Global Overcapacity And Weak Demand Will Pressure Margins And Depress Long-Term Earnings

Catalysts

About Elkem

Elkem is a global producer of silicon-based advanced materials, supplying silicon products, silicones and carbon solutions to industries such as automotive, construction, aluminum and chemicals.

What are the underlying business or industry changes driving this perspective?

• Persistent global overcapacity in silicon metal and commodity silicones, particularly in China, risks structurally depressed pricing even if volume growth resumes. This may cap revenue growth and put continued pressure on EBITDA margins.
• Increasing trade barriers, safeguard measures and countervailing duties in key regions could force suboptimal asset utilization and complex product flows. This can raise logistics and compliance costs and weigh on net margins.
• Rising capital intensity to maintain low carbon, energy efficient production and comply with stricter environmental regulation may demand higher sustaining and upgrade investments. This can limit free cash flow and constrain future earnings growth.
• Any delay, repricing or adverse terms in the planned divestment of the Silicones division would prolong exposure to low margin commodity cycles and high leverage. This would reduce the scope for deleveraging and dampen earnings per share improvement.
• Weak and uneven demand recovery in downstream sectors such as European automotive, construction and steel, despite policy support and electrification trends, could keep capacity underutilized for longer. This may suppress revenue and prevent a return to targeted EBITDA margins.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on Elkem compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Elkem's revenue will grow by 3.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 2.0% today to 11.4% in 3 years time.
• The bearish analysts expect earnings to reach NOK 2.1 billion (and earnings per share of NOK 3.7) by about July 2029, up from NOK 331.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as NOK2.7 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 10.2x on those 2029 earnings, down from 33.5x today. This future PE is lower than the current PE for the NO Chemicals industry at 27.3x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.47%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Elkem's strong cost leadership, supported by long term renewable power contracts and positioning of key Norwegian plants at the low end of the global silicon cost curve, may allow it to gain share as higher cost competitors curtail capacity. This could support higher realized prices and lift EBITDA margins and earnings over time.
• Structural demand from the green transition, including growth in electric vehicles, aluminum, steel decarbonization and other applications using Microsilica and Carbon Solutions, could drive sustained volume growth in specialty products with historically high and stable margins. This could support revenue and net margins even if commodity prices stay volatile.
• Ongoing cost reduction programs, operational optimization and yield improvements across plants, together with expected lower CO2 quota costs following improved allocation, could structurally improve unit economics. This could help restore EBITDA margins closer to long term targets and strengthen earnings.
• The strategic sale of the Silicones division to a major industrial buyer, followed by management’s stated plan to deleverage, may significantly reduce net interest bearing debt and financial risk. This could improve equity value through lower leverage and higher net income.
• Potential EU safeguard measures and trade defense regimes designed to support regional production, combined with government actions in China to curb overcapacity and tighten energy standards, could rebalance supply and demand. This may support higher silicon and ferrosilicon prices and thereby improve revenue and EBITDA margins more than currently assumed.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Elkem is NOK26.0, which represents up to two standard deviations below the consensus price target of NOK35.0. This valuation is based on what can be assumed as the expectations of Elkem's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NOK40.0, and the most bearish reporting a price target of just NOK26.0.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be NOK18.1 billion, earnings will come to NOK2.1 billion, and it would be trading on a PE ratio of 10.2x, assuming you use a discount rate of 8.5%.
• Given the current share price of NOK30.58, the analyst price target of NOK26.0 is 17.6% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.