copper-bottomed · 52-week price range (pln) 111.4 – 194.5 . 2012 dividend yield : 24.2% . market...

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



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



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




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



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



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%



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



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



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



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



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



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



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

?



Multipliers pricing

5

10

15

LSE TSX NYSE WSE

P/E on selected exchanges


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

?



Multipliers pricing

-50% Historical discount Impact of the State Treasury

-20% Discount

Chemicals

Energy coal

Industrial metals

Electricity

Insurance

Banks

Oil

International competitors



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


-25% -20% -25% -20% Applied discount

10.25 8.8 4.6 4.1 Adjusted multipliers

PLN 192.1



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



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



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



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



Cost inflation



Main risks



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



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



Costs inflation

Prob

abili

ty

Current price PLN 185

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!

copper-bottomed · 52-week price range (pln) 111.4 – 194.5 . 2012 dividend yield : 24.2% . market...

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