PX (PHP11.44): BUY even with valuation changes

...from ATR Kim Eng Securities

What’s New

Changes in mineralogy, among others, led to milling costs going up even as recovery rates declined in Padcal mine, thus revenues and costs were negatively affected. 1H14 net income to common shareholders of PHP627m fell 42% YoY, much weaker than we expected. 

The pre-feasibility study results of Silangan mine indicate a viable project with payback in less than five years since cash operating costs are low at USD2.00/lb for copper and USD800/oz for gold. In the first five years of a 30-year mine life, costs are even lower at USD1.50/lb and USD500/oz, respectively, since grades are higher. However, throughput for the mine was placed at 15k tons per day, lower than the 30k we assumed in our model 

What’s Our View 

Management has undertaken cost-cutting measures and productivity enhancements in Padcal mine. But until we see concrete results we are downgrading earnings in 2014F to PHP2.3b (-29%) and valuation to PHP3.67/sh (-18%). 

The bank feasibility study for Silangan mine which will be the basis of mining operations still has to be submitted. For now, we are adopting PX’s assumption at the same time we lower our discount on Silangan to 35% from 50% as the mine’s viability has been affirmed. Consequently, our DCF-based valuation of Silangan is PHP12.31/sh (-3%). Based on SOTP, we value PX at PHP15.98/sh. 

Forecast and valuation changes in Padcal 

Philex Mining Corp’s (PX) 1H14 net income fell 42% YoY to PHP627m due to higher operating costs brought about by a drop in grades and the presence of more slime. Padcal mine used to yield ores which were predominantly bornite (high-grade copper). That changed this year to being predominantly chalcopyrite which contains lower-grade copper. The change in mineralogy affects the amount of grinding to produce the same volume of copper concentrate as before while the presence of slime suppresses recoveries. In effect, milling costs go up even as recovery rates decline, thus revenues and costs are negatively affected. 

This is clearly seen in 2Q14 when revenues dropped 13% YoY while operating expenses increased 7% resulting in a 43% plunge in net income to common shareholders of PHP374m. In 1H14 there was an even bigger increase in operating expenses due to remedial measures undertaken in 1Q14 to fix water intrusion and increase safety factors in operations. However, the impact was softened by the 38% increase in 1H14 revenues as it will be recalled Padcal mine resumed operations in April 2013. Still, net income to common slid 42% to PHP627m. 

Management is trying to mitigate the impact of these issues with cost-cutting measures and productivity enhancements. However, it may take time for concrete results so we downgrade our 2014F net income 29% to PHP2.3b and 2015F 13% to PHP2.7b. Taking these into account and increasing our risk-free rate 50bps reduces our DCF-based valuation of Padcal mine 18% to PHP3.67/sh. 

Silangan mine moves a step forward 

PX disclosed recently the pre-feasibility study results of Silangan mine which indicated a viable project with payback in less than five years since cash operating costs are low at USD2.00/lb for copper and USD800/oz for gold. In the first five years of a 30-year mine life, costs are even lower at USD1.50/lb and USD500/oz, respectively, since grades are higher. However, throughput for the mine was placed at 15k tons per day, lower than the 30k we assumed in our model which we believe is feasible. Apparently the lower figure is being used because this is the level PX has been operating Padcal mine. It was applied to Silangan mine even though Silangan contains richer deposits than Padcal. 

PX still has to submit the bank feasibility study which will be the basis of mining operations to be undertaken. It is still possible PX’s plan can change to assume higher throughput. However, until this happens we are adopting PX’s assumption at the same time we lower our discount on Silangan to 35% from 50% as the mine’s viability has been affirmed. Consequently, our DCF-based valuation of Silangan is PHP12.31/sh from PHP12.69/sh previously. 

PX valuation revised down, but still BUY 

Using sum-of-parts method, we value PX at PHP15.98/sh, the combined value of the Padcal and Silangan mines. With this as target price, potential upside is 40%, thus our recommendation remains BUY.