Copper price on the verge of breakout

UOBKayHian: LME copper price reached US$8,877/tonne (or US$4.03/lb) yesterday, an all time high based on closing price. The demand from China continues to grow rapidly while global miners are facing more challenges to maintain output level.

Chile is the biggest copper producer in the world, accounting for roughly one third of global copper output. However, Chile is about to face an energy shortage that may have a significant impact on the country's copper production. Reduced natural gas imports from Argentina and a drought that cut hydropower output may force Chile to ration electricity to major mining companies such as Codelco, Anglo American, and Freeport-McMoRan. Such power shortage could take a very long time to fix.Peru, the second-largest copper producer in the world, has serious labour disputes in its mining industry because workers are seeking a greater share of the record profits from mining companies. Peru's Mining Federation, a group that represents 28,000 miners, was reported to have called for a national strike on 12 May. Furthermore, LME inventory has plummeted by 42.5% from 201,000 tonnes at the beginning of the year to 115,575 tonnes recently, sufficient for less than three days of global consumption. Total global copper inventory available as monitored by LME, COMEX and Shanghai Futures Exchange is only 181,594 tonnes (or about 3.5 days of global consumption). The top two copper producers in the world could cut their copper output in the coming months while global copper inventory is falling to historical low level. Coupled with the depreciating US dollar, we believe copper price should breakout soon to the upside from the key resistance level of US$4.00/lb.
The major beneficiaries of the surging copper price are Zijin Mining and Jiangxi Copper as both have large copper reserves. Maintain BUY on both companies and OVERWEIGHT on the sector.

MyTake: We have a few stocks which deals with copper namely, Zijin-C1, Metrod, Leader (subsidiary Alpha) and Tawin. How will they perform with the increasing copper prices? Two of them warrant special mention. One, Zijin-C1, a covered warrant expiring 16/5/08. The conversion is 20:1 and exercise price is HKD10.90. The quoted mother share price in HK is only HKD7.91. As you can see, there is no incentive to buy the call warrant as it is does not have any value after conversion; unless the mother share goes up +HKD11.00.

The second stock is Metrod, a low profile but a fundamentally good stock involves in the procurement of raw materials, manufacturing and marketing of electrical conductivity grade copper wire rods and wires etc. Metrod is the largest producer of copper rods and wires in ASEAN while its subsidiary ASTA in Austria is a global market leader in the electrical transformer industry.The company is headed by its founder and major shareholder Lord Bagri who was formerly the Chairman of London Metal Exchange (LME) from 1993 - 2002.

Based on the unaudited accounts for 31st December 2007, the revenue is RM2billion, net profit is RM36.5million, eps is 60.86sen. Due to the increasing copper prices and higher fuel and electricity cost, Metrod is anticipated to face higher working capital and higher margin cost. According to the 2006 Audited Report, the high and volatile copper prices have increased the credit and pricing risks on copper book by customer. An encouraging fact to note from the Report is the company has a policy of not exposing itself to copper price fluctuations.

As per the Notes to the account, it noted: Copper raw material costs represent a significant part of total cost over the Group's product range. Copper, being a traded commodity, is by nature highly volatile and fluctuates significantly. The Group purchases copper raw material from its suppliers on the basis of London Metal Exchange (LME) copper price plus premium according to trade practice. These suppliers provide back-to-back hedging for the Group's sales to customers. A subsidiary company also enters into forward copper contracts to ensure back to back copper pricing for sales to its customers. Therefore, pricing risk is optimally managed allowing the Group to concentrate on its manufacturing activities without any market exposure in terms of copper price itself. Through the facility made available from its suppliers and market, the Group is able to manage various risks of quantity, delivery, pricing, currency and payment on a cost effective basis.

Metrod currently derived more than halve of its revenue from overseas market having established its presence in Malaysia, Europe, and China. The turnover for 2007 seems to have stalled and it has curently embarked its global expansion to India and the US with an estimated outlay of RM100million. The Company's balance sheet is strong but the capital expansion coupled with the increase in copper prices may stretch it further.The earnings per share has grown 260% for the last 6 years. The share price is currently trading at low 4.5x, dividend yield is 4.4% and net asset per share is RM3.76. Besides giving consistent dividend year since 1996 (2-7%), it is known to have dividend payout ratio of at least 23% every year. The main problem with this stock is that it is an illiquid stock (65-70% held by major shareholders), low profile and does not attract many retailer's and fund manager's attention. The potential risks for this stock includes execution risks for new capital expansion, possibility of lower demand as copper prices goes up or economy slows down and forex risks. However, this company at RM2.70 is very undervalued fundamentally(privatisation candidate etc?) due to the current poor market sentiment and its a buy for the longer term. If we ascribed a p/e multiple of 8, Metrod is worth RM4.80