Kielbasa and Copper Mines: KGHM Polska Miedz $KGH.WA, $KGHPF

For the last article, I owe you 7 pushups and 31 sit ups. As a quick reminder, for the month of January, I will do 1 pushup for every restack and 1 sit up for every like that each writeup receives. If the combined number of likes and restacks reaches certain milestones, it will create a narrowing window of intermittent fasting.

It has been quite a roller coaster these last six weeks since the great value drawdown of December last year. The path has been much more gentle in the S&P 500 than in the value factor itself. Take a look at the S&P 500 Value ETF (IVE), where we seem to have bounced off of the 200 day moving average, even before this soft inflation number today sent all the indices much higher. After six weeks of demoralization, the 10% correction in the value factor has good odds of being over.

In December, it seemed that the consensus trade was to buy the election and to sell the inauguration. It still amazes me how the stronger the consensus, the more likely it is to be wrong. After this drawdown, I think odds are good now that the market will rally into the inauguration.

Maybe it’s my American love for the underdog, or maybe it’s my value inclination, but I like to keep an eye on the laggards. What isn’t moving when everything else is? What has caught my eye recently has been copper. Do you remember last summer when copper briefly ran up to $5 a pound, Jeff Curry was on CNBC saying that it is the best setup of his entire career, and all the copper mining stocks rallied? Well, now the sector has had some time to cool off, but nothing fundamental has changed, we still need copper for the electrification of everything, we don’t have enough mines, and building a new mine in less than seven years would be a heroic endeavor.

A friend was trying to convince me to take a closer look at Vale (VALE), the national iron mining company of Brazil. I took a look, mostly because along with iron, Vale mines about 300,000 tons of copper a year. But when I did a value comparison against peers, I was shocked to find that they aren’t really as cheap as they could be, trading at 0.90x price to sales. Instead, I found one of their peers trading at 0.77x price to sales, and instead of mining iron and copper, they mine copper and silver.

The world’s 8th largest copper producer at 540,000 tons annually and 2nd largest silver producer at 46,000,000 ounces annually is KGHM Polska Miedz (KGH.WA, KGHPF), and they are dirt cheap for a few reasons, most of which are resolving themselves on their own. Poland has been cheap generally since the start of the Ukraine war, I have to suspect this is due to some modern domino theory that Putin, when he is finished with Ukraine, will conduct a land invasion of a NATO member state. I find that theory laughable, and the more likely outcome is that Trump will negotiate some sort of a peace deal, the uncertainty over Poland will dissipate, and the reconstruction of Ukraine will need an awful lot of copper wire.

KGHM is also cheap because within the trailing twelve months, they did a non cash impairment of asset values. For GAAP accounting rules this shows up as an income loss, but it is just a book value writedown, no cash changed hands. Why did they write down book value? They have an accounting standard that triggers an asset review if the market capitalization is below book value. In other words, they had to do a writedown because their stock price was too cheap, and the writedown spooked the market and made the stock price even cheaper. The book value was recalculated at $4.12 per pound copper, $1,600 per ounce gold, and $22 per ounce silver, and at a time when the US dollar was weak and the Polish Zloty was strong. The current market prices are $4.30, $2,700, and $30 respectively, and the US dollar is strong and the Polish Zloty is weak. This impairment charge will roll off the trailing twelve month net income results next quarter, and commodity prices will continue to do whatever commodity prices are inclined to do.

In the long term, everyone expects copper to do well, there just aren’t any substitutes and the demand is projected to rapidly grow. But in the short term, there are a few potential catalysts that will move KGHM’s stock price, and it appears that it isn’t priced in yet. The first catalyst would be if Trump negotiates an end to the Ukraine war and removes the uncertainty over the Polish stock market. It’s safe to say the market is not anticipating this because KGHM’s stock price has only fallen since November 5th, unlike the Central and Eastern European Fund (CEE) which had a noticeable 20% jump on the election outcome. The second catalyst will be that trailing twelve month net income will flip to positive when Q4 2023 rolls off. And the third potential catalyst would be any increase in the underlying commodity price, or any operational improvements from KGHM’s management.

In the medium term, KGHM is directing most of their cashflow to growth capex, and unfortunately, renewable energy. There is a dividend policy of 1/3rd of net income, but since net income is calculated after capex, that number can be quite small. Their strategic pillars are to reach 560,000 tons of copper production in Poland, 150,000 tons in their American assets, 1,320 tons of silver, and somewhere around 200,000 ounces of gold, platinum, and palladium byproduct. KGHM also has a copper recycling business, as well as vertical integration to smelt copper cathode and wire rod. Trailing twelve month revenue was over $8 billion while market capitalization is around $6.3 billion and the company has very little long term debt. A $0.50 move in the copper price would translate to an additional $600 million of net income. A $5 move in the silver price would translate to an additional $200 million of net income.

Putting a conservative price target on KGHM for the extremely short term, before the impairment spooked the market, KGHM was trading at 1.0x price to sales. Other similar copper miners are trading at 1.5x price to sales, which I believe is obtainable after the resolution to the Ukraine War. That would make KGHM somewhere in the neighborhood of a two year double, without any changes in the copper prices. At $6 copper, the market capitalization would be about $3 billion higher.

Do I like KGHM enough to part with some of my Hudbay Minerals (HBM)? Yes, that’s a fair trade for the short term bounce. HBM doesn’t have any near term growth projects, there is no insider buying, and the CEO is in his late 60’s. I am still on the hunt for a copper miner to have and to hold for many years to come, and I don’t think that is KGHM.

KGHM Polska Miedz (KGHPF) $31.60: $60 by end of year 2026 at $4.30 copper

KGHM Polska Miedz (KGHPF) $31.60: $82.50 by end of year 2026 at $6.00 copper