most recent being in December 2021. These write-ups do a great job of giving an overview of the business and some of the changes that have occurred over the years.

Instead of re-writing a lot of this information, this write-up will focus on why now is the right time and unpack how structural business changes and industry tailwinds industry will finally be reflected in the share price.

With near-term catalysts and long-term tailwinds, we believe Ferroglobe has nearly 100% upside in the next 12 months and 200% upside over the next 2 to 3 years.

Cost Cuts and Structural Profitability Uplift:

Given the massive amount of cost cuts relative to the size of the business originally guided to by the Company, we believe the market (fairly) was/is skeptical over the sustainability of these and hesitant to give credit through the cycle vs. just a commodity price boom in the market.

We have done extensive channel checks on the sustainability of these cuts and largely believe the new cost structure is sustainable. The 2023 guidance, in our opinion, is a massive confirmatory data point. Despite material capacity being offline and recessionary environments for many of their European customers, Ferroglobe is guiding to $285 million of EBITDA at the midpoint. CEO Marco Levi has continuously maintained that this guidance range is near the Company’s trough level. With manyindustrial / cyclical companies cutting guides after 2Q, as well as material headwinds to product pricing, Ferroglobe was able to report great results and confident enough to maintain their full-year guidance. This is the end game of many of the things CEO Marco Levi has talked about publicly – running volumes through lower cost facilities, better managing customer mix, entering into longer-term agreements, and a focus on higher margin products.

“The picture is the following for us. Silicon metal, we see a slightly better situation than in the previous quarters. We think that the supply chain is rather empty. And we see our orders coming now more regularly than before.” – CEO Marco Levi on August 15^th, 2023 Earnings Call

To further support that 2023 results will be close to a business trough, Chinese silicon metal pricing has bottomed and jumped meaningfully from lows. Given this dynamic, we expect at a minimum European silicon metal prices have bottomed and have a chance to even increase which would both lead to continuing to maintain current earnings levels.

Even if trough ends up being lower, say to the extent of $200 million, the stock is still incredibly cheap and will generate cash flow throughout the cycle which is a much different scenario than historically when the Company reported negative EBITDA and burned free cash flow.

Long-Term Power Contracts in Place:

Given the issues with energy pricing in Europe, it has been a challenge to run the full asset footprint. Despite challenges in Europe, the French and Spanish asset are very important to the long-term story for Ferroglobe. We think the finalization of the power contracts in France along with the recent progress in Spain (one already signed starting Jan 1^st, 2024, and the other expected in coming months) put the Company in a strong position to compete on the global cost curve. This will ensure that as end markets recover Ferroglobe will be able to maintain its share of industry volumes.

Capital Returns are Finally Coming:

We believe this is one of the most important pieces to getting the price to appreciate closer to intrinsic value. When you look at the history of this business you see: a botched merger, a near-bankruptcy, volatile commodity end markets, and a large shareholder. It is easy to have tons of reasons not to own this stock, especially when you take a closer look and see no capital returns vs. many commodity producers undergoing massive capital return plans.

Going forward, a lot of this has changed and in short order we think a whole new shareholder base will come. Today, you have a well-integrated and operated global asset footprint and a soon to be net cash balance sheet. This reduces some of the risks that come with a volatile commodity business (will generate cash throughout the cycle, no financial risk, a lower cost producer).

So now, you are just left with a large shareholder and no capital returns. We think by the time the 3Q comes, Ferroglobe will have taken out the remaining Senior Secured notes (either through a re-finance or cash on balance sheet) that prohibit capital returns. We then expect the Company to lay out a detailed capital allocation plan that likely includes a baseline dividend, share repurchases, and high ROIC growth capital expenditures.

We believe the stock currently trades at a ~25% free cash flow yield on mid-cycle earnings with a net cash balance sheet. Given the Company can grow its silicon metal footprint by ~50% for around $100 million, that leaves a very large amount of cash that will be returned to shareholders. Say during the 2024-2026 time period the Company averages its mid-cycle free cash flow, it will generate $750 million over that time. Subtract out the $100 million of potential growth CapEx and that leaves $650 million of capital to return to shareholders or nearly 65% of the market cap in the next 3 years.

In that scenario, it’s much easier to see the path of new shareholders coming into the stock and no longer worry about the large shareholder or poor capital allocation. Especially given the ESG tailwinds for end markets. Further, we would note a new head of IR this summer that should vastly improve shareholder communication and do a better job of telling the story.

Policy Tailwinds Both Domestically and Globally:

The importance of silicon metal has been amplified in the past twelve months as is seen by both the US and EU moving it to critical raw material status. The importance of having domestic silicon metal production is seen as extremely important by governments as they look to build out supply chains in solar, battery, and even semiconductors. These end markets continue to grow at a rapid pace and will lead to incredible growth over the coming years.

The favorable energy contracts show the governments moving policy into Ferroglobe’s favor and given the challenges in Europe, we wouldn’t be surprised to see additional tariffs enacted to limit Chinese imports into the country to further protect domestic suppliers. With two highly protected markets and strong demand drivers, the outlook is incredibly favorable for Ferroglobe to capitalize on their current production while also having the ability to grow supply by 50% with minimal growth capital (combination of converting a few Ferrosilicon furnaces to silicon metal and two brownfield opportunities).

Some interesting quotes pulled from recent articles:

Batteries and Solar Products Need American Silicon Metal | RealClearPolicy

“Experts predict that demand for silicon metal will grow 21 percent each year until 2032, according to McKinsey.”

“The new silicon anodes in lithium-ion batteries have 10 times the capacity in lithium-ion batteries compared to graphite anodes, which have dominated the market for decades. They also can charge to 80 percent in less than six minutes. According to experts, electric vehicles with silicon anode batteries will go 50 percent farther.”

IRA, energy transition to spur Western silicon metal production and consumption - Fastmarkets

“In the US we’ve had duties against Chinese silicon metal of 139% for the last 30 years and these tariffs are not going away… [in fact] every country including Europe is increasing their duties against Chinese material,” he said.

“Tymko calculates that the US will need to produce an average of around 700,000 tonnes of silicon per year to meet the demand for solar production alone (based on current solar panel energy yields), far outstripping current production capacity.”

“The competition for silicon metal is going to be enormous,” he said.

“If you look at the feedstock... everyone is saying we’re looking for high-quality quartz,” Tymko said, adding that known high-quality quartz reserves are concentrated in Spain, Canada and Australia.

“Access to high-quality quartz was identified as a priority of leading silicon producer Ferroglobe in its financial results for the first quarter of 2023.”

“High-quality quartz is the most important raw material used in the production of high-purity silicon metal,” Ferroglobe CEO Marco Levi said.

China Thesis Continues to Play Out:

Recent channel checks and industry data show that China continues to focus on own production for domestic use. Even though they have grown domestic silicon metal capacity, their own demand has outpaced it. That has led to reduction in Chinese exports into other countries.

Given the Chinese economy has been weak, we see this as incredibly favorable and as their domestic consumption picks up, we expect them to continue to reduce exports to the rest of the world that is already at a structural deficit. Similarly, the same ESG drivers that are favoring Ferroglobe’s US and European footprint are also leading to massive demand in China.

Ex-China silicon producers to increase output to meet burgeoning battery anode consumption - Fastmarkets

“As with silicon metal and number of other BRMs, China is currently responsible for most of the world’s output of high-purity silicon for anodes.

Last week, Shenzhen Aipunuo New Energy Technology announced a $1.5 billion investment in a 300,000 tonnes per year silicon-based anode project at Xichang in Sichuan province in southwest China.

The first stage of the project’s construction is expected to have a capacity of some 120,000 tonnes of silicon-carbon anode material when it starts operations in December 2024.

The risks related to China’s dominance in supplies of another silicon-based net-zero technology - solar panels - have become apparent in recent years, with the United States banning imports of some Chinese solar materials over the use of forced labor in the major polysilicon-producing region Xinjiang.

And non-Chinese producers are moving to introduce additional supply, in part to allow consumers to source material while having to comply with legislation such as the US Inflation Reduction Act (IRA).”

Other Optionality:

Manganese: Per our conversations with management, they believe this segment was just as mismanaged as the other segments. The Company is making tons of improvements to the cost structure of this business which we believe will be reflected in a better environment (most of the assets are in France and Spain which are finally on competitive energy contracts). In a “normal” economic environment – this business could generate $60 to $80 million of EBITDA consistently. Given it has no synergies with the other businesses and is a non-integrated producer, we believe it is likely it is sold after the changes have been finalized. At 3-4x EBITDA, this represents $180 million to $320 million of value vs. an ~$1B EV.

Valuation and Conclusion:

All in, we think current mid-cycle EBITDA is $350 million and with the ability to grow silicon metal capacity by 50% we think mid-cycle EBITDA grows to $500 million. With two tariff protected markets, favorable policy tailwinds, massive demand drivers, and strong cash generation through the cycle, a mid-cycle multiple of 5.0x EBITDA seems reasonable. For reference, Globe Specialty Metals prior to the merger traded above 8.0x EV/EBITDA consistently given the favorable US market dynamics. Europe is quickly moving the same direction and this was before the policy tailwinds that are currently present.

Risks:

- cyclical end markets

- commodity pricing exposure

- controlled company 

- supply/demand dynamics

Catalyst

- capital returns 

- pricing bottoms 

- continued execution