Nornickel - As Good As It Will Get

We are resuming coverage of Nornickel after coverage has been handed over to a new team. Our previous recommendation on the stock had been a BUY, which was withdrawn on February 25. Our target price of $24.50 per share implies a near-zero total return (including a chunky $5.20 dividend), which warrants a HOLD. Nornickel remains a high-quality M&M name, but we do not see enough value in it now considering the risks to commodity prices, the coming increase in capex and expected changes to the dividend policy.> Earnings outlook supportive into 2022... We expect earnings to peak this year and start going downhill in 2022 amid the nascent correction in commodity prices and accelerating cost inflation. However, our $10.1 bln 2022 EBITDA forecast means an undemanding 5.5 2022E EV/EBITDA (below the long-term average of 6.5), cash returns are set to stay strong (with the 12-month dividend yield possibly reaching 17-18% based on payments during the year) and the stock has lost 20% since the May peak. So is this the right time to buy a quality name at a bargain price?> ... but beware of changes beyond. Three reasons make us think otherwise. First, the current dividend formula becomes obsolete with the expiry of the shareholder agreement next year, which we think will lead to dividends being aligned with FCF. Second, cash generation will be pressured by capex and lower metal (especially PGM) prices. Third, we see risks of the CIT rate rising after 2022, though the decision has been put on hold. We see the dividend yield falling to 7% in 2023 and possibly averaging 5% or less over 2024-27 (based on payments during the year).> With organic growth, taking path of least resistance. The company's organic growth program is aimed at fully utilizing the potential of its Polar Division rather than expanding into new geographies or commodities. The advantage of this is that the pre-existing infrastructure lowers execution risks and brings down the capital intensity. The drawback is that the growth options are limited to the existing asset perimeter, while reinvesting cash in the ageing asset base will narrow flexibility down the road. Given the mineral endowment, the strategy means rising exposure to PGMs, which is the market that we see struggling longer term amid the growing penetration of electric vehicles.> With ESG, charting its own course. The last two years have been marked by a chain of mishaps that have dented the company's ESG record. Dealing with the consequences of these mishaps undoubtedly has driven many capex decisions included in the updated strategy. While the rise in non-production capex is not exactly a good thing, it should be seen in the context of risk mitigation, which is also an important consideration for the valuation. The good news is that Nornickel does not seem to be at risk of getting behind on decarbonization. Although achieving zero emissions will not be easy, we preliminarily estimate the cost of decarbonizing at less than 10% of the company's market cap.