Sunday, December 29, 2013

Press Metal - Off To a Great Start (RHB)

Press Metal -
Target Price: MYR3.79
Price: MYR2.25
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.

Source/Extract/Excerpts/来源/转贴/摘录: RHB-Research,
Publish date: 18/12/13

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There’s no such thing as defensive stocks.Every stock can be defensive depending on what price you pay for it and what value you get,
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