We visited PMETAL’s Samalaju smelting plant at Bintulu, Sarawak, recently to gather some updates on its smelting operation. We came away feeling POSITIVE as we believe that: (i) Phase 2 of the Samalaju plant will be fully operational by end-3Q15, while (ii) Phase 3 will commence operations by end-4Q15. The new capacities will translate into superior earnings growth in FY16. All in, we reiterate our OUTPERFORM rating with a revised target price of RM3.88 (previously RM4.65). Revised TP is after adjusting: (i) earnings revisions and (ii) for full dilution impact arising from conversion of all outstanding warrants. We continue to like PMETAL for: (i) its globally competitive margins of 17.7% vs. global industry peers’ 12.6%, (ii) superior earnings growth driven by capacity expansion from Samalaju’s Phase 3 smelting plant, and (iii) the stock’s deep value, i.e. FY16 Fwd. PER of 8.0x vs. FBM70’s Fwd. PER of 14.3x.

Ramping up production in Phase 2 Samalaju smelting plant. On 8-Jun-15, PMETAL started to ramp up its Phase 2 Samalaju smelting plant, which was shut down temporarily on 21-May-15 due to a fire incident. We understand from our plant visit that c.15% of the Samalaju smelting pots are already up and running. Although the remaining pots are still under maintenance (i.e. cleaning and repair), management is confident that the plant will resume full operations by end-3Q15. We also like the fact that, unlike the previous power shutdown incident in Mukah, the pots in Samalaju remain functional and were adequately insured.

Phase 3 Samalaju smelting plant construction progress on track. The Phase 3 Samalaju smelting plant (320.0k capacity) will be trailing its Phase 2 plant (320.0k capacity). The construction progress of Phase 3 is already 60% completed and management is optimistic that it will be able to commence operations by end-4Q15. Moreover, on 16-Jun-15, the early supply and delivery of 500MW power by SESCO is timely as the group will be able to execute full production upon commissioning of Stage 3 smelting plant. As ramping up of production takes at least six months, we expect the group’s total smelting capacity to increase from existing 440.0k to 760.0k before end of FY16.

Revised aluminium price assumption to USD1,800/MT for FY15-16E. Global aluminium prices have been trending downwards since early May-15. The price has dropped to USD1,685/MT currently from USD1,960/MT (-14.0%) as at Jun- 15. The decline was mainly due to excess global aluminium supply in 1Q15. Nonetheless, we notice that aluminium prices have started showing signs of rebound from its 16-month low of USD1,650/MT. Going forward, with the fact that global consumption of aluminium has surpassed the global production by 291.1k MT as of 2Q15, we believe aluminium prices will recover over the medium-to-long term. However, we opt to be conservative for now by cutting our aluminium price assumption from USD1,900/MT-USD2,035/MT in FY15-16E to USD1,800/MT. Illustratively, our sensitivity analysis suggests that a 1% decrease in aluminium price assumption will reduce FY15-16E earnings by 6%-3% (-c. RM17.0-10.0m).

Revise higher USD/MYR assumption. We revised upwards our USD estimates, to be in line with our in-house economist forecast of RM3.68/USD for FY15E from RM3.53/USD. Based on our sensitivity analysis, a 1% increase in USD/MYR will increase FY15-16E earnings by 5% (+c. RM14.0-20.0m).

Neutral impact to earnings. All-in, after adjusting for: (i) lower aluminium price assumption and (ii) higher USD estimates, our FY15E earnings is relatively unchanged (cut by only 1%). Nonetheless, FY16E earnings are revised slightly higher by 2% as we revised the production capacity 50.0% higher in FY16 in line with the start of production in Phase 3, but this is partly offset by the full power drawdown from SESCO.

Maintain OUTPERFORM with revised TP of RM3.88 from RM4.65. Revised TP is after: (i) earnings revision and (ii) full dilution impact; as we are now assuming full conversion of warrants (expiry date: 22-Aug-19). We ascribe FY16E PER of 12.9x which is 10% discount to the FBM70’s Fwd. PER of 14.3x. We like PMETAL for: (i) its globally competitive margins of 17.7% vs global industry peers’ 12.6%, (ii) superior earnings growth (FY16E: 40.8%) driven by capacity expansion from Samalaju Phase 3 smelting plant, and (iii) the stock’s deep value, i.e. trading at Fwd. PER of 8.0x, significantly lower than that of FBM70’s Fwd. PER of 14.3x.

Source: Kenanga Research - 3 Jul 2015