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Horsehead Seems to Be Pabrai's Most Active Investment… But Why?

December 26, 2013 | About:

On Dec.11, Mohnish Pabrai added Horsehead Holding Corp. (ZINC). It was the 13th time he added the stock during 2013, which makes me feel that Pabrai is making a bet that zinc is about to get a lot more valuable. So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity.

Warehousing and Distribution Network

Horsehead Holding Corp. is a holding company that includes subsidiaries, which are: Horsehead Corporation (a producer of zinc and zinc-based products); The International Metals Reclamation Company (a recycler of nickel-bearing wastes and nickel-cadmium batteries); Horsehead Zinc Powders (a manufacturer of zinc powders for the alkaline battery business) and Zochem (a producer of zinc oxide). The last one plans to open a “zinc center” in 2014 to serve the growing market in the southeastern region of the U.S. “Our ability to supply customers through our network of outside warehouse and distribution centers is a key service advantage of Zochem. Customers will have the choice of shipping directly from Brampton in Ontario, Canada, or from a warehouse in the Southeastern U.S. which will provide associated inventory management benefits,” said Horsehead CEO, Jim Hensler. Moreover, the company has made huge investments in the expansion of the Zochem facility as well as the development of the management systems.

Analyst Recommendation

Although it made Zochem expansion efforts, due to disappointing results in the last quarter, the firm is currently Zacks Rank # 5 - Strong Sell, and it also has a longer-term recommendation of “Underperform.”

Valuation

In terms of valuation, its price-to-book ratio of 1.8 indicates a premium versus the industry average of 1 while the price-to-sales ratio of 1.6 is above the industry average of 1.2.

Earnings per share (EPS) increased in the most recent quarter compared to the same quarter a year ago and are below the historical 10-year average. It has demonstrated a negative trend over the past 10 years while volatile as well. We include in the next graph the stock price because EPS often lead the stock price movement.

Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has increased when compared to its ROE from the same quarter one year prior. This is a signal of strength but still remains negative. Competitors such as Teck Resources Limited (TCK) trade for 8 times forward earnings and 0.9 times book as well as have a positive ROE. But for those seeking for a great ROE, the option should be US Ecology Inc. (ECOL).

Final Comment

Horsehead's revenue growth has slightly outpaced the industry average and despite having found a major weakness in the result of ROE, it has improved.

Hotchkis & Wiley Capital Management LLC has also been active in the company. The fund´s objective is to find undervalued companies that have a significant potential for appreciation.

I would recommend staying away from Horsehead at the time, mainly on account of its high valuation, volatile earnings and somewhat uncertain commodity prices. Instead, I would recommend investors to consider Dynamic Materials (BOOM) for your long-term portfolios if you are seeking exposure to the metal processing industry.

Disclosure: Damian Illia holds no position in any stocks mentioned.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


Rating: 3.1/5 (32 votes)

Voters:

Comments

rijk40
Rijk40 premium member - 11 months ago
your title is misleading and your article adds no value whatsoever......
maza1985
Maza1985 premium member - 11 months ago

Information value of this article 0.00... better not to publish this kind bulls..t.

jaumepared
Jaumepared - 11 months ago
This is helpful. Based on what I see here, I agree with you. I have rarely understood the insights of Mohnish Pabrai (Trades, Portfolio).



ron
Ron premium member - 10 months ago

A few things to consider here without going into too much detail:

1. Horsehead is the largest independent Zinc producer in the US

2. The company is about to open a new manufacturing facility (as we speak it is being tested), which will be the lowest cost manufacturing facility stateside (management promises over $90m in incremental annual income)

3. Their EAF dust facilities use a proprietary technology that provides low cost inputs to Horsehead zinc manufacturing and earns income for recyling waste products. Also provides predictable source of zinc via long term recyling contracts.

4. Over the next few years, several of the world's largest zinc mines are forecast to close their doors.

5. Zinc is an essential input to the steel fabrication process. Any small uptick in demand will positively impact the price of zinc.

Just a few thoughts... I am long Horsehead Holdings - and have been for some time now.

Cheers, Ron

philtcu
Philtcu - 10 months ago

Why does Monish think ZINC will be a double or triple over the next two to three years? After studying him, that seems to be his minimum threshold retunr before considering investing in an instrument.

Phil

UVInvestors
UVInvestors premium member - 9 months ago

Any company that relies on a commodity's price is best avoided. Been there done that.

kfh227
Kfh227 premium member - 8 months ago

Took me a long time to see what hte play is in this stock. Bought in about a month ago and think that this is going to be a wonderful investment.

batbeer2
Batbeer2 premium member - 8 months ago

>> Took me a long time to see what hte play is in this stock.

Do tell!

innovestors2000
Innovestors2000 premium member - 3 months ago

Zinc is projected to be in short supply. May be Monish saw that coming.

http://www.wallstreetdaily.com/2014/06/20/zinc-shortage-coming/

Max7777
Max7777 premium member - 1 month ago

Pabrai believes the key to buying commodity businesses like Horsehead is buying the low cost producer. Then your downside is limited since they can still make some money if the commodity price goes down while high price producers have to shut production. But if the commodity price goes up, the lowest price producer is the one who makes the largest margin profit. Zinc the stock is such a play. Zinc the commodity prices range between 50 cent in crisis time and $2 in top boom times. a 10 cent increase in the price of the commodity zinc will have big impact on the stock. Today zinc the commodity is around $1, he feels it can easily go to $1.20 or more as economy improves.

Hpeterscheck
Hpeterscheck premium member - 1 week ago
Exactly max.

Pabtai's thesis is that it's a low cost producer that generates positive cash flow when competitors can't. He doesn't know if or when the price of zinc goes up or down. If you buy the low cost producer and they generate cash flow, the value goes up a lot when the commodity price goes up but the company still generated value when it's low.

So this is the "moat." Coke can raise prices because of brand... Horsehead can make money if zinc price is high or low. Since zinc was cheap when he bought most of his shares its a cheap safe cash flow machine with a free option.

of course if they cease to become the low cost producer or if people don't need zinc anymore or if they screw up their operations such that they can't generate cash flow. . That thesis changes.
batbeer2
Batbeer2 premium member - 1 week ago

>> If you buy the low cost producer and they generate cash flow, the value goes up a lot when the commodity price goes up but the company still generated value when it's low.

That is true only in theory. The theory assumes the expensive producer is quickly forced to shut down. That is not the way it works. There are fierce cycles and they overshoot in both directions because all the participants claim to be low-cost producers in the long run. They hang on untill a whole generation of investors learn that the industry is best avoided (which incidentally is the best time to buy).

Take Natgas; also a commodity. Maybe a bit less so becasue of the infrastructure required to transport the product. In the last five years I saw a lot of them go down; investors got wiped out. They all went down claiming to be low-cost producers.

In short, you could have used the same thesis to buy Chesapeake energy in 2007.

Not saying ZINC is a bad idea, just saying that it is not a good idea simply because you think it is the low-cost producer.

Dr. Paul Price
Dr. Paul Price premium member - 1 week ago

ZINC is now well below (-22%) where it traded 10-years earlier and about where it was 5-years ago - up just 14% cumulatively while the broad market surged.

It's paid no dividends along the way while consitently losing money. They have survived the cash burn only through share issuance which will dilute any future turnaround that might, or might not occur.

Every year ZINC management says that "next year will be much better". That has failed to come true so far.

Caveat emptor.

lancent
Lancent - 1 week ago

Investment thesis for ZINC has nothing to do with a play on commodity prices. ZINC is hedged against commodity price swings with long dating contracts. The company is about to open a new manufacturing facility, which will be the lowest cost manufacturing facility stateside (management promises over $90m in incremental annual income).

Best wishes.

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