Norilsk Nickel Update: Generating Significant Shareholder Returns Despite Weak Commodity Prices in 2016
· Norislk Nickel (NILSY) has de-risked its greenfield Bystrinsky project in the Chita region by selling a 13% minority stake to a consortium of Chinese investors, for US$100 million.
· Norilsk Nickel sees deficit widening in the nickel market and expects inventory drawdowns in 2016.
· Norilsk Nickel paid out $2.9 billion in dividends during 2015 and expects to pay a further $1.6 billion in 2016 representing an 8% yield at current market cap.
Nickel Market Update
Norilsk Nickel believes that current nickel spot prices are not sustainable. The nickel market showed low price elasticity in 2015, with production cuts coming mostly from Chinese nickel pig iron producers and a number of mines operating at negative cash flows. Negative cash flow mines remained operational due to some form of “sponsorship,” from large globally diversified miners, governments, or strong private backers. Nickel consumption for 2015 remained robust, with Chinese output of the nickel intensive 300-series stainless still up 5% over 2014.
Norilsk Nickel estimates global demand will remain unchanged in 2016 while supply cuts will allow for a market deficit of 70 to 90 thousand tons. However the company does not see a sustained price recovery until global supply is reduced by 20-25% and exchange inventories, which have been running around 500 thousand tons are drawn down.
I agree with Norilsk Nickel’s view of the market. I continue to use my previous nickel price estimates of $4.50/lb in 2016 and $6/lb thereafter. I estimate prices will remain low in 2016 as inventories are draw down before recovering somewhat to $6.00/lb in 2017. I conservatively estimate $6.00/lb thereafter, despite potential for prices north of $10/lb.
Major Project Updates
Norilsk is preparing to activate its new downstream configuration in 2016. The company is currently completing the modernization and capacity expansion of the Talnakh concentrator, Nadezhda metallurgical plant, and Kola MMC nickel refining facilities. The company is also entering the active construction phase of 3 mining projects; the ramp-up of the Skalisty underground mine, high IRR brownfield projects in the Polar Division, and the Bystrinsky project in the Chita Region discussed in the following section.
Minority Stake In The Bystrinsky Project Sold To Chinese Investors
In January 2016, Norilsk entered into an agreement with a consortium of Chinese investors, which bought a 13.33% minority stake in the Bystrinsky project for US$100 million. Given the projects location in the Chita region near the Chinese border, de-risking the project by taking on a Chinese minority partner was a natural and logical decision. While Norilsk did not need to take on a minority partner to finance the project, the company decided to further reduce any risks in the project by taking on an outside partner. Additionally, in December 2015, the company signed a financing deal with a group of Chinese banks for a Chinese yuan equivalent to US$750 million unsecured five year credit facility.
Project development is progressing swiftly in the Chita region. A 227 kilometer railway link with a capacity of 3.7 million metric tons per annum is set to be commissioned in 2016. A 220kv high voltage power line is under construction, with commissioning scheduled for the second half of 2017. Additionally, all concentrator equipment has been ordered and over 3 million cubic meters of waste rock was removed in 2015, in preparation for the open pit.
Dividends Update
Norilsk paid over US$2.85 billion to shareholders in 2015, with the current market capitalization around US$20.5 billion, this equates to a dividend yield of almost 14%. The company has stated it plans to disperse around $1.6 billion in annual dividends for 2016. This equates to a dividend yield of approximately 8%. While 8% is significantly lower than in 2015, it is still a significant return to shareholders and represents approximately 38% of my estimated 2016 EBITDA figure. If metals prices improve in 2017 and over the long term, shareholders can expect to see significant returns, as dividend payouts should increase to match managements stated goal of distributing 50% of EBITDA. I estimate dividend payouts of $2.7 billion in 2017, increasing to $2.9 billion in 2018, and $3.0 billion in 2019.
Valuation Using Discounted Cash Flow Method
In order to determine a price target I used a discounted cash flow analysis, assuming a 12% discount rate which is a conservative assumption given Norilsk’s market capitalization, asset base, and competitive position. I assumed a 1% growth rate to account for potential growth of the Chita division and overall production given the large reserve base of the company. After subtracting US$4.212 billion in current net debt from the present value of total cash flows, I arrive at an NPV of US$22.97 billion or US$15.03/ADR implying a 16% upside over current stock prices. My NPV estimate has come down $0.78/adr since my previous report at the end of February as a result of increased net debt. Despite this slight decrease in my estimated NPV value and the recent stock price appreciation, I still estimate a 16% upside as well as an 8% 2016 dividend yield over current prices for shareholders.
Potential Risks For Shareholders
Shareholders in Norilsk Nickel face operational risks including metals price risk and exchange rate risk. However, Norilsk has already demonstrated that it can be profitable despite significant deterioration in the spot prices of nickel, copper, platinum, and palladium. While the weakened Russian ruble has helped maintain operating margins in the current low price environment, a stronger Russian ruble would increase operational costs for the company. Additionally, since almost all of the company’s operations are located in Russia there is not much diversity of exchange rate risk.
Shareholders in Norilsk Nickel also face geopolitical risks given the current state of acrimony between the Russian government and Western nations. Additionally, roughly 67% of outstanding shares in the company are controlled by several key Russian billionaires. These include Vladimir Potanin, Norilsk’s CEO and founder of Interros, Oleg Deripaska (UC RUSAL), and Roman Abramovich, commonly known as the owner of the Chelsea F.C. However, vastly improved corporate governance has been a major initiative within the company, which has a Board of Directors with an Independent Chairman, and 13 seats, five of which are occupied by independent directors. Additionally, the company has stepped up its investor relations efforts, regularly giving updates concerning company progress.