The Recent Trading Price of Sherritt International!

Date Added: May 17, 2019 | Comments (0) | Filed under: Blog

The trading price of Sherritt International, perhaps yet to prove a deep value investors dream, took a further hit from already depressed levels late last week and early this week. The carnage began with a trickle early last week as U.S. holders of Sherritt bonds began selling them following strong anti-Cuba rhetoric from the US administration (activation of the Helms-Burton Title III legislation related to claims about naTed properties in Cuba – which is unlikely to actually affect Sherritt) and accelerated with the release of Sherritt’s quarterly result Friday, affecting further the price of the already depressed shares. I’m not sure why market and analysts were surprised by the Company’s results (more on this below) but given the share price reaction clearly both market and analysts were not up to speed. Thus began a bit of reflexive panic selling with the bond and stock markets feeding off of one another. In that panic, Sherritt’s share price moved from $0.42 at March month end to now about $0.22 for April month end.

As for Sherritt’s quarterly results, there were only two real surprises to us in these results. The first one, rather fundamental, was the impressive level of first quarter production at the Moa/Fort Saskatchewan nickel operation (best ever Q1 in the history of the company). Obviously, the on-going efforts at improving and streamlining operations to enhance production reliability (new truck fleet, ore treatment improvements, rationalization) are starting to bear fruit. The second one, a one-time event, was negative: a large sale of 200 tonnes of cobalt in December and provisionally booked at December prices before final pricing and delivery in the first quarter suffered from the strong decline of cobalt prices (-28% in Q1 2019), creating a negative accounting adjustment that lowered Q1 results.

Other than that, it is pretty easy to calculate approximately what Sherritt’s nickel business cash flow will or won’t be based on the prices of nickel and cobalt in any quarter. Given where the price of cobalt was (70% lower than last year at the same time but now rising again) and with nickel languishing around last year’s levels it was clear that there wouldn’t be much if any cash flow this quarter – depending on the level of capital expenditures, etc.

In the end, what was most surprising to me in the Quarterly Results Conference Call with Sherritt were the analysts’ questions, revealing in some a lack of awareness or understanding of some basic features of Sherritt’s accounting which have always been there (granted, Sherritt is a complex company to understand, but it should not be beyond the reach of professional analysts advising institutional investors). Analyst for example seemed to not have known or realized that some (currently about $70m) of Sherritt’s cash balance (currently about $180m) is not in Canada but rather held in local Cuban currency awaiting foreign currency translation opportunities – the end result of basic rules of accounting, disclosed in their reporting and something we have known for quite some time but apparently some analysts did not. Therefore, they now concern themselves with the thought that they had previously overestimated Sherritt’s liquidity at a time when Cuba has less available US dollars to pay Sherritt for its oil and electricity production in Cuba. Difficulty in obtaining foreign currencies and especially US dollars is an issue that Cuba has faced for 60 years. While this difficulty is aggravated by current US behaviour, it must be said that Cuba has always honoured its commitment to Sherritt – without ever changing the terms of these commitments (for comparison, think of the number of times Alberta has changed the rate of royalty payments).

Sherritt has addressed this issue by proposing a reasonable and practical plan to collect on overdue receivables. This plan is working its way to final approval in Cuba and should be implemented in the very near term. This will be a boost to balance sheet flexibility and liquidity and start to alleviate some of these concerns.

Here at Takota we have the following view of Sherritt – a view that we have held for quite some time. That view is that Sherritt is simply a levered “platform” to participate in inevitably higher nickel/cobalt prices. What we care about is that our “platform” stays intact and stable and not much else. We don’t want to be diluted. We don’t want to be restructured, or even taken over, and at this point we don’t think we will be. There was a time when I thought our past success in investing in Sherritt was due to the dynamic and maverick Board and management that led the Company at that time. It was only after the fact that I realized it was simply our being exposed to the Company at a time when the previous bullish nickel cycle finally took off that allowed our original 9 year hold to turn in to a huge money maker (<$3 to $17).

I have invested in and traded the various parts of Sherritt, its predecessor companies, its spin offs, etc. for over 30+ years and our track record so far on approximately 20 different closed transactions is 100% success, and at times spectacular success. This includes investing in the old Sherritt Inc. way back in 1990 – a firm that eventually became in part Agrium and in part the Sherritt International we own again today. It also includes many trades in Westaim, in Dynatec, in Sherritt Power bonds and equity, and several others. Since the financial crisis we have profited handsomely from another large portfolio position in Westaim sold profitably a number of years ago (it was a 20% portfolio weighting), and more recently a +135% return achieved by investing in Sherritt debentures in the depths of the commodities bear market only to tender those same bonds to an offer made by the Company last January. Currently our only open Sherritt trade is this one in Sherritt International that we have been chasing now for some time trying to get on the right side of it – trying to get our average cost to the point where even with a more modest expectation for peak nickel prices this cycle, we would still have an acceptable return. The future looks bright for nickel with the steady never ending growth in demand, with not much in the way of new Class 1 nickel supply, with long lead times to bringing new supply to market, with declining Class I inventories, and with a new and potentially world-changing use – in batteries for electric vehicles of all sorts – the end of the carbon based fuel era and the beginning of a new sustainable future.

The current world nickel production remains inadequate given demand growth, nickel prices are much too low to incent the building of new production facilities, and this dilemma can only be resolved with higher nickel prices – unless of course we are prepared to live with less stainless steel and basically forget about electric cars.

Pending Battery Metal Shortage?

However uncomfortable, and I acknowledge that the volatility is uncomfortable, we currently believe Sherritt has the means to get through this period of tighter liquidity pending higher nickel and cobalt prices.

Scott

***Takota Asset Management owns shares and bonds of Sherritt International on behalf of its Managed Accounts and Premium Value Partnership. In the future Takota may buy more shares or bonds, or sell some or all of these for its Managed Accounts and/or Partnership without notice. Investors should seek the advice of their financial advisor before considering an investment in the securities of Sherritt, or do their own in depth due diligence on the Company, its prospects, and the very high risks inherent in investing in a Company whose cash flows are cyclical in nature. This is not a recommendation to buy or sell Sherritt or any other security, but simply a comment on recent developments in the pricing of these securities.


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