MMC Norilsk Nickel (OTCPK:NILSY) enjoys a unique position among the world’s large mining companies with its balanced portfolio of base and precious metals. The latter do not include gold which only plays a negligible role for Norilsk, but to palladium and platinum which are dominantly used in industrial applications. As the leading producer of palladium (representing 39% of the global output), the company particularly benefits from the ongoing rally which has driven the price from less than $1,000/oz one-year ago to more than $1,500/oz today.
Norilsk Nickel segment revenue
Revenue by product [$M]
Source: company reports.
Palladium already became Norilsk’s biggest product last year, representing 32% of total revenue, followed by nickel and copper. Platinum is by far less important which is a major advantage in the current market environment which saw platinum prices to tumble as low as $800/oz.
Like other major mining companies, Norilsk profited from firm metal prices during the year 2018. Higher realized prices for nickel (+26%) and palladium (+19%) as well as increased copper (+18%) and palladium sales volumes (+21%) lead to total revenue growth of 28% to $11,670M.
The company’s EBITDA climbed 56% to $6,231M (corresponding to an EBITDA margin of 53%), net income rose 44% to $3,059M while the free cash flow exploded from -$173M in 2017 to $4,931M in 2018. This amount was more than enough to cover the $3,269M dividend payment so that the company’s net debt was reduced by $1,150M to $7,051M.
If working capital movements are excluded which had a positive impact of $941M in 2018 (compared to an outflow of $1,670M in 2017), the adjusted FCF grew from $1,497M in 2017 to $3,990M for FY2018.
Another important factor which influenced FCF positively was lower capital expenditures which declined by nearly $500M to $1,553M.
Norilsk Nickel is the fifth largest mining company with a current market cap of $36B. On top of the list are BHP Group (BHP)(BBL) ($138B) and Rio Tinto (RIO) ($104B), followed by Vale S.A. (VALE) ($72B) and Glencore (OTCPK:GLNCY) ($46B).
In this group, Norilsk stands out as the major mining company with the highest dividend yield, a compelling reason to consider the stock for many investors including myself.
Most of the large mining companies were forced to cut their dividends and focus on their balance sheets after the commodity price crisis of 2015/2016. However, the faster than anticipated price recovery in combination with consequent production efficiency programs and strict capital discipline led to a quick turnaround, and the companies are now printing money – only a couple of years after the crisis.
Like its peers, Norilsk reduced the dividend, however, the payout ratio in relation to the FCF remained relatively high. Furthermore, Norilsk did not slash capex as most of the others did but kept expenditures more or less at a constant level (averaging $1.7B over the past five years). As a result, the company’s net debt almost doubled from $3,537M at the end of 2014 to $7,051M as of December 31, 2018, but due to the growing EBITDA, the net debt/EBITDA ratio is still low (1.1x).
Norilsk has announced that capital expenditures will increase in the coming years due to a new investment cycle. While sustaining capex and commercial projects will remain constant (around $1.8B annually), an environmental program, as well as potential growth projects, will lead to aggregate expenditures of $2.2-2.5B in 2019 and to $2.3B-3.1B annually from 2020 to 2022. This means that depending on the actual realization of said growth projects, capex will climb by $600M to $900M this year and by $700M to $1,500M in the three years after compared to the 2018 level.
Source: company presentation.
The capital program will lead to additional cumulated cash outflows between $2.7B and $4.4B until 2022 which will have to be funded by either higher operational cash flows or more debt.
Although I am quite optimistic about the commodity market in general and a cautious approach by Norilsk when it comes to the realization of the projects in question, I expect that the capex program will unavoidably lead to an increase in net debt from 2020 on. Having said this, I believe that indebtedness can be maintained at an acceptable level and that the EBITDA/net debt ratio will not increase considerably. This ratio is very important for shareholders as it determines the dividend payout of up to 60% of the company’s EBITDA.
Unless there will be a major global economic downturn, I assume that commodity prices will stay firm enough to keep Norilsk’s EBITDA at least at the current level and that the EBITDA/net debt ratio will remain below 1.8 supporting the company’s double-digit yield. Based on the 2018 EBITDA, net debt could rise by another $4.4B to $11.4B without endangering the full 60% payout.
At least a solid 2019 result should already be bagged in with only five months to go. My 2019 revenue and EBITDA estimate below is based on Norilsk’s production guidance, the average prices in 1HY19, and a constant EBITDA margin.
Norilsk Nickel 2019 Revenue and EBITDA Estimate
Source: own calculations. Ni/Cu volumes in metric tons, PGMs in oz. Ni/Cu prices per metric ton, PGMs per oz.
Actually, I consider this estimate to be more on the conservative side, particularly because it does not reflect the strong palladium market. Using current spot prices for the four key products, Norilsk’s EBITDA would be higher than last year. A strong 2019 result could enable Norilsk to shoulder the additional capital expenditures without an increase of net debt.
While visibility for 2019 is quite good, the financial performance, net debt development, and dividend payments over the following years will primarily depend on the market environment, but fortunately, the outlook for Norilsk’s products remains solid.
The palladium market stays in a structural deficit which is even worsening, so fundamentally, there is little reason for prices to come down short term. The biggest threat is the global auto market and more exactly the demand for gasoline-powered ICE vehicles. Lower car sales translate into a lower demand for catalytic converters (the dominant application for palladium and platinum). On the other hand, tightening global emission standards increase the consumption of precious metals per unit and counter the impact of declining auto sales. Another concern which is often mentioned is that the current Pd/Pt price ratio may trigger developments to replace palladium by platinum. This is easier said than done since the physical and chemical properties of both metals are quite different, but even if such an approach was successful, it would be a long-term process and not impact palladium consumption anytime soon.
Nickel and copper prices have come down from the 2018 highs, but the long-term fundamentals for both base metals remain intact. Although quite negligible today, the nickel consumption for battery materials will increase and the copper demand will benefit from the increasing number of EVs as well. There is a wide consensus that the copper market will turn into a deficit in the next years. With the ramp-up of the Chita project, Norilsk’s copper output increases in 2019 and 2020 until the operation is expected to reach nameplate capacity. Although the outlook for nickel is not as optimistic as it is for copper, the demand for higher grade class 1 nickel will grow. Norilsk is also the world’s leading producer of this grade which is required for the use in batteries.
Share Price and Dividend
Since 2001, Norilsk has an ADR program in place, and ten ADRs represent one ordinary share. The five-year chart shows how NILSY fell to a low of $11 at the beginning of 2016 but has more than doubled since then.
The peer comparison reveals that Norilsk shares outperformed over the five-year as well as the one-year period.
Norilsk’s total return is even higher, and the extraordinarily attractive dividend is an important reason for me to invest in the company. Although the table below illustrates that the dividend is depending on commodity prices, I believe the average yield during the cycle is attractive for dividend investors.
Norilsk Nickel Annual ADR Dividend per FY
Source: company website.
Norilsk’s current dividend policy was implemented in 2016, and it is based on the EBITDA and the net debt/EBITDA ratio. Below a multiple of 1.8, 60% of EBITDA is distributed, and the payout proportionally decreases to 30% (for a 2.2 ratio or higher).
Source: company presentation.
For FY18, Norilsk declared a dividend of $2.37 per ADR of which $1.15 was paid as an interim dividend already last year and the final payment was made last week. The two installments correspond to a current yield of 10.2%. Based on my 2019 EBITDA calculation (see above), I expect a dividend of approximately $2.30 for FY19 of which the first installment should be due in the fourth quarter of 2019.
The primary risk related to an investment in Norilsk is lower commodity prices. As mentioned initially, Norilsk has a unique portfolio, however, most of its products find their way into industrial application which is dependent on the economic cycle. A recession and declining demand, particularly in China remain the biggest threat for commodities and mining companies. On a positive note, there are few threats for prices from the supply side since mining companies have slashed their investments after the last crisis.
Another risk is a political one. Norilsk is a Russian company, a fact that can lead to unpleasant surprises for investors in the prevailing geopolitical climate. For example, on April 9, 2018, the stock plunged nearly 20% on a single trading day after the U.S. imposed sanctions on seven Russian oligarchs and their companies. Retrospectively, the drop represented a great buying opportunity, and all paper losses were recovered only a few weeks later, but it surely scared off some investors.
Shareholders also have to be aware that the majority of shares is owned by a few Russian oligarchs which control the company. The largest stake is controlled by Vladimir Potanin (34.5%), Norilsk’s CEO. The second largest shareholder Oleg Deripaska (Rusal) controls a 28% stake. There have been disputes between Potanin and Deripaska over the years about Norilsk’s strategy and dividends which were settled with a shareholder agreement that remains valid until the end of 2022. Nevertheless, the controversy never really ended. Earlier in the year, Potanin commented on his intentions to cut Norilsk’s dividend in favor of larger investments, a strategy which is opposed by Deripaska.
I consider Norilsk Nickel with its unique portfolio of base and precious metals as a core investment in the mining sector, and I particularly like the company’s leading position in the palladium market. The dividend is highly attractive, and I believe also sustainable in a stable commodity market environment.
Disclaimer: Opinions expressed herein by the author are not an investment recommendation, any material in this article should be considered general information, and not relied on as a formal investment recommendation. Before making any investment decisions, investors should also use other sources of information, draw their own conclusions, and consider seeking advice from a broker or financial advisor.
Disclosure: I am/we are long NILSY, RIO, BHP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.