This article first appeared in The Edge Financial Daily on August 5, 2019

KUALA LUMPUR: After a long wait, Press Metal Aluminium Holdings Bhd shareholders can finally look forward to a third aluminium smelter plant in Samalaju.

Speaking to The Edge Financial Daily, the company said it intends to fund the new plant via borrowings and is in the midst of putting together funding plans.

“Total capex (capital expenditure) for the previous phase was approximately RM1.5 billion and we expect the cost for this new phase to be roughly similar,” a company spokesperson said.

The third plant will add 420,000 tonnes yearly — a 42% bump — to its existing annual capacity of 760,000 tonnes.

Analysts expect construction to begin next month and conclude in 11 months.

The long-awaited expansion comes as Press Metal inked a new power purchase agreement (PPA) with Sarawak Energy Bhd (SEB).

In a statement last Wednesday, Press Metal said the PPA will give it access to up to 500mw for 15 years. The drawdown for 300mw commences in October 2020 while the remaining 200mw will be made available on a “best endeavour basis”, it adds.

For perspective, half of its 500-acre (202.34ha) land in Samalaju is unutilised at present and both existing smelters have been running at full capacity since 2016. Each plant has an annual smelting capacity of 320,000 tonnes and consumes 500mw daily.

Procuring more power is essential for a third plant. However, concentration risk is understood to be a concern from SEB’s perspective. Press Metal already consumes 1,200mw under existing PPAs prior to the latest signing.

When contacted, SEB group chief executive officer Datu Sharbini Suhaili said its installed capacity at present stands at approximately 5,000mw while its reserve margin is at 34%.

He added that the 300mw commitment to Press Metal will come from existing generation capacity while the remaining 200mw will be on SEB’s “reasonable endeavour basis”.

“Yes, it (the supply to Press Metal) will involve a reduction of our current reserve margin,” Sharbini said via email.

It is worth noting that buying an additional 500mw will increase Press Metal’s consumption of SEB’s current installed capacity from 24% to 34%.

When posed the question, Sharbini said concentration risk is constantly monitored in general. “Press Metal has been performing well and the outlook of its market is healthy ... that mitigated our risk exposure.”

Apart from the Samalaju smelters, Press Metal’s other smelting plant is located in Mukah, over 200km away. The Mukah smelter’s annual capacity is 120,000 and it consumes 200mw daily.

The stock surged 6.8% last Thursday following the PPA signing, hitting a year-to-date high of RM4.86. Last Friday, it retreated by one sen to RM4.85 with a market capitalisation of RM19.57 billion.

The rally last Thursday reversed Press Metal’s one-year retreat into a slight advance of 2.28%, the second smallest gainer among FBM KLCI constituents over the past 12 months.

Power concern

However, a matter of concern to shareholders may revolve around the provision of power of the third smelter in Samalaju under the new PPA.

With only 300mw committed to and another 200mw on a “reasonable endeavour basis”, is there a risk that the third smelting plant may run under capacity for a prolonged period and possibly at a loss?

“We are confident about our cost structure as we operate in the first quartile of the production curve globally. Should there be any power constrain, we view it to be short term,” the Press Metal spokesperson said.

It is worth noting that back in 2014, Press Metal was also due for a two-stage drawdown of 330mw and 170mw respectively under a previous 500mw PPA. However, it was allocated the full 500mw upon first drawdown.

“We believe that our new smelter will run at optimum capacity as we are confident that the various ongoing power generating projects by Sarawak Energy Bhd will be completed on schedule,” the spokesperson said.

When asked when SEB expects to be able to commit to the additional 200mw, Sharbini said the targeted commitment is when the Baleh Hydroelectric Plant is commissioned.

Construction of the Baleh Hydroelectric Plant is currently ongoing, with targeted commissioning by 2025. It will add up to 1,285mw to SEB’s installed capacity.

As for Press Metal, market conditions are aligning with respect of its expected expansion after seeing its margins squeezed partly due to surging alumina prices in 2018. Alumina is a key raw material in the smelting process.

For the financial year ended Dec 31, 2018 (FY18), Press Metal reported RM618.93 million in net profit, up 4.3% year-on-year (y-o-y), as revenue grew 12.16% to RM9.17 billion — marking a net profit margin decline from 7.26% to 6.75%.

For the first quarter of FY19 (1QFY19), its quarterly net profit fell 23.51% y-o-y to RM115.11 million despite a 2.16% uptick in revenue to RM2.17 billion.

However, the company noted that prices of alumina — which typically comprises up to a fifth of production costs — had more than halved since its peak of US$707 per tonne in 2018 to US$301 (RM1,252.16) at present.

Prices of carbon anodes, used in aluminium reduction, have also declined, going from 4,300 yuan (RM2,575.59) to around 3,300 yuan presently, Press Metal added.

“With raw material prices normalising, production costs are expected to fall and margins to improve in the later part of 2019,” the spokesperson told The Edge Financial Daily.

Analysts are generally positive about the expansion plan itself, though five out of six tracking the stock retained a “neutral” perspective. Only Kenanga Research upgraded the stock to “outperform” after the PPA signing with a higher target price of RM5.50 versus RM4.55 previously.

In a report last Thursday, Kenanga Research estimated that the third smelter in Samalaju will boost earnings for Press Metal by RM39 million in FY20 and approximately RM240 million yearly from FY21 onwards.

“The new debt should raise gearing to 0.8 times in FY20 from our previous estimate of 0.5 times in the same forecast year. We deem this manageable given Press Metal’s excellent cash flow generation capabilities, as demonstrated by how rapidly the group pared down its gearing from 1.9 times in FY13 to 0.7 times in FY18,” it said.