Eco-Friendly Smelters In Sarawak Set To Be Global Champions
We came away from our site visit to SIP feeling positive on the outlook of smelters
there. OM Holdings and Press Metal are among the prime beneficiaries that have a
significant advantage over global peers, given their access to eco-friendly low-cost
hydropower. Commodity prices may stage a reversal once the lockdowns in China are
eased, which will improve demand and support prices, backed by favourable supply-demand balance. Maintain OVERWEIGHT.
WHAT’S NEW
• Positioning to be global eco-friendly industrial park. Samalaju Indglobustrial Park (SIP)
is a part of the Sarawak Corridor of Renewable Energy (SCORE) initiative, which leverages
on the state’s abundance of low-cost long-term renewable energy. It is strategically located
close to Samalaju Port (deep-sea port), giving vessels easy access to global shipping
routes. Among the pioneers that have invested >RM25.3b to set up manufacturing plants
there are OM Holdings (OMH), Press Metal (PMetal), Sakura Ferroalloys, Malaysian
Phosphate Additives (MPA), Pertama Ferroalloys and OCIM. As they are from energyintensive industries such as ferroalloy and aluminium, operating at SIP puts them ahead of
their global peers in terms of power cost. The Bakun dam, coupled with more dams planned
in the coming years, will ensure a constant supply of cheap electricity in the long run.
• Expansion plan to boost earnings moving forward. OMH is currently running 12 out of
16 furnaces (six FeSi and six Mn alloy) as evidenced by our recent ground checks. The
conversion of two of the idle furnaces to produce manganese (Mn) alloys is expected to be
completed in 3Q22, targeting to produce an additional 100,000mt/year. OMH pivots towards
producing more Mn alloy because it offers: a) higher average returns per kWh consumed, b)
improved hedging ratio with ore, c) better supply-demand, and d) higher efficiency. A new
major steel plant, Wenan Steel, which is under construction in SIP, is set to be a major steel
manufacturer in the region once it is completed in 2024-25, producing around 10m mt per
year. This will boost further demand for OMH’s alloys in the future.
• Embracing volatility in 2022. After reaching new record-high prices in 1Q22, prices of
exported commodities have retraced to a lower range in 2Q22, mainly due to the weak
market sentiment caused by the fear of recession. This presents an attractive buying
opportunity entering 2H22, in anticipation of a recovery in commodity prices as inflation
expectations ease, US Fed hikes moderate and China fully emerges from lockdown. Hard
commodity prices will remain at the higher end of the historical range, supported by
favourable long-term structural supply-demand dynamics and the global decarbonisation
agenda. As Russia and Ukraine are the world’s second largest ferroalloy producers, the
prolonged conflict will support the ferroalloy prices further. Despite the lockdowns in China,
policymakers have highlighted efforts to stabilise the economy. This will improve demand
and help to support prices once the current restrictions are lifted in 2H22.
ACTION
• Maintain OVERWEIGHT as we expect the favourable structural supply-demand to support
the lofty commodity prices, especially after China gradually lifts its lockdown in 2H22. We
favour the ferroalloy, tin and aluminium segments as they are poised to post strong results
this year due to: a) elevated ASPs, b) improved production, and c) healthy demand. Most of
our target prices imply close to -0.5SD from historical mean PE (vs current share prices
trading between -1 to -1.5SD). Top pick: PMetal.
ESSENTIALS
• Remain selective in current economic landscape. Under our coverage, tin and aluminium
prices were impacted the most, declining to about US$32,000/mt (-6% mom, +3% yoy) and
US$2,500/mt (-14% mom, +9% yoy) respectively. FeSi and Mn alloy prices remain stable in
1H22 at US$2,000-2,300/mt and US$1,500-1,700/mt respectively. We believe prices will
remain elevated (at well above pre-pandemic levels) as structural supply shortage may
persist. In the midst of the global power crisis and increase in electricity costs, we believe
companies such as OMH and PMetal have a significant advantage over global peers given
their access to the eco-friendly low-cost hydropower in SIP.
• Clear cost price leader. Smelters like OMH and PMetal offer significantly lower costs than
their peers mainly due to the >20-year take-or-pay power purchase agreement with Sarawak
Energy. It provides them with 300MW of inexpensive hydropower. Generally, electricity
accounts for 40% of smelting cost. For OMH, we estimate electricity costs at US$0.04-
0.06/kwhr, with a 1.5-2.5% p.a. escalation, placing OMH in the lowest quartile for production
costs (fifth-largest FeSi producer, ex-China). A long-term low price for a key input places
OMH at the bottom of the cost curve, giving it a significant advantage over its peers,
enhancing its strategic position. Note that comparable smelters in China and Europe run at a
cost that can be 2x or 3x higher. The use of hydropower, solar panels and waste heat
recovery help to reduce their carbon footprint too.
• Diversification to ensure long-term earnings growth. OMH is also in the midst of
converting the remaining two idle furnaces to produce silicon metal (MetSi), which is
expected to be completed in 4Q22 (30,000mt/year). This marks OMH’s first step in
diversifying into the aluminium, chemicals and solar downstream industries in order to deliver
higher value-added products, which offer better margins. MetSi is typically used for
manufacturing microchips, steel and solar cells. The MetSi furnaces are expected to also be
able to produce FeSi for more flexibility in terms of product mix. Depending on the
grade/purity level, MetSi prices are currently hovering at US$3,000-4,000/mt vs. historical
average of around US$2,000/mt. The price trajectory and cost structure are similar to FeSi.
The only major difference is it commands 50% higher for power intensity.
• Ahead of global competitors. For Mn alloy, OMH is in the first quartile of the global cash
cost curve. We believe that over time, higher-cost producers like India and South Korea will
feel more pressure from the rising cost of domestic electricity. For China, its environmental
policy will force non-compliant smelters to shut down, further reducing supply. Moving
forward, low electricity cost will be the key differentiator and OMH together with PMetal stand
to be the beneficiaries of this factor. They also enjoy a tax holiday until 2022 and another
additional five-year exemption on 70% of their statutory income. These benefits will ensure
the sustainability of their margins vs peers’. OMH also plans to expand its smelting capacity
significantly, yielding an additional 150,000mt/year of Mn alloy by end-23 via bigger 2-4
33MVA furnaces. This can potentially put OMH among the top three largest Mn alloy
producers globally (ex-China).
• Consolidating control to boost profitability. OMH announced that it has entered into a
conditional share purchase agreement with Cahya Mata Sarawak (CMS) for CMS to sell its
25% stake in OM Sarawak to OMH for US$120m (RM525m). The deal is expected to be
completed by 4Q22. We believe it is a win-win deal for both CMS and OMH. The proceeds
can be reinvested by CMS to capture the growth opportunities within its core businesses. For
OMH, this will allow it to have full control (100% stake) of its smelting business in Sarawak
and will enhance its earnings further going forward. The deal will be earnings-accretive in the
long term and will solidify OMH’s position as a major ferroalloy player in the region. Due to its
hedging practice, OMH has locked in most of its sales volume in 1H22 at above
US$2,000/mt. OMH is also training local workers so as to reduce reliance on foreign workers
going forward. It has created about 1,700 jobs so far for its operation in Sarawak.