CHINA-ECONOMY-GROWTH

Shares of specialty materials company Advance Metallurgical Group (AMS.Amsterdam) have taken a beating lately, but that’s exactly why you should consider buying them.

Put simply the negativity on the stock may be overdone.

Over the last year the share price has fallen a shocking 42%, versus a drop of less than 1% for the FTSE 100 index which tracks the UK’s largest stocks, according to Yahoo data. That slide has come on the back of changes in the specialty materials sector.

Vanadium Vicissitudes

One key part of the story revolves around ferro-vanadium (FV,) an alloying material which is used to reduce the brittleness of reinforcing bar (rebar). These alloyed steel rods, which are less brittle than is un-alloyed rebar, make buildings more resilient during earthquake tremors.

Unfortunately for AMG, which is a major player in FV, prices of the material have collapsed this year in part because of a delayed change to the Chinese building code which would have mandated the use of FV-rebar. That regulatory flip-flop crimped demand for the material and the prices slid – down 69% this year through September 25, according to AMG data. China is by far the largest steel producer in the world.

In response to the FV price collapse, AMG had to mark down the value of its FV inventory to current market prices.

The good news is that the problem of FV inventory markdowns won’t happen again, at least for the foreseeable future, due to a recently announced deal which means that mining giant Glencore (GLEN.London) will now buy all of AMGs FV that isn’t already pledged to other customers.

The deal looks tremendous for AMG as it reduces the price risks of holding inventory and apparently came as the result of some lengthy and serious negotiations by Heinz Schimmelbusch, AMG’s CEO and chairman the management board.

“With Glencore we avoid being caught out with an inventory exposure that is subject to price risk,” says Steve Hanke, chairman AMG’s supervisory board, and a professor of applied economics at Johns Hopkins University.

Or put another way, AMG won’t hold much if any FV inventory, as a result there won’t be any markdowns to mess up the financials.

That’s good because investors tend only to look forward when evaluating a stock’s potential.

The deal with Glencore also reduces the company’s working capital, so boosting cash flow, and it lowers the commercial risks involved in marketing a specialty product.

Shell Deal

Schimmelbusch has also been busy cutting other deals.

Tuesday AMG announced that it would partner with oil giant Royal Dutch Shell (RDS-A). This time the two companies are forming a joint venture to recycle/reclaim spent catalysts including those that contain FV.

“With the implementation of the IMO 2020 fuel sulfur regulation we expect significant spent-catalyst volume growth,” the AMG release states.

In other words, the deal means more business should find its way to AMG so helping boost profits.

Guaranteed Future Stock Buyers

There’s more good news for the stock due to the intense negativity of some investors.

AMG is “One of the most shorted stocks in Europe….” according to a recent report from Amsterdam-based bank Kempen. Short sellers sell borrowed stock in the hopes of buying back the shares for a profit at a lower price.

Kempen pegged the overall short position totaled at a staggering 30% of the outstanding shares, in the recent report which was August-dated. Others, such as the Shortics website, which tracks short selling, says the total reported short position is 21% of the outstanding share floatation, up from less than 1% at the beginning of 2018.

Either way, some investors are extremely bearish, but that is exactly why you should be bullish.

Short sellers can be defined as guaranteed future buyers. Sooner or later short sellers must return their stock to the brokerage from whom they borrowed it.

That 21% short position would take a staggering 30 days to unwind based on current trading patterns, according Shortics. Put in practical terms, that means that when a rally comes, it could be fast and fierce.

Catalysts?

What could prompt a short-covering rally?

Even a modest lift in FV prices could be a catalyst for an upswing in AMG earnings.

“Vanadium prices could be a tailwin, if they recover even modestly from current levels,” states a recent report from Citi Research.

Also AMG’s earnings trajectory looks set to turn positive soon. Citi Research sees earnings “recovery from 3Q onwards,” according to a recent report.

Citi says the stock is worth €31.50 ($35) up from a recent price of €21.36. Kempen says the stock is worth €38, while European broker Berenberg pegs the value at €30.

As with all commodities-related investments there are risks. The sector is volatile subject to large swings in prices.

www.forbes.com