Disappointing Result Presents Opportunity CSM has earned a...

Disappointing Result Presents Opportunity


CSM has earned a reputation for achieving ambitious targets. Strong profit growth saw the company as a candidate to fill the vacant midcap mining sector. The market in turn started to price the stock for growth. Yet CSM’s 1H06 result was a stinker and the shares have been belted. NPAT was down 90% to $3.2m and CSM expects a full year NPAT of $20m.


CSM wrapped warnings of softer 1H06 prices around guidance for a record 2H06. More direct guidance was appropriate. New MD, Rod Baxter, will take over at the start of FY07. The "benchmark" manganese price was settled in April 2005 at US$3.99/dmtu or A$235/t. We expected CSM to get US$3.00/dmtu or A$175/t for 1H06, but estimate the achieved price at around US$2.30/dmtu or $145/t. Management says high Chinese steel maker inventories have worked through the system. CSM expects prices of US$2.85/dmtu in 3Q06 and US$3.00/dmtu in 4Q06 before rising to US$3.25 in FY07.


The positive was that costs were held in check. The issue was with prices, particularly for manganese. Taking CSM at its word, long term earnings are unaffected and profits can rise quickly with prices. Guidance is for NPAT of $85m in FY07 and $115m in FY08 based on rebounding manganese prices and growth in nickel production. In the next few years, CSM wants annual production of 1Mt manganese, 250kt chromite, 5Mt iron ore, 20kt nickel, 8kt copper, 20kt zinc and 800koz silver.


The manganese and chromite operations are already at capacity and should generate sales of $230m a year. Nickel output is around 5ktpa but at 20kt, annual revenues of over $200m could be expected. Iron ore would add a similar amount. Copper, zinc and silver from 33% owned Jabiru Metals (JML) could add $70m assuming CSM gains full control. Sales could triple before the end of the decade. EBITDA margins at the new nickel, iron ore and base metals operations should be similar to the existing businesses at around 30%.


CSM is no longer priced for growth after the shocking 1H06 result. We see the share price moving substantially higher given the growth in train, but it’s not without risk. The shares will be sin binned for some time. Manganese prices are an unpredictable black box and the relatively small market size of 14Mt, or approximately A$2bn, makes the commodity susceptible to oversupply compared to iron ore.


On the flipside, we always expected blips in the China story and this may be one - a buying opportunity presented by short term oversupply. Forward multiples are attractive and the company is committed to paying dividends. Significant growth is in train and will diversify earnings away from manganese. The balance sheet is in good shape with net debt of $57m.


We slash our FY06 NPAT forecast by two thirds to $20.0m due to lower than expected manganese prices and higher depreciation and amortisation. We reduce our FY07 NPAT forecast by 8% to $74.3m, based on a US$3.00/dmtu manganese price and US$6.50/lb nickel. Our net present value of $2.65 a share assumes a 10% discount rate, US$3.00/dmtu manganese, US$4.50/lb nickel and an A$1.00 = US$0.76 exchange rate. We maintain our Buy recommendation but note that the investment has risk.