Press Metal is all set to post record earnings with its Phase III aluminium smelter at the end stage of commissioning, while its production costs remain in the first quartile of the global cost curve. we lift our earningsestimates for the next three years (FY16-18) by 3.3-15.5% due to: 1. The recent strengthening of aluminium prices; and, 2. Strengthening of the MYR/USD exchange rate, Coupled with the revision in terminal growth to -3%, a 20% discount to our fully-diluted DF valuation derives a higher TP of MYR4.50. Keep BUY. Making a comeback. Press Metal’s Phase III smelter in Samalaju is at the tail-end of ramping up and is expected to be fully commissioned in the next few weeks. Phase II of its Samalaju smelter also returned to normal operations in late Nov 2015 after six months of fire damage repair while the Mukah smelter (Phase I) continues its regular production. We expect its aluminium smelting capacity to rise to 760,000 tonnes per annum (tpa) or 1.5% of global primary aluminium production, and sales tonnage to surge 65.7%/11.8% YoY in FY16-17 respectively. Its aluminium smelters in Sarawak represent a successful lowcost model currently in the first quartile of the global production cost curve.

Forecasts and key risks. The strengthening of aluminium prices and the MYR/USD prompted us to raise our FY16-18 earnings estimates by 3.3-15.5% respectively. Key risks include further downward pressure on aluminium prices and a sharp weakening of the USD that may hurt its profitability. In addition, an unexpected power supply interruption at its smelting plant may damage machineries and disrupt its operations.

Keep BUY with a higher TP. While headline profit was lifted by a one-off insurance claim of MYR40m (net of MI), we deem 1Q16 core results to be largely in line with our expectations but above street estimates. We continue to value Press Metal based on DCF on a 20% discount and fully-diluted basis, but lift our terminal growth rate to -3% (from -15%) to derive a higher TP of MYR4.50 (from MYR3.56). Reiterate BUY.

Aluminium price and forex revisions. Aluminium cash prices have been hovering above USD1,600 per tonne for the past two weeks, which prompted us to revisit our aluminium price assumption. We have revised up the London Metal Exchange (LME) aluminium spot price to the average of USD1,600 and USD1,650 a tonne in FY16F-17F respectively (from USD1,525 and USD1,548 respectively), with a 1.5% pa increase expected from FY18F onwards. Still, we remain prudent and continue to project the physical premium paid on top of the LME cash price for the standard aluminium ingot (P1020) to stay flat at USD100 per tonne.

We believe our latest all-in aluminium price assumption is conservative vs its long-term price movement. The nominal all-in aluminium price fell below this level for short period spost the global financial crisis (GFC) in 2008 and 2009, the 1997’s Asian financial crisis, and the recession in the early 2000s. Furthermore, this is also the lowest level in real terms on a 3% inflation-adjusted basis. In addition, we noted that the recent strengthening of the MYR/USD is mildly negative to Press Metal’s profitability. Our latest house assumptions on MYR/USD are 4.00/3.80/3.70 for FY16/FY17/FY18 respectively (from 4.20/4.10/4.00).

Earnings set to surge. Despite our prudent assumption revisions, our latest projection shows that Press Metal is capable of recording a MYR411m (from MYR383m) core net profit in FY16. With the Samalaju smelter (Phase III) set to resume full operations by midMay 2016, we project a profit of MYR100m in 2Q16 with an average all-in-aluminium price of USD1,700 a tonne. Earnings are set to improve further to MYR125m in 3Q16 and MYR130m in 4Q16 when all plants start to run at full capacity and the all-in aluminium price escalates to USD1,745 a tonne in 2H16. We project Press Metal’s FY17 profit to reach MYR534m (from MYR479m), with the all-in aluminium price expected to average USD1,750 a tonne.

Ride on this earnings wave. We urge investors to take the opportunity to ride on this potential earnings wave. We project core earnings of MYR411m for FY16 and MYR534m for FY17, implying YoY growth of 50.0% and 29.9% respectively. These would mark new profit milestones for the company upon its first full-year operations for all its smelters in Sarawak.

BUY with TP revised up to MYR4.50. We continue to believe that the DCF approach may be the closest approximation to the stock’s long-term value. We incorporate the group’s warrants – issued in late 2011 – into our valuation. That said, our previous terminal growth assumption of -1.5% may be overly conservative as Sarawak Energy islikely to continue offering power tariffs at competitive rates so that its major client could maintain its operations. Hence, we lift our terminal growth assumption to -3%. At a 20% discount on the stock’s fully-diluted DCF valuation, we derive a higher TP of MYR4.50 (from MYR3.56), which implies 14.2x, 10.9x and 10.5x P/Es as well as 2.6x, 2.2x and 1.9x P/BVs based on FY16, FY7 and FY18 forecasts respectively. With that, we reiterate our BUY call on Press Metal, which is our Top Pick for the basic materials sector.

Calculated Investment Risks Volatility in aluminium prices and demand. Press Metal’s operations are undeniably vulnerable to fluctuations in prices and volume in the domestic and export markets. In particular, its primary aluminium businesses are sensitive to commodity price fluctuations. However, we are not overly concerned over the demand for its primary aluminium products, as the commodity is widely tradable. The company enjoys cost advantages such as competitive power tariffs and lower overheads, which should ensure profitability once Phase III of its Samalaju smelting plant is fully commissioned. Our all-in aluminium priceassumption of USD1,700 a tonne (FY16) is also at a multiple-year low since 1988, on a3% inflation-adjusted basis. Given that current prices have dragged many major smelters into the red, we have no assurance that prices would not drop further. Our sensitivity test (Figure 8) provides a rough gauge of the breakeven point of its smelting operations in Sarawak. At our USD/MYR assumption of 4.00, at the PATMI level, the price is around USD1,425 (spot + premium) a tonne vs the last (as at 29 Apr 2016) aluminium selling price of USD1,795 (USD1,679 (spot) + USD116 (premium)).

Source: RHB Research - 4 May 2016