Press Metal -
Target Price: MYR3.79
Off To a Great Start
Press’ management remains concerned over depressed aluminium prices, although we are impressed with its potential 143.6% y-o-y earning surge in FY14 despite our lower price assumptions. We are also excited by its strategic asset swap, PMB’s commissioning, Mukah plant’s re-commissioning, and its landmark deal with Sumitomo. Maintain BUY, with a lower MYR3.79 FV (from MYR3.82).
Corporate digest lunch. Press Metal’s (Press) management participated in our “Corporate Digest Lunch” last week. Fund managers who attended the meeting focused on the aluminium price outlook, for which management conservatively predicts little changes from the 2013 average. That said, most agreed that Press enjoys lower costs vs its peers given its competitive electricity cost, logistics advantage and lower overheads. It also plans to expand its value-added production to enhance earnings.
Off to a better start? Newsflow seem to be improving after Press disposed of its loss-making Hubei smelter while acquiring a profitable extrusion unit via an asset swap in September. The Samalaju smelter was fully commissioned in October while the Mukah smelter resumed stage re-commissioning with 30% of its pots now back in operation. We are also excited about Press’ recent landmark MYR444m deal with Sumitomo Corp, which saw the latter taking up a 20% stake in Press Metal Bintulu SB (PMB)’s smelter. The standalone implied valuation of MYR2.2bn is double the group’s latest market capitalisation.
Maintain BUY. The London Metal Exchange (LME)’s new warehouse policy may exert more pressure on already distressed aluminium prices, but we believe Press can better withstand any sharp price drop vis-à-vis its higher-cost peers. The price fall may also help remove excess capacity and improve long-term industry dynamics. We are revising down our aluminium price assumption to a long-term price of USD2,200 plus a physical premium of USD150 a tonne. This accordingly lowers our FY13/14 earnings estimates by 2.3%/20.1% respectively. Our new fully-diluted DCF after a 25% discount leads to a slightly lower MYR3.79 FV (from MYR3.82). This implies an undemanding 1.1x P/BV and 9.1x FY14 EPS. We reiterate our BUY call.
Landmark deal with Sumitomo. In early November, Press entered into a conditional sale and purchase agreement with a subsidiary of Sumitomo Corp (Sumitomo) which saw the latter acquiring a 20% stake in PMB. We give this deal a double thumbs-up since the disposal consideration of MYR444m matches our DCF value for PMB. This will also pare down Press’ gearing to 1x from 1.74x, and give rise to a MYR336.4m disposal gain. Meanwhile, as the disposal gain will only be adjusted in its balance sheet without flowing to its profit and loss statement (based on new accounting standard) guided by its management, we made necessary adjustments to our financial model. Nonetheless, the disposal price tag sets a benchmark-to-equity value for PMB and Press’ other business units. PMB's full implied valuation of MYR2.22bn supports our view that Press is grossly undervalued. We have factored in annual interest cost saving amounting to MYR24.4m from the disposal proceeds.
Proceeds adjustments until 2018 fair. The disposal consideration of PMB will be subject to certain adjustments, namely adjustments on balance sheet at completion, capital expenditure, earn-out and production costs for the period until end-FY18. Press is subject to a negative adjustment or “penalty” if it fails to meet certain agreed conditions, but the amount is capped at USD43m (30.7% of the original disposal consideration).
Likewise, Sumitomo will revise up the disposal price tag or “reward” if Press surpasses certain targets stipulated in the sale and purchase agreement (SPA), subject to a maximum of USD69m (49.3% of the original disposal consideration). Management believes that the adjustment conditions are fair considering the currently depressed aluminium prices and good checks and balances of its operation. Meanwhile, we are more hopeful of the potential reward of not more than USD21m upon Press meeting certain production cost targets by end-FY18. However, we are looking out for a potential negative earn-out adjustment (ie penalty) of up to USD16m, as the target set on PMB's yearly free cash flow until FY18 is highly dependent on aluminium prices, which management cannot control. Meanwhile, we prefer not to include any potential adjustment to disposal consideration until it is finally determined in FY18.
Moving PMS up the value chain. The smelter is normally required to run at optimum utilisation upon commissioning, which leaves little room for any volume growth. Therefore, the only way to raise revenue is by moving the product up its value chain. Following the full commissioning of PMS’ plant in Mukah, Press’ management added an “A356” ingot casting line. However, during our visit to its Mukah plant on 21 May, we observed that PMB was in the process of installing the third billet rolling line, which is expected to raise its billet production to a maximum 120,000 tpy from 84,000 tpy currently. Given that aluminium billets enjoy a premium of around USD150 a tonne to the standard “P1020” ingot and cost no more than USD70-80 a tonne to produce, this may help to further improve PMS’ profitability. The third line is ready but we expect Mukah to focus on billets production from March 2014 onwards as its smelting plant is currently at the re-commissioning stage. We expect the Samalaju plant, which focuses on standard ingot “P1020” and some “A356” ingot, to reach optimum production in 2014. PMS, in Mukah, focuses on aluminium billets production
PMB exploring value-added products. Following the successful implementation of the “A356” ingot line in PMS, management is installing an “A356” line in Samalaju. Going forward, PMB will focus on “A356” on top of the “P1020” standard ingot. A356, which comprises a blend of aluminium and 8% silicone, is a type of aluminium used in alloy wheels manufacturing. The alloy-added “A356” also enjoys almost the same premium as aluminium billets, but involves an additional production cost estimated at around USD50-80 a tonne. For FY14/15, we project PMB to produce up to 20%/30% of its production capacity respectively at the Samalaju “A356” line, instead of the original 10% estimate. The “A356” is mainly exported to South Korea – one of the major alloy wheels producers in the world – to enjoy certain import tax advantages. That said, we do not discount the possibility of PMB installing a new billet casting line after its billet capacity in PMS is fully taken up in order to further enhance the group’s profitability.
Market volatility and blackout. Despite aggressively expanding since 2005, the group failed to attract investors’ attention as its performance in past years have been affected by volatile aluminium prices, which dampened its overall performance. In addition, the situation worsened as its smelting plants were hit by a Sarawak state-wide power blackout in June, which damaged its Mukah smelter and some of its pots at Samalaju smelter.
PMB’s earnings overshadowed by 3Q13 headline loss. Press posted a headline loss of MYR1.6m in 3Q13, during which it also recorded a few exceptional items, including a well-guided disposal loss of MYR51.6m from its asset swap of the loss-making Hubei smelter in exchange for an extrusion plant. This was announced back in September. Press also recorded an operating loss of MYR20.3m (MYR19.5m after netting off minority interest) from the Mukah smelter, mainly due to fixed operating charges and financing costs incurred following a temporary halt in operations after the power blackout on 27 June. However, we were pleasantly surprised by the recognition of a deferred tax asset from the tax incentives granted to its subsidiary. We suspect this was for the Mukah smelter, which resulted in a positive tax charge of MYR50.2m in 3Q13. This helped partly cut down Press’ exceptional loss to only MYR17.6m for the quarter. Excluding these exceptional items, we derive a core net profit of MYR19.5m for 3Q13 and 9M13 core earnings of MYR64.8m, which was marginally higher than our estimates but in line with consensus forecasts.
Aluminium price still key to profit. The better core results despite distressed aluminium prices – averaging USD1,782 per tonne in 3Q (-2.9% q-o-q) – support our view that its Sarawak smelters enjoy lower cost curves on the back of competitive power costs and strategic location. Again, this is a testament to its smelting plants being lower cost producers. We believe Press is able to better withstand the distressed aluminium prices compared to its peers. Nonetheless, we reckon that as the aluminium smelting business is typically vulnerable to commodity price fluctuations, weak aluminium prices do not bode well for the company.
Lower aluminium price assumptions. During certain quarters, there were concerns of the lengthy queues at LME’s warehouse, which were linked to high premium charges for physical delivery of the commodity since 2012. On 7 Nov, the LME made some modifications in its warehousing policy, requiring a higher load-out vis-à-vis load-in rate at an affected warehouse to help ease the queues. Meanwhile, spot aluminium prices slipped below USD1,700 per tonne after the announcement before rebounding near to USD1,750 per tonne recently. While we are unable to say with certainty that aluminium prices will not drop further, we are not overly concerned with any price decline, although this may compound Press’ short-term profitability and cash flow. We view it as “short-term pain, long-term gain”, given the group’s better-than-expected 3Q13 results vs its peers, who were largely in the red. Any sharp plunge in aluminium prices may actually help expedite the closure of high-cost smelters. This will in turn improve the supply and demand dynamics within the industry and hence, prices. Considering the weak market sentiment, we lower our aluminium price assumptions but accordingly adjust up our premium estimates given the continued strength in physical demand (see Figure 4). This reduces our aluminium selling price assumptions by USD40-135 a tonne.
2013/14 a year for volume growth. Following the full commissioning on 14 March of its smelting pots at the Samalaju plant, which is 2.66x the size of the Mukah plant, we expect PMB’s primary aluminium production to reach 240,000/316,800 tonnes in 2013/14 respectively. We also expect the Mukah smelter to resume operation from March 2014 onwards as we project 102,000 tonnes of production in 2014 vs 66,000 tonnes estimated in 2013. PMS is expected to run at optimum tonnage around 118,800 tonne p.a. from 2015 onwards. The substantial volume could boost group volume by 119.6%/36.9%/4% y-o-y for 2013/14/15, based on our in-house estimates. The growth could be even more impressive if it were not for the weak aluminum prices in a distressed market.
Sensitivity to aluminium prices. We think volume growth is very much within Press management’s control and may not change much from our latest revision. However, aluminium prices remain volatile and no one can correctly predict its price movement. Therefore, we decided to run a back-of-the-envelope test on Press’ earnings toward its sensitivity against aluminium price movement. For simplicity, we use all-in prices which include spot aluminium prices quoted at the LME plus its physical premium for the test. We found that every increase of USD100 a tonne in selling prices may lift Press’ bottomline by around MYR50m. However, the impact of lower aluminium prices is slightly greater as both alumina and carbon anode prices may not drop as much.
Core net profit is set to surge in FY13 and FY14, as we expect stable earnings post-full commissioning of the smelting operation, unless there are new undertakings.
Earnings to surge regardless of weak aluminium price? Hence, we are not overly concerned over the weakening aluminium prices. We conservatively assume realised selling prices at USD2150 a tonne, or almost a USD52 increase from the estimated average in 2013. However, after making some necessary adjustments, our latest projection shows that Press is capable of making a MYR212m profit, although this will be 20.1% lower than our previous estimates. With the Mukah unit only expected to resume full operation in 1Q14, we project a profit of MYR35m in 1Q14, compared with MYR22m in 4Q13. Press’ earnings are expected to improve further to MYR55m in 2Q14 before hitting the MYR60m mark each in 3Q14 and 4Q14.
Surf on this earnings wave. We urge investors to take the opportunity to ride on the this potential earnings wave before the market gets wind of its actual earnings potential in the next few months, as there will be limited room to capitalise on the stock’s valuation by then. Meanwhile, we are projecting for Press to report core earnings of MYR87m for FY13 and MYR212m for FY14, or a y-o-y growth of 36.2% and 143.6% respectively. The earning will mark another profit milestone of MYR275m in FY15 (+29.8% y-o-y) after its reaches its first full year of full operation for both smelters in Sarawak, plus a USD100/tonne improvement in aluminium selling price.
Net profit is set to surge in FY14, as we expect stable earnings post-full commissioning of the Samalaju smelter and re-commissioning of its Mukah operation, unless there are new undertakings
Don’t Miss Out On Such Undemanding Valuations
A hidden jewel. As the company’s management has shied away from investors, the stock is still under researched despite its decent market capitalisation of about MYR1.2bn. We initiated coverage on Press in June 2013. Press has, over the years, quietly developed its expertise across the aluminium value chain and expanded its network to become a competitive global player. However, its share price movement suggests that the market may have overlooked this hidden gem. We sense that investors may have been frustrated with the stock’s performance some quarters back, as their earlier fervour had been fanned by the group’s move years ago to begin talks to set up its smelting operations in Sarawak.
Undemanding valuation. Although the power blackout and the sluggish aluminium prices have delayed its recognition of huge earnings, we think a potential earnings surge is just around the corner, with both smelters in Sarawak set to run full steam ahead from March 2014. Press is now trading at a very attractive P/E and P/BV valuations. In this report, we will take a quick look at where the valuations of its regional peers are to ensure that we apply the right parameters to the group. As Press will own the country’s first smelter (and thus becoming the first aluminium smelter counter under our coverage), we conducted a cursory peer comparison based on consensus estimates. We found that its global peers are currently trading between 14.7x FY13 P/E and 20.3x FY14 P/E, which are at a significant premium to Press’ earnings-based valuation. Our earnings estimates show that the group is currently trading at undemanding P/Es of 13.2x FY13 and 5.4x FY14.
Conservative DCF assumptions. The bulk of Press’ earnings will be attributed to its aluminium smelting business, which benefits greatly from a 25-year power purchase agreement (PPA) that charges competitive prices via a take-or-pay arrangement. While other costs may affect its smelting margin, the cost of its key material, alumina, is priced at a percentage of aluminium prices on the LME. Hence, the production cost, to a certain extent, is correlated to selling prices, which in turn reduces its operating risk. Furthermore, we are using our conservative aluminium price estimate for 2014 as the price is close to its historical low, or USD50/tonne higher than preceding year. We deem our forward price assumption reasonable as we expect prices to stabilise at USD2,200 in 2017 and grow by a marginal 1.5% thereafter. Our long-term physical premium of USD150/tonne is also not aggressive compared to 2013 average of USD248/tonne.
Publish date: 18/12/13