Befesa, the European market leader in the recycling of hazardous waste, was a solid contributor to SKAGEN Focus during 2020 and a unique value creator for all its stakeholders. Our former investment in Befesa* serves as a good example of how value opportunities can arise even among ESG pearls like Befesa, as temporary market dislocations continuously create opportunities for contrarian investors.
Role in the circular economy
Befesa plays a vital role in the circular economy as a provider of hazardous waste recycling services to steel and aluminium recycling companies. Befesa recycles around 1.5m tonnes of hazardous residues annually, avoiding landfill and recovering and reintroducing around 1.2m tonnes valuable new materials. As such, Befesa holds a key position in the value chain of the steel and aluminium circular economy and the company’s core business is focused on sustainability.
The company operates in a niche market and has an "implicit" monopoly with solid underlying trends while it provides a critical service with high barriers to entry. Steel dust and aluminium salt slag recycling is a highly regulated and necessary service. Befesa is therefore uniquely positioned to benefit from the long-term secular trends in the demand for EAF steel and aluminium production, driven by a stable commercial construction outlook and the ongoing lite-weighting of vehicles in both Europe and Asia.
A full-service approach
Befesa’s business model is based on a full-service approach offering waste management solutions to its customers in the steel and aluminium industries. The services cover timely and efficient collection and treatment of hazardous waste – mainly steel dust and salt slags – from customers’ facilities. This enables Befesa's customers to meet their environmental and regulatory obligations, namely, to recycle the hazardous waste generated in their operations. The company has several sources of revenue as it charges service fees for the treatment and collection of residues as well as a fee for returning the metals/selling them on the market, which exposes them partly to the cyclicality of raw material prices.
We have followed Befesa since their IPO in 2017 but first established a position in mid-2019 at a significant discount, when overcapacity within the European steel sector and lower commodity prices clouded the company's short-term prospects. We later added to our position during the outbreak of the Covid pandemic in 2020 when shares unjustly sold off in line with other European industrial producers, not giving credit to the rigidity of the business model and its operations, which are regarded as a critical service. SKAGEN Focus sold out of Befesa in the first quarter of 2021 following a rerating of the stock towards our target price.
Expansion potential in China
A second leg to our Befesa investment case was their significant expansion potential in China, a market in great need of their services. With about 100m tonnes of EAF steel produced in 2019, China generated approx. 2m tonnes of EAF dust, most of which would not have been recycled. In 2016-17, China declared EAF dust a hazardous waste, providing momentum for steel dust recyclers in China. Befesa is still the only international player moving into the market and had its first plant up and running at the end of Q1 2021, giving them a unique advantage. China has also introduced measures that are favourable to the long-term production of EAF steel, which is further supportive for the growth in EAF dust volumes.
Befesa entered the fund when the share price discounted a permanent collapse in demand, while we believed Befesa was exposed to positive structural long-term growth opportunities, especially from environmental legislation, rising zinc content in steel dust and international expansion. Its market-leading position, favourable competitive environment and high capacity utilisation, coupled with a de-risked strategy of long-term raw material hedging, leads to strong margins and high-quality cash conversion. The company benefits from the growing awareness of sustainability, as Befesa's business model is a vital part of the circular economy.
* This article first appeared in our ESG Report 2020. SKAGEN Focus sold out of Befesa at a profit in the first quarter of 2021, following a rerating towards its price target, as our investment thesis had played out.