Declining tin prices have raised concerns over Malaysia Smelting Corp (MSC)’s earnings. We slash our FY12 tin price estimate to USD20,000 per tonne, which in turn leads to a 55.1% cut in MSC’s FY12 earnings estimates. However, despite the negative macro impact, MSC made efforts to expand its tin business in 1HFY12, including an extension on Rahman Hydraulic Tin’s (RHT) mining concession, striking a strategic agreement with an influential Indon partner to extend PT Koba’s Contract of Works (CoW), and establishing a presence in Africa. We are trimming MSC’s FV to RM5.50 following the earnings revision. Nonetheless, we still like the company’s future prospects and hence maintain our BUY call.
Lowering tin price, earnings assumptions. We had earlier warned investors of a potential earnings downgrade as tin prices fell on renewed concerns over Europe’s growing sovereign debt crisis. The current tin price of USD18,500 and 1HFY12 average of USD21,821 are significantly lower than our projection for USD24,000 a tonne. This prompts us to revise down our tin price estimate to USD20,000 and USD22,000 a tonne for FY12 and FY13 respectively. On top of the tin price revision, we also incorporate higher mining costs at PT Koba Tin as the sharp plunge in tin prices may have caught the company’s management off-guard. As the shift from a higher cost mining pit to one of lower cost one spurred by falling tin prices may take time and affect the company more severely, we are prompted to slash our FY12f earnings forecast drastically - by 55.1% - to RM39.5m.
On to better times Notwithstanding the declining tin prices, the company has actually made efforts to expand its tin business. In 1H, it made several announcements which were positive for the group’s long-term prospects, such as: i)extending RHT’s mining concession until 2030, ii) entering into a Strategic Alliance Agreement (SAA) with Optimus Synergy Limited (OSRL) to pursue the extension of its CoW in Bangka Island, and iii) JV with Mineral Mining Resources Ltd for a 40% stake in Africa Smelting Corp as a first step towards venturing into the Democratic Republic of Congo’s tin smelting industry. We are delighted with these developments as the company’s enlarged footprint in the tin market certainly puts it in a better position to capitalize on any tin price appreciation, which we are confident may happen anytime soon, riding on the recovering demand for tin soldering in the electronic industry.
Reiterate BUY, lower FV at RM5.50. We are toning downMSC’s FV to RM5.50 after the revisions in earnings and tin price estimates. That said, we still think MSC justifies a BUY recommendation. Given its ongoing expansion plans and solid fundamentals, the stock is still trading at a cheaper valuation versus its peers in China and Indonesia.
RECENT STRATEGIC UPDATES
Challenging yet fruitful period. Putting aside the negative macro outlook and concerns over the drop in tin price, MSC made several significant announcements in the past six months that helped strengthen its footing in the tin industry. These announcements were: i) extension of RHT’s mining concession, ii) entering into a SAA with OSRL, and iii) venturing into Africa’s tin smelting sector via a joint-venture agreement. We think that these moves may help to position MSC to ride a potential tin price appreciation. We are still confident that tin prices may recover anytime soon, in view of the possible recovery of demand in tin soldering in the electronic industry, which accounts for almost 50% of the world’s total tin consumption.
The joys of extending RHT’s concession. On 26 March 2012, MSC announced that it has extended RHT’s mining right concession from 2019 up to 2030. This is indeed a boon as the extension will allow the company to continue to tap into Klian Intan’s rich tin deposits for 18 more years. Based on the company’s latest annual report, RHT’s total tin resources as at 29 March 2012 are estimated at 41,092 tonnes, versus the previous estimate of 39,433 tonnes. Assuming that RHT is running at a capacity of 2,000 to 2,500 tonnes of tin metal per year, the mine can last up to 2030. The extension is on condition that MSC pays a royalty fee of 5% (previously 2.5%) of the selling price of tin-in-concentrate to the Perak state government. Although the royalty fee has doubled and will thus narrow MSC’s margins, we think the 11-year extension more than compensates for the higher royalty to be paid.
PT Koba Tin may turn around. On 9 March 2012, MSC entered into a SAA with OSRL to help it pursue an extension on PT Koba Tin’s CoW in Bangka Island. Upon the successful extension of the CoW, OSRL will subscribe for a 50% equity stake in Bemban Corporation Limited (BCL), a wholly-owned subsidiary of MSC, which will ultimately hold 75% equity stake in PT Koba Tin. OSRL’s 50% subscription in BCL will effectively result in it holding 37.5% of PT Koba Tin, while MSC’s stake will be diluted to 37.5%. Following another announcement on 4 July 2012, the addendum stated that upon successful CoW extension, OSRL will subscribe up to a 60% equity stake in BCL and effectively own 45% of PT Koba Tin while MSC’s stake in PT Koba Tin will be further diluted to 30%. Although the dilution in equity interest might seem negative to MSC’s bottomline, we have incorporated the worst-case scenario of a no-extension for PT Koba Tin’s CoW beyond March 2013. Meanwhile, we view the deal positively as it will enable MSC to comply with the Indonesia government’s new regulations, which stipulate that foreign investors can hold no more than 49% in mining companies. We believe this move will put PT Koba Tin in a better position to clinch the CoW extension for the Bangka Island mine. The estimated time-frame for completion is the third quarter of 2012, which may also suggest that the new partner may be confident of securing the CoW extension. This development is also in line with our view that PT Koba Tin may turn around in 2HFY12.
Enters a powerful partner. We learn from market intelligence that OSRL is connected to an influential figure in Indonesia, which indicates that MSC has actually found a strong and influential partner in Indonesia. We view this as positive. Just like other emerging markets, strong political ties are essential in operating a business in Indonesia.
Setting up shop in Congo. MSC is now directly participating in the tin smelting sector in the Democratic Republic of Congo (DRC) via Africa Smelting Corp (ASC), its joint venture company with Mining Mineral Resources (MMR). MSC’s 40% stake in ASC is worth a total investment of USD2.6m, while MMR holds the balance 60%. ASC is expected to commence production by end-2012 with total capacity of 3,500 tonnes per annum. Although the investment and the capacity are not significant, it nevertheless represents a victory for MSC as it now has access to a tin rich territory. We believe this could be the first and crucial step for MSC in expanding its presence in the tin market, and potentially secure mining rights from the DRC government.
EARNINGS REVISION
Metal prices, including tin, head south. Metal prices in the London Metal Exchange (LME) have been declining for the past six months, mainly due to renewed concerns over Europe’s sovereign debt crisis and the feeble recovery in the global economy. As shown in Figures 1 and 2, metal prices peaked in Jan and Feb this year and have retraced since then. Tin prices experienced the worst decline, plunging from the peak of USD25,500 per tonne in Feb 2012 to USD18,800 per tonne in July 2012. Tin has been range-bound between USD18,000 and USD20,000 per tonne in the past two months. The 1HFY12 average tin price of USD21,821 is significantly below our estimate of USD24,000 per tonne. Tin price at this level may potentially deepen PT Koba Tin’s losses and narrow the profit contribution from RHT. Thus, we expect the MSC’s 2QFY12 results to be anaemic. Having said that, we are revisiting the stock and making the necessary revisions to our earnings model.
Earnings revision from sensitivity test. As we mentioned in our initiation report, MSC's operations are very vulnerable to the production volume of tin and twice as sensitive to the movement in tin price. In view of the unfavourable tin price movement, we decided to run another sensitivity test on tin price vis-à-vis MSC's earnings. This time, we lower our tin price estimate for 2012 to USD20,000 per tonne but maintain the production volume. We also incorporate higher mining costs at PT Koba Tin. The sharp plunge in tin price may have caught management off-guard and efforts to shift from a high-cost mining pit to the lower cost one may take time. As such, we factor in a 55.1% downwards revision in FY12 earnings to RM39.5m, which is more severe than our earlier sensitivity analysis. We are also revising downward our tin price estimate for 2013 to USD22,000 a tonne from USD23,000 previously, as well as our FY13 earnings estimate. This is, however, higher than our estimate for 2012, as we expect tin price to rebound in view of a possible recovery in tin soldering demand in the electronics industry.
VALUATION AND RECOMMENDATION
Revising FV on adjusting earnings estimates. Following the downward revision on MSC's earnings estimate from RM88.0m to RM39.5m attributed to the significant weakening of tin price to levels below our forecast USD24,000, we are trimming our Fair Value for the stock to RM5.50 from RM5.60 previously. Our conservative valuation takes into account some of the assumptions below:
1) Assuming a moderate EBITDA contribution from its core business units (smelting facilities and RHT mining operation) in Malaysia.
2) The assumption that PT Koba Tin will wind up its mining operations after the expiry of its CoW in March 2013, with the group's effective interest in the unit remaining at 75%. We also slice off RM34.1m from our SOP as this amount represents the potential net loss to be borne by MSC in the event of non-extension of the CoW.
3) Excluding the potential earnings contribution from Africa Smelting Corporation.
4) Applying a discount of 11.6%, which is double the WACC for MSC, taking into account the poor liquidity in the counter plus the uncertainties surrounding the extension of the company’s mining operations and the award of other new mining assets.
Valuation still cheap. Compared to its peers, namely the world’s largest tin producer, Yunnan Tin in China, and the world’s third largest tin producer, PT Timah of Indonesia, MSC – being the world’s second largest tin producer - still looks cheap in terms of price-to-earnings and price-to-book value (see Figure 3). As at 1QFY12, MSC's net tangible assets (NTA) stood at RM4.18, which is 9.4% higher than the current trading price of RM3.82, while its balance sheet as at 1QFY12 remains solid, with a cash pile of RM200m.
Source: OSK
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