Recession risks are rising, attributed to elevated inflation and less accommodative monetary policy.
Amid this backdrop, it’s no surprise that “Dr. Copper” has caught a whiff of the recessionary stench, promptly dethroning the base metal from its previous position as one of the top performers among asset classes in 2022.
In fact, copper was one of the top performers in March with a 10% gain and is now staring down a 20% year-to-date decline.
For companies that produce the commodity, the technical damage has been much more violent, with the Copper Miners Index (COPX) sliding over 40% from its highs.
This spells opportunity for investors, with copper miners trading at their most attractive valuations since Q1 2020, against a backdrop that could be different this time, acknowledging that those are the four most dangerous words in investing.
A Growth Story on Sale
Hudbay Minerals (HBM) is a $1.0BB copper producer with operations in Peru (the massive Constancia Mine), Canada (Snow Lake Operations), and several development projects in the United States.
While it may not be the largest producer (99,000 tonnes produced in 2021), it is a clear leader from a cost standpoint, producing at cash costs below $1.00/lb and sustaining costs below $2.40/lb.
The company reported Q1 earnings of $0.02 per share in May of this year and saw a 21% increase in revenue, with revenue improving to $378.6MM.
However, with copper prices under pressure, the outlook is less robust for Q2 and the remainder of the year, given that the commodity it sells is down over 20% sequentially.
Hudbay expects to grow copper production by 16% this year and gold production by 28%, meaning it’s one of the few producers whose sales volume increases will offset any metals prices decline (copper/gold).
This is a key differentiator for the company relative to its peers. Based on 2023 estimates, Hudbay’s copper production is forecasted to increase another 15%, while gold production will increase another 17%.
In total, the planned growth translates to a more than 30% increase in metals production between 2021 and 2023, meaning that Hudbay will grow annual earnings per share and revenue plus maintain a strong free cash flow profile even if copper prices remain weak (below $3.50/lb).
Perhaps the biggest reason to own Hudbay is that while copper prices are down, they’re unlikely to stay down, with a major shift in the market.
This is related to the demand for electric vehicles [EVs] and negative policy changes in some South American countries, which will lead to a significant supply crunch for copper.
So, while copper prices are under pressure, and in past cycles, it might be better to stay away from the producers due to margin pressure, I would argue that this cycle is different due to the rapidly increasing demand and inability to bring supply online in time.
Lastly, Hudbay released a study on its Copper World Project in Arizona, with the potential for this asset to produce 86,000 tonnes per year at sub $1.20/lb costs for 44 years, translating to an After-Tax NPV (10%) of $1.3BB.
This means that the project would increase Hudbay’s production by 60% from FY2023 levels, and this project alone is worth more than HBM’s market cap.
Unfortunately for investors, this phenomenal news was lost in the noise of a declining copper price, and HBM didn’t benefit at all. So, investors on the sidelines are getting this news and the huge upgrade to the investment thesis for free.
The Fundamental Case
Hudbay trades at a discount to its peer group of just ~9.5x FY2022 earnings estimates ($0.78), being a smaller producer with a higher debt load.
From 2021 to 2025, the company expects to grow its annual EPS from $0.23 to $1.01, leaving it with an industry-leading growth rate of 340% (44.7% CAGR). This translates to a PEG ratio of 0.22, making HBM significantly undervalued even for a cyclical stock.
The Technical Setup
For investors looking to buy momentum and most interested in trend-following, HBM’s chart leaves a lot to be desired. This is because it’s trading below its 50-day and 200-day moving averages, and up until last week, it was making lower lows and lower highs.
See the Full Technical Analysis Report for HBM
However, with the stock more than 45% below its 200-day moving average, it is stretched like an elastic band, at its most oversold levels since March 2020.
This decline preceded a 500% rally in the stock over the next 12 months, and in a similarly oversold instance in October 2018, the stock rallied 120% in less than six months.
Obviously, stepping in front of a falling knife is not an ideal trading strategy, but there are signs of life here.
HBM printed a weekly Doji candlestick in the second week of July and saw follow-through to the upside, suggesting a potential change in trend.
This suggests the stock’s decline is nearing its end. So, any positive change in sentiment could spark a sharp rally.
The Bottom Line
Based on an estimated net asset value of $2.08BB and a conservative P/NAV multiple of 0.90, Hudbay Minerals’ fair value comes in at $1.87BB. Notably, this uses $3.25/lb copper price assumptions.
After dividing this figure by 261MM shares, HBM’s fair value comes in at $7.16 – a gain of 99% from current levels to fair value.
Using a price-to-earnings method that doesn’t ascribe value to development projects and a multiple of 8 (FY2023 estimates: $0.78), HBM’s fair value comes in at $6.24.
So, no matter how we slice it, HBM is dirt-cheap at current levels.
Some investors might prefer to shy away from small-cap cyclical names, which is perfectly understandable due to their volatility.
However, with HBM sporting a 25% free cash flow yield (FY2023), trading at a massive discount to fair value, and being out of favor after its 60% decline, I see this as an attractive setup to go long the stock for a trade back above $5.00 in the next 12 months with limited downside risk.
Disclosure: I am long HBM
The above analysis of Hudbay Minerals (HBM) was provided by financial writer Taylor Dart. Taylor Dart is not a Registered Investment Advisor or Financial Planner. This writing is for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Taylor Dart expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
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