LME  aluminium  prices  rose  10.5%  in  the  last  three  weeks.  While  this may  not  form  a  firm  uptrend,  the  new  support  level  will  benefit  Press Metal’s  world-class  low-cost  smelters.  We  are  also  excited  by  PMS’ recommissioning,  PMB’s full commissioning,  its  strategic asset swap,and  landmark  deal  with  Sumitomo.  Maintain  BUY,  with  a  higher MYR4.11 FV (vs MYR3.79), at a 40% discount to fully-diluted DCF.

• Early  signs  of  aluminium  market  bottoming  out.  Aluminium  prices jumped 10.5% in the last three weeks, particularly after the London Metal Exchange  (LME)  lost  a  lawsuit  that  forced  it  to  shelve  its  new warehousing  policy,  which  was  designed  to  reduce  its  deadlocked inventory,  which many believe was  tied to contango financing. While we concur that the event may have boosted market sentiment and resulted in  an  uptick  in  aluminium  prices,  we  think  this  coincides  with  the improving fundamentals of the aluminium industry. After almost a decade of  capacity  curtailment,  the  moderate  growth  in  demand  may  finally translate  into  a  supply deficit in  the global  ex-China market  from 2014. This may suggest that the aluminium industry is hitting bottom.
• All  geared  for  better  tomorrow.  The  improved  market  dynamics  are timely  as  both  of  Press  Metal’s  Samalaju  and  Mukah  smelters  are operating at full steam after  a  ramping-up exercise  was  completed last month.  Meanwhile,  news  flow  seems  to  have  improved  after  the company  disposed  of  its  loss-making  Hubei  smelter  while  acquiring  a profitable  extrusion  unit  via  an  asset  swap  in  Sept  2013.  We  are  also excited  about  its  recent  landmark  USD140m  deal  with  Sumitomo  Corp(8053  JP,  NR),  in  which  the  latter  took  up  a  20%  stake  in  Samalaju smelter, which implied a standalone valuation of MYR2.3bn for this unit.
• BUY, with a MYR4.11 FV. Press Metal is set to enjoy the fruit of years of aggressively  investing  in  world-class low-cost aluminium smelters. This is  on  the  back  of  aluminium  prices  bottoming  out  (and  rising  in  the future), while  both smelters are now  in  full production mode.  We expect group  earnings  to  surge  87.7/29% in  FY14/15  –  largely unchanged from our  previous  numbers.  We  value  the  stock  at  a  40%  discount  to  our newly-derived  fully-diluted  conservative  DCF,  which  implies  9.9/7.6x P/Es and 1.2/1.0x P/BVs on FY14/15 estimates respectively.

Positive Developments Pick Up Steam

Sarawak  experienced  its  worst  ever  state-wide  power  outage  just  weeks  after  we initiated coverage on Press Metal. The event was a  major setback  for the company. However,  not  many  may  realise  that  positive  developments  have  since  picked  up steam since the unprecedented incident  occurred. We list  a few major  developments the followed the power blackout below.

Farewell to loss-making  Hubei smelter.  The first  piece of positive news was when Press Metal  finally  reached  settlement  of its assets with its Chinese  partners  in Sept 2013. The settlement ended years of losses  for the company  from its erstwhile  Hubei smelter,  as  the  smelter  was  exchanged  for  an  extrusion  plant.  Although  the transaction  involved  an  impairment  of  MYR50m  that  was  recognised  as  a  one-off loss, it  was  non-cash in nature. Furthermore, the disposal of  this  smelter  will stem Press Metal’s  losses from this upstream unit  –  which  recorded  losses  of MYR10.2m in FY12 and  MYR12.8m in 1HFY13 – while allowing it to enjoy stable, albeit minimal, earnings moving forward  from the extrusion plant.  Therefore, we  give two thumbs up to this innovative asset swap.

Samalaju  smelter  reaches  full  commissioning.  Following  that,  Press  Metal’s Samalaju smelter  (via PMB)  reached full commissioning in Oct  2013,  atlhough this excludes  the seven smelter pots that  were damaged during  Sarawak  state’s  power blackout.  This  was  another  important  milestone  for  the  group.  We  learnt  from management that  the  plant  reached  full capacity of 320,000  tonnes  per annum (tpa) at  end-March  2014.  Given  that  the  smelting  business  is  a  volume  game,  every additional tonnage will add to the group’s bottomline

Landmark  deal  with  Sumitomo.  In  early  Nov  2013,  Press  Metal  entered  into  a conditional  sale  and  purchase  agreement  with  a  subsidiary  of  Sumitomo  Corp (Sumitomo)  which  saw  the  latter  acquiring  a  20%  stake  in  Press  Metal  Bintulu  SB (PMB).  We  are  most  positive  on  this  deal,  since  the  disposal  consideration  of USD140m matches our DCF value for PMB. Accordingly, the company announced on 1 April 2014 that it has received the provisional cash consideration of MYR456.6m for the disposal  from Sumitomo. We expect the proceeds,  together with  the  coming year’s  profit,  to pare down Press Metal’s gearing to 0.93x (by end -FY14) from 1.87x (as at end-FY13), as well as  give rise to a MYR336.4m disposal gain that  will flow directly  to  its  shareholders  funds.  We  also  project  annual  interest  cost  savings amounting to MYR24.4m from the disposal proceeds.

Adjustments  of  proceeds  until  2018  are  fair.  Meanwhile,  the  disposal consideration  of  PMB  will  be  subject  to  certain  adjustments  until  end-FY18.  Press Metal is subject to a negative adjustment or “penalty” if it fails to meet certain agreed conditions,  but  the  amount  is  capped  at  USD43m  (30.7%  of  the  original  disposal consideration). Likewise, Sumitomo will revise up the disposal price tag or “reward” if Press Metal surpasses certain targets stipulated in the sale and purchase agreement (SPA),  subject  to  a  maximum  of  USD69m  (49.3%  of  the  original  disposal consideration).  We  believe  that  the  adjustment  conditions  are  fair,  considering  the currently depressed aluminium prices and good checks and balances in its operation. Meanwhile, we are more hopeful about a  potential reward of not more than USD21m upon  Press Metal  meeting certain production cost targets by end-FY18  –  which are generally within management’s  control. 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  highly  dependent  on  aluminium  prices, which management cannot control.

Mukah smelter back in action.  As  we  said  earlier, the Sarawak state-wide power outage  was  a  major  setback  although  this  was  an  unprecedented  event.  As  the blackout  in Mukah lasted  for almost six hours,  the content in the pots’ reduction cells solidified,  following  the  sharp  drop  in  temperature   –  which  abruptly  shut  down smelting  operations  at  80%-owned  Press  Metal  Sarawak  SB  (PMS).  Repairs  on damaged  pots  in  the  Mukah  smelter  began  immediately  after  the  damage  was assessed by its insurance company’s adjusters.  We understand from Press Metal’s management that the plant had  resumed  full operation from early this month,  after a ramping-up exercise that lasted months.

A better tomorrow.  With both  the  Mukah smelter and remaining seven pots in  the Samalaju smelter all back in action from April 2014,  as well as  an asset swap on the loss-making Hubei smelter  that  was completed in Sept  2013,  we believe the worst  is now  over for  the group.  Furthermore,  its management had impaired MYR40.5m and MYR51.3m  as  an  asset  write-off  and  loss  of  income  respectively,  from  the  Mukah plant shutdown in 2H13 pending compensation from its insurer  –  even though  PMS had adequate insurance coverage for both. Meanwhile, we reckon there is a potential further loss of income amounting  to around MYR10m in 1Q14 as the Mukah plant still in  a  ramping-up  stage.  However,  any  compensation  received  from  the  insurance company moving forward will be a bonus for the group.

Get Set For a Great Restart

Back to full steam from 2Q14. The full commissioning and recommissioning started early  this  month  (April  2014).  Meanwhile,  both  the  Samalaju  and  Mukah  smelters estimate  their  combined  upstream  aluminium  production  to  increase  to  405,200 tonnes in 2014 and 435,600 tonnes in 2015, vs 290,772 tonnes in 2013. Considering that  the  smelting business  is a  volume game, every additional tonnage  is  crucial  to the group’s earnings.

PMS on full value-added billet production. As a smelter is normally required to run at  optimum  utilisation  upon  commissioning,  this  leaves  little  room  for  any  volume growth. Thus, the only way to raise revenue is by moving the product up  the  value chain.  Following  the  recommissioning  of  PMS’  plant  in  Mukah,  Press  Metal’s management  decided to  focus on billet production in Mukah.  During our visit to  the Mukah plant  on 21 May  2013, we  found  PMB in the  process of installing a  third billet rolling line, which is expected to raise its billet production to a maximum  of  120,000 tpa  from  84,000  tpa  previously.  Given  that  aluminium  billets  enjoy  a  premium  of around  USD150  a  tonne  to  the  standard  “P1020”  ingot  and  cost  no  more  than USD70-80  a  tonne  to  produce,  this  is  timely  in  compensating  PMS’  higher  costs,compare  with  PMB’s  smelter  in  Samalaju,  of  which  we  estimate  the  cost  of production at around USD90-100 per tonne (refer to our 5 June 2013 initiation report, Getting Set For a Blast-Off, for more details).

Moving  PMB  up  the  value  chain.  Press  Metal  has  successfully  implemented  the A356  ingot  line  in  PMS,  but  has  also  decided  to  focus  only  on  billet  production. Therefore,  its  management  installed  another  A356  ingot  line  in  Samalaju,  with production kicking  off in late 2013.  Going forward, PMB will focus on A356 on top of the  “P1020” standard ingot. A356 comprises a blend of aluminium and 8% silicone,which  is  used  in  alloy  wheels  manufacturing.  The  alloy-added  A356  also  enjoys almost  the  same  premium  as  aluminium  billets,  with  additional  production  costs estimated  at  around  USD60-70  a  tonne.  Meanwhile,  we  project  the  company  to produce  up  to  15/20%  of  its  production  capacity  at  the  Samalaju  A356  line  in FY14/15  respectively.  However,  we  do  not  discount  the  possibility  of  the  group ramping up its A356 production and exporting  more A356 to other countries such as South Korea – which is one of the major alloy wheel producers in the world – in order to enjoy certain import tax advantages.

Further enhancements  in power usage  a  near-term target.  Aluminium smelting is in  the process of extracting aluminium from oxide alumina . It  requires vast quantities of electricity  ranging from 13,000  kiloWatts per hour (kWh)  to 16,000kWh to produce one tonne of aluminium. The PMB plant currently employs the latest energy-efficient 400  kiloamperes  (kA)  of  smelting  technology,  which generates  a  higher  production output  while consuming  lower energy.  Without going into the technical details of the smelting technology, we made a simple comparison between 200MW of power to run PMS’  120,000-tpy  operation  in  Mukah  using  the  215kA  technology,  and  480MW power to produce 320,000 tpy at PMB.  A  quick computation showed that PMB may have  saved  some  10%  in  power  usage  compared  with  PMS  when  its  newly commissioned plant matures and reaches the optimum production.  Although  it  has limited  room  to  substantially  lower  the  power  usage  based  on  its  unchanged production platform, we do see Press Metal’s management working hard to gradually reduce  power  consumption,  especially  when  the  plants  are  still  at  the  stabilisation phase,  over the next few quarters. Potential savings  in terms  of an absolute amount remains enormous, in our opinion.

Source: RHB