TURKEY e.research@burgansecurities.com +90 212 317 27 27 February 4, 2013 INITIATING COVERAGE PARK ELEKTRIK Min(d)ing the Growth We initiate coverage of Madencilik (Park Elektrik) with BUY (L/T) and MARKETPERFORM (S/T) ratings. Our target price of TRL8.5/share implies 43% upside potential. has garnered significant investor attention following its updated resource base disclosure (37.6mn tonnes; nearly triple the prior level) in Oct 11. The update has been pivotal in the re-rating of the stock, with 96% and 22% outperformance since YE11 vis-à-vis copper prices and the ISE, respectively. This notwithstanding, we believe still offers notable upside. It is trading at 2013E 4.4x EV/EBITDA and 7.3x P/E, at 31% and 42% discounts to int l peers (in US$). Ample scope for volume growth -- We estimate 16% topline growth for the Company in 2013, on 25% increase in effective milling capacity, while average grade should be lower due to the transition from underground mine to open-pit mine in 2H13. We, therefore, anticipate a 10% yoy rise in volumes to 97K dmt and flat pure copper prices in 2013, estimated at US$8,000/dmt. Substantial earnings accretion in 2013 -- We forecast 12% and 20% yoy EBITDA and net income growth, respectively, for 2013, driven by volume growth and slightly higher prices in TRL. Risks -- We view political risks due to location of copper and asphaltite mines in southeast Turkey; a sharp drop in copper prices along with the global slowdown; and any disputes with the local community and employees as downside risks. Consolidated Financials and Multiples (TRL) 2011A Δ 2012E Δ 2013E Δ 2014E Δ Revenue 173 106% 254 47% 294 16% 363 23% EBITDA 98 146% 148 51% 165 12% 187 13% Net Income 101 171% 106 5% 126 20% 147 16% P/E 8.8 8.4 7.0 6.0 EV/EBITDA 6.9 4.7 4.5 3.8 EV/SALES 3.9 2.7 2.5 2.0 Div. Yield 0.0% 11.3% 6.0% 7.1% FCF Yield 2.5% 0.3% -2.7% 5.1% Ratings & Actions L/T Rating S/T Rating Target Target Price BUY MARKETPERFORM TRL8.5 Upside (Downside) 43% Share Data Ticker Close Price PRKME.TI / PRKME.IS TRL5.94 Current MCap. (TRL/US$ mn) 884 / 506 Number of Shares (mn) 149 Free Float 31% 3m Avg. Daily Turnover (TRL/US$ mn) 5.76 / 3.25 Trading Range (High / Low) 1-month 6.82 / 5.88 1-year 6.84 / 3.49 Ytd 6.82 / 5.88 Performance Absolute Relative 1-month -3% -6% 3-months -10% -19% 1-year 70% 23% Ytd -3% -6% 12 11 10 9 8 7 6 5 4 3 2 1 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 as of February 01, 2013 Relativ es are against the ISE-100 Performance Index Oct-12 Price (LHS) Rel. Perf. (RHS) Feb-13 250 200 150 100 50 Ece Mandaci ece.mandaci@burgansecurities.com +90 212 317 2738 1
Income Statement (TRL mn) 2010 2011 2012E 2013E 2014E Revenues 84 173 254 294 363 COGS -40-66 -127-125 -165 Gross Profit 44 107 127 169 198 Marketing expenses -5-9 -12-15 -19 G&A -13-17 -16-17 -17 R&D 0 0 0 0 0 Operational expenses -18-26 -28-31 -36 EBIT 25 81 99 138 161 EBITDA 40 98 148 165 187 Other income, net -3 13 8-3 -3 Profit/loss from subsidiaries 0 0 0 0 0 Financial income, net 23 33 24 23 25 Profit before tax 46 126 130 158 183 Tax -8-25 -24-31 -36 Profit from continuing operations 37 101 106 126 147 Minority interest 0 0 0 0 0 Reported net earnings 37 101 106 126 147 Reported EPS 0.25 0.68 0.71 0.85 0.99 DPS 0.00 0.00 0.67 0.35 0.42 Company Description Located in Siirt, Southeast Turkey, Park Elektrik is the sole listed copper producer in Turkey with a 37.6mn-tonne measured and indicated resource base. We expect total concentrated copper sales volume by the Company to have reached 88K tonnes in 2012, implying 43% yoy growth. Driven by the increase in its milling capacity as of Jan'13, we forecast 16% additional volume growth for 2013. The Company is also engaged in asphaltite mining in Silopi- Sirnak, which represents a mere 3% of its gross profit. Balance Sheet (TRL mn) 2010 2011 2012E 2013E 2014E Cash & Equivalents 22 52 17 10 34 Receivables 17 11 20 23 29 Receivables from Park Holding 216 196 213 213 226 Inventories 14 37 43 44 54 Fixed Assets 57 61 133 247 285 Goodwill 0 0 0 0 0 Investment Property & Other Assets 45 128 68 71 75 Total Assets 370 484 493 609 703 Total Debt 0 3 1 37 40 Payables 10 21 25 29 36 Other Liabilities 18 17 18 19 21 Minority Interest 0 0 0 0 0 Shareholders' Equity 343 443 449 523 606 Net Debt -22-49 -16 28 6 Cash Flow Summary (TRL mn) 2010 2011 2012E 2013E 2014E Net earnings 37 101 106 126 147 Depreciation 19 20 52 31 29 Δ in WCR -3-6 -12-0 -9 Taxes 8 25 24 31 36 CAPEX -16-51 -62-144 -65 Dividend paid 0 0-100 -53-63 Rights issue 0 0 0 0 0 Δ in borrowing 0 0 0 37 2 Other cash in/out -24-60 -43-35 -53 Cash generated during the year 22 30-35 -7 24 Cash at the end of the year 22 52 17 10 34 Ownership Structure Other; 32.0% Turgay Ciner; 6.8% Park Holding; 61.3% Growth 2010 2011 2012E 2013E 2014E Sales 6% 106% 47% 16% 23% EBITDA 68% 146% 51% 12% 13% Net earnings 91% 171% 5% 20% 16% Key financial ratios 2010 2011 2012E 2013E 2014E ROE 10.9% 22.8% 23.5% 24.2% 24.2% ROIC 5.5% 13.3% 16.0% 18.1% 18.4% EBITDA Margin 47.4% 56.7% 58.2% 56.3% 51.6% Free cash flow margin 23.0% 12.8% 21.9% -1.2% 23.3% Net Margin 44.4% 58.5% 41.5% 43.1% 40.5% Net debt/equity -6.4% -11.1% -3.5% 5.3% 0.9% Net debt/ebitda -0.6-0.5-0.1 0.2 0.0 Equity/Total Assets 92% 92% 91% 86% 86% Current Ratio n.m. n.m. n.m. n.m. n.m. Pay-out Ratio 0% 0% 99% 50% 50% Valuation Metrics 2010 2011 2012E 2013E 2014E EV/Resource (US$) n.m. 530 462 565 664 Volume Growth -46% 91% 43% 10% 16% Avg. Copper Price/dmt (US$) 7,470 8,813 7,949 8,000 7,500 Copper Price @ 20% Concen./dmt (US$) 1,329 1,465 1,419 1,431 1,337 2
TABLE OF CONTENTS INVESTMENT THEME... 4 RISKS... 6 VALUATION... 7 COMPANY OVERVIEW... 10 Copper Operations: Eye-catching Resource Prospects... 11 Asphaltite Operations: Crucial Capacity Growth at Silopi Elektrik...13 Electricity Generation Projects in the Pipeline... 14 FINANCIALS & FORECASTS... 16 Substantial Volume Growth in 2013... 16 Margin Squeeze on Lower Grade in 2013... 16 High Capital Expenditures Foreseen to Continue in 2013... 18 Growth at the Bottom Line Will Continue Until 2015... 18 APPENDIX:... 19 Global Copper Prices: The Spectre of Oversupply in 2013... 19 Turkish Copper Sector: Snapshot of a Thriving Market... 21 Copper Flow Chart... 22 Glossary... 23 3
INVESTMENT THEME Madencilik () has garnered significant investor attention following its updated resource base announcement (37.6mn tonnes; nearly triple the prior level) in Oct 11. The update and the capacity increase of 2.0x within Oct 11 and Jan 13, have been pivotal in the re-rating of the stock, with 96% and 22% outperformance vis-à-vis copper prices and the ISE, respectively since YE11. This outperformance was achieved despite the downtrend in global copper prices, after having peaked at US$10,150/dmt in Feb 11. More recently, since Sep 12, the share price performance has been similar to copper prices, yet has trailed the ISE, due to profit taking after its remarkable outperformance since YE11. At current price levels, we believe still offers notable value with 20% 2013E EPS growth. Based on our TRL8.5/share target price, promises 43% upside potential. The stock is trading at 2013E 4.4x EV/EBITDA and 7.3x P/E, at 31% and 42% respective discounts to international peers. Exhibit 1: Performance- vs. ISE and Copper Price (in US$ terms) 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 PRKME vs. Copper Price PRKME vs. ISE Source: ISE & Bloomberg We estimate 16% topline growth for the Company in 2013, on the back of the 25% increase in effective milling capacity, while average grade should decline by around 15% due to the transition from underground mine to open-pit mine in 2H13. Therefore, we forecast a 10% yoy rise in concentrated copper volumes to 97K dmt and flat pure copper prices at US$8,000/dmt in 2013. For 2014, along with the improvement in the average grade to 1.8% and higher asphaltite sales associated with the capacity increase in Silopi Elektrik, we estimate a further 16% growth in volumes. We forecast 12% EBITDA growth for 2013, with a 2pp yoy drop in EBITDA margin to 56.3%, due to the lower grade to be recorded during the transition period. In 2014, EBITDA should rise by a further 13%, thanks to the factors mentioned above, while a forecast 6% slide in copper price should cap growth. On the other hand, we estimate a yoy margin contraction in 2014, on the back of a higher contribution from the lower margin (14% gross margin) asphaltite sales. Accordingly, we expect asphaltite sales to represent 21% and 30% of total sales in 2014 and 2017, respectively. 4
We project 20% and 16% growth at the bottom line for 2013 and 2014, respectively, driven by higher volumes and slightly higher copper prices in TRL terms. Given that the Company has a long FX position with liquid assets; S/T trade receivables are US$-denominated; and 90% of the revenues are in US$, the Company benefits from a weaker TRL. A factor to weigh on the cash flow would be the inception of electricity generation plants construction in Diyarbakir, Edirne and Adana, with 51MW, 423MW and 423MW capacities, respectively. However, based on recent indications by the management, they may not be keen to construct the plants, should they track a better opportunity via selling the licenses to a 3 rd party, as they did back in 2006. Assuming that the construction of generation plants will not begin in 2013, we foresee a 50% dividend payout, corresponding to a 6% dividend yield. Exhibit 2: Dividend Yields on Different Payout Ratios 14% 12% 10% 8% 6% 4% 2% 2013E 2014E 2015E 2016E 2017E 50% 60% 70% Source: Burgan Research Estimates Furthermore, has started drilling in the open-pit zone to unearth further resources. In case of a potentially positive outcome, the Company will mandate Micromine Consulting for an update of the resource base. We expect such a study to be conducted within 2013. A positive outcome would prompt us to revise upwards our volume assumptions, and extend our 20-year valuation horizon for the Company. 5
RISKS Political risks: Copper and asphaltite mines located in southeast Turkey -- Located at the northeast of Turkey s southeast Anatolia region, Siirt province -- home to s copper mine has seen fewer instances of terrorism compared to Van, Sirnak and Hakkari provinces in the same region. Moreover, the mine has not faced any terrorism related threat to date. On the other hand, we attach a higher probability to a temporary cessation, due to terrorism, of the asphaltite operations, which are located in Sirnak -- at Turkey s southeast border -- and which currently represent 10% of the revenues. Regulatory risks, although not an imminent threat for now -- As per the license agreement, the copper mine is not obliged to pay royalty fees to the government, unlike its peers such as Cayeli mine operated by Inmet mining. Although a royalty fee payment does not loom from today s vantage point for the Company, we perceive it as a risk to our forecasts. Sharp drop in copper prices along with the global slowdown -- Thanks to the high grade generated at the copper mine, s cash costs are relatively lower than its global peers. Nevertheless, a fall in copper prices such as in 2009 (down 26% on average) would hurt the Company s margins, which had shrunk 26pp to 30% back then. Any disputes with/amongst workers -- temporarily shut down its copper mine for 4 months in 2010, due to a dispute amongst mine workers. Finally, the management agreed with the workers for an upward adjustment to their wages, and operations resumed at the mine. We consider any discord with the employees, which might result in a strike, as a risk factor for the operations. 6
VALUATION We derived our target price from a blended valuation comprising discounted cash flow and international comparison analysis. Our 12-month target price of TRL8.50/share represents 43% upside potential. In our DCF analysis, we based our valuation on a 20-year forecast period, assuming that the mine operations would be terminated by YE32. In addition to our cash flow assumptions, we incorporated net cash, receivables from Park Holding (at 20% discount) and the value of the building (Sarkuysan Building) acquired in 2011. In our international peer comparison, we based our valuation on P/E and EV/EBITDA medians of international peers for 2014. Given that most of the peers produce various kinds of metal and are larger in size, we believe they are not comparable with, whose operations are limited to copper and asphaltite. Therefore, we attach a 40% weight to the value derived from the international peer comparison. The stock is trading at 2013E 4.4x EV/EBITDA and 7.3x P/E, at 31% and 42% respective discounts to international peers. Exhibit 3: Valuation Summary US$mn Target Weighted Valuation Method Value Weight Value DCF 649 60% 390 Multiple Comparison 753 40% 301 Blended Target Value 691 Current Mcap 506 Target Price (TRL) 8.50 Current Price 5.94 Upside Potential 43% Source : The Company and Burgan Research Estimates 7
Exhibit 4: DCF Model US$mn 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2032E Effective Milling Capacity (K wmt) 1,200 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 1,500 Copper Sales Volume (K dmt) 88 97 112 115 115 121 128 134 140 140 Copper Price (LME 1 ) /dmt 7,949 8,000 7,500 7,000 6,500 6,500 6,500 6,500 6,500 6,500 Concentrated Copper Price/dmt (20%) 2 1,419 1,431 1,337 1,242 1,147 1,147 1,147 1,147 1,147 1,147 US$/TRL Avg 1.792 1.824 1.908 2.017 2.123 2.229 2.341 2.458 2.581 4.634 Revenues 142 161 190 188 177 199 211 220 227 227 Copper 125 139 150 143 132 139 146 153 160 160 Asphaltite 14 22 40 45 45 60 65 67 67 67 EBITDA 83 91 98 91 81 87 93 98 103 103 EBITDA Margin 58% 56% 52% 49% 46% 44% 44% 44% 45% 45% Taxes on EBIT 11 15 17 15 13 14 15 16 17 17 in working capital 5 0 4 0-1 3 2 1 1 0 Capital Expenditures 35 78 33 15 15 15 15 15 15 6 Free Cash Flow 31-2 44 61 54 55 61 66 70 80 Discount Factor 1.05 1.17 1.29 1.43 1.58 1.75 1.94 6.56 Discounted DCF 42 53 42 39 39 37 36 12 PV of Free Cash Flow 533 Net Debt (as of YE13) 15 Real Estate - Building in Istanbul 34 Intra-Group Receivables@ 20% Discount 97 Fair Value 649 Source : The Company and Burgan Research Estimates 1 London Metal Exchange 2 Price adjusted for content losses and Treatment & Refining Charge; based on 20% concentration ratio after 2012. 3 We expect operations to cease by 2032 Exhibit 5: WACC Assumptions 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2032E Turkish Eurobond 30yrs 4.7% 4.7% 4.7% 4.7% 4.7% 4.7% 4.7% 4.7% 4.7% 4.7% Turkish Equity Risk Premium 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% Unlevered Beta 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 Cost of Equity 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% Weight of Debt 0.0% 5.0% 0.9% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% Weight of Equity 100% 95% 99% 100% 100% 100% 100% 100% 100% 100% Tax 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% Cost of Debt 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% 7.0% WACC (US$) 10.7% 10.4% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% 10.7% Source: Burgan Research Estimates 8
Exhibit 6: International Peer Comparison (US$) Mcap EV EV/EBITDA P/E P/CF 1 Company Country 2012E 2013E 2014E 2012E 2013E 2014E 2012E 2013E 2014E Rio Tinto UK 112,436 135,738 7.2 5.9 5.2 11.6 9.6 8.4 9.2 6.6 6.1 Xstrata UK 56,331 70,168 8.9 7.2 6.1 16.3 14.8 11.9 8.1 7.5 6.9 Freeport-McMoran US 33,919 37,509 4.8 4.0 3.7 11.3 7.9 7.9 7.3 4.9 4.3 Southern Copper US 33,687 35,331 9.8 9.1 8.4 16.4 14.7 13.9 9.9 13.4 13.0 Grupo Mexico Mexico 30,187 33,873 6.6 6.0 5.7 13.3 12.5 11.8 8.7 9.0 8.9 Antofagasta UK 17,938 18,384 4.3 4.4 4.4 13.6 13.1 13.9 7.4 7.2 7.7 Teck Resources US 21,614 25,527 6.8 6.5 5.4 15.5 14.3 11.5 7.5 7.5 6.5 First Quantum Min. Canada 9,786 9,997 6.5 6.1 4.8 17.1 13.9 10.9 12.3 9.4 7.3 Kazakhmys UK 6,199 6,623 6.7 7.0 8.3 10.1 9.2 9.4 8.9 8.0 9.1 Vedanta UK 5,264 29,351 4.1 2.8 2.2 14.8 12.4 7.4 2.4 1.4 1.2 Inmet Mining Canada 4,965 4,421 7.9 9.0 10.2 13.7 14.2 15.1 8.9 10.8 11.1 Lundin Canada 3,098 2,835 8.6 6.8 5.8 16.3 11.5 10.1 11.3 8.2 7.5 Hudbay Canada 2,000 960 6.1 12.1 9.4 50.7 54.0 26.4 11.3 23.5 14.5 Taseko Mines Canada 630 662 n.a. n.a. n.a. 1,645.0 11.2 6.8 19.5 6.3 4.8 Copper Mountain Canada 340 719 10.5 4.7 3.4 14.3 4.8 4.0 7.5 3.1 2.5 Median 6.8 6.3 5.5 14.8 12.5 10.9 8.9 7.5 7.3 PRKME 506 396 4.5 4.4 4.3 8.6 7.3 6.6 n.m. 9.4 11.3 Discount to Peers -34% -31% -23% -42% -42% -40% n.m. 26% 54% Source: Bloomberg & Burgan Research Estimates 1 Operating Cash Flow Exhibit 7: Earnings Growth Comparison for 2013 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Source: Bloomberg & Burgan Research Estimates 9
Exhibit 8: Ciner Holding, Lines of Business COMPANY OVERVIEW Established in 1994 as a subsidiary of Ciner Holding, Madencilik () was initially active in the textiles sector. Following a protracted adaptation process, it was transformed into a mining and energy company. is the sole listed subsidiary of Ciner Group, a conglomerate operating in energy & mining, media and tourism & commerce sectors. Among the energy & mining companies in Ciner Group s portfolio, Park Termik and Silopi Elektrik have respective electricity capacities of 620MW and 135MW, while Eti Soda extracts trona (natural soda ash) with a capacity of 1.1mn tonnes. The Group has established a new entity dubbed Kazan Soda, which will install 2.5mn tonnes of soda ash capacity. The media group incorporates one of Turkey s leading newspapers, Haberturk, and has launched Bloomberg HT in Turkey. Energy & Mining, Park Termik, Park Teknik, Eti Soda, Silopi Elektrik, Kazan Soda, Park Cam CINER HOLDING Media Haberturk Newspaper-TV-Radio-Web, Bloomberg HT Tourism & Commerce Ciner Marine, Ciner Aviation, Lares Park Hotels, Park Insurance, Denmar Logistics, UCZ Retail Chain Source: The Company The Company initiated its mining operations via its coal extraction and washing business in 2000, and ceased its textile operations in 2002. It shifted its focus fully to copper production by 2006, along with the initiation of copper extraction in Siirt-Madenkoy, located in southeast Turkey. The Company acquired the asphaltite mining operations in Silopi-Sirnak to serve its sister company Silopi Elektrik, also located in southeast Turkey, upon merger with the listed sister company, Ceytas Madencilik, in 2009. is owned mainly by Park Holding (Ciner Holding) and Turgay Ciner, Chairman of the BoD of Ciner Holding. The remaining 32% shares are the free float, with foreign ownership at 40% as of Jan 12. In the 9-member BoD, A group (12% of total shares) and B group shareholders are entitled to appoint 6 and 3 members, respectively. Apart from voting rights, no other privileges are granted to shareholders. 10
Copper Operations: Eye-catching Resource Prospects acquired the copper mine in Siirt-Madenkoy from Eti Holding (the public mining entity) in 2004 for TRL9.4mn and initiated copper production in 2006. The Company s key area of activity is extraction and processing of ore into concentrated copper with 19-20% concentration rate. Due to its smaller scale, the Company at this stage does not plan investments in smelting business, i.e. the process of transforming concentrate copper into pure copper. At the initial phase of the copper operations, the ore milling capacity was 750K tonnes and was adequate at that time, given the 13K-tonne ore resource base. However, given the lucrative growth prospects of its resource base and the recovery in copper prices, expanded its capacity to 1.2mn tonnes as of Oct 11. Furthermore, as of Jan 13, the Company expanded its capacity to 1.5mn tonnes, implying a 25% increase. Note, though, that the Company s technical capacity is 1.8mn tonnes, and the 1.5mn tonnes correspond to the amount it plans to extract annually. announced its new resource base as of Oct 11, based on studies conducted by JORC Compliant Micromine Consulting Services. According to the studies, s measured and indicated (M&I) resources nearly tripled to 37.6mn tonnes, while its inferred resource base was determined at 2.2mn tonnes. Note that the management does not provide separate reserve figures; therefore, we have based our valuation on M&I resource figures. Exhibit 9: Resource Base Resource (mn tonnes) 2011 g/t Measured 31.2 2.26 Indicated 6.4 2.79 M&I 37.6 2.34 Inferred 2.2 3.38 Total Resource 39.8 2.40 Source: Micromine Consulting Services, in compliance to JORC The mine s resource base has a higher grade of 2.3% Cu compared to global peers and its production based on 1.9% g/t in 2012. According to recent management guidance, average g/t should decline from 1.9% to 1.6% in 2013, driven by value losses during the transition of production from underground mine to open-pit mine. On the other hand, average grade should recover to 1.8-1.85% levels in 2014 and remain at around 1.9% in the next 3 years. For the long term, we foresee a gradual recovery in the grade to 2.3% by 2020, and expect it to remain at that level through the rest of our valuation horizon. plans to run the open-pit mine until 2025, upon depletion of the high grade ore. The Company will subsequently re-open its underground mine and cease production by 2032. The 20-year life of s current mine is similar to those of global peers. Previously, the Company was unable to extract copper from the open-pit zone included in its license agreement, due to the existence of a village on parts of 11
the land. However, upon conclusion of expropriation transactions in 2012, the Company mandated 2 contractors for the stripping of the mine. Total cost of stripping in 2013 is estimated at around TRL88mn. Once initial stripping is completed, will start ore processing through the open-pit mine in 2H13. started drilling in the open-pit zone to determine further resource potential of the land. In case of a potentially positive outcome, the Company will mandate Micromine Consulting for an update of the resource base. We expect such a study to be conducted within 2013. A positive outcome would prompt us to revise upwards our volume assumptions, and extend our 20-year valuation horizon for the Company. The Company holds a mining license for the land until 2037. The Company exports concentrated copper through a Belgian copper broker that ships copper mainly to smelters based in China. Furthermore, the Company was engaged in sales of cathode copper in 2011 due its higher profit margin at that time. Accordingly, a local smelter, Eti Bakir, was processing s concentrated copper into cathode copper as test production. However, ceased cathode copper sales, after it concluded that cathode sales would not be as feasible as concentrated copper exports from Turkey. Accordingly, for the rest of our valuation horizon, we do not assume any cathode copper sales. The sales price of copper/dmt is determined based on global prices posted at the London Metal Exchange. For 20% of its output, has forward contracts, thanks to which the Company recorded TRL15mn additional income in 2011. Thus, s average price might differ from the LME price, particularly in quarterly analyses. Exhibit 10: CoGS Structure 4% 3% 9% 31% Labour Machinery-Spare Parts 17% Fuel Depreciation 12% 24% Machinery Rent Maintenance Other Source: The Company Labour and machinery parts represent 55% of the CoGS of the copper operations, followed by fuel and depreciation expenses. Among cost items, only 50% of machinery parts costs are in FX terms. Hence, total costs in FX 12
terms represent only 10-12% of the CoGS, compared to the 90% share of US$-denominated revenues in total revenues. Unlike its local peers, such as Cayeli mine operated by Inmet mining, does not pay royalty to the government, as per its license agreement. s cash cost of US$1.1/lb (treatment and refining charges included) was below the median of top copper producers US$1.3/lb in 2011, thanks to its lower production costs, attributable to its higher grade. However, its cash cost is above that of Cayeli mine (northeast Turkey), whose production is of a higher grade (3.2% Cu). Exhibit 11: Cash Costs Including Treatment and Refining Charges (US$/lb) in 2011 Median Inmet-Cayeli Vedanta Kazakhmys First Quantum Min. Teck Resources Antofagasta Grupo Mexico Southern Copper Freeport-McMoran Xstrata 0.0 0.5 1.0 1.5 2.0 2.5 Source: ISE & The Companies Asphaltite Operations: Crucial Capacity Growth at Silopi Elektrik initiated asphaltite mining in 2Q09 at the asphaltite zone based in Silopi Sirnak (southeast Turkey) to serve Silopi Elektrik Uretim, the sister electricity generation company with a capacity of 135MW. Asphaltite is a petroleum-origin hydrocarbon with 5,000-5,800 kcal/kg thermal value, similar to coal. Turkey s aggregate asphaltite reserve potential is estimated at 82mn tonnes, 35mn of which is located in s Silopi mine as proven reserve. The Company holds a mining license for the land until 2033. Although annual asphaltite production at the mine stands at 450K tonnes, it is expected to triple in tandem with the capacity increase to 405MW in 2 phases at Silopi Elektrik Uretim until 2016. Recall that the sister company is the sole customer of the asphaltite mine. Silopi Elektrik Uretim received the approval of the Energy Market Regulatory Authority (EMRA) and construction has started. We expect asphaltite production to rise to 900K tonnes by 2015 and 13
to 1,200K tonnes by 2017. Hence, by 2017, we expect asphaltite operations to comprise 30% of the revenues. applies a 15% mark-up on asphaltite mining costs, which has been lowered from 20% as of 2011. As such, we base our asphaltite forecasts on the fixed price adjusted for inflation and a 15% margin. However, due to a lower gross margin compared to copper mining operations, we expect gross profit derived from asphaltite operations to represent only 9% of total gross profit by 2017. Electricity Generation Projects in the Pipeline is also engaged in various electricity generation investments that are currently at project stage. For the low-scale Diyarbakir hydroelectric power plant (HPP), the Company has received the EMRA license in May 09, with construction to begin once feasibility studies are completed. The management aims to finance part of the investments through the receivables (TRL218mn as of 9M12) to be collected from Park Holding during the construction phase. Exhibit 12: Electricity Generation Projects Project Diyarbakir Ceyhan Edirne Type 1 HPP NGPP NGPP Capacity 51MW 423MW 423MW EMRA License Received Received Not Received License Period (Years) 49 49 49 Capex (US$mn) 100 325 325 Initiation Date 2015 -- -- 1 NGPP-natural gas power plant; HPP-hydroelectric power plant Source: The Company We do not plan to incorporate the electricity generation projects into our valuation until the initiation of the construction phase, as the Company is yet to provide the exact date for the inauguration of the plants. Assuming Diyarbakir (Siirt-Tarihler) HPP project is operational by 1Q15, we attach US$28mn value to this project, which would extend our target Mcap by 4%. According to recent indications by the management, they may not be keen to construct the plants, should they track a better opportunity via selling the licenses to a 3 rd party. As might be recalled, sold its 45% stake in 300MW Tufanbeyli Thermic Power Plant project license for US$47mn to Enerjisa, subsidiary of Sabanci Holding back in 2006. Moreover, due to sizable investments at the plants -- above the TRL50mn threshold set by the government -- we think the projects might be classified as large scale investments in the new incentive programme. In that case, c.30% of project investments (60% for Diyarbakir) would be met by tax incentives, which would bring additional value to the projects. 14
Exhicit 13: Key Financials 2015E 2016E 2017E 2018E 2019E 2020E Installed Capacity (MW) Diyarbakir 51 51 51 51 51 51 Ceyhan (Adana) 423 423 423 423 423 Net Electricity Generation (mnkwh) Diyarbakir 126 168 168 168 168 168 Ceyhan (Adana) 1,403 1,754 2,105 2,105 2,105 2,105 Avg. DUY Price (TRLcents/KWh) 24.5 25.8 27.1 28.4 29.8 31.3 Revenue (US$mn) Diyarbakir 15 20 20 20 20 20 Ceyhan (Adana) 213 256 256 256 256 EBITDA Margin Diyarbakir 80% 80% 80% 80% 80% 80% Ceyhan (Adana) 20% 30% 30% 30% 30% 30% Source: The Company and Burgan Research Estimates 15
FINANCIALS & FORECASTS Substantial Volume Growth in 2013 has expanded its effective milling capacity by 25% to 1.5mn tonnes by Jan 13. However, we do not expect the capacity to fully translate into volume growth due to the expected drop in the average g/t. According to recent management guidance, average g/t should decline from 1.9% to 1.6% in 2013, attributable to value losses during the transition of production from underground mine to open-pit mine. Therefore, we foresee a 10% rise in sales volumes to 97K dmt. For 2014, yoy growth should be higher at 16%, in view of a possibly higher grade at 1.80-1.85% post transition period. Note that the Company sells its concentrated copper in dry metric-tonne form, which is 8% lighter than wmt. Exhibit 14: Copper Sales Volume (K dmt)* 140 120 100 80 60 40 20 0 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E Copper Cathode Copper Source: The Company & Burgan Research Estimates * The decline in copper volumes in 3Q10 stemmed from a temporary shutdown of the plant. We think the management might decide for further capacity expansion, in the event of an upward revision to resource figures in 2013. For the time being, however, our valuation model does not incorporate an increase in capacity post 2013. Margin Squeeze on Lower Grade in 2013 Our price estimate for 20% copper concentrate is derived from our forecasts for pure copper, based on prices on the London Metal Exchange (LME). We apply a 1pp discount for content losses, due to technical price adjustments, as copper concentrate features silver, nickel and lead. We then subtract smelting fees from the price, i.e. treatment charge (TC) and refining charge (RC) of US$75/dmt and US$13/dmt, respectively, set by major copper smelting companies. As discussed in detail in the Global Copper Demand section (Appendix) of our report, we assume copper prices flat at US$8,000/dmt in 2013, and lower by 6% yoy at US$7,500/dmt in 2014, based on Bloomberg consensus for copper prices. Furthermore, we assume copper prices sliding to US$7,000/dmt 16
by 2015. For the remainder of our forecast horizon, we factor in a price level of US$6,500/dmt for pure copper. Exhibit 15: Sales Model (US$) 2012E 2013E 2014E 2015E 2016E 2017E Copper Sales Volume (K dmt) 88 97 112 115 115 121 YoY 43% 10% 16% 3% 0% 5% Price (LME 1 ) /dmt 7,949 8,000 7,500 7,000 6,500 6,500 Growth at the Bottom line to Continue Concentrated Copper Price/dmt (20%) 2 1,419 1,431 1,337 1,242 1,147 1,147 YoY -3% 1% -7% -7% -8% 0% Asphaltite Asphaltite Sales Volume (Ktonnes) 300 450 800 900 900 1,200 Price/tonne 47 49 50 50 50 50 Huge Capital Expenditure Strong Balance Sheet vs. vs. Revenues (US$mn) 142 161 190 188 177 199 Revenues 125 139 150 143 132 139 Copper 14 22 40 45 45 60 Source : The Company and Burgan Research Estimates 1 London Metal Exchange 2 Price adjusted for content losses and Treatment & Refining Charge; 19% concentration rate for 2012 On the cost side, apart from the impact of volume growth, we do not foresee any major increase in cost items, which we assume to be consistent with our inflation forecasts. However, due to the lower grade to be recorded during the transition period, any cost savings through higher scale will disappear. Consequently, we forecast a 2pp yoy drop in EBITDA margin to 56.3% for 2013. For 2014, we foresee a further 4.7pp contraction in EBITDA margin, given a higher contribution from lower margin (14% gross margin) asphaltite sales, associated with the capacity increase at Silopi Elektrik. Accordingly, we expect asphaltite sales to represent 21% and 30% of total sales in 2014 and 2017, respectively. Moreover, a 6% expected decline in copper prices should also result in margin attrition in 2014. Exhibit 16: ROE and EBITDA Margin 30% 25% 20% 15% 10% 5% 0% 2009 2010 2011 2012E 2013E 2014E 2015E 80% 70% 60% 50% 40% 30% 20% 10% 0% ROE (LHS) EBITDA Margin (RHS) Source: The Company & Burgan Research Estimates 17
All in all, we expect 12% and 13% rise in EBITDA in 2013 and 2014, respectively, based on the considerations cited above. A higher grade at the early years of the open-pit operations poses an upside risk to our forecasts. High Capital Expenditures Foreseen to Continue in 2013 will likely post higher annual capital expenditure within the 2012-2014 period than in previous years, due to i) stripping expenditures for the open-pit mine amounting to TRL88mn; ii) TRL30mn expenditure for the capacity increase at the processing plant and tailing dam construction; iii) TRL20mn for expropriation; iv) TRL40mn for the rehabilitation of the underground mine. Including all these factors, we estimate US$78mn and US$33mn capex for 2013 and 2014, respectively. For the rest of our forecast horizon, we factor in US$15mn maintenance capex until the open-pit mine ceases operations by 2025. Only for 2025, we assume US$20mn additional capex for the re-opening of the underground mine. Our depreciation forecasts are based on the life of the open-pit and underground mines for both stripping expenditures and investment for the processing plant. Therefore, our depreciation forecasts tend to be somewhat volatile and higher during the final years of the mine life. As a result, EBITDA margin forecasts serve as a better gauge of s profitability than gross and EBIT margins. Growth at the Bottom Line Will Continue Until 2015 We project 20% and 16% growth at the bottom line in 2013 and 2014, respectively, driven by higher sales volumes, as well as slightly higher copper prices in TRL terms in 2013. For 2013, given the massive capital expenditure, we think the Company would need a short-term loan. We, therefore, foresee TRL28mn in net debt, excluding the receivables from Park Holding. Given that the Company has a long FX position with liquid assets; S/T trade receivables are US$denominated; and 90% of the revenues are in US$, it tends to benefit from a weaker TRL. For the receivables from Park Holding of TRL218mn as at 9M12, the Company received 10-11% interest in 9M12. We calculate 10% average interest rate for receivables and apply a 20% discount to the receivables in our valuation. The management had said they would collect the receivables once funding was necessary for the construction of the electricity generation projects discussed in the Electricity Generation Projects in the Pipeline section of this report. For the time being, we do not incorporate these projects into our valuation. The investment programme for 2013 notwithstanding, we expect to distribute 50% of its net income as dividend, corresponding to a 6% dividend yield. Note that the management has not provided any guidance regarding the dividend payout; however, we reckon they should be willing to 18
pay dividends, also considering growing interest in the stock by the investor community. APPENDIX: Global Copper Prices: The Spectre of Oversupply in 2013 Copper demand is highly cyclical due to its usage mainly in consumer industries, such as automobiles, appliances, electronics, etc. Although copper demand can vary significantly on the back of cyclical patterns and GDP growth, it has trailed (2.2%) global GDP growth (2.8%) over the last six years. In addition, during the global economic shock in 2009, copper demand responded earlier to the slowdown, having contracted by 1.0% in 2008. Conversely, during the recovery in 2010, copper demand growth (6.0%) surpassed GDP growth (5.0%). Within 2011-2012, global copper demand lagged behind GDP growth. Likewise, International Copper Study Group (ICSG) forecasts 1.5% growth in copper demand for 2013, compared to IMF s 3.5% GDP growth forecast. Exhibit 17: Copper Demand Growth vs. World GDP Growth 20% 15% 10% 5% 0% -5% -10% 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012E Copper Demand World GDP Source: International Copper Study Group & IMF Akin to the broader trend in consumer industries, copper demand has shifted from Europe to Asia over the last 20 years, as a result of robust demand in the Chinese market. Consequently, Asia s share in global refined copper demand has risen from c.20% in the 1980s to c.60% by 2012. A similar trend has been observed in the smelter market, where Asia dominates with a c.50% share. Latin America and Eastern European markets also see buoyant copper demand with 5% growth rate each, though they represent 3% and 6% of global demand, respectively. We expect Asia to continue to dominate global copper industry through strong growth, estimated at 4.0% for 2013. 19
Exhibit 18: Refined Copper Usage 16% 6% 1% 1% 11% 3% 4% Africa N. America Latin America 0% Asean-10 Asia ex Asean/CIS Asia-CIS EU-27 Europe Other Ocenia 58% Source: International Copper Study Group In contrast to the trend in refined copper production, copper mining is focused largely in Latin America, which accounts for 40% of global mining production. The largest mines, located in Chile and Peru, are operated mainly by BHP Billiton and Codelco. The US, China and Indonesia are the other largest copper mine producers. Total mine production is estimated at 18mn tonnes for 2013, implying a 6% rise yoy, on the back of capacity installations in Asia and Africa, according to ISCG s forecasts. Therefore, global oversupply, also considering scrap recycling, might exert pressure on global copper prices. It should also be underlined that the Chinese copper demand estimate by ISCG might be slightly higher, as it does not incorporate unreported stocks. Exhibit 19: Copper Mine Production 5% 4% 3% 7% 9% 14% Africa N. America Latin America Asean-10 13% Asia ex Asean/CIS Asia-CIS EU-27 5% Europe Other 40% Ocenia Source: International Copper Study Group 20
Although we think ISCG might err on the conservative side with its global growth forecast for 2013, given IMF s 3.5% global growth estimate, we view oversupply in copper as a risk mainly for small-scale copper producers such as. For copper prices -- excluding the 2003-2005 period when all commodity prices were on an upswing -- in periods of oversupply, copper prices have plummeted, based on data for the past 27 years. Although copper prices have slightly recovered on a monthly basis, we view any fall in copper prices as a risk factor for 2013. The median Bloomberg estimate updated as of December points to US$8,000/tonne level, indicating a flat performance in copper prices for 2013, based on the average price as of 2012. For 2014, the price forecast is US$7,500. Exhibit 20: Copper Demand and Production vs. Copper Price 9,000 1,000 8,000 800 7,000 600 6,000 5,000 4,000 3,000 400 200 0-200 -400 2,000-600 1,000-800 0-1,000 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012E Diff. Btw Production & Demand (Kdmt, rhs) Copper Price (US$/dmt, lhs) Source: International Copper Study Group & Bloomberg & Burgan Research Estimates Based on the aforementioned information compiled from different sources, we assume US$8,000/tonne copper price for 2013, flat yoy, and US$7,500/tonne for 2014. Turkish Copper Sector: Snapshot of a Thriving Market Despite its 70-year history, Turkish copper industry prospered only after an amendment to the Mining Law introduced in 2006. This amendment set the stage for increased involvement by the private sector, and hence the discovery of new deposits. Copper mines in northern Turkey were previously owned by a public entity dubbed Eti Maden. The acquisition in 2004 of a 45% stake in Cayeli mine in Rize (northeast Turkey) by Inmet mining marked the first private involvement in the sector. 21
Cayeli mine, which operates with 1.2mn tonnes of ore annual milling capacity, has a remaining life of only 7 years. Its current grade is 3.2% Cu, above Park Elektrik s 2% Cu. The mine operates at US$0.6/lb cash cost for concentrated copper, thanks to its high grade above that of, as well as those of international peers. The second private involvement came with the acquisition by Cengiz Holding - - a well-known Turkish unlisted contractor and energy company -- of the copper mines and smelting facility owned by Eti Bakir in 2004 and 2005, upon privatisation by the government. The mines, owned by Cengiz Holding, are located in northern Turkey: i) Kastamonu with 1mn tonnes of milling capacity at roughly 2% Cu; ii) Artvin with 2.7mn tonnes of milling capacity at roughly 0.7% Cu. In total, the mines produce 165K tonnes of concentrated copper and process cathode copper via the smelting facility with 75K tonnes of cathode copper capacity. Annual cathode copper consumption in Turkey is estimated at 500K tonnes (as of 2011). Additionally, the listed Koza Anadolu (KOZAA TI), which is exploring copper with Teck Resources in Giresun (northeast Turkey), has announced 1.1mn tonnes of inferred copper resource as of Dec 12. The mine, with a lower grade of 0.23% Cu, is foreseen to be one of Turkey s largest copper mines. Copper Flow Chart Exhibit 21: Copper Flow Chart Source: International Copper Association Copper Cathode 22
Glossary Cathode: In an acid solution of copper sulphate, cathode copper is deposited through refining. Concentration: The process after crushing, grinding and floatation Copper Concentrates: Copper with 20-30% concentration rate Crushing and Grinding: The process of breaking ore into small pieces Cut-Off Grade: The lowest grade of mineralised material considered feasible Deposit: Mineralised body that contains average grade of metal and metals that warrant exploration Electrolytic Refining: Transfer of copper anodes with refined copper sheets to pure copper sheets, producing 99.9% copper cathodes Electrowinning: The process of removal of copper from solution by the action of electric currents Exploration: The phase including prospecting, sampling, mapping, and drilling for ore discovery Grade: The percentage of metal content in ore High Grade: High percentage of metal content in ore London Metal Exchange (LME): Major exchange for base metals Milling: The grinding process of ore Open-Pit Mine: A mine that is entirely on the surface Ore: Mineral in which economically feasible metal is found Ore Reserves: The calculated tonnage and grade of mineralisation that can be extracted feasibly; classified as possible, probable and proven Oxide: Portion of a mineral deposit that has been oxidised within sulphide minerals Porphyry Copper Deposit: A low grade, large tonnage deposit, in which copper minerals occur as discrete grains Probable Reserves: Please refer to proven reserves. Proven Reserves: In proven reserves, the mineral content, size, depth and shape are well determined based on the samples revealed in outcrops, trenches, workings or drill holes. Sites for inspection, sampling and measurement are closer than probable reserves. Recovery: The percentage of valuable metal in the ore that is recovered Refining: Purifying impure metal Smelting: A pyro-metallurgical process of separating metal by fusion from those impurities Solvent Extraction: Process of using solvent for separation of one or more metals from ore via dissolving Stripping: The process of removing overburden over ore Stripping Ratio: The ratio of waste materials plus leaching ore to ore mined in an open-pit operation Sulphide Ore: Ore characterised by inclusion of metal in the crystal structure of a sulphide mineral Ton (metric ton): A unit of mass equivalent to 1,000 kilograms or 2,204.6 pounds Treatment and Refining Charges: Charges levied by smelter/refineries for the transfer of concentrate to pure form 23
Burgan Securities - Equity Rating System 12-month Rating: Our 12-month rating system comprises the following designations: BUY (B), HOLD (H), SELL (S). The absolute upside to target value implied by the current market capitalisation is the main determinant of our rating system. Valuation tools employed most frequently are Discounted Cash Flow (DCF) and international peer group comparison, though other metrics such as historical relative valuation, price to book, return on equity, replacement value are also used wherever appropriate. Our analysts set the fair/target values with a 12-month investment horizon. Comparing the upside in a specific stock with the market s upside (determined through the aggregate upside of our coverage based on free float Mcaps), in addition to taking other yardsticks into consideration, analysts recommend BUY (B), HOLD (H), SELL (S) based on their 12-month total return views. Sector Rating Our investment horizon for industry ratings is again 12 months. This rating gives an indication as to how the analyst sees that particular industry for the next 12-month period in terms of growth, profitability, pricing power, competitive dynamics etc. The rating in this category thus reflects our analyst s assessment of the conjunctural outlook for the industry, without involving any specific benchmarks. The ratings employed are Overweight (OW), Neutral (N), Underweight (UW). 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Buyukdere Cad. Apa Giz Plaza No: 191 Levent, Istanbul Tel: +90 212 317 2727 Fax: +90 212 317 2726 info@burgansecurities.com Burgan Securities (formerly EFG Istanbul Equities) is a prominent investment firm active in the fields of brokerage, corporate finance and asset management in Turkish capital markets. Our firm, a member of Burgan Group, one of the leading financial institutions of Kuwait, caters to the entirety of domestic/international retail/institutional investor spectrum. Supporting our corporate finance and institutional sales activities is a highly qualified research team that offers premium quality and timely research products covering a broad array of sectors and companies. Our corporate finance activities comprise mergers and acquisitions, as well as private and public equity and debt transactions. Our new product development activities are centred around derivative products, along with online trading platforms for retail clients. Burgan Securities goal is to be the investment firm of choice in Turkey through exemplary service and product quality, with a view to becoming a regional player. Mehmet Sonmez Chairman msonmez@burgan.com.tr +90 212 371 3431 Zafer Onat CEO zafer.onat@burgansecurities.com +90 212 317 2867 INSTITUTIONAL SALES (sales@burgansecurities.com) Tolga Atac Head of Sales & Trading tolga.atac@burgansecurities.com +90 212 317 2770 Can Yazgan Head of Sales can.yazgan@burgansecurities.com +90 212 317 2757 Yilmaz Manisali Sales yilmaz.manisali@burgansecurities.com +90 212 317 2878 Cansev Sanli Sales cansev.sanli@burgansecurities.com +90 212 317 2860 Canan Uras Sales & Trading canan.uras@burgansecurities.com +90 212 317 2825 Aysegul Yilmaz Sales & Trading aysegul.yilmaz@burgansecurities.com +90 212 317 2759 Burak Demircioglu Sales & Trading burak.demircioglu@burgansecurities.com +90 212 317 2765 EQUITY RESEARCH (e.research@burgansecurities.com) Nergis Kasabali Banking & Head of Research nergis.kasabali@burgansecurities.com +90 212 317 2753 Burak Isyar, CFA Murat Ignebekcili Retail, Beverages, Automotive, Consumer Durables, Aviation Telecom, Construction, Real Estate, Utilities, Conglomerates burak.isyar@burgansecurities.com +90 212 317 2709 murat.ignebekcili@burgansecurities.com +90 212 317 2761 Duygun Kutucu, CFA Banking duygun.kutucu@burgansecurities.com +90 212 317 2784 Umut Ozturk Oil & Gas, Steel, Fertilizers, Mid-Cap Autos umut.ozturk@burgansecurities.com +90 212 317 2703 Ece Mandaci Mining, Glass, Cement, Small Caps ece.mandaci@burgansecurities.com +90 212 317 2738 Ismail Ozer Quantitative Analysis ismail.ozer@burgansecurities.com +90 212 317 2705 Nuray Apari Senior Database Manager nuray.apari@burgansecurities.com +90 212 317 2707 Lolita Haleva Editor lolita.haleva@burgansecurities.com +90 212 317 2704 MACROECONOMIC RESEARCH (m.research@burgansecurities.com) Haluk Burumcekci Chief Economist haluk.burumcekci@burgansecurities.com +90 212 317 2737 Asli Savranoglu Senior Economist asli.savranoglu@burgansecurities.com +90 212 317 2866