Kempen (Lux) Global Small-cap Fund Investment case: Circular Zinc

02 June 2020


Steel is one of the most commonly used materials in the world, found in various end uses such as construction, infrastructure, automotive and industrial applications. There are two ways to produce steel. One way is by mining iron ore, which continuously depletes the earth by taking scarce resources. A second, more sustainable, way to produce steel is by using recycled scrap, i.e. turning old cars and washing machines into new steel. In Europe, approximately 40 percent of all steel produced is from recycled scrap, in the US this percentage is even 60 percent.

Sustainable steel dust
When using scrap to produce steel, steelmakers run into operational issues. Today’s cars for instance are galvanized using zinc in order to prevent corrosion. By using old cars in a recycled steelmaking process, these impurities result in a by-product being generated: steel dust. This is a hazardous material that needs to be handled carefully and landfilling is restricted by law in many countries. Fortunately, steel dust contains zinc concentrates, which can be extracted from the steel dust and re-used again.

Befesa is European market leader in collecting steel dust at steelmakers and recycling the zinc content for re-sale. Therefore, sustainability is at the heart of Befesa’s business model. It plays a critical role in the recycled steel value chain, which is more sustainable than steelmaking from iron ore. Befesa handles the hazardous steel dust and prevents it from being landfilled; instead it is recycling and selling the zinc content again. This in turn reduces the need to mine natural zinc resources. Befesa shows that it operates right in the center of the circular economy and contributes to the re-use of steel and zinc.

Opportunity in China: Befesa being the first mover
Today, Befesa’s geographical presence is limited to Europe and South Korea. China, however, is the world’s largest steelmaking country, representing nearly half of the global steel output. Today almost all steel volumes from China are produced from mined iron ore (and not from recycled scrap). With the Chinese government becoming increasingly concerned about the environmental impact of its  production footprint, the government is driving a shift in steelmaking towards using recycled scrap. This potentially leaves China with a significant amount of steel dust that can – or actually needs to – be recycled.

A decade ago Befesa started preparing an entry into the Chinese market. Now the time seems right. As the first mover, Befesa started building the first two zinc recycling plants in China. The first plan is expected to come on stream at the beginning of 2021, with the second one mid-2021.

Befesa’s management team conservatively assumes that it can eventually expand its footprint in China to up to six recycling plants. By building these six plants, Befesa would nearly double its total steel dust recycling capacity. We believe the potential could be significantly larger, but understand the management’s cautious approach given the early stages of the market development and its entrance. To put the potential into perspective: if the proportion of recycled scrap and Befesa’s market share in China
would be similar to Europe, Befesa’s capacity in China would be equal to four times the current size of its business.

Active ownershiP
We started investing in Befesa mid-2019, so we are just in the early stages of our investment. Our investment horizon typically extends beyond five years. 

Our fund’s investment philosophy is based on acting as longterm engaged shareholder. This means we often talk to the companies that we invest in. These discussions tend to centre around strategic directions of the firm, mid-term financial targets and underlying initiatives to get there, as well as ESG topics. At the end of the day, we believe a more sustainable company means a better company that deserves to trade at a higher valuation. This benefits all stakeholders. 

Over the last few months we spoke to Befesa several times, visited their offices in Germany and also spoke to a competitor and joint venture partner. These encounters left us with a positive impression of the quality of Befesa’s management team. 

When reviewing Befesa’s sustainability reports, but also based on external ESG research by Sustainalytics and MSCI ESG, we identified further room for improvement on ESG at Befesa. We shared a list with proposed improvements both with Befesa and Sustainalytics. The first actions have been implemented, resulting in a higher ESG rating at Sustainalytics. We seek for further improvements on topics such as (reporting on) carbon emissions and waste control, corporate governance/remuneration and capital allocation.

All in all, we are excited about the future prospects of Befesa. We like the company’s business model, its sustainability profile, the high quality management team, further room for improvement on ESG, and the growth prospects in China. 

Disclaimer  - this article was written in April 2020 and published in Kempen Insight- May 2020  

This document is compiled by the fund managers of Kempen (Lux) Global Small-cap Fund (‘the Fund’), managed by Kempen Capital Management N.V. (‘Kempen‘). The Fund currently holds shares in Befesa. As asset manager Kempen may have investments, generally for the benefit of third parties, in financial instruments mentioned in this document and it may at any time decide to execute buy or sell  ransactions in these financial instruments. The information in this document is solely for your  information. This document is for information purposes only and provides insufficient information for an investment decision. This document does not contain investment advice, no investment recommendation, no research, or an invitation to buy or sell any financial instruments, and should not be interpreted as such. The views expressed in this document may be subject to change at any given time, without prior notice. Kempen has no obligation to update the contents of this document. This document is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The views expressed herein are our current views as of the date appearing on this document. This document has been produced independently of the company and the views contained herein are entirely those of Kempen. 

The author

Chris Kaashoek

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