Description

Long- Ferroglobe PLC (GSM)

We believe that Ferroglobe PLC (GSM) represents a multi-bagger opportunity in a market with very few distressed values, particularly for beneficiaries of the powerful reflation trade in the global economy. Over the last several months, the Company has transformed its balance sheet allowing it to pursue a credible cost-cutting plan under a new CEO who is a proven turnaround specialist. Meanwhile, GSM is experiencing the strongest pricing environment for its end products since 2014. While the shares have rallied off of their distressed lows, they are still down by over 76% from their late 2017 highs despite the fact that the Company’s business prospects appear to be better than they were at that time. We believe that GSM’s shares should be worth $18.60 to $26.86 over time, representing upside of between 348% and 547%. This price target is derived from putting a historical EBITDA multiple on the Company’s estimated EBITDA in its recent business plan. While GSM’s shares currently trade as if its plan is unachievable, we believe that the Company’s projections are actually quite conservative if prices of silicon metal and alloys stay at current levels.

Ferroglobe is a dominant low-cost leader in the growing North American and European silicon metal industry with strong market share in silicon and manganese alloys.  The Company is the product of the 2015 merger between the largest silicon metal producer in North America, Globe Specialty Metals, and the largest silicon producer in Europe, Grupo FerroAtlántica. Since the merger, the shares have declined precipitously as a combination of management missteps, weak commodity prices for their products and a failed trade case have damaged shareholder confidence. This has caused investors to sour on the Company and all sell-side analysts to drop coverage as GSM teetered on the verge of bankruptcy.

However, we believe that this year represents a massive inflection point for GSM’s business as several major catalysts should drive material upside in the shares. First, strong commodity prices should begin to flow through the Company’s financials over the coming quarters demonstrating GSM’s substantial earnings power in the current environment. Second, the company should finalize a debt restructuring that will push out maturities and leave the Company with adequate capital to pursue its operational restructuring plan. Third, a new management team should begin to execute on a credible restructuring plan driving structurally higher earnings power regardless of the commodity pricing environment.

Brief Business Description

GSM breaks its business into three primary segments: 1) silicon metal, 2) silicon alloys, and 3) manganese alloys.  Silicon metal are sold into three primary end markets: 1) aluminum and related alloys, 2) silicones, which are used in a wide array of industrial and consumer products, and 3) high purity silicon which is used in computer chips and photovoltaic (solar) panels. Meanwhile, silicon alloys and manganese alloys are typically sold into the steel and stainless-steel industries. While the Company has not updated its end market exposure in a while, historically GSM’s end market demand has broken down as follows: 35% steel, 23% aluminum, 15% silicones, 13% photovoltaic, and 15% other applications.

Commodity Price Tailwinds Should Drive Substantial Upside to Earnings

At its core, the key driver of GSM’s profitability, and its share price, will be the price of silicon metal and alloys, which are currently moving substantially higher.  GSM is a vertically integrated producer of these products with high fixed costs.  Therefore, the higher the price of silicon products and the more volume GSM can produce, the more profitable the Company will be.  The manganese business is slightly different because the Company and its competitors do not control manganese ore, the key raw material in the production process.  This business is based on pricing spreads where the Company can benefit from volatility in manganese ore prices but does not have the same operating leverage as in its other segments. 

The prices of silicon metals and silicon alloys are currently soaring but very little benefit from these price increases have been baked into GSM’s shares price. Since there is limited transparency around the price of silicon metals or alloys, we believe that investors have simply missed the run-up in prices and the dramatic impact it should have on GSM’s profitability over time. There are tickers on Bloomberg tracking some of the Company’s end products. However, with no analysts covering the stock, they are not widely publicized or put into context in how they translate into earnings power.  Looking at current commodity prices, US benchmark silicon metal Index prices are up by 45.2% on a year-to-date basis and 68.7% since the end of Q3 20. European silicon metals prices in US Dollars are up by 15.7% year-to-date and 48.8% since the end of Q3 20. US Ferrosilicon prices are up by 38.3% on a year-to-date basis and 58.5% since the end of Q3 20. Finally, US Silicomanganese prices are up by 37.3% year-to-date and 45.8% since the end of Q3 20. This contrasts with manganese ore prices that are up by 6.6% year-to-date and 2.5% since the end of Q3 20, suggesting a dramatic spread widening. Indeed, prices for these key commodities significantly exceed the levels they reached in the industry’s last cyclical peak in early 2018, when GSM’s shares peaked at a price of $17.32 per share, highlighting the upside potential for GSM’s shares.

There are several reasons for the elevated prices in silicon metals and alloys. First, the industry reduced capacity and channel inventories in 2020 and now are met with demand that has surprised to the upside as the global economy recovers. Encouragingly, little capacity has reopened signaling a more disciplined supply response. Second, Chinese environmental and financial regulations have reduced output available for export to Europe allowing prices to firm there. Additionally, there is increased talk about Europe increasing tariffs on Chinese material. Third, Covid and technical production issues have hit major exporters like Brazil. These issues are compounded by extremely high shipping costs and shipping container shortages. Fourth, the US put new anti-dumping duties on Silicon Metal from Iceland, Kazakhstan and Bosnia/Herzegovina. However, while all these issues can partially explain the positive pricing dynamics for GSM, we believe that high prices will remain for some time given industry rationalization after years of subpar returns for Western producers.

The impact of these elevated silicon metal and alloy prices should have a dramatic impact on GSM’s earnings power as we move through 2021 and into 2022.  While 70% of silicon metal prices are locked in annually, the rest of GSM’s volumes tend to be repriced quarterly with a lag. This means we will not see the full benefit of higher pricing until 2022, but we should see nice progress beginning in Q2 21, which will be reported in August. In February, GSM laid out a detailed plan for volumes, revenue and EBITDA estimates from 2021 through 2024. The market is currently giving the Company very little credit for achieving its plan as the shares are trading at 9.6 x 21 EBITDA, but a mere 3.2 x of 22 EBITDA and 2.4 x 23 EBITDA. This compares with a historical trading range of 6 to 9 x EBITDA prior to the Company’s financial difficulties. While the share price suggests that GSM’s targets in 2022 and beyond are unachievable, the current price deck for ferrosilicon and silicon metals suggests that these EBITDA targets are actually very conservative. Based on current prices for silicon metals and ferrosilicon, we believe that GSM should exceed its 2021 EBITDA target by $50 mm or 43% and its 2022 target by $140 mm or 40%. This suggests that GSM is actually trading closer to 6.7 x its 2021 EBITDA and 2.3 x 2022.

If we were to put GSM’s historical 6-9 x EBITDA multiple on GSM’s plan 2022 EBITDA and adjust for current pricing levels, the shares would be worth between $14.40 and $22.74 per share, representing between 247% and 448% upside. Moreover, GSM is anticipated to achieve an additional $66 mm of annualized cost benefits in 2023 and 2024, so even if prices were to drop, GSM should be able to cushion the blow to its EBITDA in the out years.

Balance Sheet Restructuring Should Remove Overhang from Shares

Despite a rapidly improving pricing environment for GSM, the share price appears to be stuck in a holding pattern as the Company completes a major refinancing of its debt and a concurrent equity raise or rights issue. Fortunately, recent events appear to have accelerated that process, which should conclude within the next couple of months. In February, GSM announced that it would pursue an extension of its Senior Unsecured Notes from March 2022 to December 2025. As part of this deal, existing bondholders would add $60 mm of new debt and existing equity holders would have the right to participate in a $40 mm equity raise or rights offering. The $60 mm debt raise will be backstopped by an ad hoc committee of existing noteholders. Meanwhile, the rights offering will be backstopped by Tyrus Capital, who has provided a crucial financing for GSM’s 50% shareholder Grupo Villar Mir. On April 21, GSM announced that 96% of bondholder have committed to support this transaction which means it can be done as an exchange offer. As such, we expect this deal to close by the end of the second quarter with the equity or rights offering announced in the coming weeks. The equity offering represents a relatively small 5.7% of the Company’s market cap, yet it still appears to have prevented GSM’s shares from breaking out of their recent trading range.

From a strategic perspective, this transaction will provide crucial breathing room for the Company to pursue two important financial objectives outside of extending the maturities of the Company’s debt. First, on a longer-term basis, this will provide GSM with capital to close high-cost capacity as part of the Company’s strategic plan. Second, on a near-term basis, the cash infusion will allow GSM to build additional working capital in order to capitalize on the high prices for its end products and pursue extremely profitable sales in the second half of this year.

Restructuring Plan Under New CEO Should Provide Enhanced Profitability Across the Cycle

After years of false starts and broken promises, GSM finally has installed a strong CEO who has developed a credible turnaround plan. From the time of its 2015 merger, GSM destroyed substantial shareholder value under former CEO Pedro Larrea Paguaga. However, in early 2020, Larrea was finally replaced by Marco Levi, a CEO with a formidable track record but little exposure to American investors. Levi has had a long career or turnarounds at industrial and materials companies, most notably as CEO of Ahlstrom Corporation (AM1 FH), a Finnish publicly traded company. At Ahlstrom, Levi led an impressive transformation which resulted in a near tripling of the share price over his two-and-a-half-years at the helm. From the year before Levi took over to his final year at the Company, Ahlstrom’s EBITDA increased by 101% driven by an improvement in margins from 6.4% to 12.0%. Meanwhile, Levi managed to reduce working capital by 25% driving strong free cash flows and reducing net debt by 54%. This proved transformational bringing debt to EBITDA from an uncomfortable 4.3 x to a pristine 1.0 x and positioned Ahlstrom to pursue a merger with Munksjo Oyj.

Levi was unable to do much to improve GSM in 2020, as he focused on keeping the Company afloat during Covid but is currently making up for lost time. In February of this year, GSM announced an ambitious cost improvement plan that should drive significant shareholder value. This plan has strong similarities to Levi’s work at Ahlstrom as it focuses on cost reductions and working capital improvement. Finally, GSM identified its cost-cutting goals through a rigorous, bottoms-up process with the help of Bain consulting. Levi had successfully worked with Bain during his time turning around a troubled division at Dow Chemical Company earlier in his career. Reportedly, Bain is working on a contingency basis, so its compensation level depends on achieving success in hitting these targets. Bain has a strong reputation for delivering when working in this manner and has even taken equity positions in its clients in the past, lending further credibility to GSM’s plan. 

This plan is expected to reduce GSM’s costs by $180 mm. The Company expects to generate $40 mm from footprint optimization which is already underway as the Company announced plans to close high-cost smelters in France. An additional $60 mm, $25 mm and $15 mm will come from continuous plant efficiency improvements, SG&A reductions and centralized procurement respectively. Levi will follow the Ahlstrom playbook to achieve these cost reductions. Finally, GSM will target $40 mm from commercial excellence, using its market leadership position to improve industry pricing and intelligence to sell the most profitable mix of products. This initiative already seems to be bearing fruit as GSM shifted substantial volume in its silicon metals business from the fixed price chemicals business to the variable price aluminum business, which will allow the Company to better capitalize on rapidly escalating prices in 2021. In addition to cost-cutting, GSM plans to bring in an additional $70 mm in cash from working capital. The Company has historically managed working capital extremely poorly, especially in its manganese business, leading to many of the balance sheet issues that it is currently working through.

If this plan is successful, the upside in GSM’s shares is tremendous. The plan suggests that GSM will bring EBITDA from $33 mm in 2020 to $483 mm in 2024 while transforming the balance sheet from $391 mm of pro forma net debt to $358 mm of net cash. If this plan is successful and GSM trades at its historical 6-9 x EBITDA multiple range, the shares would be worth between $18.60 and $26.68, representing 448% upside at the midpoint. Moreover, as detailed earlier, this plan is based on prices and spreads that are materially below current levels for silicon metal, silicon alloys and manganese alloys.    

Conclusion

While GSM has had a troubled history since its transformational merger in 2015, we believe that the Company is on the road to recovery. The balance sheet and commodity price environment are finally well positioned to support a dramatic operational turnaround under a strong new CEO. Based on achieving a publicly available business plan, GSM’s shares have between 348% and 547% upside. Moreover, we believe that the estimates in this plan have substantial upside given the current pricing environment for GSM’s end products. Finally, GSM currently has a majority owner in Grupo Villar Mir (GVM) who owns a little over 50% of the shares outstanding. It is clear from reports in the Spanish media that GVM is financially distressed and had considered selling its stake in GSM or putting the whole Company up for sale prior to Covid. For GVM, realizing value from GSM is its top priority to keep the group alive, further tipping the risk-reward balance in the favor of GSM shareholders. Indeed, over time, we suspect that GSM is likely to be sold as the turnaround progresses, crystalizing very attractive returns from current levels. 

Any forward-looking opinions, assumptions, assessments, or similar statements constitute only subjective views. This information should not be relied on for investment decisions and is subject to change due many factors, including fluctuating market conditions and economic factors.  Such Statements involve inherent risks, many of which cannot be predicted or quantified and are beyond our control. Future evidence and actual results could differ materially from those set forth in, contemplated by, or underlying these Statements, which are subject to change without notice.  In light of the foregoing, there can be no assurance and no representation is given that these Statements are now, or will prove to be, accurate or complete. We undertake no responsibility or obligation to revise or update such

Catalyst

1. GSM completes rights offering and exchange offer in the coming months

2. GSM reports Q2 earnings in August highlighting the potential earnings power in the current commodity price environment

3. GSM continues to execute on its cost savings plan, improving the Company's earnings power over the cycle

4. The potential sale of the Company is GSM's majority equity holder looks to improve its own liquidity

NB. GSM reports Q1 earnings on 5/18/21. This earnings report would be too soon for the Company to see much impact from higher silicon metals and alloy prices, which should begin to materialize in Q2. As such, we don't view the Q1 earnings report as a strong catalyst either way. As management has often been cautious in communicating their outlook, it may even present a buying opportunity.