Aurubis: Uncertainty, But Long-Term Upside Remains (AIAGF)

Dear readers/followers,

I have previously written about the copper/metals player Aurubis (OTCPK:AIAGF) (OTCPK:AIAGY). After being neutral on the business due to overvaluation for the better part of a year I finally went to “BUY” back in June of this year. Unfortunately, a few things happened to ensure that the company fell even further, meaning that my position is currently in the red.

Does this bother me?

Not especially. It would bother me if the implication was that I paid too much for the company to begin with. But that is not the case here, not as I see it. Copper is a great space to be in. I’ve made myself fairly known on Seeking Alpha for my investments in basic materials, including metals. Norsk Hydro (OTCQX:NHYDY) is a good example of this. My foray into copper was announced when I looked at Southern Copper (SCCO) and other companies in the same space.

Aurubis was the latest move into copper, and a few months ago I finally went long – so let’s look at what has prevented the company from outperforming the market here.

Aurubis – 3Q23 came with some worries, but overall long-term strong trends

So, if you recall, the company is a player in the field of metals, and specifically has quite a bit of exposure to copper. Out of metal investments, copper and aluminum are by far my favorite exposures. Aurubis is a great business, with a lot of tradition. It was formerly known as the Norddeutsche Affinerie AG, and at one point provided 50% of all German copper needs. It’s also M&A’ed some great copper producers in Europe, and remains, today, one of the most relevant producers and handlers of copper and recycling in the entire continent.

Aurubis is largely owned (just south of 30%) by German Steel company Salzgitter AG (OTCPK:SZGPY), which owns a total of 100+ subsidiaries in various parts of the metal segment. I don’t own Salzgitter (yet), but I do own shares in Aurubis.

So, what does the company do? Copper Cathodes. The business uses various types of copper concentrates, scrap copper, and recyclables to create copper cathodes, in the form of wire rods, shaped rod rolled products, and strips/wires.

Just how good is the company at doing this?

Very good, given that they’ve been doing metallurgy for over 240 years.

And while copper remains the main focus of the company’s operations, Aurubis does other things today as well. Specifically, the company does this.

Aside from copper, Aurubis works with the metals Gold, Silver, Lead, Nickel, Tin, Zinc, Platinum, and “minor metals”. The company has a bit of a broken fiscal, which is why we’re seeing the 3Q results back in August.

Those results were… okay. Not great, but okay. The company generated over €400M worth of 9MEBIT at a return on employed capital of 15%+, which is a slight drop in earnings and a drop of 200 bps in ROCE. Net cash flow came in substantially higher, and for the full year, Aurubis expects something close to over half a billion euros in operational EBT.

The state of the underlying markets was good. Cathode premiums are up, and the demand for rod and wire, despite macro issues out of China, was actually up. So metal results were up, though we saw some softness on sulfuric acid. But with energy costs dropping substantially from PY levels, the overall development was positive.

The primary reasons for the lower results despite this was ongoing maintenance in Pirdrop as well as investments for the company’s growth, which came in at above-targeted levels. Also, a shutdown in Bulgaria definitely contributed to the trends here.

Sulfuric Acid, which has been on an absolute tear for years, is now normalizing at perhaps a lower level than I would have expected. The gross margins for the company and the cost mix is an interesting picture to look at, showing increased costs for consumables, more external service costs, significant energy cost reduction, and other OpEx, but otherwise a favorable cost environment.

The latest few years of extremely positive results have also seen the company being able, like many others, to shore up its balance sheet and remain in a very positive financial situation to manage any sort of challenge that comes its way. As a way of exemplifying this, the company has a targeted equity ratio of above 40%. The current equity ratio is 57.5%. The company also has no debt, leading to a debt coverage of zero, despite a target of above 3x.

The metal markets are a very volatile place to invest in. In order to see success here, you must cultivate a strong stomach – the same thing is true if you intend to invest in companies that work in the metal markets, such as Aurubis. The current market outlook is mixed.

Concentrates are expected to go up due to mining, with capacity expansion and greenfield projects. The company’s smelters are already at capacity and they can produce on existing supply well beyond the end of this year. The scrap supply is also expected to grow, and smelters here once again are well-supplied beyond the year’s end.

On the demand side, the company expects reduced demand for sulfuric acid, which has been up for years but is now coming up due to demand declines from both the chemical and fertilizer industries. For copper and metals though, the demand for wire rods is expected to be at a continued high level, while rolled products and other subsegments are expected to be in slight decline.

Aurubis is on a mission of expansion. The addition of more smelting furnaces will enable the company to fulfill the multi-metal growth strategy that it began many years ago.

Overall, I see Aurubis only growing stronger. It’s also making fans of ESG happy, by introducing carbon-neutral copper production through its new Hamburg Furnace.

What are the issues here that have been causing the company to drop?

There is unfortunately a bit of a lack of clarity as to how this may play out, and if the instance was any more limited, I probably would say not to even bother with it, but the substantial discrepancies in inventories that were found in the company’s stores, and which also means the company likely won’t make guidance, is considerable enough to discuss.

It’s a well-known fact that copper is a target for theft and criminal activity due to the large value of the metal – but this also suggests perhaps a bit too much laxity on the part of the company’s reviewing processes. Fortunately, it seems that parts of their scrap suppliers/players were allegedly involved, which means that the company has relatively direct routes of starting to recoup some of these losses. Time will tell how big an impact this has. This piece of news was reported around two weeks back, so I haven’t heard much more since then, but I’ll keep a definite eye on this, as this has the potential to delay the company’s upside for some time.

However, in the end, it’s really only a bump in the road to larger things for Aurubis. Let’s go into valuation and see what we have going on here.

Aurubis Valuation – the undervaluation makes things even better

So, Aurubis was cheap enough to buy the last time I reviewed it. Now it’s looking even better thanks to the most recent drop. The company, if you recall, trades under the native ticker NDA on the German stock market. This plunge in the coming year is expected to be roughly 11%, followed by another 5-7% before climbing back up in the 2025 fiscal year.

However, when looking at or estimating the company, I want to clarify that the market has a recorded tendency of substantially underestimating this company. 50% of the time, even with a 10% margin of error. That means that the likelihood of the company performing better is at least within the realm of possibility.

The company isn’t trading at trough valuations any longer, but it’s getting close to them. The company, at this time, is at around 8x P/E. That’s substantially below any valuation we’ve seen for the company for the past 20 years. Despite a yield of only 2.6%, the upside here is well within my investment target range of 15% annualized.

It all depends on where you forecast the company. Compared to a 5-year normalized P/E of 12.7x, this is the upside we’re seeing.

Even if we only estimate a valuation for the company of 10x P/E, that’s still an upside of above 15% annualized for the longer term based on a conservative growth estimate of less than 2% per year on average. So even under very conservative estimates, this company has the sort of market-beating upside that I’m looking for.

S&P Global estimates for the company are significantly above what we have here – and many analysts have actually shifted their targets in the last 3 months. We’re now at a low target of €61 to €123 on the high side, with an average of €95/share. 9 analysts follow the company, and a full 6 of them are at “BUY” or equivalent rating for the business, with an upside of almost 40%.

So, my stance of a “BUY” remains. I will not change my PT of €80/share as a result of the theft or the drop. I believe the company is now an even better buying opportunity, and will add more shares of Aurubis to my portfolio.

Here is my updated thesis.

Thesis

• Aurubis is a market-leading German metallurgy company in the segment of copper, other non-ferrous metals, and precious metals, as well as the byproduct of Sulfuric Acid. The company has one of the most extensive expertise on the planet for this particular field, and it deserves more than the attention it’s getting here at this time.
• As of the latest quarterly report, some of the expectations for 2023E are somewhat more crystallized, and what I would consider clearer than before. This enables us to act with more confidence and also shift our PT.
• I own stock in Aurubis, and I’m down over 40% in less than 6 months – and now I believe we can add more.
• I say that Aurubis remains a “BUY” at around €80/share or below for the common.

Remember, I’m all about:

1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

There’s still enough positives here, and I would now also argue the company is getting closer and closer to “cheap”.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.