Malaysia Smelting Corporation: Stepping Into Resource-Rich Territory

THE BUZZ

Malaysia Smelting Corporation (MSC) told Bursa Malaysia yesterday that it has entered into a Sales and Purchase Agreement (SPA) for a 40% stake in Africa Smelting Corp (ASC) for USD400,000. The remaining 60% will be held by Mining Mineral Resources (MMR), a private company and major resource player incorporated in the Democratic Republic of Congo (DRC) conducting trading as well as owning and developing tin assets in Katanga Province, DRC. ASC is currently constructing its second electric furnace and expects to commence production by end-November 2012, with a total annual capacity of 3,500 tonnes per year (tpy) of tin metal.

OUR TAKE

A milestone. The deal indeed opens a new chapter for MSC as this represents the company’s first foray into the tin smelting sector in the African continent. This is also a good start in that it will help MSC position itself at the right spot to win any potential mining concessions from the DRC government in the near future which may be more lucrative in terms of earnings and valuations. The fact that DRC’s previous governing party won in the recent General Election will possibly expedite MSC’s mining cooperation in that country.

First mover advantage. AsDRC is an emerging economy with abundant natural resources, MSC’s move will give it first-mover advantage and solidify its position in the African continent’s tin market. That said, we believe that DRC will soon be following in the footsteps of emerging countries like Indonesia to curb the exports of raw resources in order to ensure that the nation derives more value from the exports of value added resources. As DRC is one of the main suppliers of crude tin to MSC’s Butterworth plant, this may somewhat expose MSC to some political risk. With the deal now inked, MSC will be able to mitigate this risk as it is allowed to operate a smelting plant in DRC.

Minimal risk of cannibalization. We understand that the tin concentrates sourced and produced by MMR were sent to MSC’s Butterworth smelter in the past. The commissioning of ASC’s smelting plant will naturally reduce the export of MMR’s tin concentrates to the Butterworth smelter and thus, possibly give rise to cannibalization. However, we are confident that management may be able to replace the supply from other suppliers, especially since the annual capacity of ASC’s smelter is only 3,500 tpy while the Butterworth plant has been running at almost optimum capacity. As ASC is only now installing its tin smelting capacity, the crude tin produced at ASC may be eventually be sent to Butterworth for further refining, which would then reduce the risk of cannibalization.

Contribution likely from 2013. Meanwhile, ASC is targeting to commission its smelting plant by end-November 2012. While we reckon that MSC has expertise in tin smelting, we still expect the new plant to undergo a gestation period, with contribution likely only from FY13. Thus, we will monitor the situation before incorporating any earnings contribution from the plant.

Risk from weak tin price. The good news aside, we are more concerned about MSC’s short-term earnings as tin price has been range-bound at about USD19,000 to USD20,000 per tonne in the past one month due to renewed economic worries over the debt crisis in the European Union. As tin price is now significantly below our FY12 projection of USD24,000 a tonne, and may potentially deepen the loss in PT Koba Tin and narrow the profit contribution from Rahman Hydraulic Tin SB (RHT), we expect the company’s 2QFY12 results to be anaemic. Nevertheless, we continue to be hopeful of tin price recovery in the medium to longer term as the reinstallation and refurbishment of electrical and electronic production facilities in Japan and Thailand following the massive earthquake and severe floods may give rise to a surge in demand for solder, and hence tin.

Maintain BUY. We continue to like MSC, especially since its participation in ASC marks an important milestone for the group in strengthening its foothold in the resource-rich African continent. This may also prompt its participation in the lucrative tin mining business in DRC. Although we believe the currently weak tin price movement may negatively affect MSC’s near term performance with a possible downward revision in earnings, we are compelled to keep our BUY recommendation given that our Fair Value of RM5.60 is mainly derived on a conservative DCF discount rate that is double the company’s actual WACC. The stable smelting business will continue to provide stable earnings and a stream of cash flow to the group.

Source: OSK