Press  posted  9M13  core  earnings  of  MYR64.8m,  on  its  Samalaju smelter’s  timely  commissioning  and  stable  profits  from  its  extrusion division.  While  we  are  not  overly  concerned  over  the  distressed aluminium prices,  we are excited by its strategic asset swap,  Samalaju smelter’s  commissioning,  the  Mukah  plant’s  re-commissioning  and  its landmark deal with Sumitomo. Maintain BUY with a MYR3.82 FV.

• Core profit ahead of  expectation.  Press’s MYR19.5m  3Q13  core  profit of MYR19.5m  was achieved  after  excluding  an  asset disposal  loss and the  fixed  and  financing  costs  for  the  Mukah  smelter  post  the  power outage that halted operations, and recognising  a  deferred tax asset. Its MYR64.8m 9M13 core profit was marginally ahead of  our estimates, but spot  on  with  consensus.  This  was  on  the  Samalaju  smelter’s  timely commissioning  and  earnings contribution,  coupled  with  stable  earnings from  its  extrusion  division.  The  better  results  despite  the  distressed aluminium prices  –  averaging  at  USD1,782 per  tonne in 3Q  (-2.9% q-oq)  –  supports  our  view  of  that  its  Sarawak  smelters  enjoy  lower  cost curves, derived from competitive power costs and strategic location.
• A start  to  a  better  tomorrow?  Positive news seems to be picking up after Press’ disposal of  its  loss-making Hubei smelter  in September  via an  asset  swap,  which  sees  it  acquire  a  profitable  extrusion  unit.  The Samalaju  smelter  reached  full-commissioning  in  October  while  the Mukah smelter resumed stage operations on 18 Nov. We are excited too on  Press’  recent  landmark  MYR444m  deal with Sumitomo Corp, which will see the latter take a 20% stake in the Samalaju smelter.
• Reiterate  BUY.  The  London  Metal  Exchange  (LME)’s  new  warehouse policy may give additional pressure to  the already distressed aluminium prices,  but  we believe Press can  better  withstand any sharp drop  vis-àvis  its higher cost peers. Such  a  drop  may  also  help to  remove  excess capacity and improve long-term industry dynamics. We have revised our FY13  core  earnings  estimates  upwards  by  13.1%  to  account  for  its better-than-expected results. Accordingly, our new fully-diluted DCF after 25%  discount  leads  to  a  slightly  higher  MYR3.82  FV  (from  MYR3.77). The  FV  also  implies  an  undemanding  1.1x  P/BV  and  7.3x  FY14  EPS. We maintain our BUY call.

Timely contribution by from the Bintulu smelter
Commendable  3Q  core  profit.  We  remain  calm  despite  Press  posting  a  headline loss  of  MYR1.6m  in  3Q13.  There  were  few  exceptional  items  recorded  during  this quarter,  which  included  its  well-guided  disposal  loss  of  MYR51.6m  from  its  asset swap  of  the  loss-making Hubei smelter in exchange for an extrusion plant. This was announced back in September. Press  also recorded an operating loss  of MYR20.3m(MYR19.5m after net-off minority interest) from  the  Mukah smelter  –  mainly on the fixed operating charges  and financing costs incurred following the temporary halt  in operations  post  the  power  blackout  that  occurred  on  27  June.  However,  we  are pleasantly surprised on the recognition of a deferred tax asset from the tax incentives granted to its subsidiary – we suspect this is for  the Mukah smelter, which resulted in a positive tax charge of MYR50.2m in 3Q13. This helped partly cut Press’ exceptional loss  to  only  MYR17.6m  for  the  quarter.  Excluding  those  exceptional  items,  we derived  a  core  net  profit  of  MYR19.5m  for  the  quarter  and  9M13  core  earnings  of MYR64.8m,  which  was  marginally  higher  than  our  estimates  but  spot  on  with consensus.

Results could be better? The aluminium smelting business is typically vulnerable to commodity price fluctuations. While Press  enjoys lower costs vs its peers given its competitive  electricity  costs,  logistics  advantage  and  lower  overheads,  weak aluminium prices do not bode well for the company. Since our initiation report titled Getting Set For Blast-Off  on 5 June, the spot month aluminium price has  slid further to  USD1,782  per  tonne  in  3Q13  from  USD1,836  per  tonne  in  2Q13.  Despite  the timely  commissioning  of  its  wholly-owned  Press  Metal  Bintulu  SB  (PMB)  plant  in Samalaju,  whose utilisation is projected at around 75%  during the  quarter, the lower aluminium prices have  capped contributions  from this subsidiary.  That aside,  heavy leverage by its holding company to finance its aggressive  capex in the past couple of years  has  also translated  into higher interest expenditure and reduced  contributions from its  Klang extrusion plant,  which  operates  directly  under  the  holding company. However, its extrusion plants in Guangdong and Hubei in China continue to generate stable, albeit small profits. Also, the better-than-expected results suggest that the last power outage may have less implication to Press’ Samalaju smelter plant’s efficiency than we had earlier anticipated.

A better tomorrow
Mukah smelter resumes  stage operation.  Positive news seems to be picking up after Press’ September  disposal of its  loss-making Hubei smelter via an asset swap, which saw it acquire a profitable extrusion unit in exchange. While ongoing repairs at its Mukah smelter are still concerns, the group told Bursa Malaysia that this plant has resumed  operations  as  of  yesterday  (18  Nov).  Meanwhile,  this  unit  is  expected  to achieve its optimum capacity of 120,000 tonnes per annum (tpa) within the next three months.  This  is  within  our  last  projection,  but  about  two  months  behind  our  initial expectations,  as the insurance company  took  longer to assess  the damage claim  –the  first  of  its  kind  in  the  country.  Apart  from  that,  this  80%-owned  Press  Metal Sarawak (PMS)  subsidiary  has submitted a preliminary claim to its insurers on the cost of the reconstruction works and repairs,  but has yet to reach an agreement with them on the amount  to be  claimed. We believe PMS will try its  best to pursue a fair and justifiable compensation from all relevant parties involved.

Full  commissioning  for  the  Samalaju  smelter.  We  also  understand  from management that its Samalaju smelter finally reached full commissioning in October, aside from  seven smelter pots that were damaged during the last  State-wide power blackout.  This  was  indeed  another  positive  development  for  the  group,  as  we  can expect additional  production from this plant in 4Q13  vis-à-vis 3Q13. We also expect this plant to attain  its  full capacity of 320,000-tpa from Feb-March 2014. Given that the  smelting business is a  volumes  game, every tonne of additional tonnage will  flow into  higher  bottomline.  The  full  commissioning  and  re-commissioning  of  Samalaju and Mukah smelters  respectively  will see  Press’ upstream aluminium  capacity  rising to 440,000-tpa from the 300,000-tpa projected for 2013. 

Landmark  deal  with  Sumitomo.  Press  has  entered  into  a  conditional  sale  and purchase  agreement  with  a  subsidiary  of  Sumitomo  Corp  (Sumitomo)  in  early November, which will see the latter acquire  a 20% stake in PMB. We give a double thumbs-up on this deal, as the disposal consideration of MYR444m matches our DCF value  for  PMB.  This  will  cut  Press’  gearing  to  1.2x  from  1.74x,  giving  rise  to  a MYR336.4m disposal gain. This  transaction also offers  further value adjustments, for which we are more hopeful on the potential reward of not more than USD21m upon Press meeting certain production cost targets by end-FY18. However, we are looking out for a potential negative earn-out adjustment (ie penalty) of up to USD16m, as the target set on PMB's yearly free cash flow until FY18 is very dependent on aluminium prices, which management cannot control. Apart from that, the disposal price tag sets a benchmark-to-equity value for PMB and other business units of Press. PMB's full implied valuation of MYR2.22bn supports our view that P ress is grossly undervalued.

Near  term  aluminium  price  unknown.  Certain  quarters  have  raised  concerns  on the  lengthy  queues  in  the  LME’s  warehouse  and  have  linked  it  to  high  premium charges  for  physical  delivery  of  the  commodity  since  2012.  The  LME,  on  7  Nov, made some modifications  to its warehousing policy, which  requires  higher load-out vis-à-vis load-in rate, at an affected warehouse to help ease the queues.  Meanwhile, the  spot  aluminium  price  had  slipped  below  USD1,800  per  tonne  after  the announcement  and  last traded at USD1,745  per tonne.  We are unable to  say  with certainty  that  the  commodity’s  prices  will  not  drop  further,  but  are  not  overly concerned  on  any fall,  although it  may  compound Press’ short-term profitability and cash  flow. We view it as  “short-term pain, long-term gain”,  given the  group’s betterthan-expected 3Q13  results  when compared  to its peers, who are  largely  in the red.

Again, this is testament  to  its smelting plants  as  lower  cost  producers.  We believe Press  is  able to  better withstand  the  distressed  aluminium prices  and  such  a  sharp plunge  in the price of the  commodity may  actually  help  expedite the  closure of high cost  producers.  This  can  only  improve  the  supply  vs  demand  dynamic  within  the industry and, hence, its pricing.

Share price upsurge just a matter of timing

Huge upside to DCF. We prefer to value Press based on DCF valuation, as it offers the closest approximation to the stock’s value. The majority of  the group’s earnings is attributed to its aluminium smelting business, which benefits greatly from a 25-year power purchase agreement (PPA) that charges competitive prices. While other costs may impact its smelting margins, the cost of its key material, alumina, is priced at a percentage of aluminium prices on the LME. Hence, its production costs, to a certain extent,  are  correlated  to  selling  prices.  This,  in  turn,  reduces  its  operating  risk. Furthermore, we deem our forward price assumption reasonable,  as we expect the prices  to  stabilise  at  USD2,250  in  2017  and  grow  by  a  marginal  1.5%  thereafter. Apart from that, our premium is stagnant at USD150 per tonne from 2017 onward.

BUY,  with  FV  tweaked  up  slightly  to  MYR3.82.  Although  a  significant  earning surge is still dependent on medium-term aluminium price movement, we are  excited over the last few positive developments within the group. Meanwhile, the better 3Q13 results  prompt us to revise upwards  our FY13 estimates by 13.1%,  but keep FY14 numbers largely unchanged. Preferring to be prudent in our valuation, we factor in the  potential  dilution  from  the  group’s  redeemable  convertible  secured  loan  stocks (RCSLS) and warrants  –  issued in late-2011 to partially finance its Samalaju plant  –into  our  valuation.  That  said,  we  derive  a  marginally  higher  total  DCF  va lue  of MYR3.63bn  on  a  fully-diluted  basis,  which  translates  into  a  DCF  per  share  of MYR5.09. As near-term distressed aluminium prices remain burning issues for many investors,  we  have  applied  a  25%  discount  on  the  stock’s  fully-diluted  valuations. From this, we derive a FV of MYR3.82  (from MYR3.77), which implies a 21.8x/7.4x P/E and 1.5x/1.1x P/BV, based on our FY13/FY14 forecasts.  We maintain  our  BUY recommendation on Press and urge investors to look beyond the  temporary volatility of aluminium prices. 

Financial Exhibits

• The power outage in Sarawak will delay the expected earnings surge to FY14
• While cash flow remains tight, we expect the company to be able to weather a tough 2H13
• The balance sheet is set to improve as its Sarawak smelters return to full operations, as well as proceeds from disposal of a 20% stake in PMB
• Key ratios are set for a major improvements from FY14 onwards

SWOT Analysis

Company Profile
Press  Metal  is  a  Malaysian-based  aluminium  company  with  an  extensive  global  presence.  Today,  the  group  has  a  downstream extrusion operation that is integrated with its greenfield aluminium smelting plants in Muka h and Samalaju in Sarawak, which have an annual  combined  capacity  of  440,000  tonnes.  The  company  also  operates  aluminium  extrusion  plants  in  Selangor,  Malaysia,  and Guangdong and Hubei, both in China.

Recommendation Chart

Source: RHB