Copper-bottomed investment
Wroclaw University of Economics
Marta, Katarzyna, Kamil, Jan, Piotr
London, April 2013
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Introduction
Market profile Ticker(Bloomberg) KGH:PW
52-week price range (PLN) 111.4 – 194.5
2012 dividend yield 24.2%
Market capitalization (USD bn) 12.1
Average daily traded value (USD mn) 40.6
Free float 68%
Share in WIG 20 14.3%
P/E2012 7.5
State Treasury
32%
23%
39%
6%
Other Diluted
68%
State Treasury Polish institutional investorsForeign institutional investors Individual investors
Shareholder structure
2013 HY report July 30, 2013
Strategy update Mid-2013
New projects update Mid-2013
Forthcoming Events
Main features 9th copper producer globally
1st silver producer globally
4th resource base in the world
High quality products
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Recommendation
Key drivers
Robust pipeline of new projects (58% increase in
production volume by 2017)
Increasing operational efficiency (EBITDA margin
increase from 35% in 2012 to 45% in 2017)
Stable market conditions
Sound financial position (USD 6.4bn Balance sheet
headroom)
Holding period return
End of 2013 End of 2014 End of 2015
27% 39% 56%
Upside: 18.6%
Target price: PLN 220
BUY
Recommendation
80
100
120
140
160
180
200
220
240
Feb/
12
Mar
/12
Apr/
12
May
/12
Jun/
12
Jul/1
2
Aug/
12
Sep/
12
Oct
/12
Nov
/12
Dec/
12
Jan/
13
Feb/
13
Target price (12 M) Current price (at 15-Feb-13) Closing price
18.6% upside
PLN 220
PLN 185.5
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Limited risk of Quadra’s acquisition
Quadra’s experience in M&A
Know-how regarding open pit mines
Strong financial position of KGHM before acquisition
Takeover price < NAV
1961 Establishment of
KGHM
1997 IPO on Warsaw Stock
Exchange
2010 Afton-Ajax – first overseas
expansion project in Canada
2012 Acquisition of Quadra FNX Mining Ltd -
Friendly takeover through Plan of Arrangement
Business description
New projects in business-friendly countries
Exhaustive due-diligence prior to acquisition
Positive updates
Strict monitoring
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Business description
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Business description
Specification High operational leverage - strong labour
unions, underground mines conditions Revenues dependent on copper price and
USD/PLN exchange rate – effective hedging strategies
Foreign operations contribution to EBITDA
0
2
4
6
8
10
12
2012E 2013E 2014E 2015E 2016E 2017E
EBITDA (PLN bn) KGHM EBITDA (PLN bn) KGHM International
Industry overview & competitive positioning
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
012345
Threat of NewEntrants
BargainingPower ofBuyers
Threat ofSubstituteProducts
Competitionin the
Industry
BargainingPower ofSuppliers
Industry overview
Key copper market characteristics
High entry barriers
Low product differentiation
Lack of copper perfect substitutes
Individual copper producer as price-taker
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
6000
11000
16000
21000
26000
31000
2011 2012 2013E 2014E 2015E 2016E 2017E
'000t Copper surplus expected
Base Case Mine Output Highly Probable ProjectsProbable Projects Possible ProjectsDemand For Mine Output
0
2000
4000
6000
8000
10000
1999 2002 2005 2008 2011 2014E 2017E 2020E
USD/t Copper price decrease
2012 KGHM cash extraction cost
Industry overview
Source: World Bank Commodity Price Forecast Source: Wood Mackenzie
-15%
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
0
2000
4000
6000
8000
10000
1999 2002 2005 2008 2011 2014E 2017E 2020E
USD/t Copper price decrease
2012 KGHM cash extraction cost
Industry overview
Source: World Bank Commodity Price Forecast
-15%
QE1* QE2**
Copper 108% 20%
Silver 64% 81%
*(11/2008-03/2010) ** (08/2010-06/2011)
QE positive effects on copper and silver prices
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
35.2 31.6
BHP Billiton Anglo American
KGHM
KGHM vs. Competitors
Codelco Southern Copper
Freeport McMoRan
Xstrata Rio Tinto
RAO Norilsk Antofagasta
1 2 3 4 5 6 7 8 9 10
93.2 58.2 55.8
18.1 17.0 9.1 8.9
Resource base Quadra acquisition (mn t)
after
37.5
0.0%
0.5%
1.0%
1.5%
2.0%
0
20
40
60
80
SCCO FCX KGHM ANTO FM KAZ
KGHM best quality of ore
Copper base in2011 mn t(LHS)
Ore grade in2011 (RHS)
0%
20%
40%
60%
EBITDA margin 2012E NI margin 2012E
In line profitability
KGHM
peers' median
Source: Company data
0%
20%
40%
60%
80%
2008 2009 2010 2011
Persistently higher ROE
KGHMROE
peers'medianROE
Financial Analysis
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
International expansion improves financial position
CapEx will translate into production
Source: Team estimates, Company data
CapEx vs. production
Cash extraction cost vs. EBITDA
0
500
1000
1500
2000
2500
3000
25%
30%
35%
40%
45%
50%
2012E 2013E 2014E 2015E 2016E 2017E 2018E
Cash extraction cost in $/t (RHS) EBITDA margin (LHS)
KGHM will significantly increase its pipeline
Falling cash extraction cost will improve EBITDA margin
300,000
400,000
500,000
600,000
700,000
2013E 2014E 2015E 2016E 2017E
Victoria Afton-Ajax
Sierra Gorda
Carlota
Franke Robinson
McCreedy West
Domestic production
Morrison
Detailed copper production in t
0
100
200
300
400
500
600
700
0.00.51.01.52.02.53.03.54.04.5
2013E 2014E 2015E 2016E 2017E
CapEx in PLN bn (LHS) Production in kt (RHS)
Domestic
USD/PLN rate = 3.30
Sierra Gorda
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
High debt capacity for possible further expansion
CFO breakdown 2013E
CFOs will cover expenditures and high dividends The least indebted mining company among its peers Net debt/EBITDA at low levels Possible easy access to debt in case of new big projects/acquisitions
8.03
4.09
3.09
0.85 0123456789
CFO CapEx Dividends Surplus
PLN bn
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
2012E 2013E 2014E 2015E 2016E 2017E
Net debt/EBITDA
PLN 20 bn Balance
sheet headroom
0
10
20
30
40
50
60
70
0%
20%
40%
60%
80%
100%
2012E 2013E 2014E 2015E 2016E 2017E
Debtratio(LHS)
Interestcoverageratio (RHS)
Debt ratio and interest coverage
Net debt/EBITDA and balance sheet headroom
USD/PLN rate = 3.30
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Attractive dividend policy, unique in copper sector
Dividends per share and payout ratios of KGHM
0
5
10
15
20
25
15% 25% 35% 45% 55% 65% 75%
DPS
Payout ratio
Median 2007-2012
2015
2017
Estimated median dividend per share in period 2013E-2017E at level of PLN 16.91 Estimated median payout ratio in period 2013E-2017E at level of 62%
0%
5%
10%
15%
20%
25%
30%
2008 2009 2010 2011 2012
Dividend yields in period 2008-2012
Median=11%
PEERS
Valuation
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
P/E EV/EBITDA
PLN 247.5
50% 50% 50% 50%
50% 50% Weights for multipliers
Weights for years
2014 2013 2014 2013 Forward years
13.6 10.9 6.0 5.1 Multipliers’ values
Multipliers
Multipliers pricing
At least 75% of revenues derived from copper sales
Total revenues of at least USD 5bn
Copper sold produced primarily from own resources
Peer group selection criteria
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Multipliers pricing
0.00.51.01.52.02.5
KAZ
KGH
FM FCX
ANTO
SCCO
Peer group beta – higher KGHM’s systematic risk
0
100
200
300
400
500
2007 2008 2009 2010 2011
Mined copper production (kt) - no organic growth in the past
5
10
15
LSE TSX NYSE WSE
P/E on selected exchanges
-50% Historical discount
Impact of the State Treasury
?
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Multipliers pricing
5
10
15
LSE TSX NYSE WSE
P/E on selected exchanges
-50% Historical discount
0
200
400
600
800
2012 2013 2014 2015 2016 2017
KGHM KGHM Int.
Growth in production (kt)
Poland
Canada USA
Chile
Diversification
Impact of the State Treasury
?
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Multipliers pricing
-50% Historical discount Impact of the State Treasury
-20% Discount
Chemicals
Energy coal
Industrial metals
Electricity
Insurance
Banks
Oil
International competitors
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
50% 50% 50% 50%
50% 50%
PLN 247.5
Weights for multipliers
Weights for years
Final price
13.6 10.9 6.0 5.1 Multipliers’ values
2014
P/E EV/EBITDA
2013 2014 2013 Forward years
Multipliers
Multipliers pricing
-50% Historical discount
-25% -20% -25% -20% Applied discount
10.25 8.8 4.6 4.1 Adjusted multipliers
PLN 192.1
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
0%
5%
10%
15%
20%
25%
30%
median 2007-2011 median 2012-2017E
KGHM net income margin
DCF assumptions
Decrease in the main revenue drivers: copper and silver prices – according to World Bank forecasts
2012E 2013E 2014E 2015E 2016E 2017E
Cu price USD/t 7 962 7 800 7 400 7 000 6 900 6 800
Ag price USD/troz 31.14 31 29.5 28 27.68 26.5
USD/PLN 3.30 3.23 3.14 3.10 3.06 3.05
Source: World Bank Commodity Price Forecast, exchange rate EMIS database (based on a analysts’ consensus)
2012 residual value
Risk free rate 3.44% 3.44%
Beta 1.9 1.4
Market risk premium 5% 5%
Country risk premium 1.5% 1.5%
Cost of debt 6.2% 6.2% WACC 15.3% 11.5%
Changing WACC
Introduction of Mineral Extraction Tax (MET) in 2012 increases COGS and effective tax rate
0
4000
8000
12000
16000
0%
5%
10%
15%
20%
25%
2011 2012E
mn PLN MET effects
MET (RHS)COGS (RHS)effective tax rate (LHS)
PEERS
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
PLN 248
PLN 192
PLN 220
DCF analysis 50%
Multiples analysis 50%
Target price
Year-end target price Upside : 18.6%
Holding period return: 27%
Risk Analysis
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Main risks Market Economic
Operational Political
PRO
BABI
LITY
low
mod
erat
e
hi
gh
insignificant moderate severe
IMPACT
Influence of the State Treasury
Fluctuations of Cu and Ag prices FX risk
Changes in environmental policy
Cost inflation
Strikes Deterioration in the quality of ore
Delay in the growth projects Drop in GDP growth rate
Poland entering the Euro Zone
Lack of extension of the mining concessions
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Main risks
State Treasury - influence on strategic decisions acquisitions
limiting new acquisitions due to savings for high dividends
investments shale gas, energy sector, atomic power plant – risky and highly capital consuming
high dividend payout putting pressure on high dividends (as they can be a way to decrease fiscal deficit)
32%
68%
StateTresury
minorityinvestors
average dividend payout ratio
2009-2017E 60%
average dividend per share 2009-2017E PLN 16
250
300
350
revenues expenditures
PLN 35bn deficit
PLN bn
Shareholders structure Polish Fiscal Deficit based on 2013 Budget Act
Dividend statistics
Influence of the State Treasury
Fluctuations of Cu and Ag prices FX risk
Cost inflation
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Main risks
Influence of the State Treasury
Fluctuations of Cu and Ag prices FX risk
Costs inflation
0
1000
2000
3000
2012 2018
$/t -20%
49%
22%
13%
16% Materials andenergy
Employeebenefitexpenses
Taxes andcharges
investments in energy sector (joint venture with Tauron)
maintaining good relations with labour unions
development of new cost-efficient technologies
decreasing the average Group extraction cash cost (C1) after acquisition of Quadra
89%
11% members oflabour unions
other
2012 Q3 expenses by nature Employees in labour unions C1 extraction cash cost
Reducing the impact of possible increase in energy, labour and extraction costs
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Monte Carlo simulation
The main revenue drivers Copper & silver prices USD/PLN exchange rate
Mean 233.15
10th percentile PLN 146.41
90th percentile PLN 319.81
Upside potential 75%
Monte Carlo summarizing statistics
Influence of the State Treasury
Fluctuations of Cu and Ag prices FX risk
Costs inflation
Prob
abili
ty
Current price PLN 185
Conclusion
Company Overview Industry & Competitors
Financial Analysis Valuation Risk Analysis Conclusion
Conclusion
12 M Target price Upside potential 3Y HPR
PLN 220 18.6% 56%
Robust pipeline of new
projects
Increasing operational efficiency
Stable copper price supported by macro factors
Sound financial position
BUY
Thank you for your attention!
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