Smelting plant scrapped - 28 March 2012

It was reported that Rio Tinto and  Cahya Mata Sarawak have scrapped plans for a USD2b (RM6.1b) aluminum smelter project in Sarawak as it could not agree on the commercial  power supply terms with Sarawak Energy Berhad. This will be an advantage to Press Metal's existing Mukah smelting plant as it will have less competition from the other bigger player thus. Given ASEAN and China’s base consumption of c.17m tpy and Malaysia’s consumption of c.250,000 tpy, we see a good potential for Press Metal given its status as one of the only two players in the region to fill the demand. On construction,  we opined that selective Sarawakbased construction companies like KKB  (Not Rated) will likely to be affected by this news as KKB is eyeing for the smelter plant construction works, which could be worth more than RM1.0b. Although there are no tangible losses to the contractors,  the sentiments and prospects of Sarawak-based contractors will be weak as most of the contractors are relying on SCORE as the re-rating catalyst for their earnings growth. We maintain our Neutral recommendation on the sector. 

Rio-Tinto and Cahya Mata scrapped smelting plant. It was reported by Reuters  that Rio Tinto and Cahya Mata Sarawak have scrapped plans for a USD2.0b (RM6.1b) aluminum smelter project in Sarawak. It is understood  that they could not agree on the commercial power supply terms with Sarawak Energy Berhad. To recap, both companies have been working to set up an aluminium smelter plant since the project was announced in 2007. The aluminium smelter was supposed to have an annual capacity of 1.5m tonnes per year (tpy) to meet surging demand from China and other developing economies. However, the collaboration has not gone beyond the planning stage due to delays in constructing the Bakun dam, that would have provided cheap power to the energy-guzzling smelter. 

Good for Press Metal (NOT RATED, TP: RM2.46).  With Sarawak Aluminum Company (SALCO - which is a 60:40 partnership between Rio Tinto-CMS) gone, it would be an advantage to Press Metal's existing Mukah smelting plant as it will have less competition from the other bigger player. Aside from Salco, the other known proposed smelting projects locally is Smelter Asia, albeit the project is still at  its preliminary stage. According to management, the average world demand growth for aluminium stands at 7% while China alone sees a 16% growth. Given ASEAN and China’s base consumption of c.17m tpy and Malaysia’s consumption of c.250,000 tpy, we see a good potential for Press Metal given its status as one of the only two players in the region to fill the demand. Furthermore, China has also tightened its policy on aluminium producers through suspending approvals for new smelters and electrolytic aluminium. The country also has a higher electricity cost for its smelters, as its electricity cost is half that of the Chinese smelters’ cost (c.US$37/MWh locally versus c.US$75/MWh in China). Last year, Press Metal managed to sign a power purchase agreement (PPA) with Sarawak Energy for a long term supply of energy at an indicated electricity rates of 11-12sen/kWh (61.2% discount to industrial rate). Another point to note is that the company has also recently secured two new offtake agreements with LG and Alcom for the supply of billets and aluminium ingots aside from Japan’s Sumitomo’s 20% stake in both Phase 1 of the smelting plant, which has ensured a 20% offtake agreement with Press Metal. As  we  do  not  have  an  official  coverage on the stock, we do not have a rating on the stock. However, we see Press Metal as the potential beneficiary due to potential earnings visibility from its new smelting plant. We value the stock based on the average sector PER of 10x and against our FY12 EPS forecast of RM0.25, this translates to a fair value of RM2.46, which offers a 17.7% upside for the stock from its current level.

Impact on Sarawak based construction muted. We expect the sector’s sentiment to be affected as they have been waiting for these contracts. We believe that the impact will be far muted to Naim and Bintulu and we opined that KKB  (Not  rated) and HSL  (Not Rated) will be the immediate looser to the news.  (see below for more details ). 

OTHER POINTS

Impact to construction sector. We opine that selective Sarawak-based construction companies will likely be the first to be affected by this news. Although there are no tangible losses to the contractors, the sentiments and prospects of Sarawak-based contractors will be weak. Most of the contractors are relying on SCORE as the re-rating catalyst for their earnings growth. To recap, in 2011, KKB (Not Rated) was awarded a contract worth RM70m from OM Minerals Sdn Bhd, a JV company between OM Holding and CMS (Not Rated). Other than that, KKB has 2 ongoing water contracts in  the  Samalaju  industrial  area  worth  up  to RM300m. KKB is also mulling for the construction of a smelter facility for Rio Tinto Alcan, which  is  now  likely  to  be  scrapped.  We  also  note  that  Naim  currently  owns  a  few  property investments in the Samalaju area to house  its Tokuyama and Asia Mineral’s workers. At present, it has about 4000 acres of land to be developed in the area. Bintulu Port (OP TP RM: 7.00) meanwhile is known to be actively finalising the terms for its proposed Samalaju Port. This  news  will  likely  to  be  negative  for  Bintulu  Port’s  long  term  outlook  as  it  could  lead  to greater uncertainties to its port’s activities (for industrial).

No change to Naim and Bintulu recommendations. We believe that the impact will be far muted to Naim and Bintulu with our view that KKB (Not rated) and HSL (Not Rated) will be the likely immediate losers on the news. These companies are heavily reliance on marine construction works and pure contractor works. We are maintaining our recommendation on Naim (OP, RM: 2.94) and Bintulu (MP, TP RM: 7.00). 

Source: Kenanga