Sherritt International Corpora S CN W
December 29, 2004 - 9:16am EST by
2004 2005
Price: 8.99 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,175 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Sherritt is a diversified resource company with coal, nickel, cobalt, oil and power operations in Canada, Cuba and internationally. The company’s has a strong management team—its chairman, Ian Delaney, took control of the company on the floor of a shareholder’s meeting in the early 90’s and, through improving the operations of the company and a series of asset sales, swaps and spin-offs and other value unlocking transactions, has taken a set of assets worth a few hundred million and created several billion dollars worth of assets in the aggregate. Additionally, the company’s balance sheet is rock solid with approximately $700 million in debt and over $500 million in cash (note: now $400 m as they just tendered for $100m of convert debentures) and a market cap of approximately $1.1 billion. Total EBITDA for 2004 will be somewhere north of $450 million and could approach $500 m in 2005 making this a very cheap stock (2.6x EBITDA).[note that all dollar references in this write-up are in Canadian Dollars]

The company is the largest producer of thermal coal in Canada, with production levels of 38m tons and capacity of approximately 45million tons. The company’s coal operations are held in the Luscar Energy Partnership, which is a 50/50 joint venture with the Ontario Teachers Pension Plan. The coal business has almost 30 years of proven and probably low sulphur thermal coal reserves and has substantial undeveloped low sulphur reserves. The mines are efficient surface mines for which the company employs 10 draglines and the bulk of its business is pursuant to long-term contracts with Canadian utilities. As the low-cost provider of coal to these utilities, this mine-to-mouth business is very predictable and stable. In addition, the Company has been expanding production to take advantage of the very strong export markets, which are expected to continue for the foreseeable future. One catalyst that may occur in 2005 is that the Company may turn its coal operations into an income trust. This would unlock substantial value for the company. Distributable cash flow in the coal business currently is around $110 -120 million, which would have a value of approximately 600-700 million for Sherritt, assuming a 9% yield.

Further, very few investors/analysts have taken into account the massive reserves (greater than 2 billion tons, possibly as high as 4 billion) the company possesses which are close to the Canadian oil sands. The oil sands producers will spend north of $25 billion over the next 5 years or so to increase their production capacity. Currently they utilize natural gas as their energy feedstock. However, natural gas is significantly more expensive than coal and it is likely that Sherritt will supply coal in large quantities to these producers as they finalize their CAPEX plans. This is a massive opportunity for the company.

The company’s nickel and cobalt operations are based upon laterite technology and produce approximately 35,000 tons of nickel and approximately 3,500 tons of cobalt (a by-product of nickel mining) which is sold in Europe and Asia. While the prices of nickel and cobalt are higher than they have been in recent years, there have been few expansion projects announced and the fundamentals of nickel look strong. Current nickel mining technologies require significant CAPEX and nickel is much less prevalent than many of the other commodity metals. The company is currently considering expanding its nickel production. This would reduced the company’s overall costs and increase its profitability from nickel production.

Sherritt is Cuba’s largest producer of oil (produces 69% of Cuba’s oil). It produces approximately 45,000 barrels per day and the company is reinvesting a portion of its cash flows into expanding its production. There are significant new prospects and the company has completed its seismic program on two million acres of deep water exploration blocks. Additionally, Sherritt is the largest independent power producer in Cuba through a joint venture with the government of Cuba and a natural gas producer. Currently there is 226 mw and the company will is increasing its capacity by 150 mw over the next 4 years, which will cost approx $150million. Phase I, which constitutes 80 mw, will be completed in 2005.

At current nickel and cobalt prices, I believe that Sherritt will generate approximately $470-$500 of EBITDA, approximately $250 - $300m of free cash flow and EPS of at least $1.40, making this a very cheap stock. Even if you were to assume that nickel goes to its longer term price of $4.00 per pound, the company would generate approximately $360 of EBITDA (3.6x EBITDA), free cash flows of $200-260 million and earnings per share of approximately $0.85. So even with a significant decline in the price of nickel, the company is still an incredible bargain. A sum-of-the parts valuation of the business/assets gives me a value of approximately $17 dollars a share. The following is a breakdown of what i believe is the true asset value of the Company:

Luscar (mine to mouth coal buz)EBITDA $164
Annual Capex 35
Distributable Cash Flow 129
Value of Coal trust (assume co forms trust)-9% yield $1,433

Value of add coal resources (oil sands and add'l export) 100
[note: I believe that these coal values are very conservative]
Value to Sherritt (50% owner) 717
Long term debt of Sherrit (105)
Dec '06 Conv Debentures ($8.775 Conversion Price) (200)
Dec '13 Conv Debentures ($7.00 conversion Price) (300)
Cash 400
Loans receivable from Power assets 97
Oil/power business (3.5x 04 cash flow) 600
Nicker company (6x 04 cash flow) 1,100

Value sum of the parts $17/sh

An approximate breakdown of EBITDA by business segment for 2004 is as follows:

Coal $82
Power 27
metals 230
oil 160
corp (33)
total 466

note: coal ebitda does not include additional 4 tons of coal to be provided to the export markets which will provide a significant boost to coal ebitda

total Enterprise value approx $1.375 b
EV/EBITDA 2004E 2.95x

One concern that investors may have is the cyclicality of the metals business. While, as i stated above, i feel pretty good about the prospects for their nickel/cobalt business for the next several years and the fundamentals of the nickel industry as a whole, even if you were to completely zero out the ebitda that the company derives from nickel, the company is still trading at less than 6x ebitda. It is not forseeable that the company would earn zero ebitda from nickel as the company can make money on their nickel business even if the price of nickel were to drop over 40%. This should provide even the most cautious investors with an adequate margin of safety. Accordingly, i see very little downside to this stock and meaningful upside over the next 12 months.

Additionally, the company recently tendered for $100 million of outstanding converts –I expect that they will buy back more of their converts over time.


1- continued buyback of converts
2- continued strength of operating performance
3- decision by the company in 2005 to trust its luscar coal business
4- enhanced operating performance from expansion of coal production for export markets which is not in analysts numbers.
5- further progress and announcements regarding the company's ability to provide a massive amount of coal to the oil sands producers.
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