Timah, Target price Rp2,850

Spike in costs

What’s New
􀂃 We lower our forecast for Timah after its costs ran rampant. Production cash cost in 1H11 was US$22.1k/tonne, or 57% higher y/y. Cost overrun ate into margin that fell sharply to US$5.1k/tonne in 2Q11 from US$7.9k/tonne in 1Q11, despite similar ASPs.
􀂃 On the positive side, Timah successfully moved into the downstream business, generating Rp43b in revenue from selling tin chemical.

Our View
􀂃 Timah’s 1H11 production came mostly from inland mining (53%); in other words, production came from third parties at an elevated, LMElinked price. Meanwhile, at‐sea production cost also surged due to rising fuel price. Our back‐of‐the‐envelope calculation yields an offshore production cost of around US$20.4k/tonne, which is far
higher than the company’s guidance of US$12k/tonne.
􀂃 We do not believe that the higher cost would taper off in the near future. We think oil price would remain high going forward, despite the weakening global growth due to turmoil in the Middle East. Thus, fuel and lubricant costs that comprise ~50% of at‐sea and 30% of inland production costs are unlikely to go down.
􀂃 We welcome the company’s venture into the downstream business, especially tin chemical, as it is the fastest‐growing segment in the tin market. This niche market offers a better margin as the products are highly customised.

Action & Recommendation
􀂃 We cut our net profit estimates for Timah in 2011 and 2012 by 31% and 52%, respectively, following our higher cost assumption and our lower exchange rate assumption from Rp9,000/US$ to Rp8,650 and Rp8,285 in 2011 and 2012, respectively. We lower our TP to Rp2,825 (2012F PER of 12.1x), but maintain our BUY recommendation.

Cost ran rampant
In the company’s operating metrics, Timah acknowledged that the 1H11 production cost of US$22.1k/tonne was 57% y/y higher than the US$14.1k/tonne in 1H10. During the same period, crude oil price, a major cost component, climbed by 26% y/y in terms of the US$, while the Rupiah grew stronger by 5%. Margin was higher at 19.9% in 1H11 vis‐à‐vis 13.7% in 1H10, but down on a quarterly basis (17.5% in 2Q11 vis‐à‐vis 23.5%in 1Q11) due to higher freight expenses.

We think the culprit behind the surging cost is none other than Timah’s permissiveness towards illegal mining activities, resulting in a cost structure
that is tied to the LME tin price movement, thus capping its margin. As a comparison, Timah’s production margin was 40.4% in FY07 when ASP was just US$14.5k/tonne, compared to 19.9% at the ASP of US$29.5k/tonne in 1H11.

The company’s rising dependence on illegal miners is visible in its production figure: inland production once again contributes the largest chunk (53%) to its total production, despite the company’s vision that clearly delineates its intention to rely more on offshore (at‐sea) production where it considers the barrier to illegal miners is far higher. More over, there are already signs that illegal miners are increasingly encroaching upon Timah’s offshore operation: Timah’s annual report shows that the number of third party‐owned cutter suction dredgers working in its concession grew substantially last year to 50 units from 35 units the year before.

Timah’s guidance for offshore production cost is around US$12k/tonne. However, we do not think that the company can achieve its target anytime soon, if ever, not even when the company completes its new bucket wheel dredge. The reason is that its “partners” are now getting too big: the thirdparty production capacity of 60m cubic metres constitutes 57% of the company’s total offshore production capacity of 105m cubic metres. On paper, the company has ample offshore production capacity to selfproduce, as its offshore production level is only around 35m tonnes p.a.
However, we do not think the company has the willingness, or the ability, to play tough with the local miners, as the latter can always retaliate by selling to other smelters. Law enforcement is lacking and the regional government seems to have turned a blind eye on this practice. Against this backdrop, we now assume higher offshore production costs of US$19k and US$18k/tonne in 2011 and 2012 from our previous assumptions of US$14k and US$12.5k/tonne, and then gradually declining to bottom at US$15k/tonne, instead of our previous estimate of US$12k/tonne.

Moving to downstream – revenue contribution from tin chemical
Timah has started to recognise revenue from a new product, tin chemical, following the completion of the first phase of its tin chemical factory in November 2010. Revenue contribution in 1H11 is still minimal at just Rp43b, or 1% of its consolidated revenue. Tin chemical is used mostly as a stabiliser in the production of PVC: without a stabiliser, a chemical reaction that is inherent in the production process can cause the degradation in the quality of the PVC.

Tin chemical is also a product that is highly customisable, characterised by
hundreds of possible mixtures, including the level of tin content. We gather
that the tin content of the most‐consumed tin chemical is more than 20%, which can fetch a price of US$6k‐8k/tonne, which translates into a tin sales price of US$30k‐US$40k/tonne. Currently, tin chemical is the third largest consumer of tin in the world, with a global share of around 12% of tin consumption.

We think that there are good opportunities in this segment, as there is no single major producer controlling the market. With Timah’s dominant position in the upstream tin business and ample supply of sulphur, another essential material for tin chemical in Indonesia, Timah holds a major cost advantage over other tin chemical producers. We have not received guidance from the company on its margin expectation, but we estimate in our model that its gross margin would be at least 3% higher than the sale of tin bar/ingot. We expect the contribution from tin chemical for FY11 to be around Rp260b, or 2% of consolidated revenue, from selling 1k tonnes of tin in tin chemical at US$30k/tonne. We assume that sales volume would increase
gradually and reach 4k tonnes of tin in tin chemical p.a. by 2017. We have factored in Timah’s plan to set up another tin chemical plant with a production capacity of 20k tonnes pa in Bangka. Otherwise, Timah’s production capacity would be limited to just 10k tonnes of tin chemical, or only about 2k tonnes of tin in tin chemical.

source: KIMENG dated 15 September 2011