Smelting plant scrapped - 28 March 2012

Stock Name: NAIM
Company Name: NAIM HOLDINGS BHD

Research House: KENANGA

Price Call: BUY

Target Price: 2.94

It was reported that Rio Tinto and  Cahya Mata Sarawak have scrapped plans for aUSD2b (RM6.1b) aluminum smelter project in Sarawak as it could not agree on thecommercial  power supply terms withSarawak Energy Berhad. This will be an advantage to Press Metal's existingMukah smelting plant as it will have less competition from the other bigger playerthus. Given ASEAN and China's base consumption of c.17m tpy and Malaysia'sconsumption of c.250,000 tpy, we see a good potential for Press Metal given itsstatus as one of the only two players in the region to fill the demand. Onconstruction,  we opined that selectiveSarawakbased construction companies like KKB (Not Rated) will likely to be affected by this news as KKB is eyeing forthe 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-basedcontractors will be weak as most of the contractors are relying on SCORE as there-rating catalyst for their earnings growth. We maintain our Neutralrecommendation on the sector. 

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

Good for Press Metal(NOT RATED, TP: RM2.46).  WithSarawak Aluminum Company (SALCO - which is a 60:40 partnership between RioTinto-CMS) gone, it would be an advantage to Press Metal's existing Mukahsmelting plant as it will have less competition from the other bigger player.Aside from Salco, the other known proposed smelting projects locally is SmelterAsia, albeit the project is still at  itspreliminary stage. According to management, the average world demand growth foraluminium stands at 7% while China alone sees a 16% growth. Given ASEAN andChina's base consumption of c.17m tpy and Malaysia's consumption of c.250,000tpy, we see a good potential for Press Metal given its status as one of theonly two players in the region to fill the demand. Furthermore, China has also tightenedits policy on aluminium producers through suspending approvals for new smeltersand electrolytic aluminium. The country also has a higher electricity cost forits 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 Metalmanaged to sign a power purchase agreement (PPA) with Sarawak Energy for a longterm 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 hasalso recently secured two new offtake agreements with LG and Alcom for thesupply of billets and aluminium ingots aside from Japan's Sumitomo's 20% stakein both Phase 1 of the smelting plant, which has ensured a 20% offtakeagreement 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 thepotential beneficiary due to potential earnings visibility from its newsmelting plant. We value the stock based on the average sector PER of 10x andagainst our FY12 EPS forecast of RM0.25, this translates to a fair value ofRM2.46, which offers a 17.7% upside for the stock from its current level.

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

OTHER POINTS

Impact to constructionsector. We opine that selective Sarawak-based construction companies willlikely be the first to be affected by this news. Although there are no tangiblelosses to the contractors, the sentiments and prospects of Sarawak-basedcontractors will be weak. Most of the contractors are relying on SCORE as there-rating catalyst for their earnings growth. To recap, in 2011, KKB (NotRated) was awarded a contract worth RM70m from OM Minerals Sdn Bhd, a JVcompany between OM Holding and CMS (Not Rated). Other than that, KKB has 2ongoing water contracts in  the  Samalaju industrial  area  worth up  to RM300m. KKB is also mullingfor 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 tohouse  its Tokuyama and Asia Mineral'sworkers. At present, it has about 4000 acres of land to be developed in thearea. Bintulu Port (OP TP RM: 7.00) meanwhile is known to be activelyfinalising 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 andBintulu recommendations. We believe that the impact will be far muted toNaim and Bintulu with our view that KKB (Not rated) and HSL (Not Rated) will bethe likely immediate losers on the news. These companies are heavily relianceon marine construction works and pure contractor works. We are maintaining ourrecommendation on Naim (OP, RM: 2.94) and Bintulu (MP, TP RM: 7.00). 

Source: Kenanga