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China Molybdenum (3993 HK) China M Ol Ybdenum China Materials 7 August 2019 China Molybdenum (3993 HK) China M ol ybdenum Target price: HKD2.75 Share price (7 Aug): HKD2.50 | Up/downside: +10.0% Initiation: once a red-hot metal, now cool to touch Dennis Ip, CFA (852) 2848 4068 Attractive play for cobalt market turnaround [email protected] Low-cost copper assets buoy earnings in a downcycle; M&A upside Tony Wu, CFA (852) 2848 4469 Initiating with an Outperform (2) and PBR-based TP of HKD2.75 [email protected] Investment case: We initiate coverage of China Molybdenum (CMOC), one Share price performance of the leading non-ferrous metal producers in the world, with an Outperform (HKD) (%) (2) rating. Due to oversupply in the cobalt market, CMOC’s share price 3.9 110 declined by more than 60% from its peak in 2018, and we now see an 3.4 98 3.0 85 attractive entry point for investors. We prefer cobalt over lithium, as we 2.5 73 expect the cobalt industry to re-enter a supply deficit in 2020E and lithium to 2.0 60 remain in severe supply surplus. Also, the cobalt price is below the incentive Aug-18 Nov-18 Feb-19 May-19 Aug-19 price, whereas the lithium price is 50% above the cost of production. China Moly (LHS) Relative to HSI (RHS) Low-cost copper assets less vulnerable to downcycle. Relative to peers, 12-month range 2.09-3.86 CMOC looks well placed to weather temporary copper-price weakness Market cap (USDbn) 6.89 thanks to its low-cost copper mine asset, which we see aiding profitability of 3m avg daily turnover (USDm) 7.79 Shares outstanding (m) 21,599 its copper business and helping maintain positive CF. We estimate its Tenke Major shareholder Cathay Fortune Corporation (24.7%) Fungurume Mining (TFM) (Democratic Republic of Congo [DRC]) and Northparkes (NPM) (Australia) copper mines are at the bottom 20% of the Financial summary (CNY) industry cash cost curve due to their high mine grades and by-product prices. Year to 31 Dec 19E 20E 21E Revenue (m) 21,995 22,977 23,759 Operating profit (m) 2,844 3,635 4,257 Strong balance sheet for M&A, proven record. Given its strong track Net profit (m) 2,077 2,530 2,961 record and balance sheet (ranked 3rd on quick ratio and 4th on net-debt-to- Core EPS (fully-diluted) 0.096 0.117 0.137 EBITDA ratio among the 13 largest global mining companies globally), we EPS change (%) (54.5) 21.8 17.1 see CMOC as well placed to undertake more value-accretive M&A and Daiwa vs Cons. EPS (%) (15.6) (10.6) (7.4) PER (x) 23.3 19.2 16.4 inorganic growth going forward amid currently weak commodity prices. Dividend yield (%) 2.3 2.8 3.2 DPS 0.051 0.062 0.072 Catalysts: Weak cobalt price well reflected. The price of cobalt has fallen PBR (x) 1.2 1.1 1.1 EV/EBITDA (x) 8.6 7.1 6.1 by 40% YTD to USD28k/tonne. Under our base-case scenario, we assume a ROE (%) 4.0 4.9 5.8 58% YoY decline to USD30.5k/tonne for 2019, and a 5% YoY hike to Source: FactSet, Daiwa forecasts USD32.0k/tonne for 2020E on the back of a deficit of 0.1-0.5% over 2020- 21E. Despite its healthy balance sheet and market-leading position, CMOC is trading at a 2019E PBR of 1.2x and 2020E PBR of 1.1x, a 40% discount to global peers’ 2x /1.9x, implying much of the downside risk is factored in. Moreover, we see a possibility of supply growth slowing further, leading to a wider deficit in the cobalt market and a potential upside surprise for cobalt prices, given: 1) the banning of child labour in artisanal mines in the DRC, and 2) a production halt at Glencore’s Mutanda mine and slow production ramp-up of new DRC mines. Valuation: Our 12-month TP of HKD2.75 is based on a 1.2x 1-year forward PBR (0.5SD below its 3-year average PBR of 1.5x) with a 2019E cobalt ASP of USD30.5k/tonne. Our 1.2x target PBR represents a 40% discount to the average 2.0x 1-year forward PBR of global mining companies. Risks: A larger-than-expected drop in cobalt prices; hike in royalties and profit tax rate; political and social instability in the DRC. See important disclosures, including any required research certifications, beginning on page 42 China Molybdenum (3993 HK): 7 August 2019 Table of contents Investment thesis ..................................................................................................... 6 Diversified mining portfolio with second-largest cobalt reserve in the world .... 9 Healthier market after the sharp cobalt price drop ...............................................13 Low-cost copper assets offer strong defensiveness in a downcycle .................19 Strong balance sheet to fuel M&A growth ambitions with a proven track record ...........................................................................................................24 Favourable molybdenum and tungsten demand- supply to provide price support near term .......................................................................................26 Financials .................................................................................................................28 Valuation ..................................................................................................................32 Investment risks ......................................................................................................36 Appendix ..................................................................................................................37 2 China Molybdenum (3993 HK): 7 August 2019 How do we justify our view? Growth outlook Valuation Earnings revisions CMOC: gross-profit breakdown Growth outlook The YoY rise in CMOC’s product ASPs in 2018 (40% for 12,000 300% molybdenum, 17% for tungsten, 15% for niobium, and 19% 10,000 for phosphate) contributed to a 16% YoY increase in its 200% 8,000 adjusted net profit for 2018. For 2019E, we forecast its gross profit margin to decline by 13.6pp to 24.0%, driven 6,000 100% by a 58% YoY decline in the cobalt ASP. Thus, we forecast 4,000 0% net profit to fall substantially by 54% YoY for 2019. 2,000 However, we forecast gross profit to expand by 16% YoY 0 -100% for 2020 and 11% YoY for 2021 as we see cobalt prices 2016 2017 2018 2019E 2020E 2021E stabilising, as the current price will likely drive out artisanal Molybdenum and tungsten Copper and gold supply and slow down the ramp-up of new mine supplies. Niobium and phosphate Copper and cobalt Others YoY This leads to our forecasts for 22% YoY net-profit growth Source: Company, Daiwa forecasts for 2020 and 17% for 2021. Valuation CMOC: 12-month forward PBR Based on a 1.2x 1-year forward PBR (0.5SD below its past PBR (x) USD/ton 3-year average of 1.5x), we derive our 12-month TP of 3.0 100,000 90,000 HKD2.75. Our 1.2x target PBR also represents a 40% 2.5x Avg+2SD 2.5 80,000 discount to the average 2.0x 1-year forward PBR of global 2.0 2.0x Avg+1SD 70,000 mining companies, given CMOC’s healthy balance sheet 60,000 and market-leading position of its respective product 1.5 1.5x Avg 50,000 40,000 offerings. 1.0 0.9x Avg-1SD 30,000 0.5 20,000 0.4x Avg-2SD 10,000 0.0 0 Jul-16 Jul-17 Jul-18 Jan-17 Jan-16 Jan-18 Jan-19 Mar-16 Mar-17 Mar-18 Mar-19 Sep-16 Nov-16 Sep-17 Nov-17 Sep-18 Nov-18 May-16 May-17 May-18 May-19 PB LME Cobalt - RHS Source: Bloomberg, Daiwa forecasts Note : Correlation of PB and cobalt price 0.87 Earnings revisions CMOC: Bloomberg consensus EPS forecast revision Since March 2018, the LME cobalt spot price has corrected by more than 70% on oversupply concerns. The (CNY) 0.40 Bloomberg consensus EPS for CMOC was revised down 0.35 significantly from March 2018 with 2020E EPS consensus 0.30 lowered by 65% since then. We believe the street has only 0.25 partially factored in the current cobalt price weakness and 0.20 hence has higher GPM forecasts as the cobalt price is 0.15 expected to recover in 2020E. Hence, our 2019/20E EPS 0.10 are 16%/10% below the Bloomberg consensus. That said, 0.05 we believe the share price has already reflected much of 0.00 the earnings downside given the over-60% share-price correction since its peak in March 2018. 2019E EPS 2020E EPS 2021E EPS Source: Bloomberg 3 China Molybdenum (3993 HK): 7 August 2019 Financial summary Key assumptions Year to 31 Dec 2014 2015 2016 2017 2018 2019E 2020E 2021E LME copper spot price (USD/ tonne) 6,862 5,494 4,863 6,166 6,521 6,350 6,500 6,600 LME cobalt spot price (USD/ tonne) 30,884 28,477 25,529 55,583 72,958 30,500 32,000 32,000 Copper sales volume (tonne) 43,760 39,964 59,798 248,756 200,240 197,000 201,500 209,000 Cobalt sales volume (tonne) 0 0 1,574 16,419 18,747 18,800 19,000 19,500 Profit and loss (CNYm) Year to 31 Dec 2014 2015 2016 2017 2018 2019E 2020E 2021E Molybdenum and tungsten 3,615 2,421 2,816 3,772 4,749 4,156 4,390 4,589 Copper and cobalt 0 0 1,296 13,845 14,374 10,194 10,700 11,196 Other Revenue 3,047 1,776 2,838 6,531 6,840 7,645 7,886 7,975 Total Revenue 6,662 4,197 6,950 24,148 25,963 21,995 22,977 23,759 Other income 0 0 0 0 0 0 0 0 COGS (3,871) (2,622) (4,624) (15,212) (16,180) (16,706) (16,852) (16,979) SG&A (422) (362) (696) (1,272) (1,030) (1,041) (1,024) (1,008) Other op.expenses (477) (323) (339) (446) (1,273) (1,403) (1,466) (1,516) Operating profit 1,893 890 1,290 7,217 7,479 2,844 3,635 4,257 Net-interest inc./(exp.) (113) 37 (212) (669) (625) (593) (590) (437) Assoc/forex/extraord./others 369 (244) 119 (1,166) 135 285 290 295 Pre-tax profit 2,148 683 1,197 5,382 6,990 2,537 3,335 4,114 Tax (348) 20 (171) (1,786) (1,840) (457) (734) (987) Min.
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