Central Omega Resources – Reborn?

In April 2012, I found a ‘hidden pearl’ in stock of Central Omega Resources (DKFT), which then priced at Rp1,670, or equal to Rp334 per share after stocksplit, and the analysis was simple: DKFT posted net income of Rp177 billion in 2011, which is entirely derived from the export of nickel ore from two mines in Morowali (Central Sulawesi), and Konawe (Southeast Sulawesi), where the two mines were still in an early stage of exploration. So if later the company carried out further exploration, then DKFT would produce more ore, and the company's revenue would significantly increased. The management themselves had targeting a net income of Rp475 billion in 2012, and Rp792 billion in 2013, and it was of course very attractive.

However, also in that year of 2012, I realized that DKFT had an investment risk, namely: Since 2009, the Government of Indonesia asked mining companies, including DKFT, to build a smelter to process nickel ore into products with added value, no later than 2014. If in 2014 the company had not yet completed the smelter construction, DKFT would lose its only source of income, because the Government would completely ban the export of nickel ore. The problem is, DKFT had to raise funds amounting to Rp4.5 trillion (about US$ 400 million) to build the smelter, and of course it was not easy to raise such huge money, and in such a short time (just two years, from 2012 to 2014).

So if DKFT could not complete the construction of its smelter until 2014, the income of the company will be zero. And unfortunately that's exactly what happened: As of 2014, let alone finished the construction of its smelter, the management of DKFT have not even started the construction. And unfortunately the government did not tolerate it: We don’t care what you say, you just cannot export the nickel ore anymore! As a result, the company’s mines stop its production, and DKFT posted income of Rp0 in 2014. The stock itself, which had rose to Rp600 per share in 2013 (thus still generate significant profits for investors who acquired it in 2012, not including dividends), dropped sharply in early 2014. And to prevent a further decline, the IDX as the market authority immediately suspended the stock.

But in March 2016, the suspension has been lifted. And since DKFT still posted revenue of Rp0 in the First Quarter 2016, then of course the stock dropped to its current position, ie Rp200’s per share. However, if you are observant, you would ask, why the IDX lifted the stock suspension? If the company is still generate no income at all, then why didn’t the IDX kicked DKFT out from the stock market? Because, of course, it is impossible for any mindful investors to buy shares of a company who do not make money at all.

And the answer is, yes! DKFT will not stop its operation forever, because today the company is already on track to complete the construction of its smelters. Yup, although it takes several years, but finally DKFT will have a smelter, and will export nickel ore that has been processed first into value-added products.

So here’s the story. Since 2012, DKFT management has attempted to begin the construction of the smelter. And also in that year, the company gained the commitment from E-United Group from Taiwan, to establish a joint venture company which would build a smelter in Indonesia. Unfortunately, after some time, E-United pulled themselves out from the deal, and the smelter was never constructed. Had been DKFT and E-United build the smelter in 2012, then in 2014, both companies should be able to export downstream products of nickel, but it did not happen.

DKFT management took a long time to find other strategic partners, but that strategic partner finally come. In 2015, DKFT, in cooperation with Macrolink Group from China, established a joint venture company, PT Macrolink Omega Adiperkasa (MOA). MOA would then build a smelter in Morowali, which will process nickel ore into nickel pig iron (NPI), then export it into China. NPI is more or less similar to ferronickel that produced by Aneka Tambang (ANTM) and Vale Indonesia (INCO), and also used as a raw material for the manufacture of stainless steel, but the selling price is much cheaper. In 2017, the NPI price is estimated at US$ 880 per ton.

And by the end of 2015, the construction of the smelter had finally begun. The whole work is expected to be completed by the third quarter of 2016, and the smelter will begin its commercial operation in early 2017. So, yep, if all goes well, DKFT will be back to generate revenue starting in 2017. The company itself will start digging its mines in mid-2016, to supply nickel ore to the smelter later.

The scenery of Central Omega Resources' smelter construction in North Morowali, Central Sulawesi Province. Click image to enlarge

The question is, how much the income that would be generated by DKFT after the smelter is in operation? Well, in its public expose, the management clearly convey the company’s projected financial performance for 2017, which, if DKFT was able export 72,500 tonnes of NPI out of the production capacity of 100,000 tonnes per annum, then the net income will be US$ 11.2 million, or equivalent to Rp149 billion, so the company’s ROE for 2017 will be about 15%.

Another point, for the smelter that operating in 2017, it is only a first stage of the development. Overall, until 2019, the company will build three smelters with a total production capacity of 300,000 tonnes of NPI. So in 2019, assuming the selling price of NPI is unchanged, the Rupiah exchange rate also stable, and the company successfully exporting 250 – 300 thousand tonnes of NPI, then the net income will be about Rp500 – 600 billion, or even more! Another point of interest is that the price of nickel is currently at its bottom of US$ 8,500, decreased significantly compared to the year of 2012 which was US$ 16,000 per ton. But for 2017, it is expected that the nickel prices will rise to US$ 10,000 per tonne, thus increasing the price of NPI, so the net income generated by DKFT could be larger than projection above. Again another point, DKFT will be one of the few mining companies in Sulawesi which has its own smelter, so that the company may be able to buy nickel ore from other mining companies at a discounted price (and for those mining companies, it’s still a better option than not making money at all, as the Government still ban the export of nickel ore), and it will lower the production cost.

And if DKFT successfully posted a large net income starting from 2017, then what about the stock price? You know the answer.

Nevertheless, there are still some other things to consider. First, the smelter is still under construction, and there is no guarantee that the construction will be completed on time. Second, even if the smelter operates on time in early 2017, then usually the volume of production will not directly reached 100,000 tons, or 72,500 tons as projected above, but will grow gradually until the production capacity is entirely utilized (for the very early stage, production volume may only be 20 - 30 thousand tons). And third, the selling price of nickel, as well as other commodities, could fall sharply in last few years because of economic slowdown in China, while China remains the sole buyer of the NPI. So even though there are projections that nickel prices will go up (and so did the price of NPI), but it is also not impossible that the NPI selling prices would instead fall down, so that the net income of DKFT would not be as huge as expected.

The point is, even though DKFT may provide an excellent investment opportunity, but for now we should just wait and see, as for this year of 2016, the company’s income will still be zero, so the stock could fell further. But in the next year, do not forget to look at this DKFT once again.

Any inquiries about investment in Indonesia Stock Market, please send an email to teguh@averepartners.com