CMS’ associate has been seeing strong interest from investors and the outlook for its subsidiary OMS remains bright with global demand-supply dynamics remaining favourable. We expect OMS to turn around significantly in 2018 (from loss-making in 2017) and become one of the biggest contributors to CMS’ earnings. Maintain BUY and target price of RM4.00 which implies 13.6x PE based on 2019F EPS.

WHAT’S NEW

• A closer look at OMH. Investors are keen on the significant turnaround story expected for OM Holdings (OMH) which has a 75% stake in OM Materials Sarawak (OMS). The turnaround at OMH is expected to have a positive impact on Cahya Mata Sarawak (CMS) which has a 25% stake in OMS.

ESSENTIALS

• OMS the world’s third-largest producer of ferrosilicon alloy. OMH was founded in 1994 and subsequently listed on the Australian Stock Exchange in 1998. It started up the Bootu Creek mine and Qinzhou smelter in 2005-06 and initiated the Sarawak smelter project in 2011. Its 75%-owned OMS operates a plant in Sarawak which is located at the Samalaju Industrial Park where it has 10 furnaces to produce ferrosilicon alloy and 6 furnaces to produce manganese; both are essential raw materials for steel production. The plant has a design capacity to produce 200,000-210,000 tonnes of ferrosilicon and 250,000-300,000 tonnes of manganese alloy p.a.. OMH’s key customers are leading steel players such as China Steel Corporation, Hyundai Steel, Nippon Steel & Sumitomo Metal and Thyssenkrupp. Today, OMS is the world’s third-largest producer of ferrosilicon alloy, after China and Russia.
• Encouraging production data. As at 1H18, OMS produced 104,602 and 124,979 tonnes of ferrosilicon and manganese respectively, representing an increase of 30% yoy and >100% yoy from 1H17. To note, OMS fired its last furnace at the Samalaju plant on 1 Jun 18. Hence, we think production in 2H18 could be much stronger hoh. On a qoq comparison, production of ferrosilicon was stable in 2Q18. However, manganese production declined 4% qoq in 2Q18 due to a shift to higher grade manganese production to cater to market demand. Separately, OMS also shared that sales of ferrosilicon and manganese in 2Q18 dropped by 25% qoq and 18% qoq due to the festive season (which hampered port activities) but are expected to rebound in 3Q18.
• Favourable global demand-supply dynamics. We think OMS’ success largely depends on China’s tight control on environmental protection. We understand that since China’s steel industry reform, the country’s ferrosilicon production has dropped considerably from 6m tonnes at its peak to only 3.2m tonnes. This led to a surge in ASP from US$900/tonne at the point when OMS started production compared to US$1,450/tonne now. Apart from that, OMS is also enjoying cheap power supply thanks to a 20-year contract for a fixed power price is approximately 50% cheaper compared to that recorded by other smelters. We believe that this is another key contributor to OMS’ success as power makes up about half of its total cost of production.
• Future expansion depends on availability of power sources. As all of OMS’ 16 furnaces are up and running, future growth will be driven by Phase 2 operations at the Samalaju Industrial Park. Although it is still in the preliminary stage, Phase 2 will likely house another four furnaces and the timeline for construction is heavily dependent on the availability of power supply sources. The next source of power supply for Phase 2 in Sarawak will come from the Baleh Dam which is slated for full completion by 2025. However, management does not rule out the possibility of sourcing power from other sources (apart from the Baleh Dam). Management also remains confident that OMS will at least receive a partial allocation of the additional power supply that they have requested.
• Ancillary income to support earnings. Organically, OMH shared that they intend to embark on an ore concentrate project as well as sinter plant project as part of its initiatives to re-use waste products and turn them into income generating products. OMH expects the projects to be commissioned by 1H19 and contribute 10-20% to revenue.

EARNINGS REVISION/RISK

• None.

VALUATION/RECOMMENDATION

• Maintain BUY and target price of RM4.00 based on a 25% holding company discount to our SOTP valuation, which implies 13.6x PE based on 2019F EPS. We also imputed a 23 sen “option value” for Malaysian Phosphate Additives (Sarawak) (MPAS) (assumption: 50% success rate, RM1.4b investment cost) from a NPV of RM490.1m based on CMS’ 40% stake in MPAS. CMS currently trades at a forward PE of 10x. Share price has fallen 13% from its recent high and with the strong fundamentals, we expect the PE to trend closer to pre-general election levels.

CATALYSTS

• Significant earnings recovery at OMS which will be driven by higher ASPs as well as higher utilisation of furnaces.
• Gradual improvement at other business segments which will be fuelled by the construction of Pan Borneo Highway and Baleh Dam.

Source: UOB Kay Hian Research - 3 Aug 2018