Description

All figures in CAD, unless specified.

Overview

Sherritt is a levered play on strong nickel/cobalt and fertilizer prices. In 2021, Sherritt derived roughly 66% of its revenues from Nickel, 18% from Cobalt, 13% from Fertilizer and 3% from power generation. At current nickel spot prices of ~US$15/lb, Sherritt would generate $320 mln of EBITDA (~1.5x EV/EBITDA) and be net-debt free by mid-2023. At US$10/lb nickel price, Sherritt would generate $160 mln of EBITDA (~3x EV/EBITDA). Every 10% change in nickel price impacts Sherritt’s NAV by ~60% and 2022E CFPS by 35%. Sherritt has nickel puts in place for 25% of Q1/22 nickel production but no puts, forward contracts and/or calls to limit upside through the rest of 2022.

Sherritt shares many similarities with some of my biggest winners in the commodity space last couple of years:

-          - High leverage causing fears of insolvency but a long debt maturity runway to solve the issue

-          - Multi-year bullish thesis for core commodity facing a skeptical investor base

-          - History of management missteps, but old management replaced by a new competent management team

-          - High probability of earning its market cap in one year, taking leverage risk off the table and driving rerating

-          - Investor base limited due to jurisdiction, liquidity, small market cap concerns that ameliorate as the Company rerates

-          - Multiple free options that provide valuation upside

Company overview

Sherritt mines nickel and cobalt in Cuba and refines them in Canada. The Company also has a power business and oil and gas concessions in Cuba as well as a technology business aimed at extracting commodities in a cheaper and more environmentally friendly fashion, but these operations are not material to the investment thesis currently.

Moa JV - Sherritt has a 50/50 partnership with General Nickel Company of Cuba (the Moa Joint Venture) and a wholly-owned fertilizer business and sulphuric acid, utilities and fertilizer storage facilities in Fort Saskatchewan, Alberta, Canada. The Moa Joint Venture mines, processes and refines nickel and cobalt for sale worldwide (except in the United States). It is a vertically-integrated operation that mines lateritic ore by open pit methods and processes them at its facilities at Moa, Cuba into mixed sulphides containing nickel and cobalt. The mixed sulphides are transported to the refining facilities in Fort Saskatchewan, Alberta. The resulting nickel and cobalt products are sold to various markets, primarily in Europe, Japan and China. At current depletion rates, the concessions of the Moa Joint Venture are planned to be mined until at least 2034. Sherritt has embarked on a multi-pronged growth strategy focused on expanding nickel and cobalt production by up to 20% from the 34,710 tonnes produced in 2021 and extending the life of mine at Moa beyond 2040. The metals refinery facilities in Fort Saskatchewan currently has an annual production capacity of approximately 35,000 tonnes of nickel and approximately 3,800 (100% basis) tonnes of cobalt. On a “Combined” basis, the Company has guided to 32,000 to 34,000 tons of nickel and 3,400 to 3,700 tons of Cobalt at a net direct cash cost of US$4.0 -US$4.5 per lb for 2022. The Company’s share of this production is 50%. The fully owned Fort Saskatchewan facilities provides inputs (ammonia, sulphuric acid and utilities) for the Moa Joint Venture metals refinery, produces agriculture fertilizer for sale in Western Canada and provides additional fertilizer storage and administrative facilities. The Company produced 168K tons of fertilizer in 2021.

Power Group- The Company is the largest independent energy producer in Cuba. These assets are held through its one-third interest in Energas, which is a Cuban joint arrangement established to process raw natural gas and generate electricity for sale to the Cuban national electrical grid. Cuban government agencies hold the remaining two-thirds interest in Energas. Energas’ electrical generating capacity is 506 MW. The Company continues to be in discussion with its Cuban partners to extend its power generation agreement with Energas, which expires in March 2023. A feasibility study on the extension was approved by the Energas JV Board and a formal application for the extension has been submitted to the Cuban government. Approval is expected before year end.

Technologies Group - This business provides technical support, process optimization and technology development services to improve operations and support growth initiatives at the Moa Joint Venture and Fort Site operations. Technologies also develops proprietary solutions for commercialization within the natural resource-based industries

Oil and Gas Division - Sherritt’s shuttered it oil and gas operations due to low commodity prices and capital constraints in mid-2021. Its commercial production sharing contracts (PSCs) expired during 2021 and it currently has an interest in three PSCs that are in the exploration phase.

Industry Dynamics

I believe that the bull case for nickel, cobalt and fertilizers is well understood. If there are specific questions, I can address them in the comments section.

Cuba Risk

Cash and Overdue Receivables – The Company has US$156MM of overdue receivables from Cuba and $80.6MM cash in Cuba. Collections on overdue amounts from Sherritt’s Cuban partners continue to be adversely impacted by Cuba’s access to foreign currency as a result of ongoing U.S. sanctions and the global pandemic. These receivables relate to a conditional sales agreement between the Company and Energas to finance construction activity on the power generating assets in Cuba. Sherritt retains title to the constructed assets until the loan is fully repaid. The facility bears interest at 8.0%. Income generated by the constructed assets is to be used to repay the facilities. Sherritt continues to anticipate full payment and has not reserved any amounts against these receivables and has indicated its relationship with the Cuban government is very strong. The cash in Cuba is held at Energas and is expected to be remitted to the Company upon foreign exchange approval. I have not haircut these assets in my valuation analysis below. To be in this investment, one must believe that the Cuban government would remit these amounts as soon as practicable, otherwise it’ll be confiscation and the whole thesis falls apart. I’m of the view that Cuba will not do anything to jeopardize its relationship with Canada and Sherritt has some leverage as the Moa production is processed in Canada. In the past, Cuban government has used its Moa earnings to finance expenditures at the power plants. If we get sustained high prices for nickel/cobalt this year, I believe a significant portion of the liabilities could be paid. The Company is focusing on opportunities to utilize the Moa Joint Venture to settle the outstanding receivables

US sanctions – Cuba is under sanctions by the US and the Trump administration had announced that it would no longer suspend the right of claimants to bring lawsuits under Title III of the Helms-Burton Act, effective May 2, 2019. Sherritt has received letters in the past from U.S. nationals claiming ownership of certain Cuban properties or rights in which the Corporation has an indirect interest, however, no lawsuits against Sherritt have been initiated or threatened. In the event that any such lawsuits were to be filed, Sherritt does not believe that its operations would be materially affected because Sherritt’s minimal contacts with the United States would likely deprive any U.S. court of personal jurisdiction over Sherritt. Even if personal jurisdiction were exercised, any successful U.S. claimant would have to seek enforcement of the U.S. court judgment outside the U.S. in order to reach material Sherritt assets. The Corporation believes it unlikely that a court in any country in which Sherritt has material assets would enforce a Helms-Burton Act judgment against it.

Valuation

The Company’s cap structure and TEV calculation are as follows:

At US$10/lb nickel price, Sherritt would generate $160 mln of EBITDA (~3x EV/EBITDA). Every 10% change in nickel price impacts Sherritt’s NAV by ~60% and 2022E CFPS by 35%. At current nickel spot prices of ~US$15/lb, Sherritt would generate $320 mln of EBITDA (~1.5x EV/EBITDA) and be net-debt free by mid-2023. If one is constructive on the Company’s core commodities, the upside is many multiples of current price.

Upsides

The following possibilities provide options for further valuation upside:

Production Increase - The Company is pursuing a 15%-20% expansion at Moa and Fort Saskatchewan which will likely require ~US$130-$150 mln (100% basis) by mid-2024. US$27 mln of funding has been approved to date with the rest of expansion capital to be finalized and approved by mid-2022 with development expected to be complete by mid-2024. Cuban partners are well aligned and in early stages in planning incremental expansions beyond the initial 15%-20%. The capital to complete expansion would largely be funded through operating cash flow at the JV level, requiring no further commitments from Sherritt. A 15% to 20% increase in production would generate an incremental $60 -$80MM in EBITDA at US$15.00/lb Nickel price.

Removal of Cuba sanctions – Biden administration is using war powers to spur production of metals like nickel/cobalt needed for the low carbon transition. Cuba has the world’s fifth and third largest reserves of nickel and cobalt, respectively. Not only are these reserves in our backyard but there is a strong motivation to prevent China from claiming these assets. A lifting of sanctions, even just targeted just to these types of commodities, would open up tremendous new opportunities for Sherrit for further development, as they have the strongest experience and relationships in Cuba. In that scenario, Sherritt becomes a very attractive acquisition target as well.

Offshore Oil and Gas Development - The increase in oil and gas prices has prompted Sherritt to pursue additional funding partners/sale of operations/exploration concessions in Cuba.

Technologies Monetization - Sherritt has developed three primary technologies related to bitumen refining, lateritic ore processes and treatment of high-arsenic copper concentrates for which it is seeking partnership agreements and/or monetization in 2022 and has hired a senior executive to pursue those options. This operation currently is burning $13MM annually but the Company expects it to provide “transformational growth opportunities”.

NOLs - The Company has non-capital losses of $948.2 million and capital losses of $1,128.8 million which can be used to shield from taxes.

Catalyst

- Continued strong commodity prices

- Detail on MOA expansion

- Collection of Receivables

- Progress on Technologies unit monetization