Is Malaysia Smelting an investment opportunity?

Value Investing Case Study 55-1: A fundamental analysis of Malaysia Smelting to see whether it is a value trap or an investment opportunity.  

Is Malaysia Smelting an investment opportunity?
Over the past 6 months, the market price of Malaysia Smelting Corporation Bhd (MSC or the Group) has gone up by about 50%.

I was surprised as I had viewed the tin sector as a sunset one. In the 70s when I first started working, the tin mining industry in Malaysia was at its height. Tin mining companies were regarded as the top paymasters and getting a job in in such a company was akin to working for the top global Oil & Gas companies today.

But as tin in the ground in Malaysia began to run out, the fortunes of tin mining companies declined. I thought of MSC in this context. You can imagine my surprise to see the run-up in the share price. I wanted to know whether the interest in AI and EV has given the company a new growth path.


50% of the global tin production is used for soldering and tin is also used in the production of lithium batteries for EVs. You must have heard of the story that in a gold rush, you can make lots of money selling shovels and wheelbarrows to the gold miners.

Join me as I explore whether MSC is a significant beneficiary of the AI and EV rush. Sad to say, I think we have missed the boat as there is not enough margin of safety at the current market price.

Should you go and short it? Well, read my Disclaimer.  

Contents

  • Company background
  • Operating performance
  • Financial position
  • Valuation
  • Is MSC an investment opportunity
  • Conclusion
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Company background

With roots dating back to 1887, MSC is currently one of the world’s leading integrated producers of tin metal and tin-based products. MSC also holds a prominent position as the world’s largest custom toll smelter, offering external toll smelting solutions to customers with tin ore.

The Group is involved in the upstream and downstream sectors of the tin industry through tin mining and custom tin smelting. The Group strategy is as follows:

“At MSC, our priority is on enhancing our core capabilities in the smelting and mining divisions, ensuring we remain at the forefront of the tin industry irrespective of the volatility in tin prices.”  2023 Annual Report. 

In 2004, the Group acquired Rahman Hydraulic Tin Sdn. Bhd. (RHT). RHT operates the largest open-pit eluvial tin mine in Malaysia. Tin ore is extracted and refined into tin-in-concentrates, used as raw material for the Group’s smelting activities. 

The Group’s tin smelting activities are carried out via two smelting plants - one located in Pulau Indah, Port Klang, and the other in Butterworth, Penang.
  • RHT’s tin-in-concentrates comprise around 10% of the Group’s smelting intake. The remaining ores are sourced from local artisanal miners, international tin ore traders, and third-party mines outside Malaysia.
  • The state-of-the-art 60,000 tonnes of tin metal capacity plant in Port Klang operated at 60 % to 70 % average utilization in 2023. It uses the modern Top Submerged Lance furnace technology to convert primary, secondary, and often complex tin-bearing ores into high-purity tin metal for industrial applications.
  • The Group is in the process of winding down its smelting works in Butterworth which has been in production since 1902. The shutdown is planned to be completed by 2025. This will centralize all smelting activities at the Pulau Indah plant. 

In its 2021 Annual Report, the Group stated that it “…intends to gradually phase out production at the Butterworth plant, freeing up the land which it currently sits on. This will allow us to unlock the value of our 13.9 acres of land in Butterworth. Along with the adjacent 26.2 acres owned by MSC’s parent company…the combined 40.1 acres of land will be utilized for mixed commercial and residential development…”

The Group sees itself as an integrated producer of tin metal and tin-based products. In 2023, about 1/3 of its net assets were deployed for the tin mining operations. The smelting operations accounted for about 58% of the net assets with the balance under Others.
  • However, over the past 12 years, the tin mining operations contributed an average of RM 60 million to the PBT before inter-segment elimination. 
  • The smelting operations, with 3 years of losses accounted for an average of RM 15 million PBT. Refer to the left part of Chart 1. 

I find it strange that as a smelting company, the bigger earnings contribution came from tin mining. This tin mining operation that used 1/3 of the 2023 assets on average accounted for 4/5 of the PBT over the past 12 years (before Interco elimination).

It makes you wonder whether the smelting business is viable from a standalone perspective. This is especially true when the Group experienced declining smelting tonnage over the past 12 years. Refer to the right part of Chart 1. 

MSC Chart 1: Segment EBIT and Production before Interco elimination
Chart 1: Segment EBIT and Production before Interco elimination
Note: Before 2012/13, the Group had operations in Indonesia. But this was shut down in 2012/13. The 2012 to 2023 segment performance shown here does not include the Indonesia ones.

When you compare MSC shipment with global tin production, you can see that the MSC shipment trend is opposite that of the global tin output. Refer to the left part of Chart 2. From 2012 to 2023, 
  • The Group’s smelting shipment tonnage declined by 5.3 % compounded annually. 
  • Global tin production grew at 1.7 % CAGR.

I am of course assuming that all the tin produced would be smelted. While this is a back-of-envelope analysis, it does indicate that MSC probably has lost market share. 

Tin prices are cyclical as can be seen from the right part of Chart 2. This makes MSC a cyclical company. You can see that prices spiked in 2021/22 but have since declined. Despite its cyclical nature, there is a long-term uptrend in the tin price. 

MSC Chart 2: Global Tin Production and Price
Chart 2: Global Tin Production and Price

Operating performance

I looked at 2 groups of metrics to get a sense of where the business is heading. Refer to Chart 3.
  • The left part of Chart 1 tracks the trends of 3 metrics – revenue, PAT, and gross profitability (gross profits/total assets).
  • The right part of Chart 1 tracks the trends of 3 return metrics – operating return (NOPAT/total capital employed), ROE, and ROA.

You can see that revenue declined from 2012 to 2023. There was also hardly any growth in gross profitability. However, PAT had improved.
  • The loss in 2012 can be attributed to the Indonesian operations that were shut down in 2021/13. 
  • The loss in 2015 was due to “…Depressed tin prices coupled with volatile local currency movement in 2015…Included in 2015 pretax profit was…unfavourable stock valuation adjustment arising from a lower tin price as of end December 2015.”

Notice that the profit improvement in 2021 and 2022 coincided with the spike in tin prices (as shown in the right part of Chart 2. “Whilst our smelting division was affected by these supply chain issues, our mining division thrived on the back of stronger tin prices and higher output.”

MSC Chart 3: Performance Index and Returns
Chart 3: Performance Index and Returns

Returns

Given the profit trends, we see similar improving return trends. From 2012 to 2023.
  • Operating return averaged 8.1 % compared to the current 8.7 % WACC.
  • There was an average negative ROE compared to the current 10.1 % cost of equity.

From an overall perspective, the Group did not create shareholders’ value. This was because the average returns were lower than the respective cost of funds.

The average returns were also pulled down by the loss in 2012 due to the Indonesian operations. This led to low Operating returns and a negative ROE for the year. 

To get a better understanding of the operations, I broke down the operating profit into various components as shown in the left part of Chart 4. The gap between revenue and total cost (fixed and variable cost) represents the operating profit.
  • Contribution margin has been improving over the past 12 years. A large part of the improvements came in 2019 and 2021 driven by the tin mining operations. 
  • The Group operated with a low operating leverage. However, fixed costs had grown from an average of 4 % of the total cost in 2012/13 to an average of 7 % in 2022/23.

The shift from the Butterworth plant to the Port Klang plant is intended to improve processing efficiency and throughput. This shift started in 2020 but there is not enough history to see whether the improvement has been achieved. At this stage, there have yet to be signs of improving capital efficiencies.
  • Gross profitability had been declining. Looking at Chart 3, I cannot tell whether there has been a significant improvement from 2020 to 2023.
  • A DuPont Analysis showed declining asset turnover. Refer to the right part of Chart 4. While 2020 seemed to be the bottom, there is no clear sign of an upturn since 2020. 
  • While the contribution margin had improved since 2020, this was “distorted” by the price increases. 
MSC Chart 4: Operating Profit and DuPont Analysis
Chart 4: Operating Profit and DuPont Analysis
Note to Op Profit Profile. I broke down the operating profits into fixed costs and variable costs.
  • Fixed cost = SGA, Depreciation & Amortization and Others.
  • Variable cost = Cost of Sales – Depreciation & Amortization.
  • Contribution = Revenue – Variable Cost.
  • Contribution margin = Contribution/Revenue.

Prospects

According to Mordor Intelligence, the tin market is highly consolidated, with the five major producers accounting for more than 60% of the global market. 

In its 2023 Annual Report, the Group stated that 

“…we remain confident in the tin sector’s long-term outlook and promising growth…The role of tin in critical emerging technologies will continue to drive demand over time.
  • For 2024, the anticipated recovery of the semiconductor industry is set to boost usage…With 50% of the world’s tin used as solder, a rebound in the semiconductor sector is expected to support tin prices. 
  • Tin plays a crucial role in green transportation. Its potential use in lithium-ion batteries for electric vehicles is promising, with tin-based anodes being explored for their ability to increase battery energy density and charging speed. 
  • Tin is also an essential component in the renewable energy sector as it is used as solder ribbons that bind solar panels together, making it a vital player. “

But as shown in Chart 2, this is not a high-growth sector.

“The Tin Market size is estimated at 418.40 kilotons in 2024…growing at a CAGR of 2.59% during the forecast period (2024-2029).” Mordor Intelligence

“The global tin market size reached 406.8 Kilo Tonnes in 2023…exhibiting a growth rate (CAGR) of 1.2% during 2024-2032.” IMARC

Peer comparison

According to the International Tin Association, MSC ranked No. 4 in 2023 in terms of refined tin production. Refer to Chart 5. 

MSC Chart 5: Top 10 Tin Producers.
Chart 5: Top 10 Tin Producers. 

As such I compared MSC's performance with several global tin players: 
  • Minsur S.A. Minsur S.A. operates as a mining company exploring metals such as tin, gold, and ferroalloys. (Ref: MINSURI1)
  • Yunnan Tin Company Limited engages in tin production and processing activities in China. (Ref: 000960)
  • PT TIMAH Tbk engages in tin mining and smelting operations in Indonesia. (Ref: TINS)

You can see from Chart 6 that MSC's performance did not stand out in terms of return on capital or gross profit margin. 

MSC Chart 6: Global Peer Return on Capital and Gross Profit Margin
Chart 6: Global Peer Return on Capital and Gross Profit Margin

Summary

What are the key takeaways from the above analyses of the operating performance?
  • MSC is in a cyclical sector. Over the cycle, its returns did not create shareholders' value. 
  • This is not a high-growth sector. MSC did not achieve any revenue growth over the past 12 years.
  • While tin price spiked in 2021/22, it has come down by about half since then.
  • Although its main business is the smelting of tin, over the past 12 years, the bulk of the profits before tax was contributed by the tin mining operations. 
  • While it has begun to shift its smelting operations to a modern plant, there is no clear sign of improving efficiencies so far. 

Case Notes

There is a concept known as a company life cycle that refers to the various stages a business goes through from its inception to its eventual closure or transformation. 

While the specifics can vary depending on the industry and individual circumstances, the typical company life cycle consists of several stages:
  • Start-up
  • Growth
  • Maturity
  • Decline

The process is not inevitable as some companies find ways to rejuvenate themselves by innovating, restructuring, or finding new markets. 

This might involve launching new products or services, entering new geographic markets, or adopting new business models.

Understanding where a company is in the life cycle is important from a valuation perspective as it affects the projection of earnings. 

I normally play in the mature stage as I have problems projecting earnings for companies at the start-up or early growth stages. In this context, a company like MSC could be in the rejuvenation stage. I hope you can understand why I have provided 2 different valuation perspectives for MSC.

If you are a newbie, how can you tell which is which? One sanity check is to look at the view of other experts in the sector. One good source of such information is Seeking Alpha*.




Financial position

MSC has a strong Balance Sheet and Cash Flow from Operations. As of the end of Dec 2023, 
  • It had a debt-equity ratio of 0.45. This had reduced significantly from its 2012 debt-equity ratio of 2.21.
  • It had RM 266 million cash, equal to 19 % of its total assets.
  • It had an EBIT interest coverage ratio of 8.8. This is equal to an A1 (Fitch) rating based on the Damodaran synthetic rating approach. 

Over the past 12 years, its total cash flow from operations amounted to RM 501 million compared to its total PAT of RM 205 million. This is a very good cash conversion ratio.

It has a reasonable capital allocation plan as shown in Table 3.
  • Funds not reinvested into the business were either used to reduce debt or returned to shareholders as dividends. 
  • Over the past 12 years, the Group had a low Reinvestment rate of 2% (Reinvestment/NOPAT). This meant that a big part of the NOPAT could be used to repay debt or returned to shareholders.

I defined Reinvestment = CAPEX – Depreciation & Amortization + Increase in Net Working Capital. The low Reinvestment rate was because the were many years where the CAPEX was less than the Depreciation and Amortization. 

However, I have some concerns with the capital allocation plan in that the amount Reinvested has yet to show improving returns or capital efficiency. 

MSC Table 1: Sources and Uses of Funds 2012 to 2023
Table 1: Sources and Uses of Funds 2012 to 2023

Valuation

MSC is a cyclical company. According to Damodaran, when valuing cyclical companies, it is better to look at the normalized performance over the cycle. In the context of MSC and the tin cycle, the past 12 years' performance covered at least one peak-to-peak cycle. I estimated the Earnings Value of MSC on such as basis. 

At the same time, given its poor topline growth history, I used the Earnings Power Value – that ignored growth - as the Earnings Value. 

I estimated MSC’s Asset Value to be RM 1.80 per share and its Earnings Power Value (EPV) to be RM 1.62 per share. The market price as of 13 May 2024 was RM 3.05 per share. There is no margin of safety from both bases. Refer to Chart 7.

The low EPV is because it was based on the normalized performance over the past 12 years. I have shown that the past 12 years' results were not something to shout about. 

Note I have not taken into account the potential gain in the Butterworth plan given the group’s land development plan. The land is currently carried in its books at the 2018 value of RM 141 per sq ft. Assuming that MSC could achieve a gain of 1.5 times the book value, this is only equal to an additional RM 0.29 per share. 

MSC Chart 7: Valuation
Chart 7: Valuation

The Earnings Power Value was determined based on the average of 2 valuation approaches:
  • Free Cash Flow to the Firm model as per Damodaran.
  • Residual Income model as per Penman.

I used the past 12 years’ time-weighted values to determine the relevant inputs. The cost of equity of 10.1 % and WACC of 8.7 % was based on Damodaran’s build-up approach. 

To give you another perspective, Table 2 compares MSC on several valuation multiples with its international peers. I would not consider MSC cheap.

MSC Table 2: International Peer Valuation Multiples
Table 2: International Peer Valuation Multiples

Valuation based on improved process

MSC is relocating its smelting operations to a more efficient plant. As such using the past 12 years' historical data may not reflect the future improved performance.

To get a sense of the value given the improvements, I used the 2023 results as the base. If you look at Charts 2 and 4, you can see that:
  • The tin price in 2023 seems to be around the past 12 years' cycle average price. 
  • The 2023 contribution margin seems to exclude the 2022 price spike effect.

Assuming the 2023 performance represents the improved future, I obtained an intrinsic value of RM 3.08 per share. Refer to Table 3. While the estimated intrinsic value has gone up, I cannot get my 30% margin of safety.  

MSC Table 3: Turnaround case valuation
Table 3: Turnaround case valuation


There are 2 reasons why I am looking for a 30% margin of safety under the Table 3 model:
  • I valued MSC based on the operating model shown in the left part of Chart 4. This is an optimistic valuation as I assumed that there is a 4% perpetual growth rate.
  • I assumed that the 2023 better performance came from shifting the smelting operations to the new Port Klang plant. But I had shown earlier that the bulk of the earnings came from the tin mining operations. There is not enough data to separate the tin mining contribution from the smelting contribution. The combined data used in the model shown in Table 5 could be skewed by the tin mining operation. 

Is MSC an investment opportunity?

While MSC has been able to grow its profits over the past 12 years, this does not seem to be due to topline growth or improved operating efficiencies.
  • There was no revenue growth over the past 12 years. Smelting shipment tonnage had also declined. 
  • While the contribution margin improved, I could not attribute this to improving operating capital efficiencies. I am more inclined to attribute to the increase in selling prices over the past few years.
  • Selling prices spiked in 2022 but seem to be a one-off phenomenon rather than a sustained feature.

While the Group is in the process of relocating its smelting operations to a more efficient plant, there is yet not enough evidence that this can deliver significant operating improvements.

As such when valuing MSC, I look at it from 2 perspectives:
  • As a mature company whose performance is represented by its historical one.
  • As a company undergoing a renewal. 

My valuation under both bases did not provide a sufficient margin of safety. An investment opportunity is a stock that can enable you to make money. The key factor to consider is the margin of safety. In the context of MSC, I could not find any. As such I do not see this as an investment opportunity. 

Conclusion

The Group traced its roots to the 1902 smelting plant. You would be forgiven for thinking that this is a smelting company. 
  • In 2023, about 58% of the net assets were deployed for the smelting operations. 
  • Although all the tin produced by RHT was “sold” to the smelting operations, this accounted for only 10% of the tin used by the smelting operations.

But when you look at the PBT contribution, the bulk came from the tin mining operations. Unlike the smelting operation, the tin mining operation was profitable every year over the past 12 years.

From an earnings perspective, MSC is a tin mining company with a small smelting arm. If I valued MSC from this perspective, I would base it on a sum-of-parts approach where:
  • The value of the tin mining operation would be pegged to the tin reserves. This meant that there was a finite life to the operations.
  • Only the smelting operation would be valued with a perpetual cash flow.

However, in my valuation of MSC, I had assumed that all the earnings would continue in perpetuity. This does not reflect the primacy of tin mining which has a finite life. As such my estimated EPV of MSC is on the high side. Even with this, there is no margin of safety.

Before you undertake any valuation, you have to determine MSC’s business. Do you look at it from a net asset basis or do you look at it from an earnings perspective?
Throughout the article, I have taken the perspective that MSC is primarily in the smelting business. But is this correct?

Given this dilemma, you can understand why I would place MSC in the “too-hard-to-analyse” category and look for investment opportunities elsewhere. 




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