Market Economy is the best friend of circular economy.Jyrki Katainen
Befesa is a company that was founded in 1993 through the merger of Berzelius Umwelt Service and two more firms. In 2000, Abengoa acquired the 51% of Befesa and sold its participation to Triton Fund in 2013.
Nowadays, there is a global trend towards waste management that companies and investors cannot ignore. In addition, China has declared steel waste hazardous.
Befesa stock market is slightly below its initial price. Would it make sense to invest in Befesa at this moment?
Since its foundation, Befesa has focused its operations in two lines of business: steel dust and aluminium waste management. They have a double way of reiciving cash: one of them is by collecting steel dust and aluminium wastes. The second one is by selling zinc oxide, WOX and secondary aluminium products.
We can see it graphically in the following excerpt from the public information available on its corporate website:
Since 2006, Befesa has expanded its operations through the following movements:
- 2006: Befesa became the first steel dust recycling company.
- 2009: Befesa acquired three more plants for aluminium waste and became the first European recycling company in this second line of business.
- 2010: the company landed in Turkey through a joint venture with Canadian Silvermet.
- 2012: Befesa inaugurated its first plant in South Korea.
- 2015: Befesa increased its presence in South Korea.
- 2018: started constructing its first plant in China.
- 2019: Befesa signed an association agreement to construct a second plant in China.
A key aspect of Befesa’s core business is the geographical location. The fact of placing its plants close to its customers allows a reduction in transportation costs. Thus, during difficult periods, the company can lower prices without harming margins excessively.
As we saw in the previous section, Befesa has always invested in the most important steel poles, such as China, South Korea, Turkey and Germany. In the following excerpt, we can see geographical presence as well as its market share for both Europe and Asia (ex-China) markets:
Regulation factor always needs to be taken into account. In this case, Befesa counts on the support of regulators due to the impact steel and aluminium wastes have on the environment. The world is more and more concerned about such issues and is reasonable to think that regulators will follow this trend. China, for example, has recently considered steel dust waste as hazardous. Other countries, such as India are expected to do the same in the future.
Befesa holds a leading position in Europe with a market share of 50% and another 20% in Asia (ex-China). Previously, I stated that location is important. However, installed capacity is also a key factor for such companies because it enables economies of scale and cost reduction. The question that arises is the following: Can Befesa maintain or even increase its leading position?
Because many competitors are local and private, there is not much available information. Nevertheless, I have found Zinc Nacional (part of the holding Promax). Zinc Nacional is a firm that also processes steel dust to produce WOX and has also expanded its operations:
- in USA (through the acquisition of SDR, with a capacity of 230k tons/year.
- in South Korea through a joint venture with SDR with a capacity of 113k tons/year.
- in Thailand, through GSD, with a capacity of 110k tons / year.
Befesa is not present neither in Thailand nor USA, so they do not compete against Promax in such markets. By the contrary, both companies compete in South Korea. Regarding capacity, it must be said that the spanish company is two times larger (220k tons /year vs 110k tons /year). What is more, Befesa is planning to increase capacity in this market.
In Japan, Steel companies Nippon Steel Co. and Kobe Steel Ltd. created in 2011 a joint venture to process their steel waste with a capacity to process 220k tons/year. Befesa does not have any plant in Japan, so they do not compete in this market.
Due to location and economies of scale, I personally think that this is a business that tends to market distribution instead of fierce competition. Thus, I think that the risk here is not expanding instead of losing local market share.
Accounting policies & recasting
Reading Befesa consolidated statements and employed NIIFs, I have found two aspects that could be used by managers to manage earnings:
- Proportion of R&D expenses that are capitalized and expensed.
- Provisions against certain assets.
For that reason, I have recasted both Income Statement and Balance Sheet in order to capitalize 100% of R&D costs and revert provisions agains assets. In the following images, pre and post recasting can be compared and analyzed:
Recasted Income Statement:
Recasted Balance Sheet:
To value Befesa ordinary shares, I have followed the following steps:
- Firstly, I have recasted the financial statements (Balance sheet and Income Statement).
- Secondly, I have calculated a sustainable growth rate through: %g = ROCE (1-payout)
- Thirdly, I have created two scenarios (pessimistic and optimistic) to find an intrinsic value for Befesa.
Obtained Results are the following:
I rarely use generic formulas and rules of thumb when valuing a company. Nevertheless, the sustainable growth rate obtained is a 8,5%. Interestingly, this figure is in line with the expansion program of Befesa.
Subsequently, two different scenarios have been created. The intrinsic value obtained in both scenarios are the following:
Since earnings are based on accrual principles rather than cash inflows and outflows, I have repeated the same exercise but instead of using recasted earnings per share, I have employed the free cash flow to the firm metric. The results are the following:
Thus, the margin of safety estimated using both methods range between 16% and 98%.
The fact that more and more governments are considering steel dust as a hazardous waste is a key driver for Befesa growth prospects. Moreover, it is reasonable to think that this trend will continue in the future.
I also commented that localization and expansion are key for this business. Regarding this aspect, it needs to be mentioned that one of the pillars of Befesa strategy is organic growth. The company is planning to expand its capacity in both Korea and China. What is more, this plan is being executed with a controled level of leverage.
As a differentiating element, Befesa has proprietary technology and continues to allocate resources in R&D activities.
By no means this article is an investment recommendation. However, I personally think that this company is trading at an attractive price and can give us higher returns than its reference stock index.