We welcome Sesco’s decision to combine its entire 500MW power supply to Press Metal’s Phase 3 Samalaju smelter starting 4Q15. BUY, with a lower TP of MYR3.21 (22% upside) to reflect our lower long-term aluminium price assumption of USD2,000/tonne. Investors should look beyond the potential losses arising from its recent fire, as it is adequately insured and aluminium prices are likely to rebound.

• Early power drawdown for Phase 3B smelter. Yesterday, Press Metal announced that it has executed an amended and restated power purchase agreement (PPA) with Syarikat SESCO (Sesco) to combine the supply and delivery of 500MW of power to Phase 3 of its Samalaju smelter into a single stage by 4Q15. Its board also confirmed that Phase 2 of the smelter, which caught fire last month, begun ramping up operations on 8 Jun. It expects Phase 2 to be fully operating, before Phase 3 is commissioned.
• Higher volume helps to offset lower aluminium prices. We are positive on the early power drawdown as every additional tonnage mayeventually help to boost earnings. Meanwhile, London Metal Exchange (LME) aluminium prices and the physical premium paid on top of the LME rate by the rest of the world (ex-China) have continued to decline. While there are multiple signs pointing to the possible bottoming out of aluminium prices, we opt to be conservative and cut our aluminium price assumptions by USD50 for FY15 and USD100 each for FY16 and FY17.
• Maintain BUY, with lower MYR3.21 TP. We believe Press Metal’s expansion plan is certainly timely for it to ride on the potential bottoming out of aluminium prices and to expand its presence in the aluminium industry. We still project record earnings for the company in the coming years as its proven low-cost model in the first quartile of the global production cost curve may enable it to weather challenging times. Therefore, we reiterate BUY but pare down our TP to MYR3.21 (from MYR3.55) as we cut our long-term aluminium price assumption to USD2,000 a tonne. We value Press Metal based on a 25% discount to our latest DCF analysis, on a fully-diluted basis.

All eyes on Samalaju smelter Repair works for Phase 2 smelter are well in progress. As mentioned in our report yesterda, we visited Press Metal’s smelting operations in Samalaju, Sarawak last Friday. We witnessed repair works at its Phase 2 smelter, which caught fire last month, and saw that things were well in progress with six pots powered and running at the point of visit. There are 300 pots at this phase of the operation. Meanwhile, its management targets the plant to return to full operations by end-3Q15. Yesterday, it also announced that the plant has begun ramping up operations on 8 Jun, and expects it to be in full swing before Phase 3 of the smelter, where construction is ongoing, begins running.

Construction of Phase 3 smelter at an advanced stage. Press Metal also brought us to its Phase 3 expansion, and construction works are well into the advancedstages even though works only began in late 2014. Some workers were seen busy installing machinery and smelting pots while others were co ntinuing with civil works that we believe were at 70%-completion. We were told the stage commissioning is still targeted to begin in November.

Early power drawdown for Phase 3B a welcome development. Thanks to the early power allocation, Press Metal’s Phase 3 expansion would result in an increase in production volume moving into 2016. Thus, we now expect a 54.5% YoY increase in the group’s primary aluminium production in FY16 vs our earlier projection of 40% YoY. Meanwhile, we expect Press Metal’s smelters to run at 100% utilisation from 2017 onwards, unless there is a new expansion plan in place – as FY17 would be the last stage of volume growth (of 11.8% YoY) after a spillover from the commisioningstage. Other than that, the all-in aluminium price may also affect the company’s profitability, and every additional tonne of production would help to drive its bottomline.

Room to ramp up value-added products. Meanwhile, Press Metal has converted its Mukah smelter to produce only aluminium billets. Since aluminium billets have an up-charge of USD100-150/tonne for the standard “P1020” ingot and cost not more than USD50/tonne to produce, this may help to further improve the smelter’s margins. Separately, the company also successfully put in place the “A356” ingot line in its Samalaju smelter which could lead to a similar margin increase (just like Mukah, if it markets billets), which enjoy a similar up-charge over standard ingots. For now, we are rather conservative in our assumptions and projections. We expect it to allocate only 30%/28%/30% of capacity for FY15-17 in the Samalaju smelter for “A356” production. We also do not discount the possibility of Press Metal exploringother value-added products to further enhance its profitability after Phase 3 comes on line.

Is the aluminium market bottoming out? Aluminium prices continue to slide. The London Metal Exchange (LME) aluminium cash price continues to drop after breaching the USD2,100 a tonne level in Sep2014. Apart from that, the premium charge on top of the LME price has also plunged since early this year. Meanwhile, the Main Japan Port (MJP) quarterly premium is still at USD380 a tonne for 2Q15, and the spot market is only trading at USD135 a tonne currently. Meanwhile, the LME cash price for aluminium broke below USD1,700 a tonne on Monday. The present level of the all-in aluminium price has certainly broken way below its past 10-year average of USD2,331 a tonne.

China’s export of aluminium products may start to drop. We earlier expected that the export tax cut in China may not boost exported aluminium products from the country – but its export volume remained high at 410,000 tonnes in May. That said, we believe the export volume from China may start to decline in the coming months. To better explain the dynamics, Figure 8 depicts the movement of aluminium prices at the Shanghai Futures Exchange (SHFE), which is the benchmark used by China’s domestic market, and at the LME plus the physical premium paid on top of LME rates to secure the physical aluminium delivery by the rest of the world . We also included in the chart the price difference between the two, after assuming a USD50/tonne cost to transport aluminium out from China (freight, price discount, trading margin, etc). As SHFE aluminium contract prices stay firmly above CNY13,000/tonne or USD2,100/tonne vs the falling LME prices and premium elsewhere, exporting aluminium products from China would no longer be profitable – even after assuming that no export tariff is applied to these products. Therefore, unless the aluminium prices in the SHFE decline or the LME price or physical premium (at the rest of the world) rises, exports from China may eventually normalise.

Limited downside, but timing of rebound remains unknown. As the LME aluminium price and premium across the regions has dropped to well below its 10-year average – on top of the possibility that exported aluminium products from China may start to decline due to the negative arbitrage margin for Chinese exports – we believe the downside to the price weakness may be limited. Nonetheless, while we are unable to say with certainty that aluminium prices will not drop further, we believe the increasing deficit in supply is a good sign that aluminium prices are bottoming out at the current level – and this could lead to an upside surprise moving forward.

Proven low-cost model is vital for survival. During challenging times, we believe lower-cost producers tend to stand out. Press Metal is already operating successful aluminium smelters in Sarawak that are in the first quartile of the global production cost curve. Although the actual tariff for the additional power supply is confidential, we understand from its management that the profitability of Phases II and III of the smelter is almost the same, if not better, after accounting for the lower capex and potentially improved efficiency for the new plant, based on its enlarged estimated volume. Meanwhile, its Sarawak smelters are benefiting from competitive 25-yearPPAs, state-of-the-art smelting technology and strategic plant locations that reduce its logistics costs. All these factors should help to keep the company in generating healthy cash flow and reasonable profits, in our opinion.

Source: RHB Research - 17 Jun 2015