The outlook for base metals is bullish because of the global economic upswing gaining further momentum, as the U.S. economy gains steam, and key emerging markets, India and China, continue to grow at a rapid clip. This is particularly positive for base metals and beaten-down nickel producer Sherritt International Corp. (TSX:S), which has seen its market value plummet by 35% for the year to date.
Analysts expect nickel prices to move higher, as demand starts to outstrip supply. Much of that initial spike in demand is forecast to be triggered by growing consumption of stainless steel, in which nickel is a key ingredient.
You see, while nickel is an important element used in the fabrication of batteries for electric vehicles, which are growing in popularity, it is stainless steel which amounts to 69% of nickel consumption compared to 3% for batteries. Nickel has firmed markedly in recent months to be trading at its highest price since early 2015. That trend should continue over the remainder of 2018 and into 2019 because of growing stainless steel consumption. It is projected that consumption will outpace global nickel production, creating a supply deficit which will further support higher prices.
The trend to higher nickel prices can be seen in Sherritt’s first-quarter 2018 results, where the average realized price for nickel during the quarter was 26% higher year over year. The average cobalt price received by Sherritt also rose significantly for the quarter, being nearly double what it had been a year earlier.
Higher nickel and cobalt prices were beneficial for Sherritt, because nickel is responsible for 52% of its revenue while 36% comes from cobalt, with the remainder being earned from fertilizer, oil, and electricity production. That saw cash flow from operations rise by an impressive 22%, while free cash flow for the quarter shot up by 8%.
Nonetheless, Sherritt’s bottom line didn’t benefit from improved metals prices, because production outages at its Cuban Moa joint venture, caused by heavy rains, saw production volumes decline by 26% year over year. That resulted in Sherritt recording a net loss of $600,000, although this was a vast improvement over the net loss of almost $73 million reported for the first quarter 2017.
However, Sherritt’s 2018 guidance remains unchanged, and it is predicting that nickel as well as cobalt production will rise compared to a year earlier. This coupled with firmer prices will give earnings a healthy lift.
The only disappointing aspect of the miner’s operations for 2018 is that oil output has declined significantly. First-quarter oil output dropped by a massive 56% year over year to 3,916 barrels daily because of the expiration of the Varadero West Production Sharing Contract, natural reservoir declines, and a lack of new development drilling. That means it is incapable of truly benefiting from the recent oil rally, which sees the North American benchmark West Texas Intermediate trading at over the psychologically important US$70 a barrel mark.
The short-term outlook for nickel as well as cobalt is favourable, and this will give Sherritt’s earnings a solid boost, which should translate into a firmer share price. The increasing demand for both metals, because of the growing popularity of electric vehicles and secular trend to cleaner renewable sources of energy, will be a powerful tailwind for Sherritt. When these factors are considered in conjunction with the work that has gone into strengthening Sherritt’s balance sheet, it becomes a more appealing investment.