PHOENIX-LIKE OUTOKUMPU

Outokumpu seems to have had a fantastic performance as of late. The share price has in fact increased by almost 60% over the past two years and nearly doubled since the onset of the pandemic. Not bad. This is hiding a more brutal reality: it is still sharply down on a five-year perspective, the stock having lost about half of its value. It has yet to reward its shareholders after the painful FY18-FY20 period.

Back from hell

Outokumpu is definitely a story recovery. Despite a growing stainless steel market, its prime business, its operational performance has long been disappointing. As a quick reminder, the stainless-steel market is significantly less cyclical than carbon steel, owing to the more diversified customer base (e.g. Healthcare or Food & Beverages which are not cyclical). It is also growing at a reasonable pace (say +5% p.a) due to its increased usage. As is the case for peers Aperam and Acerinox, the Finnish group also benefits from the fact that this sub-segment of the steel market is less fragmented and therefore less competitive than is the case for carbon steel at large. A telling figure is that the top 3 players produce one third of the world’s output whereas it takes as many as 20 steel makers to reach the same percentage of global carbon steel production. However, this has not prevented Outokumpu from underperforming for years, to the point that it was on the brink of going bust a few years ago. Former CEO Mr. Baan, who left in FY20, had clearly been unable to deliver on his promises, leaving the group with a very modest 3% margin (EBITDA) for his last year at the helm. His successor did better. True, Mr Malinen has benefited from an improved context, with stainless steel prices rising sharply over the past two years and some action being taken against Asian exports, but the fact remains that the group has been able to partly catch up in terms of profitability, at least vis-à-vis Acerinox. We’d also like to stress that Aperam’s margin for FY21 was largely penalized by the non-contributing ELG acquisition, without which it would have been similar to that of FY20, and way above its two peers. Much more is thus possible for Outokumpu, we think.

More to come, hopefully

Stainless steel growth is here to stay. The stuff lasts forever, is 100% recyclable, requires low maintenance and is resistant to corrosion, among other features, all of which explains the market growth over decades. With this background, there is no reason why Outokumpu should not successfully improve its margins, having fixed its profitability issues in the US and sold its low-margin Long Products division. True, the geographic mix of the three players is different (more US for Outokumpu, Europe for Aperam and a global footprint for Acerinox) but there still could be a further operating improvement for the Finnish player, particularly when one looks at best-in-class Aperam. Another idiosyncrasy is its exposure to Ferrochrome, that the group mines in Finland, which somehow pollutes the reading of the previous graph. As of late, this has been a blessing for Outokumpu with high prices but this can obviously become more of a burden when the cycle is less favourable. Still, the run-rate improvement in the EBITDA (€250m) has been achieved ahead of schedule and the strategy of the company for FY22-26 is (rightly) to further improve returns before thinking of investing in growth. 

A candidate for ESG investors?

The group achieves a very decent score in terms of sustainability according to AlphaValue’s independent and proprietary metrics (no exclusion for a start). This is despite the fact that it comprises a mining activity in ferrochrome, which is not that environmentally-friendly. However, Outokumpu has succeeded in posting regularly improving results in terms of CO2 emissions and water withdrawal (to name but a few) and can also pride itself in its governance, with an independent board that also happens to include a high proportion women (half of the total). Its emissions should be cut by 42% by 2030 (from a 2016 base line) and disappear altogether by 2050. Only 20% of its energy need comes from fossil fuels, the rest being a mix between nuclear (c.60%) and renewables (c.20%). It is worth mentioning that Outokumpu participated in the Fennovoima nuclear plant project with a 14% stake in it (alongside SSAB and Fortum), which should have given it further access to nuclear power, before the project was unfortunately scrapped last May due to the role of Rosatom (plant designer & risk taker, Russia) in it. Energy questions aside, it also remains that stainless steel is a durable material that fits with the circular economy, saving resources, with recycled stainless and carbon steel as the main raw materials used. Needless to say the group has the full backing of the Finnish government, its reference shareholder with 15.5% through Solidium, in that field as well as more generally speaking. All in all, the stock thus appears a serious candidate for investors who pay attention to the dynamic of emission cuts.

54% worth going for

One might argue that our valuation looks optimistic in the current market, with more uncertainties as of late, but in our view the stock is cheap at current levels. Actually, the group should be able to benefit from the features of its end-markets and continue to close the gap with peers in terms of profitability, while its current P/E for FY23 is a mere 3.3x. Of course, its results may be a tad more volatile due to the ferrochrome business, but this should altogether translate into a rather healthy EPS growth in the next few years. Barring a strong downturn in the group’s end-markets, which again are not as cyclical as one may think, Outokumpu has its unconventional attractions.