News  Press Metal Berhad (PMETAL) announced that they have signed a power supply term sheet with Syarikat Sesco Berhad (SESCO) for the supply of electricity (500MW) to the former’s proposed Phase III of its aluminium smelter, which will be located at Samalaju Industrial Park, Sarawak.

 Furthermore, both parties have agreed to work expeditiously to enter into a 25-year Power Purchase Agreement (PPA) and Connection Agreement to be utilised for the Proposed Phase III Smelter.

 The Proposed Phase III Smelter with a designed capacity of 320k metric tons (MT) will be built next to the current Samalaju Smelter, which is 80% owned by PMETAL and 20% owned by Sumitomo Corporation (Sumitomo).

Comments  The news took us by surprise as we did not expect the conclusion of the power supply for Phase III to take place so soon. This is definitely a positive for PMETAL because securing the additional power supply will allow the company to further expand its production capacity. Additionally, we did not take this new capacity into our estimates.

 We expect PMETAL’s total capacity to increase from the current 440k MT/year to 520k MT/year (+18%) by 2016 and ultimately to 760k MT/year (+73%) by 2018.

 We expect CAPEX for Phase III to be 10-15% less than the RM1.8b spent on Phase II (the first Samalaju smelter) since the infrastructure and land cost has already been invested. We also believe that Sumitomo is likely to exercise its option to participate in the new smelter project, which should further subsidise construction costs. The company is now finalizing its costing structure, which will be revealed soon. Recall that Phase II was financed with issuance of RCULS. Financing structure for Phase III has not been finalized yet although we reckon the group will rely more on its internally generated funds and borrowings given its strong operating cash flow and strong interest coverage of more than 4x.

 We expect additional bottom line contributions of RM47m-RM153m (+13% - +33%) to RM403m - RM617m in FY16E-FY18E from the new smelter project. This is after taking into account additional finance cost of RM16m-RM18m arising from new borrowings required for CAPEX; but net finance cost impact could be lower if the group pares down existing loans. Our forecast net gearing will be close to 1.0x once it is completed by 2018, which is lower than current levels as the group’s current strong operating cash flow allows them to pare down existing borrowings. We assumed the following; (i) CAPEX of RM1.3b, (ii) 70:30 debtequity ratio, (iii) 14-month construction period, and (iv) finance costs capitalised during construction.

Outlook  Besides the positive news, outlook for PMETAL is also bright as we expect aluminium prices to continue strengthening in 4Q14 and FY15 towards the 8-year historical average of USD2,200/MT. This is due to the growing usage of aluminium in the auto sector and narrowing available supply as global consumption outstrips existing production levels.

Forecast  Maintain FY14E-FY15E Core Net Profit (CNP) of RM236m-RM322m as contributions will only be felt from FY16E onwards.

Rating Maintain OUTPERFORM

 We continue to favour PMETAL due to its solid earnings growth potential and globally competitive margins at 10.1% vs. industry peers of 5.7%.

Valuation  Upgrade TP to RM4.99 from RM4.50 previously. As we believe the news of additional power supply, implying new capacity, is a major re-rating catalyst, we partly roll forward our valuation base from FY15E to an average of FY15-16E to appropriately capture the effect of this newsflow. Hence, our TP is driven by an unchanged 14x Fwd PER on average FY15-16E EPS of 35.6 sen.

Risks to Our Call Lower-than-expected aluminium prices  Interruption to power supply

Source: Kenanga