ANTAM – SELL Target price Rp1,830

Nickel price outlook improves. China’s PMI increased slightly in January, suggesting that the economy is on course for a soft landing. Demand for nickel will likely remain strong, and we raise our nickel price estimate to US$9.5/lb (from US$8.5/lb) accordingly. A weak US dollar is helping to reduce supply from countries such as Australia, whose strong currency is hurting competitiveness.

Ferronickel production exceeded target. Antam produced 19.7k tonnes of ferronickel, surpassing its target by 9%. This was made possible because Antam moved back the maintenance schedule for its FeNi 2 smelter to 2012. The smelter produced 6.3k tonnes vs. the initial planned production of 4.8k tonnes. Antam however expects that 2012 production will not stray far from its target of 18k tonnes.

Slow gold production ramp up. Gold production slipped 4% YoY to 2,667kg as the company failed to ramp up production at Cibaliung mine according to plan due to lower gold grade deposits encountered. Antam extracted just 680kg of gold from the mine in 2011 compared with a target of 1,797kg. Gold grades from Pongkor are already on the decline, and at best, Antam can expect flat production from the mine.

Uneven transition to downstream business. Antam has finally started construction on its 27k tonnes pa nickel processing facilities in Halmahera. But, due to a late start, Antam expects project completion only in end-2014 from initial target of early 2014. Given further possible delays and the required trial run, the plant would only be able to start producing in 2015, we believe. Since the export ban on raw materials will take effect in 2014, earnings for that year will fall sharply.

Target price raised, but downgrade to SELL. We raise our TP for Antam on a lower WACC to reflect a lower risk free rate and lower borrowing cost. We also make a potpourri of changes in our model, mainly to factor in higher costs and the one-year delay in FeNi Halmahera. The stock has rallied ahead of fundamentals, and we downgrade it to SELL with Rp1,830 TP (2012F PER of 10.4x).

Nickel price outlook improves
Soft landing in China. China’s manufacturing expanded modestly in January from a month earlier. PMI increased a tad to 50.5 from 50.3 in December, giving rise to the sentiment that the world’s second-largest economy is on course for a controlled descent despite falling asset prices and rising bad debts. The PMI readings in the US and Eurozone also show resilience in economic activities in these regions.

Stainless steel market not as weak as expected. Even though the European steel market was in the doldrums, strong growth in China lifted the global steel market into positive territory. Data from the International Stainless Steel Forum shows that stainless steel production in 9M11 was growing at 4% YoY to 24.18m tonnes. 3Q11 production fell 4% QoQ to 7.73m tonnes due to weak demand in Western Europe (-19% QoQ). But the situation is expected to change in 2012, with the industry expected to post positive, albeit small, growth for the year.

Weak US dollar might reduce global nickel supply. Bloomberg reports that BHP Billiton is scaling down its nickel operations in Western Australia by around 30% because of weak prices and a strong Australian Dollar. BHP produced 50.8k tonnes of nickel in 2011. This might only be the tip of the iceberg, as we think there are many other producers suffering the same fate, especially nickel pig iron producers in China, as their costs are high and operations are only borderline profitable even without a strong currency.



FY11 performance a mixed bag
Strong nickel production volume… Antam managed to exceed internal production targets for both ferronickel and nickel ore. Ferronickel production volumes rose 5% YoY to 19.7k tonnes, 9%
above target. The company moved back the maintenance schedule on FeNi 2 smelter to 2012, resulting in higher production from the smelter (6.3k tonnes from target of 4.8k tonnes). Nickel ore production volume was also 4% above target at 7.96m MT (+13% YoY).

… but the gold business failed to deliver. Antam’s gold business failed to achieve its target on the back of a slower production ramp up at Cibaliung mine, which produced just 680kg of gold vs. a target of around 1,800kg, due to lower-than-expected gold grades encountered.
This could be a problem, as Cibaliung had been expected to pick up the slack in gold production as production from Pongkor has hit a plateau due to declining gold grades.

Additional exposure to gold from refining business... Although its own gold mines are not performing as planned, Antam did not entirely miss the gold boom as it has additional exposure to gold from its refining business. The business tends to follow the gold price cycle, where demand picks up when gold price rallies, as was the case in 2011 where the volume of gold refined surged 41% YoY to 5,342kg.

…and from its JV. Antam owns a 17.5% stake in Nusa Halmahera Minerals (NHM), its JV with Newcrest (NCM.AU). NHM is among the lowest-cost gold producers in the world, with cash cost of only US$350- 400/T.oz (vis-à-vis Antam’s cash production cost of US$600-700/T.oz).
NHM produced ~463k T.oz of gold in 2011 (14,400kg), and is expected to maintain the same production level this year. Antam’s hypothetical share in the JV is thus ~2,520kg, or almost similar to its own production volume.

Coal business operating at a loss? Antam sold 364k tonnes of coal in 2011 from its recently acquired mine at Sarolangun, Jambi, and booked Rp78b revenue. The ASP looks extremely low at US$24/tonne for a coal with medium CV (5,300-5,500kcal/kg). At this level, the coal business is likely loss-making, as production cost should be in the region of US$35-40/tonne.

Execution risk is high, downgrade to SELL
FeNi Halmahera project started…. Antam commenced the construction of FeNi Halmahera nickel processing plant in late Nov 2011. The project is expected to cost US$1.6b, including a 260MW power plant which in our calculation will consume the company’s entire coal production from Sarolangun (1m tonnes). The plant has nameplate capacity of 27k tonnes of nickel contained in ferronickel, which will use ore feeds in the order of ~2.3m tonnes.

…but might be a little too late. Antam expects the project to be completed in late 2014. Factoring a trial run and further potential delays, we think 2015 is a more reasonable timeline to expect the plant to start commercial production. The delay will cost Antam sizable revenues, as the export ban on ore sales will be effective in early 2014. Antam booked Rp2.5t nickel ore sales in FY11, or 24% of its consolidated revenues.

We do not expect relief from contingency plans. Theoretically, Antam might be able to push the production at Pomalaa smelters to the maximum for a short period, as the three smelters combined have a design capacity of 26.5k tonnes. But this is a tall order for Antam, as the
company has never been able to produce anywhere close to this level in its history. Antam plans to modernise its facilities in Pomalaa, but we have doubts about its ability to finish the modernisation in time.

Running ahead of fundamentals, downgrade to SELL. We lower our WACC assumption to 10.0% from 11.2% previously to factor in a lower risk free rate and also lower borrowing costs after the successful issuance of Antam’s bonds. We also make a potpourri of changes in
our model, mainly to factor in higher costs and a one-year delay in FeNi Halmahera. We raise our TP to Rp1,830 (2012F PER of 10.4x) but downgrade our recommendation to SELL due to high execution risk, a heavy financial burden on existing projects, and limited growth potential in the near future.

Source: KIMENG dated 8 February 2012