Midas - Capacity and expansion at Jilin

Balance sheet. Midas had net cash of S$11.3m as at 31 Dec 08. It holds its cash mainly in deposits placed with Chinese mainland banks, ICBC, BoC and CCB for its China operations. It deals with OCBC for Singapore operations. It does not have any long-term loans, while short-term loans with the same banks above are essentially revolving credit lines, renewable annually. It has no convertible instruments. Operating cash flow is about S$30m and accounts receivables are within management’s acceptable levels. The only related party transaction is the supply of large section aluminium extrusion profiles to its 32.5%-owned associate, NPRT. NPRT uses these profiles to make rolling stock traincars for metropolitan rail operators.

Capacity and expansion at Jilin. Capacity for two lines is 20,000 mt, running at about 80% utilisation, which is near peak levels. The breakeven is about 30-40%. A third line will add 10,000 mt in 1QFY10 and cost S$35m. There will be further capex of S$40m-45m in 2009-10 for expansion as well as fabrication facilities. Although management says a full ramp-up could take up to three years, the process could be shortened if order flows are strong. Jilin’s order book is S$100m, and it is actively pursuing S$200m-300m worth of contracts. Should it clinch a large order, management may have to consider a fourth or even fifth line. For now, it will defer that decision until there is clarity on order flows and delivery schedules as it will still have sufficient lead time to set up additional lines. Jilin Midas has a dominant 80% share of this industry and does not see competition rising.

Impact from Chinese stimulus package. Midas’s order flows originate from the Ministry of Railways to rolling stock manufacturers which are mainly related companies of the China North Railway and China South Railway groups. About Rmb1.75tr of the Rmb4tr stimulus package announced in Nov 08 is for rail infrastructure development, and will only translate into orders for component manufacturers some 9-12 months on, and orders clinched would be for delivery over the next 24 months. Based on the Rmb1.75tr package, the value of the rolling stock is about 20-25%, and the aluminium extrusion value is only 3-5% of the rolling stock value. This translates to Rmb10.5bn-21.9bn of potential business for Jilin Midas.

NPRT. Capacity is currently being increased from 100 to 500 traincars. The bulk of its Rmb4.5bn order book of 768 traincars will be delivered in FY10. NPRT is also pursuing a number of projects – Hangzhou and Suzhou metro projects – which may involve another 400 traincars worth Rmb3bn-4bn. Management believes that it is a matter of time before NPRT needs to increase its capacity to 1,000 traincars as a number of cities are embarking on metro rail projects. As for possible expansion into high-speed trains, that will be highly unlikely due to the nature of its licence.
Raw material hedging. With volatile aluminium prices in the last 18 months, questions were raised on how Midas hedges itself. Midas’s contracts are firstly signed with established large players in the rail industry, and pricing is typically negotiated. There are two main contracts used by Midas: 1) cost-plus, in which case aluminium prices are not hedged and Midas adds absolute dollar processing costs or value-added fees. Gross margins for this type of contract rise when aluminium prices fall and vice versa; and 2) fixed-price, in which aluminium prices are fixed. Midas adds a premium to the aluminium price for its risk, and adds on its absolute dollar processing costs or value-added fees. With rising aluminium prices, the customer benefits and the risk is mitigated for Midas, and vice versa. However, management highlights that the practice of offering a cost-plus or fixed-price contract is a normal part of business and the group does not take any positions or deploy derivative instruments.

Chinalco. The proposed joint venture remains at the letter-of-intent stage. Given current market conditions and weak demand in the aerospace and shipbuilding industries, management is quite willing to defer it. There is not been any definite financial commitment but initial estimates put the investment figure at S$60m-80m for a 35% stake. Should the other parties push ahead with the joint venture in the near term, management may choose not to proceed as near term-risks are high.

Financing for the business. Backed by healthy operating cash flow of S$30m, management is confident that its financial needs can be funded internally. For its capex of S$40m-45m, it may take on some debt with the Chinese banks, which should carry favourable terms as these banks are very keen to lend out money. Management has ruled out equity fund-raising or financial instruments, other than straightforward loans with banks. That has been its policy all along. Business financing for NPRT will come from internal sources, aided by 10-30% downpayments for traincar orders. NPRT is self-sufficient and its shareholders have not been approached for any fund-raising.

Dividend policy. Midas has no fixed dividend policy. Dividends are contingent on the level of capex. However, it has been giving shareholders good dividends since IPO. It recently reduced its quarterly dividend to conserve cash for capex and operations. We expect payouts in 2009 to be about 10-15%. Management may consider consolidating quarterly dividends into half-yearly payments as this may be more efficient.

Maintain Outperform. Midas’s peers should not be the S-chips. Its closest peers are in fact H-shares listed in Hong Kong. Valuations remain attractive against these railrelated peers. We maintain our forecasts and DCF-based target price of S$0.70 (WACC 11.2%).

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