Morningstar | Hydro Shares Rally After 2Q Earnings Release, but Our NOK 34 FVE Is Unchanged
Norsk Hydro shares traded sharply higher after the company delivered encouraging news about the ramp-up of its bauxite and alumina production. After updating our valuation model, our fair value estimate is unchanged at NOK 34 per share. Our no-moat rating also remains intact, as we don't expect the company to generate returns on invested capital above its weighted average cost of capital over our explicit forecast period.Although underlying operating profits remain well below the prior-year period, Norsk Hydro is on the verge of materially higher profitability. This comes as the company's bauxite and alumina segment works its way back toward more typical profitability levels now that the Alunorte production embargo has ceased. Underlying operating margins for the segment expanded to 7.2% in the quarter, up from only 3.1% sequentially. Although alumina prices have softened from elevated levels in 2018, they still remain above historical levels, which should allow for further margin expansion in the second half of the year. Indeed, the removal of the Alunorte production embargo lifts a significant headwind that has weighed heavily on profits since it was enacted in February 2018.
The burden from limited production at Alunorte has also taken a major toll on profitability for the company's aluminum smelting operations. While underlying segment operating margins averaged 11% in the trailing five years before 2018, Hydro suffered massive underlying losses in each of the last three quarters. This, too, should reverse as the company works to restore its historically enviable positioning on the global cost curve for aluminum smelting.
Regardless, we view shares as fairly valued, as current market prices sit just below our fair value estimate. We maintain a cautious outlook for the global aluminum industry, as demand is likely to remain soft, and we foresee lower aluminum prices over the long run.
Norsk Hydro is an aluminium group based in Norway. Co. is engaged in the supply of aluminium and aluminium products. Co. supplies casthouse products, such as extrusion ingots, sheet ingots and foundry alloys. Co's customers are active in sectors such as the packaging, lithographic, building, automotive and transport sectors. In addition, Co. is engaged in the production of power in Norway. Its business is divided into six operating segments: Bauxite & Alumina, Primary Metal, Metal Markets, Rolled Products, and Energy and Other and Eliminations.
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