Cobalt is an interesting metal. It has a deep-blue pigment. It is also often found in combination with sulfur and arsenic. Miners of old, noting these things and also seeing as how it had bad effects on nearby silver ores, dubbed the metal cobalt. The word comes from “kobold,” a German word that translates as “goblin.” As the Brewer’s Dictionary of Phrase and Fable puts it: “[Miners] named it after the malicious mine demon who they believed had put it there.”
We know a lot more about cobalt today, of course, and it has all kinds of uses. As with many of these quirky metals I’ve written about recently -- molybdenum, vanadium -- they’ve been through years and years of neglect. Now demand for them is high, and since you can’t just flick a switch and make more, prices skyrocket.
Booming Cobalt Markets Look Here to Stay
In 2007, cobalt had its big year. It’s not as sexy as uranium or gold, but in 2007, cobalt prices rose 60%, to reach heights never seen since trading began in 1978. But it’s the same old story. The price was low as the U.S. and the Soviet Union unloaded their stockpiles of the metal. (Cobalt has an important role to play in defense, as it is used in jet engines and as an important alloy for many metals).
Meanwhile, the Chinese economy woke up and started devouring the stuff.
And cobalt became a favorite material for rechargeable batteries. In fact, over the past four years, cobalt use in rechargeable batteries has increased over 300%. The fastest growing use for cobalt is in hybrid cars. In a typical hybrid car battery, there is anywhere from 5-18 pounds of cobalt. As one metals analyst put it: “Even at 10 pounds per car, if the market did triple to 1.5 million units, that would make 15 million new pounds of cobalt needed annually -- a substantial increase in a small, 120 million pound market.”
So that’s a big potential market… but there is another market that eats up a lot of cobalt: aerospace.
Aluminum is the metal most widely used in aircraft. But cobalt is also as important, if less well-known, metal. Cobalt trades for about 30 times the price of aluminum. This from the Financial Times :
“In 2007, almost a quarter of the world's cobalt was used in materials known as 'superalloys' that are capable of withstanding temperatures of up to 1,100 degrees Celsius. Some 75% of these went into aircraft, according to figures from industry group the Cobalt Development Institute.
“Sustaining cobalt prices is the fear that as demand accelerates, supply may not be able to grow quickly enough to meet the world's needs. Though there are new mines scheduled to come onstream around the end of the decade, many in the market are uncertain they will reach production as quickly as their owners plan.”
Most of the cobalt on world markets comes from the Democratic Republic of the Congo, Australia and Canada. But power issues in the Congo hurt development. And in a story told a thousand times across the metals spectrum, the costs to bring new mines on is high. According to J. Scott Bending, president of Canadian metals explorer and refiner Formation Capital: "Very few entrants into the high-purity cobalt market within the next decade are anticipated."
The cobalt price took a dip recently because of growing stockpiles in China. But keep in mind the market for cobalt is still very tight. And the backdrop for demand looks quite good -- hybrid cars and fuel-efficient jets! Come on, it’s nearly a cinch that demand for those things will rise. And this brief decline in price may actually help, because if the price gets too high, users will start to push for substitutes. Even at 2007 levels, OM Group will make plenty of money.
I think investors also look at OM Group as a sort of flash in the pan, a company that was put together during two great years, but otherwise is mediocre.
OM Group has made big money really only in 2007 and 2008. It earned over $5 per share in 2007. It should earn around $7 per share this year. Before that, it had a couple of years in the wilderness when it didn’t earn much money at all.
But past comparisons are no good here. OM Group is a vastly different business than what it was even two years ago. The company sold its nickel business, instantly improving its financial condition. It also made two acquisitions, bolstering its portfolio of value-added chemicals.
The bottom line is that this is a very different business than what it was two years ago. OM Group today has a great balance sheet with no net debt. And it generates tremendous cash flow.
Another point in OM’s favor, given the fragile state of the U.S. economy, is that most of its sales come from overseas. About 43% of its sales come from booming Asia.
I think we have to take a shot at a company like this. The fundamentals seem firmly in place. The stock sell-off has been way overdone -- from $66 to under $30. The stock right now trades for only about five times this year’s earning guess. You have a lot of room for error when you buy stocks at those kinds of prices. It also trades for 90% of stated book value, which is $36 per share. Seems to me it ought to be worth at least book. Looks like a steal.
Recommendation: Buy OM Group (OMG:nyse) up to $36 per share.