As marijuana investors, we have been taking body blows over the last few weeks. We all need a reprieve, but no one wants to sacrifice the massive gains we’re used to.
Enter stage left the Noranda Income Fund
A sleeper for the last two years, Noranda’s management has recently secured new contracts and issued cash flow guidance that sets this stock up for significant growth over the next 12 months. But before diving into that, we will provide some background.
Refining the Investment Opportunity
The Noranda Income Fund operates the second-largest zinc processing facility in North America, where they refine zinc concentrate into metal. Their operations are based in Salaberry-de-Valleyfield, Quebec on the St-Lawrence river. This gives them access to major transportation networks and connection to end markets in Canada and the United States.
While zinc isn’t as glamorous as gold, it’s still central to our everyday life. The metal’s primary use is to galvanize steel for construction and automotive industries. It’s also used in the manufacturing of batteries, tires, and pigments.
Noranda’s processing facility produces refined zinc metal and various by-products from zinc concentrate that they purchase from mining operations. This refined metal is then sold back into the market. The fund generates most of its revenue through treatment charges.
At the beginning of this year, spot treatment charges for zinc were above $200 per tonne, signalling a strong year for zinc refiners. A Bloomberg article echoed this sentiment, noting smelter disruptions in China were leading to a refinery shortage. While these charges will likely remain volatile over time, right now it’s trending in the right direction for zinc processors.
Noranda can also earn additional revenue from zinc metal gains, premiums, and by-product revenues.
For example, under their current contract, Noranda pays for 85% of the zinc contained in the concentrate. However, the value of any zinc metal recovered above 85% is captured by Noranda as zinc metal recovery gains. Over 2017 and 2018, Noranda’s recovery has averaged 96.5% and 97.5%, leaving room for significant additional revenue.
Multiple Forms of Stability from Glencore Canada
Noranda Income Fund has a market capitalization of $128 million and is currently trading around CAD$2.55 per share.
Balance sheets for income trusts can be difficult to decipher with cash on hand often at near-zero levels and inventory management playing a crucial role. However, when you consider the secured contracts with mining giant Glencore, Noranda’s upside is obvious.
It’s important to note Glencore Canada owns 25% of the fund, providing Noranda with serious backing. This creates advantages that include financial support, hedging arrangements, and of course those steady contracts.
In March of 2018, the Fund announced they secured a four-year agreement with Glencore Canada. The miner agreed to supply Noranda with 100% of its zinc concentrate requirements and to purchase 100% of the zinc metal produced.
This agreement doesn’t guarantee excellent economics for the zinc refining industry, but securing the supply of concentrate and sale of zinc metal is the first step to operating a profitable processing facility.
When we looked more closely at the recently announced treatment charge agreement, we became even more intrigued.
Noranda and Glencore Canada have agreed to terms on treatment charges for the next twelve months. While the specific terms have not been released, 50% of the treatment charge is based on a fixed fee, while the other 50% is a variable fee based on market movements.
This will provide Noranda with a relatively stable outlook and comes at an excellent time after having just expanded their operations. The fund increased its production capacity by 50% from 180,000 t to 270,000 t between 2017 and 2018.
With these contracts in hand, the second half of 2019 should yield significant distribution to shareholders – especially when you consider their guidance.
The Economics of the Income Fund – 3X Upside
After the announcement of this new contract, Noranda is guiding to $17-55 million in free cash flow over the next 12-months. All free cash flow will be distributed to shareholders according to the Fund’s policies.
Noranda noted that they don’t expect to realize the benefits of this contract until 2019 Q3, once their current supply of zinc concentrate has turned over.
This gives investors an excellent window to invest before the stock price adjusts to represent the underlying value of their 2019-2020 operations.
The graph below provides an overview of how we believe these cash flows will be distributed over the next 12 months. The three cases are based on the guided cash flows, with the Upside representing $55M, the conservative representing $17M, and the base case sitting between the two.
Projected Cash Distributions
The distributions alone will provide a significant return on investment, reaching 43% returns for the upside case over the 12-months. However, we expect the stock price to climb as the distributions are increased.
Specifically, we believe investors will drive up the stock price until the stocks’ yearly run-rate yield hovers around 12%.
Incorporating the increased stock price, the following graph shows the return on investment shareholders can expect if they bought in at current levels. For comparison, you can see the yield based on the previous quarter’s annualized dividend of $0.09.
Projected Return on Investment
Last but not least is a technical breakdown from our FinTwit friend Rhum01. As you can see, the chart is showing bullish signs as well.
Noranda will report 2019 Q2 earnings on July 22 after market close. If the results continue to be positive, we expect the stock price to respond quickly.
Investors will need to decide whether the story is strong enough to buy in before any more news is released. We think it is.
Employees of Capital 10x own shares in Noranda Income Fund.
The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Capital 10X hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.