UPM increased energy asset values by 217%

The Finnish company UPM is mainly known as forest industry player with pulp and paper factories. UPM actually comprises of three Business Groups: Energy and pulp, Paper, and Engineered materials. Past week UPM significantly increased its estimate of fair value of the energy business and lowered its estimate of the same for paper business.

“Energy has been the most profitable Business Area in UPM and is one of our growth businesses. I am pleased that we are now able to show the fair value of our Energy assets in our balance sheet,” says Tapio Korpeinen, CFO.

The reclassification increases Energy Business Area’s capital employed by approximately EUR 1,950 million to approximately EUR 2,850 million. That's whopping 217% increase. In comparison, after the charges, the total capital employed in the Paper business will be approximately EUR 3,400 million. Roughly speaking capital allocation of UPM is 1/3 for paper, 1/3 for energy and 1/3 for the rest.

The hydro and nuclear power assets of UPM were one of the primary reasons we initiated a position in it and continue to view UPM as an interesting play [see earlier blog post from 2011 here].

Disclosure: Long UPM at the time of writing.

Portfolio Performance 2009-2012

I track the performance of our portfolio against index investing. I have chosen MSCI All country world (ACWI) index as our benchmark index from which I calculate our "benchmark investment" record. The performance of our portfolio during 2009-2012 has been as follows in comparison to benchmark.

Our portfolio over the years has been more defensive (less risky, less volatile) than the ACWI index. Especially so in 2011 and 2012. Therefore, it has underperformed in bull market (2009, 2010, 2012) and overperformed in bear market (2011).

So far (starting from end of 2008) the benchmark investment has produced 6% higher returns compounded. This is mostly due to the big difference in returns in 2012. At end of 2011 we were at even with the benchmark.

The difference can be only partly explained by our defensive stance. Most of the difference comes from individual stocks that significantly underperformed the general market. This includes all mining companies and especially the exploration stage companies that got absolutely hammered. Luckily our allocation has been small to the sector overall and very small to exploration stage companies.

Most of my picks from IT sector did also loose to the index in 2012. Since our allocation to IT sector is about third of all assets, I think poor performance in those stocks explains most of the difference between our 2012 gains vs. index gains. Having such a big allocation to one sector is naturally risky and fairly big yearly fluctuations vs. index are to be expected. Our portfolio is slowly shifting to less defensive. Our latest pick (Metso corporation from Finland) can be considered cyclical as well as UPM from Finland, where we also increased our investment.

MSCI ACWI index 2009-2012 (Net; Euros)

I have not calculated our performance during 2007-2008 because we were off the market. During that time and also before that our benchmark index would have been different because the investment objective was different and risk level was much lower.

About the "benchmark investment"

I have chosen to construct my own imaginary benchmark index fund out of MSCI ACWI index instead of choosing one particular index fund that tracks the index. The main reason for this is that I would never invest all our money in any particular fund. I would rather choose several funds managed by several companies that as a whole would track the index close enough. My estimate for average cost level for the benchmark investment is 0.5% per transaction and 0.5% per year.

The index data itself is available via MSCI Barra web site as excel-file at least at the time of writing this post. I use a version of ACWI index which has large and mid cap companies in it. I use it with the following parameters:
- EUR (as in euros)
- Daily (as in daily quotations of the index)
- “Net” (as in “With Net Dividends” that takes into account taxes that you would have to pay before you can reinvest back into the fund. “Gross” option reinvests dividends wholly.)

The benchmark investment is always fully invested into the passive index. Starting balance was invested at end of 2008 to the index. By dividing the money with the value of the index, you get “shares in index”.

About calculating the yearly returns

The yearly return of the index and the "benchmark investment" will be different due to addition of money into the brokerage accounts during the year. The yearly returns are simply calculated as
[balance at end of year N] - [(balance at end of year N-1) + (additions to brokerage accounts during the year N)] / [(balance at end of year N-1) + (additions to brokerage accounts during the year N)]

Metso corporation

Added Metso Corporation to our portfolio.

"Metso is a global supplier of technology and services to customers in the process industries, including mining, construction, pulp and paper, power, and oil and gas."

During first three quarters of this year (2012) 44,8% of net sales came from mining and construction segment. Paper and pulp related segment also includes recycling and Valmet Automotive. 38,6% of net sales came from this segment. Automation segment was responsible of 11,6% of the top line.

Metso is a global market leader in e.g. grinding mills, mining crushers, pulp and paper control valves, and tissue machines. It has many more products in globally in top 3 positions. About 50% of their sales come from developing markets. Services account for 46% of sales. Their order book look solid with approximately 5 billion euros worth of orders at end of Q3 2012. Half of this is for mining and construction. Net sales of Metso corporation was 5,4 billion euros in the first three quarthers of 2012 and 6,5 billion euros in 2011.

Metso pays good dividend and is expected to pay 2,2 euros per share in 2012. That would be 7,6% yield based on closing price of 28,91 euros per share in Helsinki stock exchange (30.11.12). According to Nordnet bank the P/E of Metso is 12,0 while P/B is 2,1 based on the same closing price. 

Metso certainly is not a defensive pick, but it does have quite a bit of service revenue along with its fat order book to carry it forward even if times are turbulent. I decreased our gold position to get money for this purchase. Going forward I believe companies like Metso are a far better bet than gold which itself does not produce yield. However, our remaing gold positions along with our positions in gold mining companies continue still to be significant part of our overall portfolio.

Helsinki Top 10

I use a service provided by Valuatum.com via Pörssisäätiö to screen stocks listed in NASDAQ OMX Helsinki. Currently the results of my personalized screen look like this:

Rank Company (Score)
-----------------------------
#1 Technopolis (2,9)
#2 Citycon (2,8)
>>#3 Fortum (2,7)
>>#4 Orion (2,6)
#5 Sponda (2,6)
#6 Nokian Renkaat (2,5)
#7 Okmetic (2,4)
#8 PKC Group (2,4)
#9 Ponsse (2,3)
>>#10 TeliaSonera (2,3)

>>#23 UPM (2,0)
>>#79 Nokia (1,0)

Parameters used in screen (weight):
-------------------------------------------
P/B 2012 (15%)
P/E 2011, 2012 (5%,5%)
Dividend yield 2011, 2012 (5%,10%)
ROA 2011 (10%)
ROI 3 year average (5%)
ROE 3 year average (5%)
Turnover increase in past 3 years, 2012 (10%)
Gross Margin (10%)
Profit Margin (10%)
Net Profit increase in past 5 years, 2013 (10%)


Our positions are marked with prefix ">>".

Fortum and Orion are value plays with attractive dividend yield. Besides these two, all others in top 5 are property investment companies. So far I haven't initiated any positions in them. They all seem to have quite different focus within Finnish property market. I haven't yet made up my mind which would be the most interesting one for me to consider.

Our positions outside of Top 10 are UPM and Nokia. UPM is mostly value play with low P/B and attractive dividend yield. Their main business is suffering from declining fine paper usage, but they do have also substantial energy business and vast forest holdings.

Nokia, well, does not probably need any introduction. Like UPM their main business is suffering and the whole company can be considered part value play (due to businesses other than smartphones) and turnaround bet (smartphones).

Talvivaara is in trouble

In a country in which silence is preferable option to 'unnecessary' small talk, public demonstrations do not draw a whole lot of people unless something very upsetting has happened. The 3^rd gypsum waste pond leakage in Talvivaara mine was such event. It came on top of many other incidents in the same mine. No wonder the “Stop Talvivaara” movement has gathered a lot of sympathy lately from the general public. The movement has collected close to 20,000 names into petition to close Talvivaara mine.

The political risk is getting larger and larger. Ville Niinistö, minister of the environment, reportedly has said to protestors that unless he was the minister he would have been among them on that day. You better believe that because he is the chairman of The Greens of Finland. Finnish Police is also investigating Talvivaara on three separate counts of suspected environmental crime.

Ville Niinistö, minister of the environment, speaks to protesters on 14^th of November 2012. Picture by Hanna Nikkanen. Some rights reserved.


Talvivaara has approximately 52000 stockholders in Finland. Among them is husband of ex. minister of the environment Paula Lehtomäki of Centre Party of Finland with 51320 shares and their children with 3560 shares [Talouselämä 41/2012]. Talouselämä magazine also counted that so far they have lost  some 160,000 euros with those positions.

 

Among the biggest shareholders is Solidium, a wholly owned holding company of the State of Finland, with 8,89% of the shares. Pension insurance companies Varma and Ilmarinen own 8,71% and 6,15% of the shares respectively. The State of Finland pension fund owns 0,78% and The Local Government Pensions Instution 0,76%. All of these can be considered holdings for the benefit of general public in Finland.

Besides direct investments in Talvivaara, Finnish Government has high stakes in the mining sector overall. Finland has been consistently ranked as one of the best places in the world for mining investments. There is a mining boom going on in Finland. Finnish Government needs those investments because most mining prospects are in Northern and Eastern Finland where new jobs are badly needed.

Mining investments are made for tens of years and political stability and predictability are extremely important. Thus, it seems unlikely to me that extreme measures would be used such as closing the mine permanently. After all, The Greens of Finland is a rather small party with only 10 seats in the Parliament of Finland. This is not to say that there would not be MPs with sympathies towards “Stop Talvivaara” movement in other parties.

 

Production at the mine started in October 2008 and production ramp up is still ongoing. The current environmental permit is for 30,000 tonne annual capacity and does not cover uranium extraction. The company has been seeking both permit to increase annual capacity and permit for uranium extraction. Given the environmental problems, I doubt that they will get permission to increase volume. On the other hand with all of their production problems they won’t be near their full capacity any time soon.

 

The target for year 2011 was originally set to produce 30,000-35,000 tonnes of nickel. The company has lowered its guidance on Nickel production already twice this year (to 17,000 tonnes) It is unlikely that the company meets even that because their metals recovery plant has been suspended since November 4th 2012. The company told on 21st of November that it has been permitted to re-start the plant and it will ramp it up by 25th of November.

 

Even before the massive leakage from gypsum pond, the company had suspended ore production because unusually heavy rains forced the company to use the open pit mine to store some 1,7 million tons of excess water. This does not affect metal production potential short term because so much ore is stored in the heaps. However, it won’t certainly help them either.

 

The Talvivaara mining company will make this year net loss far bigger then the net loss of 10,5 million euros last year. Net loss for the first three quarters alone has been 44,5 million euros. At the end of Q3 (30th of September, 2012) the company had 87,3 million euros of cash and cash equivalents. Debt level stood at 601,9 million euros at the end of the quarter. Debt-to-equity ratio stood at 140,6%.

 

Analyst estimate according to Kauppalehti (kol 21.11.12) that the company might need up to 150 million of extra funding. Talvivaara’s management is admitting that their cash position is challenging on mid to long term. This means they will need more funding one way or another. This isn’t good news for the current shareholders.

 

I conclude my post with a quote from my previous analysis on Talvivaara:

"There is nothing Talvivaara can do about Nickel prices. There is, however, a lot it can do about environmental problems and bad press. If not handled properly these might become blocking points for uranium extraction and ramp up to full capacity (not to mention production expansion / mine area expansion)."

 

 

Full disclosure: The author does not have any positions in Talvivaara and there are no plans to initiate any in the immediate future.