Malaysia Smelting Corp (MSC)’s share price continue to slide despite the 43.6% rebound in tin price from its recent bottom. As we reexamine the group, we found potential overhands in the extension of PT Koba Tin’s CoW and the high book value in KM Resources despite its depleting ore reserve. Though MSC has taken all efforts to address both issues, the outcome is out of its hands. Hence, we downgrade MSC to NEUTRAL, with our fair value tuned down to RM3.17. That said, any panic selling may represent a good opportunity to accumulate the stock at the lower level.
Tin price and mining op making a comeback. Tin is again in the spotlight, having climbed 43.6% since hitting bottom in July 2012. Meanwhile, Indonesia has issued new export regulations restricting the sale of refined tin with less than 99.9% purity or better, which, if implemented, will certainly tighten tin supply. However, we are unsure if the new regulation will take effect. Wholly-owned Rahman Hydraulic Tin (RHT)’s mining tonnage is projected to grow marginally in the next few years. Thus, the tin price rebound will certainly boost its bottomline. The operations of PT Koba Tin are still suspended, thus while it may not benefit from the price rebound, its lower overhead may taper its losses.
PT Koba Tin and KM Resources still overhang? We understand that all the terms and conditions for the extension for PT Koba Tin’s CoW, which expires on 31 March 2013, have been fulfilled. Nonetheless, the official decision on it is still pending. That aside, we suspect that the market is also concerned that MSC’s 30%-owned KM Resources (KMR) is holding a book value of above RM100m when its ore reserves are only able to support the current rate of production till mid-2014. MSC has taken all efforts to extend the CoW as well as to dispose or extend the life of KMR’s mine, but the outcome of both is out of its hands.
Downgrade to NEUTRAL, but… We remain bullish on MSC’s basic fundamentals, and expect its core-operation to return to the black in 4QFY12. Nonetheless, potential impairment in PT Koba Tin and KMR remain obstacles until it were finally cleaned up. We are downgrading MSC to NEUTRAL with our fair value revised down to RM3.17 based on 1x FY12 BV and subtracting RM1 a share to represent potential write-downs for both units. All said, we think that any panic selling on the non-renewal of CoW or impairment in KMR may represent a good buying opportunity to accumulate the stock at the lower level.
PT Koba Tin and KM Resources still overhang? We understand that all the terms and conditions for the extension for PT Koba Tin’s CoW, which expires on 31 March 2013, have been fulfilled. Nonetheless, the official decision on it is still pending. That aside, we suspect that the market is also concerned that MSC’s 30%-owned KM Resources (KMR) is holding a book value of above RM100m when its ore reserves are only able to support the current rate of production till mid-2014. MSC has taken all efforts to extend the CoW as well as to dispose or extend the life of KMR’s mine, but the outcome of both is out of its hands.
Downgrade to NEUTRAL, but… We remain bullish on MSC’s basic fundamentals, and expect its core-operation to return to the black in 4QFY12. Nonetheless, potential impairment in PT Koba Tin and KMR remain obstacles until it were finally cleaned up. We are downgrading MSC to NEUTRAL with our fair value revised down to RM3.17 based on 1x FY12 BV and subtracting RM1 a share to represent potential write-downs for both units. All said, we think that any panic selling on the non-renewal of CoW or impairment in KMR may represent a good buying opportunity to accumulate the stock at the lower level.
KEY HIGHLIGHT
Tin price surge. Tin is again under the spotlight at the start of 2013, having gained 5.9% in the first month of the year to USD24,770 a tonne. This metal has climbed 43.6% since hitting bottom in July 2012. The sharp and quick rebound from last summer’s low can largely be attributed to Indonesia reducing its refining capacity. Indonesia top producer, PT Timah, guided a lower 2012 production. Peru’s 9M12 tin production has also slid by 10.5%. Meanwhile, Indonesia has issued new export regulations restricting the sale of refined tin with less than 99.9% purity or better from 1 July 2013. Enforcement of the new restriction will certainly tighten the supply of this base metal but we are unsure if it will be eventually imposed as many of the smelters in the country are not ready to comply with this new standard. We are keeping our conservative tin price assumption of USD22,000 for 2013, USD21,000 for 2014 and a stable USD20,000 a tonne from 2015 onward.
Cheer for tin mining op. The profitability of MSC’s tin mining operation is very sensitive to fluctuations in tin prices and production volume given that its mining costs are essentially stable, with a small correlation to tin price. Wholly-owned subsidiary Rahman Hydraulic’s mining tonnage is set to stabilise with a projected marginal growth in volume for the next few years; thus the rebound in tin price will certainly boost its bottomline. Tin price had averaged at USD19,280 in 3Q12 and then risen to USD21,525 in 4Q12, or up by 11.6% q-o-q. On the flip side, MSC’s management had halted PT Koba Tin’s operations since November 2012 pending its Cow renewal. Hence, this unit may not enjoy any upside from higher tin price for the moment. Nevertheless, we think the suspension of the Indonesian operation, and thus lower overhead expenditures, may eventually lead to its losses narrowing from that suffered in 4QFY12.
Last hour extension for PT Koba Tin’s CoW? With MSC’s share price continuing to slide despite the sharp rebound in tin price, we decided to reexamine the company. We think PT Koba Tin CoW’s extension will be the first risk that pops up in the minds of investors, especially in view of it impending expiry now counted by weeks – the CoW is slated to expire on 31 March 2013. We understand from our market source that the application for the extension, together with the terms and conditions imposed, have all been fulfilled. Nonetheless, official decision from the Indonesian government is still pending. We have since our initiation assumed that there will be no extension for PT Koba Tin’s CoW and accounted 50% of the unit’s net asset value, or RM34.1m or merely 34.1 sen per share (ex-minority interest and assumption of potential tax credit/claw back for the loss), as the potential write-down in FY13. The market may have been expecting a possible larger write-down for PTKoba Tin in the event of non-extension of CoW.
Last hour extension for PT Koba Tin’s CoW? With MSC’s share price continuing to slide despite the sharp rebound in tin price, we decided to reexamine the company. We think PT Koba Tin CoW’s extension will be the first risk that pops up in the minds of investors, especially in view of it impending expiry now counted by weeks – the CoW is slated to expire on 31 March 2013. We understand from our market source that the application for the extension, together with the terms and conditions imposed, have all been fulfilled. Nonetheless, official decision from the Indonesian government is still pending. We have since our initiation assumed that there will be no extension for PT Koba Tin’s CoW and accounted 50% of the unit’s net asset value, or RM34.1m or merely 34.1 sen per share (ex-minority interest and assumption of potential tax credit/claw back for the loss), as the potential write-down in FY13. The market may have been expecting a possible larger write-down for PTKoba Tin in the event of non-extension of CoW.
Risk in KM Resources? Other than PT Koba Tin extension, we are struggling to find other major risk for the group. MSC initiated a divestment programme for non-tin investments and assets, including equity interests in various other entities, which are engaged in the production of nickel, copper, gold and coal. Reading between the lines, we notice there is one more key investment in non-tin business that has been seating on the group’s balance sheet. MSC still holds a 30% stake in KM Resources (KMR) which is mainly involved in polymetalic mining (copper, gold, zinc and silver) in the Philippines. As revealed in its annual report, the company has a book value of RM145.7m as at 31 Dec 2011 but its remaining ore reserves can only support the current rate of production until mid-2014, or end-2014 at best. Investors at the back of their minds considered this a key risk. Nonetheless, our cross-check with a reliable source suggests that the book value of this investment has since reduced to slightly above RM100m after its progress amortization. Apart from that, feasibility studies are being undertaken to explore the option to mine gold resources at an adjacent site that could sustain production for at least another year. Also, the mine tailings, and considering the especially high gold price, this may also justify the substantial value that may have supported its high book value. Therefore, we think any write-down in this investment may not be substantial in view of the current high gold and copper price.
Butterworth smelting plant a cash cow. With a solid track record in operating custom smelting plants for over a century since 1887, we expect MSC’s smelting plant in Butterworth to continue contributing positively to the group unless a perfect substitute for tin is found. Meanwhile, we are conservative in our projections for the final refined tin produced by MSC’s key plant. We expect an almost flat production in 2012 at 40,250 tonnes and a marginal increase of 1% in the following years before hitting a peak of 42,000 tonnes in 2017 (see Figure 4). As we are aware that the smelting margin in FY11 was extraordinary, we have decided to make a one-off reduction from the previous year. In light of the combined forces of higher volume, gradual reduction in tin prices and nominal growth in smelting margin, we assume that its Butterworth’s plant EBITDA at RM67.8m in FY12 and expect it to improve to RM75.4m in FY13.
Butterworth smelting plant a cash cow. With a solid track record in operating custom smelting plants for over a century since 1887, we expect MSC’s smelting plant in Butterworth to continue contributing positively to the group unless a perfect substitute for tin is found. Meanwhile, we are conservative in our projections for the final refined tin produced by MSC’s key plant. We expect an almost flat production in 2012 at 40,250 tonnes and a marginal increase of 1% in the following years before hitting a peak of 42,000 tonnes in 2017 (see Figure 4). As we are aware that the smelting margin in FY11 was extraordinary, we have decided to make a one-off reduction from the previous year. In light of the combined forces of higher volume, gradual reduction in tin prices and nominal growth in smelting margin, we assume that its Butterworth’s plant EBITDA at RM67.8m in FY12 and expect it to improve to RM75.4m in FY13.
VALUATION & RECOMMENDATION
4QFY12 core-numbers likely black. MSC is still seeing core-loss of RM39.4 in 9MFY12, but we expect the group to record a core profit for 4Q hence narrowing its full-year loss. Among which, we are projecting, i) RHT to rack in higher contribution on the back of 11.6% increase in tin price q-o-q, ii) the Butterworth smelting plant recording constant operating earnings, especially with its production volume set to recover from its 3Q low, iii) PT Koba Tin to report a smaller loss owing to its effort to halt the production and slash overhead costs, iv) the associated – KMR also may contribute positive earnings on the back of escalating copper and stable gold price, and v) some stock valuation gain with the higher tin price q-o-q albeit this is not operational and non-recurring in nature. Meanwhile, we make no change to our core-number projections.
Potential write-down the major moving obstacle… Although we are bullish on MSC upcoming 4QFY12 results, we think management will make the decision on any risk of non-extension in PT Koba Tin. As there is no precedent to any mine closure following a non-extension of the CoW and as the information on PT Koba Tin is limited in view of it being a private company, we are unable to make a proper evaluation on the actual damage the ceasing of this Indonesian unit may potentially cause to MSC. That aside, we are also uncertain whether the management will make any impairment on its investment in KMR, in particular its proven resources, may come to an end as soon as mid-2014.
Stumbling blocks to the cheap valuation? Tin has an annual world consumption of only 366,400 tonnes in 2011, with almost 70% produced by the top 10 smelters and thus, MSC has not many direct peers. Although MSC is the second largest refined tin producer in the world, we find its valuation, be it on a book value or PER basis (expect FY12 that we expect MSC to record a loss) (see Figure 2), a lot cheaper relative to the other players in the top three list. We reckon MSC has the smallest income base among its peers because of its smaller income stream from its tin mining activities. Nonetheless, we think the major reasons behind its cheap valuation may have been attributed to few write-downs made to its divestment efforts over the past years. We suspect the pending CoW extension on PT Koba Tin CoW and KMR, being non-tin cum short-life mining asset, may concern investors in view that that both still have high book values in its balance sheet. Thus, we believe the aforementioned two issues to be last two hurdles to a re-rating.
Downgrade to NEUTRAL, but… We remain bullish on MSC’s basic fundamentals; more so if the group can finally obtain the CoW extension for PT Koba Tin or at least mitigate the damage from the ceasing of this unit’s operations. While management has indicated its intention to dispose of KMR, we are looking forward for more disclosure, including a concrete plan, and financial as well as operating numbers. Any further impairment on PT Koba Tin and KMR may result in kneejerk selling. Thus, we have decided to downgrade MSC from Trading BUY to NEUTRAL, with our fair value revised downwards to RM3.17 based on 1xFY12 BV and subtracting RM1 a share to reflect potential write-downs in both investments. All said, we would like to emphasis that the non-renewal of CoW for PT Koba Tin or further impairment in KMR may represent a good opportunity to buy MSC at lower level. Look to accumulate as some panic investors may be throwing the stocks in the open market.
Source: OSK
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