Malaysia  Smelting  Corp  (MSC)  posted  a  narrower  core  net  loss  of  RM4.5m  in 4QFY12,  buoyed  by  a  rebound  in  tin  price  that  boosted  RHT's  profit,  higher production  at  its  smelting  plant,  stronger  associates'  contribution,  and  lower overheads  at  PT  Koba  Tin  following  a  downsizing.  However,  this  was  partially watered  down  by  higher  provisions.  The  extension of PT Koba Tin's Contract of Works  (CoW)  remains  an  overhang.  As  its  disclosure  of  RM150m  in  potential impairment  may  shock  investors  and  spark  panic  selling,  we  downgrade  MSC  to SELL, with a lower FV of RM2.77, based on 1xFY13 NTA.        

No  cheer  from  tin  price  boom.  While  MSC's  financial  result  did  improve  as  we  had anticipated, its 4QFY12 core-net loss of RM4.5m was still way below our expectation. The improvement  was  mainly  attributed  to  i)  average  tin  price  rose  to  USD21,525  in  4Q  or 11.6%/3.8%  on  q-o-q/y-o-y  basis,  thus  improved  the mining  margin  of  Rahman  Hydraulic (RHT),  ii)   its  Butterworth  tin  smelting  business  recorded  higher  profit  following  the increase  in  production  volume  to  9,640  tonnes  from  6,553  tonnes  in  3Q,  iii)  associates recorded higher share in profit, and iv) downsizing of PT Koba Tin pending renewal of the CoW also helped to narrow losses. If not for PT Koba Tin making additional provisions in 4QFY12,  we  think  MSC's results  could  have  been  better.  That  aside,  the  company  also made impairment amounting to RM15.2m for its investments this quarter.

Core  operations  to  ride  on  tin  price.  Tin  is  again  in  the  spotlight.  Despite  the  recent consolidation, its price had surged some 30% since hitting bottom in July 2012. Meanwhile, Indonesia has issued new export regulations restricting the sale of refined tin with less than 99.9% purity or better, which, if implemented, will certainly tighten tin supply. However, we are  unsure  if  the  new  regulations  will  take  effect. Wholly-owned RHT's mining tonnage is projected  to  grow  marginally  over  the  next  few  years.  Thus,  the  tin  price  rebound  will certainly boost its bottomline. The operation of PT Koba Tin is still suspended, thus while it may  not  benefit  from  the  price  rebound,  the  lower  overhead  may  taper  its  losses  in 1QFY13.  With  a  solid  track  record  in  operating  custom  smelting  plants  since  1887,  we expect MSC's smelting plant in Butterworth to continue contributing positively to the group, unless a perfect substitute for tin is found.

Spring cleaning of non-tin assets. The group has embarked on a vigorous diversification strategy  in  2007  with  the  aim  of  transforming  itself  from  a  single  commodity-focused business to a global resource-based organisation in the Asia-Pacific region in the metal and mineral  space.  However,  following  the massive  credit  crunch  triggered by  the  2008 global financial crisis, MSC's board in 2009 decided to divest its non-tin business and refocus on its core tin business to strengthen its balance sheet by lowering its gearing ratio. Over the years, MSC has successfully disposed of most of its non-tin assets and recognised painful impairment and disposal losses.
 
Impairment  after  impairment, painful...  We  have  highlighted  in  our  recent  company update  dated  5  February  2013  that  MSC's  investment  in  KM  Resources  (KMR)  carries potential  impairment  risk.  As  expected,  management  has  provided  an  impairment  of RM6.6m  in  4QFY12.  While  no  elaboration  was  given  on  this  impairment,  we  think  the decision  may  have  been  made  after  the  board  considered  its  high  book  value  of  almost RM100m  despite  having  ore  reserves that can only  support  the  current  rate  of  production until  mid-2014,  or  end-2014  at  best.  That  aside,  MSC  also  made  another  impairment amounting  to  RM8.6m  in  4QFY12  for  its  investment  in  TMR  Ltd,  a  unit  which  engages  in off-shore tin mining. As MSC's holding in TMR has dwindled over time, we suspect that the provision may easily be half the latter's outstanding book value, hence we are not delving too much into this unit.
 
PT  Koba  Tin  still  an  overhang?  MSC  has  taken  all  efforts  to  extend  the  CoW,  but  the outcome  is  out  of  its  hands.  We  understand  that  all  the  terms  and  conditions  for  the extension for PT Koba Tin's CoW,  which  expires  on  31  March  2013,  have  been  fulfilled. Among others, MSC had in 2012 entered into an alliance agreement with Optima Synergy Resources  Ltd  (OSRL)  on  condition  that  the  latter  assists  it  in  the  CoW  extension  and subscribes to a 60% equity interest in BCL, its wholly-owned subsidiary which also holds a 75%  effective  interest  in  PT  Koba  Tin.  Upon  completion  of  the  60%  subscription  of  BCL shares, OSRL will own 50% of BCL and effectively 45% of PT Koba Tin. This Indonesia unit has made additional provisions for mine rehabilitation, employees' termination benefits, asset  impairments  and  other  rationalization  in  4QFY12.  The  cash  flow  statement  also showed  a  total  outflow  of  RM32.8m  being  payment  of  deferred  mine  development, exploration  and  evaluation  expenditure,  payment  for  mining  rights  plus  mine  closure deposit. 
 
Prepare  for  the  worst  for  PT  Koba  Tin.  With  the  official  decision  on  it  is  still  pending despite its contract expiry being just one month away, we prefer to incorporate for the worst case  scenario.  For  the  first  time,  management  has  disclosed  in  its  financial  note  that  non renewal  of  the  CoW  would  have  adverse  impact  on  the  company's  investment  and contingent  liabilities  totaling  approximately  RM150m  in  PT  Koba  Tin.  With  this  disclosure, we  decided  to  factor  in  the  potential  impairment  amounting  to  RM150m  mentioned  in  the note  to  account,  where  MSC  share  for  impairment  based  on  its  original  75%  effective interest will be RM113m compare to our earlier estimates of only RM34m.

Downgrade  to  SELL.  We  are  pleased  with  management's  efforts  in  seeking  renewal  for PT Koba Tin's CoW. However, the outcome is obviously out of the company's control and thus a major psychology barrier to any new investors  until the issue clears up. That aside, the  potential  loss  of  approximately  RM150m  on  non-renewal  may  also  shock  existing investors and spark a possible kneejerk sell-down on the stock. Although we remain bullish on MSC's basic fundamentals and expect its core operation to return to the black in FY13, we  are  trimming  our  core  profit  projection  by  10%/8%  for  FY13/FY14.  In  view  of  the potential  panic  selling,  we  are  downgrading  MSC  to  SELL,  with  our  FV  revised  down  to RM2.77  based  on  1x  FY13  NTA.  All  said,  we  think  market's overreaction  to  the  latest results may represent a good buying opportunity to accumulate the stock at the lower level.  

Source: OSK