We  laud  Press’  disposal  of  a  20%  stake  in  PMB  to  Sumitomo  for MYR444m, which  matches our DCF value for PMB. This  will cut  Press’ gearing from 1.74x to 1.2x, giving rise to a  MYR336.4m  disposal gain. However,  ongoing  repairs  at  the  Mukah  smelter  and  weak  aluminium prices  may  cap  its  share  price.  We  apply  a  25%  discount  to  our  new fully-diluted DCF, with a higher MYR3.77 FV (from MYR2.77). BUY.

• A win-win deal.  Press Metal (Press)  has  entered into a conditional sale and  purchase  agreement  with  a  subsidiary  of  Sumitomo  Corp (Sumitomo)  for  the  proposed  disposal  of  a  20%  stake  in  Press  Metal Bintulu SB (PMB) for a provisional cash consideration of USD140m (c. MYR444m).  We are not concerned  about  the  7.5%  earnings dilution  in FY14 core estimates to MYR265m. Instead, we believe the transaction is synergistic,  as  we  deem  the  MYR444m  price  tag  -  which  happens  to match our DCF value for PMB - fair. The transaction also crystallises the group’s investment by giving rise to a disposal gain of MYR336.4m, thus setting  a benchmark  for  Press’ equity value.  Furthermore, the proceeds will help pare down Press’ net gearing from 1.74x to a manageable 1.2x.
• Tall order for PMB. The disposal consideration of PMB will be subject to certain  adjustments.  We  are  hopeful  of  a  reward  of  not  more  than USD21m  upon  finalisation  of  PMB’s  FY18  accounts,  which  take  into account  certain  production  costs  that  are  likely  within  management’s control.  However,  we  are  mindful  of  a  potential  negative  earn-out adjustment (penalty) of up to USD16m based on PMB’s yearly free cash flow  (FCF)  until end-FY18,  as this  depends  greatly on aluminium prices, which are beyond management’s control.
• Reiterate BUY,  with  higher  MYR3.77  FV.  Positive news seems  to  be picking up after  Press’ recent disposal of  the  loss-making  Hubei smelter via  an  asset  swap  in  exchange  for  a  profitable  extrusion  unit.  While depressed  aluminium  prices  and  ongoing  repairs  at  its  Mukah  smelter are still  concerns,  these are  likely to be temporary.  All  said,  we apply  a 25% discount to our new fully-diluted DCF,  with our  FV revised upwards to MYR3.77 (from MYR2.77). Maintain BUY.  

Win-Win Tie-Up With Sumitomo

Sumitomo acquires 20% stake in PMB.  Press  has  entered into a conditional sale and purchase agreement (SPA) with Summit Global Management XII B.V. (SGM), a subsidiary of Sumitomo Corporation (Sumitomo),  for the proposed disposal of a 20% equity interest in  its  wholly-owned subsidiary,  Press Metal Bintulu SB (PMB),  for a provisional  cash  consideration  of  USD140m  (c.  MYR444m).  This  is  Sumitomo’s second  investment  in  Press’  subsidiary,  its  first  being  a  20%  stake  in  Press  Metal Sarawak  SB  (PMS),  which  operates  a  120,000  tonne  per  annum  (tpa)  aluminium smelting and billet casting plant in Mukah, Sarawak (Mukah smelter).

PMB a prized asset. PMB currently operates a 320,000 tpa aluminium smelting plant at  Samalaju  Industrial  Park,  Bintulu,  Sarawak.  The  plant,  which  started  stage commissioning  since  4Q12,  achieved  full  production  last  month.  As  this  smelter  is 2.66x larger than its Mukah smelter, it enjoys overhead cost efficiency.  In addition, its state-of-the-art  400kA  smelting  technology  consumes  10%  less  power  than  PMS, while its proximity to Bintulu Port – at 77km vs 187km from Mukah – could save PMB USD30 a tonne on  logistics costs.  Its  capex,  which only  doubles  PMS’, will also help PMB  save  on  interest  and  depreciation,  on  top  of  its  10-year  pioneer  status.

Therefore, PMB is a “prized asset” for Press and the group’s main asset. A  coup  for  Press.  As  the  disposal  of  Press’  20%  stake  in  PMB  will  be  earnings dilutive,  we  are  making  the  necessary  adjustments  by  lowering  our  FY14  core estimates  by  7.5%  to  MYR265.3m.  Nonetheless,  we  deem  the  proposed  disposal fairly valued at MYR444m, which happens  to match our  DCF valuation for  PMB (see Figure 1). This is  an opportunity to unlock and crystallise  Press’  investment in PMB, as the price tag implies  PMB’s  full valuation  at  MYR2.22bn,  far exceeding  its latest market capitalisation of only MYR1.25bn. For the time being, the disposal is expected to result in a net gain of about MYR336.4m for Press. The group is also set to realise synergies  from  the  partnership  by  capitalising  on  Sumitomo  Group’s  network  and marketing  expertise  in  the  aluminium  business.  In  addition,  the  disposal  will  help address market-wide concern over  the  group’s  high leverage,  as its  net gearing ratio of  1.74x  (as  at  30  June  2013)  is  expected  to  reduce  to  a  manageable  1.2x  upon completion of the transaction in FY14.

Sumitomo  to  reap  synergy  from PMB  too.  That said, we believe PMB is also an important  asset  of  Sumitomo,  which  is  part  of  a  consortium  of  12  Japanese companies  which  owns  a  58.88%  stake  in  PT  Indonesia  Asahan  Aluminium.  The Indonesian  government  rejected  the  consortium’s  request  for  a  30-year  extension after its agreement expired. PMB fits well into  Sumitomo’s business strategy as it will be able to continue to supply aluminium to the latter’s trading division.

Tall Order For PMB Comes With Reward And Penalty

Salient terms of SPA.  The SPA is conditional on PMB satisfying or SGM  waiving (acting at its sole discretion), inter alia, the closing conditions . Among others, PMB will  undertake  the  capitalisation  of  the  amount  owed  by  PMB  to  Press  and  its subsidiaries of at least MYR409m  (outstanding of MYR749.5m as at 31 Dec  2012), via  the  issuance  of  at  least  409m  new  ordinary  shares  of  MYR1.00  each  in  PMB, which  will  increase  its  paid-up  capital  to  at  least  MYR459m.  Apart  from  that,  PMB plant  has  to  meet  other  closing  conditions,  including:  (i)  construct  at  least  300 aluminium  smelting  pots,  of  which  at  least  290  are  fully  operational,  (ii)  achieve  a mean average daily production capacity  of not less than 852 tonnes in the rolling 30-day period (~95% utilisation rate), and (iii) maintain electrical power consumption with a  mean  average  of  below  14,000  kilowatt  hour  (kWhr)/tonne  in  the  rolling  30-day period. Barring any unforeseen circumstances, we believe these closing conditions will likely be met before the target completion in April 2014.

Proceeds  adjustments  until  2018.  The  disposal  consideration  of  PMB  will  be subject to certain adjustments, namely  adjustments on  balance sheet  at completion, capital  expenditure,  earn-out  and  production  costs  for  the  period  until  end-FY18. Press is subject to a negative adjustment or “penalty” if  it  fails to meet certain agreed conditions  but  the  amount  is  capped  at  USD69m  (49.3%  of  the  original  disposal consideration).  Likewise, SGM will  make  revise up  the disposal price tag or  “reward” Press  if it surpasses  certain targets  stipulated in the SPA,  but subject to a maximum of USD43m (30.7% of the original disposal consideration).

Tall  order,  but  this  comes  with  a  reward.  We  are  excited  that  the  disposal consideration  of  USD140m  –  which  we  already  deem  fair  –  could  see  a  potential upward adjustment of up to USD69m. However, we  are more hopeful  of a  reward of not more than USD21m upon  the  finalisation of  PMB’s  FY18  accounts,  which  takes into consideration  certain production costs.  While there is no further elaboration on what will be included in the production costs, we suspect these are likely to be limited to  production  efficiency  and  overhead  cost  controls,  which  are  still  within management’s  control. However, in the event  that  Press  fails  to achieve  the  minimal target set on  production costs, it is subject to  a penalty of up to  USD26.9m  in favour of SGM.

Transaction risk likely  to  be  contained  at USD16m  up to  2018.  Meanwhile, we are  mindful  of  a  potential  negative  earn-out  adjustment  (penalty)  –  capped  to USD16m –  in favour  of  SGM. The earn-out adjustment  will be based on  PMB’s  free cash flow  (FCF)  as and when its accounts are  finalised every year until FY18. While many  factors  could  impact  the  group’s  FCF,  we  believe  the  key  factor  lies  in  the group’s  profitability,  as  smelting  margin  is  very  sensitive  to  aluminium  price movement,  which  is  beyond  management’s  control.  That  said,  the  penalty  of USD16m will be  spread over the period of five years. Should PMB surpass  the  FCF target  set  in  the  SPA,  SGM  will  reward  up  to  USD48m  in  favour  of  PMB.  As  the transaction  value  happens  to  match  our  calculation,  we  suspect  an  average aluminium  price  of  around  USD2,200-2,400,  together  with  the  physical  delivery premium of USD150/tonne, were used as benchmarks to meet the target FCF.

Source: RHB