The weak 2QFY20 results are well anticipated given the sharp fall in aluminium price during that period. However, we are turning positive on the stock as a quick recovery in selling prices while raw material cost remains favourable should forge into strong earnings in 2HFY20 and beyond. Together with the 42% new Samalaju Phase 3 capacity, FY21 is the key focus. Hence, we upgrade the stock to OP from MP with revised TP of RM5.95.

2QFY20 results in line. 2QFY20 core profit of RM73.2m matched expectations which brought 1HFY20 core earnings to RM179.1m which made up 48%/46% of house/street FY20 estimates. However, a stronger 2HFY20 is expected given the swift recovery of aluminium prices soaring above USD1,700/MT currently from USD1,500/MT three months ago and against average spot price of USD1,598/MT in 1HFY20. Meanwhile, it declared 2nd interim NDPS of 1.0 sen (ex-date: 04 Sep; payment date: 28 Sep) in 2QFY20, firming 1HFY20 NDPS to 2.0 sen which is lower than the 2.5 sen paid in 1HFY19.

Earnings hit by lower aluminium prices. Sequentially, 2QFY20 core profit contracted 31% to RM73.2m from RM105.9m as revenue dipped 5% to RM1.73b. This was primarily due to the fall in aluminium prices where the aluminium LME average price eased 11% further to USD1,501/MT from USD1,691/MT in 1QFY20. On the other hand, PMETAL also benefited from lower alumina and carbon anode prices. The reported average spot alumina price fell to USD246/MT or 16.4% of aluminium LME price in 2QFY20 as opposed to USD289/MT or 16.5% in the preceding quarter.

But raw material costs were lower as well. YoY, 2QFY20 core profit also declined 31% from RM106.5m as revenue slumped 19% as LME aluminium prices contracted sharply by 16% from USD1,794/MT while alumina also declined sharply by 38% from USD396/MT which made up 22.0% of aluminium prices in 2QFY19. As such, the greater drop in raw material prices as opposed to ASP led to a smaller magnitude YoY drop than QOQ. Meanwhile, associate income declined to RM2.3m from RM5.3m while depreciation charges jumped 14% after reclassifying JAA to JV accounting from associate income since 1QFY20. Similarly, 1HFY20 core profit decreased 18% to RM179.1m as revenue fell 17%, due to decline in aluminium prices as LME aluminium prices fell 13% to USD1,598/MT while alumina price also plummeted by 34% to USD264/MT or 16.4% of aluminium prices.

A stronger 2HFY20 as aluminium prices recover swiftly. This 2QFY20 should be the weakest quarter in FY20 given the swift recovery in aluminium after it plunged to as low as USD1,425/MT in early Apr as the COVID-19 pandemic disrupted business activities globally. With gradual business resumption around the globe which resulted in rising commodity prices, we believe the worst is over for the aluminium prices. As such, we raised our aluminium price assumption to USD1,730-1,830/MT for FY20-21 from USD1,700-1,830/MT with alumina-to-aluminium price ratio unchanged at 17-16.5%. Thus, our FY20/FY21 estimates are upgraded by 13%/17% and NDPS also raised proportionally based on unchanged pay-out of 40%.

Upgrade to OP. We turned positive on PMETAL given the strong recovery in aluminium price, and with the Samalaju Phase 3 to kick start in early 2021, FY21 will be a strong growth year. As such, we upgrade the stock to OP from MP. We are also re-basing our valuation method back to the pre-MCO level which is +0.5SD to 5-year mean at 31.5x FY21 PER. Hence, we upgraded our target price to RM5.95 from RM4.45 which was based on 3-year PBV mean of 1.37x. Risk to our upgrade is a sharp decline in aluminium prices if the recovery of the economy is prolonged.

Source: Kenanga Research - 19 Aug 2020