Malaysia Smelting Corp (MSC) posted a narrower core net loss of RM4.5m in 4QFY12, buoyed by a rebound in tin price that boosted RHT’s profit, higher production at its smelting plant, stronger associates’ contribution, and lower overheads at PT Koba Tin following a downsizing. However, this was partially watered down by higher provisions. The extension of PT Koba Tin’s Contract of Works (CoW) remains an overhang. As its disclosure of RM150m in potential impairment may shock investors and spark panic selling, we downgrade MSC to SELL, with a lower FV of RM2.77, based on 1xFY13 NTA.
No cheer from tin price boom. While MSC’s financial result did improve as we had anticipated, its 4QFY12 core-net loss of RM4.5m was still way below our expectation. The improvement was mainly attributed to i) average tin price rose to USD21,525 in 4Q or 11.6%/3.8% on q-o-q/y-o-y basis, thus improved the mining margin of Rahman Hydraulic (RHT), ii) its Butterworth tin smelting business recorded higher profit following the increase in production volume to 9,640 tonnes from 6,553 tonnes in 3Q, iii) associates recorded higher share in profit, and iv) downsizing of PT Koba Tin pending renewal of the CoW also helped to narrow losses. If not for PT Koba Tin making additional provisions in 4QFY12, we think MSC’s results could have been better. That aside, the company also made impairment amounting to RM15.2m for its investments this quarter.
Core operations to ride on tin price. Tin is again in the spotlight. Despite the recent consolidation, its price had surged some 30% 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 regulations will take effect. Wholly-owned RHT’s mining tonnage is projected to grow marginally over the next few years. Thus, the tin price rebound will certainly boost its bottomline. The operation of PT Koba Tin is still suspended, thus while it may not benefit from the price rebound, the lower overhead may taper its losses in 1QFY13. With a solid track record in operating custom smelting plants 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.
No cheer from tin price boom. While MSC’s financial result did improve as we had anticipated, its 4QFY12 core-net loss of RM4.5m was still way below our expectation. The improvement was mainly attributed to i) average tin price rose to USD21,525 in 4Q or 11.6%/3.8% on q-o-q/y-o-y basis, thus improved the mining margin of Rahman Hydraulic (RHT), ii) its Butterworth tin smelting business recorded higher profit following the increase in production volume to 9,640 tonnes from 6,553 tonnes in 3Q, iii) associates recorded higher share in profit, and iv) downsizing of PT Koba Tin pending renewal of the CoW also helped to narrow losses. If not for PT Koba Tin making additional provisions in 4QFY12, we think MSC’s results could have been better. That aside, the company also made impairment amounting to RM15.2m for its investments this quarter.
Core operations to ride on tin price. Tin is again in the spotlight. Despite the recent consolidation, its price had surged some 30% 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 regulations will take effect. Wholly-owned RHT’s mining tonnage is projected to grow marginally over the next few years. Thus, the tin price rebound will certainly boost its bottomline. The operation of PT Koba Tin is still suspended, thus while it may not benefit from the price rebound, the lower overhead may taper its losses in 1QFY13. With a solid track record in operating custom smelting plants 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.
KEY HIGHLIGHT
Spring cleaning of non-tin assets. The group has embarked on a vigorous diversification strategy in 2007 with the aim of transforming itself from a single commodity-focused business to a global resource-based organisation in the Asia-Pacific region in the metal and mineral space. However, following the massive credit crunch triggered by the 2008 global financial crisis, MSC’s board in 2009 decided to divest its non-tin business and refocus on its core tin business to strengthen its balance sheet by lowering its gearing ratio. Over the years, MSC has successfully disposed of most of its non-tin assets and recognised painful impairment and disposal losses.
Impairment after impairment, painful… We have highlighted in our recent company update dated 5 February 2013 that MSC’s investment in KM Resources (KMR) carries potential impairment risk. As expected, management has provided an impairment of RM6.6m in 4QFY12. While no elaboration was given on this impairment, we think the decision may have been made after the board considered its high book value of almost RM100m despite having ore reserves that can only support the current rate of production until mid-2014, or end-2014 at best. That aside, MSC also made another impairment amounting to RM8.6m in 4QFY12 for its investment in TMR Ltd, a unit which engages in off-shore tin mining. As MSC’s holding in TMR has dwindled over time, we suspect that the provision may easily be half the latter’s outstanding book value, hence we are not delving too much into this unit.
PT Koba Tin still an overhang? MSC has taken all efforts to extend the CoW, but the outcome is out of its hands. 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. Among others, MSC had in 2012 entered into an alliance agreement with Optima Synergy Resources Ltd (OSRL) on condition that the latter assists it in the CoW extension and subscribes to a 60% equity interest in BCL, its wholly-owned subsidiary which also holds a 75% effective interest in PT Koba Tin. Upon completion of the 60% subscription of BCL shares, OSRL will own 50% of BCL and effectively 45% of PT Koba Tin. This Indonesia unit has made additional provisions for mine rehabilitation, employees’ termination benefits, asset impairments and other rationalization in 4QFY12. The cash flow statement also showed a total outflow of RM32.8m being payment of deferred mine development, exploration and evaluation expenditure, payment for mining rights plus mine closure deposit.
Prepare for the worst for PT Koba Tin. With the official decision on it is still pending despite its contract expiry being just one month away, we prefer to incorporate for the worst case scenario. For the first time, management has disclosed in its financial note that non renewal of the CoW would have adverse impact on the company’s investment and contingent liabilities totaling approximately RM150m in PT Koba Tin. With this disclosure, we decided to factor in the potential impairment amounting to RM150m mentioned in the note to account, where MSC share for impairment based on its original 75% effective interest will be RM113m compare to our earlier estimates of only RM34m.
Downgrade to SELL. We are pleased with management’s efforts in seeking renewal for PT Koba Tin’s CoW. However, the outcome is obviously out of the company’s control and thus a major psychology barrier to any new investors until the issue clears up. That aside, the potential loss of approximately RM150m on non-renewal may also shock existing investors and spark a possible kneejerk sell-down on the stock. Although we remain bullish on MSC’s basic fundamentals and expect its core operation to return to the black in FY13, we are trimming our core profit projection by 10%/8% for FY13/FY14. In view of the potential panic selling, we are downgrading MSC to SELL, with our FV revised down to RM2.77 based on 1x FY13 NTA. All said, we think market’s overreaction to the latest results may represent a good buying opportunity to accumulate the stock at the lower level.
Impairment after impairment, painful… We have highlighted in our recent company update dated 5 February 2013 that MSC’s investment in KM Resources (KMR) carries potential impairment risk. As expected, management has provided an impairment of RM6.6m in 4QFY12. While no elaboration was given on this impairment, we think the decision may have been made after the board considered its high book value of almost RM100m despite having ore reserves that can only support the current rate of production until mid-2014, or end-2014 at best. That aside, MSC also made another impairment amounting to RM8.6m in 4QFY12 for its investment in TMR Ltd, a unit which engages in off-shore tin mining. As MSC’s holding in TMR has dwindled over time, we suspect that the provision may easily be half the latter’s outstanding book value, hence we are not delving too much into this unit.
PT Koba Tin still an overhang? MSC has taken all efforts to extend the CoW, but the outcome is out of its hands. 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. Among others, MSC had in 2012 entered into an alliance agreement with Optima Synergy Resources Ltd (OSRL) on condition that the latter assists it in the CoW extension and subscribes to a 60% equity interest in BCL, its wholly-owned subsidiary which also holds a 75% effective interest in PT Koba Tin. Upon completion of the 60% subscription of BCL shares, OSRL will own 50% of BCL and effectively 45% of PT Koba Tin. This Indonesia unit has made additional provisions for mine rehabilitation, employees’ termination benefits, asset impairments and other rationalization in 4QFY12. The cash flow statement also showed a total outflow of RM32.8m being payment of deferred mine development, exploration and evaluation expenditure, payment for mining rights plus mine closure deposit.
Prepare for the worst for PT Koba Tin. With the official decision on it is still pending despite its contract expiry being just one month away, we prefer to incorporate for the worst case scenario. For the first time, management has disclosed in its financial note that non renewal of the CoW would have adverse impact on the company’s investment and contingent liabilities totaling approximately RM150m in PT Koba Tin. With this disclosure, we decided to factor in the potential impairment amounting to RM150m mentioned in the note to account, where MSC share for impairment based on its original 75% effective interest will be RM113m compare to our earlier estimates of only RM34m.
Downgrade to SELL. We are pleased with management’s efforts in seeking renewal for PT Koba Tin’s CoW. However, the outcome is obviously out of the company’s control and thus a major psychology barrier to any new investors until the issue clears up. That aside, the potential loss of approximately RM150m on non-renewal may also shock existing investors and spark a possible kneejerk sell-down on the stock. Although we remain bullish on MSC’s basic fundamentals and expect its core operation to return to the black in FY13, we are trimming our core profit projection by 10%/8% for FY13/FY14. In view of the potential panic selling, we are downgrading MSC to SELL, with our FV revised down to RM2.77 based on 1x FY13 NTA. All said, we think market’s overreaction to the latest results may represent a good buying opportunity to accumulate the stock at the lower level.
Source: OSK
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