The hi-tech metal that could save the airline industry

Tag : melting metals

In investing, the prospect of crisis has always been a sort ofsummons for me. It's like when I was a little boy and the ice creamtruck's jingle sent me running for loose change on a hot summerday. These days, I'm just trying to get at goodies of a differentsort - profitable investment ideas, instead of ice cream bars.
And today's aviation industry has a big crisis on its hands. As apercentage of airline costs, fuel is now about 35% of the total -up from only 13% at the start of the decade. It is the airlineindustry's number one expense. The cost of fuel puts enormouspressure on the industry. At the same time, regulators are pushingfor cleaner planes with fewer emissions.
"The price of oil has challenged and changed all realities for theaviation industry," says Tim Clark, president of Emirates, aDubai-based carrier. "This is the greatest crisis in aviation'shistory - bigger than the Gulf wars, September 11, SARS and pastoil shocks."
If oil prices stay where they are and nothing else changes, theairline industry will lose about $6 billion this year, comparedwith a profit of $5.6 billion last year. Many airlines will betaking that familiar stroll into the bankruptcy courts. Globally,24 airlines have already filed in just last the seven months.
The industry is trying - and will try - lots of different tacticsto fend off elimination. One of these is to push for morefuel-efficient aircraft. And that is the opportunity for investorsto cash in on this crisis.
It starts with the jet engine. Recently, the Wall Street Journal published "Jet Engine Makers Launch New War" - all about the drivefor new fuel-efficient engines. The piece notes that airlinesworldwide want to replace their existing fleets withnext-generation planes, not the current oil-guzzling models. Thegoal of the jet engine makers - or rather, the mandate put to themby their customers - is to deliver at least double-digit gains infuel-efficiency.
As the WSJ reports: "Developing fuel-efficient engines requires the use ofexotic alloys and ceramic coatings that can cope with internalengine temperatures that would be above the melting points ofuntreated metal components."
Enter cobalt. It's a tough metal with a high melting point of 2,700degrees Fahrenheit (1495 C). This higher melting point allows it tomaintain its strength at higher temperatures than other metals can.Cobalt alloys have higher melting points than either nickel or ironalloys.
As a result, one of the main uses of cobalt is in superalloys suchas those that jet engine makers need. In fact, the making ofsuperalloys consumed about a quarter of global cobalt production,of which about 75% wound up in aircraft.
Cobalt would seem to have a nice backdrop of long-term demand. Butit doesn't stop there. Defence spending is also on the riseglobally. A Financial Times report on aerospace notes that India, China, Brazil and certainMiddle Eastern countries are all upping their defence spending.India alone may spend $40 billion in 2009.
Cobalt is an important part of all that, too. In fact, the US andthe Soviet Union used to stockpile cobalt for defence purposes.Those stockpiles are long gone, but the role cobalt plays indefence still exists.
As exciting as the aerospace angle is, a potentially bigger marketcould be batteries for hybrid cars. There are 5-10 pounds of cobaltin a typical hybrid car battery. Hybrid car sales will probably hit500,000 cars this year. And that is growing rapidly.
Kitco recently noted that cobalt holds an electric charge betterthan almost any other metal. That makes it hard to replace, even at$50 per pound. "And the current electric batteries work so well,"Kitco notes, "[that] there is little incentive to change theirstructure (and other metal prices have skyrocketed, as well ascobalt - nothing is cheap anymore)."
With the failure of banks and the troubles of big financials suchas Fannie Mae, cobalt seems a nice place to be. A while ago, Irecommended a "cobalt play" to the readers of my investmentservice, Mayer's Special Situations. The name of the stocks is OM Group ( OMG:NYSE ). I should warn you that the stock is a bit speculative. But letme share a few of the particulars⬦
OMG carries a seemingly absurd valuation. It's not often that youfind profitable and growing companies with no net debt trading forbig discounts to book value. The speciality chemical industry - atribe to which OMG belongs - is undergoing heavy consolidation.Companies are getting bought out left and right. Dow Chemicalbought Rohm and Haas for a 74% premium. And then Ashland came alongand bought Hercules for a 38% premium.
Companies that make low-margin chemicals are looking to beef up oncompanies that make high-margin, or speciality, chemicals. BecauseOMG is cheap and very profitable, it has to be on someone's radar.I hope that it doesn't get bought out. I think we'll do betterholding the stock. But the deal-happy scene in the chemicalbusiness is another potential backstop of value here.
Hard to believe that anyone could buy all of OMG for anything lessthan at least book - which is $36 per share. And even that wouldbring howls of protest. After all, the stock was in the $50s formuch of the past year. We will see.
In any event, let's bring this back around to the aviation crisis.A familiar theme in the pages of my letters over the years has beenthis Templetonian notion of focusing on the opportunities thatproblems present. The late great John Templeton made this idea akey component of his investment - and life - philosophy.
The high price of oil is a big problem for many industries.
So if you have a good way to mitigate the high price of oil, youhave a business. I think the big winners over the next few yearsare going to be those companies that have a solution to the highprice of oil. Those companies have products that other people willpay up for, because fuel-efficiency is a must. The aerospaceindustry must become more fuel-efficient.

Cobalt alloys will be a big part of that trend.
⬢ This article was written by Chris Mayer for Whiskey and Gunpowder