BRE Bank Securities BRE Bank Securities Special comment BRE by bobbybrull


									                                                                                                                                                                    Special comment
         BRE Bank Securities
          BRE Bank Securities
                                                                                                                                                      BRE Bank Securities
24 February 2009                                                          Special comment

                          Metals                                          KGHM                                                                                              Buy
                          Poland                                          KGHM.WA; KGH.PW                                                                                (Reiterated)

   Michał Marczak
   (48 22) 697 47 38                                                      2009 Forecasts & Strategy Update

Current price PLN 33.0; Target price PLN 49.2
KGHM’s conservative earnings forecasts for 2009 (net profit pegged at PLN 488m) can be attributed to several
factors: i) uncertainty about future prices, ii) ongoing salary negotiations with trade unions, iii) the fact that
shareholders are due to decide whether to pay dividends for 2008 (the Management Board has called for retention of
last year’s earnings). If we enter current macro variables into our valuation model (Cu at $3300/t, Ag at $14.5/troz,
PLN/USD=3.65), the full-year 2009 net earnings figure to PLN 1.2 billion. The updated 2009-2018 Strategy is a
compilation of investment plans announced by KGHM’s successive management teams in the past. The only plan we
have not heard about before is a copper output target set at 700,000 tons. We are reiterating a buy rating on KGHM.

Tentative FY2009 Guidance
KGHM’s earnings projections for 2009 peg sales at PLN 7 048m, and net income at PLN 488m. The targets were set based on
the following macroeconomic assumptions: i) average price of copper at $3200/t, ii) average price of silver at $10.00/troz
($322/kg), avg. PLN/USD exchange rate at 2.90. The company estimates the full-year electrolytic copper output at 512,000
tons (a decline from the 525,000 tons produced in 2008, caused mainly by scheduled downtime at the Głogów smelter),
including 98,000 tons from scrap. The silver output is estimated at 1 125 tons. The per-ton unit cost of copper is expected to
average PLN 10,466. KGHM plans to spend PLN 1 235m on fixed assets this year (including on a fluidized-bed furnace and
two combined-cycle gas-steam power plants), and PLN 939m on capital investments (a foreign mining company which will
contribute new copper resources, and investments in the power industry). The 2009 budget provides for as-needed measures
aimed at reducing operating expenses. The 2009 budget draft is based on the assumption that KGHM will not pay dividends
from 2008 earnings, but this is subject to a vote by the shareholders (no meeting date has been set yet).

Given current prices of silver ($14.5/troz) and exchange rate trends (PLN/USD=3.65), KGHM’s budget plan seems very
conservative. Just by raising the price of silver (+$4.0/troz), without changing the exchange-rate assumptions, we get an EBIT
estimate which is a massive $140m higher than budgeted. A different exchange rate makes for over PLN 1 billion in operating
profit (even after a corresponding increase in the costs of scrap feedstock).

EBIT, Net Income projections for 2009 and 2010 based on current copper, silver, and zloty price levels
PLN m                                                                         Q1'09          Q2'09         Q3'09          Q4'09         Q1'10         Q2'10          Q3'10         Q4'10
Revenues, where                                                               2 151          2 525         2 214          2 155         2 201         2 300          2 279         2 162
 LME copper prices (USD/t)                                                    3 299          3 300         3 300          3 300         3 300         3 300          3 300         3 300
 Effective copper prices (USD/t)*                                             4 102          4 010         3 410          3 410         3 425         3 425          3 425         3 425
 Silver prices (USD/kg)                                                         378            450           450            450           450           450            450           450
 PLN/USD                                                                       3,26           3,65          3,65           3,65          3,65          3,65           3,65          3,65
 Total copper production (t), incl.:                                            128            130           129            125           132           133            133           125
   own feedstock excl. hedging                                                   78             75            98             98           115           108            102            98
   own feedstock incl. hedging                                                   33             30             0              0             0             0              0             0
   scrap feedstock                                                               17             25            31             27            17            25             31            27

Operating expenses incl.:                                                      1 761         1 858          1 963         2 041         1 806          1 879         1 985          2 065
 Amortization and depreciation                                                   117           117            117           117           117            117           117            117
 Salaries                                                                        664           601            635           711           677            613           648            725
 Materials and utilities, incl.                                                  692           828            900           897           720            834           905            902
   third-party feedstock                                                         188           301            373           325           210            301           373            325
   other                                                                         505           527            526           572           510            532           531            577
 Third-party services                                                            210           234            234           239           212            237           236            241
 Other                                                                            78            78             78            78            79             79            79             79

Unit cost of copper (PLN)                                                    10 901        10 296         11 189        12 306         10 065        10 108         10 953        12 495
Unit cost of copper (USD)                                                     3 345         2 821          3 066         3 372          2 758         2 769          3 001         3 423

EBIT                                                                             394            671           255           118            400           425            298           101
Net income                                                                       329            553           216           106            334           354            252            92
EBIT                                                                                                                      1 437                                                     1 224
Net income                                                                                                                1 205                                                     1 032
Source: BRE Bank Securities, * adjusted for hedging and product and location premium

24 Bank Securities does not rule out offering brokerage services to an issuer of securities being the subject of a recommendation. Information concerning a conflict of interest arising in
BREFebruary 2009
connection with issuing a recommendation (should such a conflict exist) is located on the final page of this report.
                                                                                                                  Special comment
      BRE Bank Securities
       BRE Bank Securities

The most surprising prediction in KGHM’s 2009 forecasts is a per-ton unit cost of just $10 500, while prices of silver are also
expected to be low. Assuming a higher price of silver (lower unit cost) and a weaker zloty (higher costs of scrap offset by
higher sales of silver), the cost of one ton of copper declines by a further PLN 1,000.

2009-2013 Strategy Plan
KGHM’s Supervisory Board approved a new 2009–2018 strategy plan, whose main target is to increase copper production to
ca. 700,000 tons, and to improve operating effectiveness. Production will be increased by: i) streamlining the management of
deep copper deposits (exploration of the Głogów Głęboki-Przemysłowy deposit, developing an exploration system for deposits
under 1,200 meters), ii) investments in international mining assets (a shortlist of investment targets has been created, the first
of which could be a done deal by the end of the year), iii) prospecting for new deposits near Lubin (Radwanice – Gaworzyce)
and in the Weisswasser area in Germany, exploration of areas surrounding existing KGHM deposits, iv) increasing scrap use.

Measures to improve operating effectiveness include: i) deployment of new technology (mechanical mining in deposits up to 2
meters deep, a fluidized–bed furnace at the “Głogów I” smelter, automated ore enrichment), ii) modernization of existing
infrastructure (replacement of 17% of mining equipment, purchases of new flotation machines, modernization of the “Głogów
II” smelter, iii) production streamlining (centralized purchases, implementation of a deposit management system, acceleration
of preparatory work underground).

Another important objective for KGHM is to diversify revenues and gradually become independent of energy prices by
investing more in telecommunications and moving into power generation. KGHM’s energy business would be based on three
main sources: i) gas (the company plans to build gas-fired steam generators in Głogów and Polkowice which are expected to
cover 25% of its energy needs), ii) hard coal (a coal-fired power station will be built together with an industry partner), iii)
renewable sources (wind). The long-term goal is to capture a ca. 3% market share in energy generation in Poland.

The estimated 2009–2018 CAPEX allocations toward strategic projects are PLN 19.8 billion. The new strategic objectives are
mostly updates of earlier plans, and should not influence KGHM’s stock price strongly. The only news is the amount of copper
output expected to be achieved after all the investments (700,000 tons), which, we suspect, will mostly be acquisitions of
deposits located abroad, currently still in the planning stage. Investors need not be concerned about the huge CAPEX (PLN
19.8bn) and its effects on future earnings distribution. Each of KGHM’s past Management Boards presented equally ambitious
plans which, since they were never actualized, did not prevent payouts. And we do not expect much change in that respect in
the future.

24 February 2009
                                                                                                                       Special comment
      BRE Bank Securities
       BRE Bank Securities

                                             Michał Marczak tel. (+48 22) 697 47 38
                                             Managing Director
                                             Head of Research
                                             Strategy, telco, mining, metals, media

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                                                                      00-950 Warszawa

24 February 2009
                                                                                                                              Special comment
      BRE Bank Securities
       BRE Bank Securities

        List of abbreviations and ratios contained in the report.
        EV – net debt + market value (EV – economic value)
        EBIT – Earnings Before Interest and Taxes
        EBITDA – EBIT + Depreciation and Amortisation
        PBA – Profit on Banking Activity
        P/CE – price to earnings with amortisation
        MC/S – market capitalisation to sales
        EBIT/EV – operating profit to economic value
        P/E – (Price/Earnings) – price divided by annual net profit per share
        ROE – (Return on Equity) – annual net profit divided by average equity
        P/BV – (Price/Book Value) – price divided by book value per share
        Net debt – credits + debt papers + interest bearing loans – cash and cash equivalents
        EBITDA margin – EBITDA/Sales

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        REDUCE – we expect that the rate of return from an investment will range from -5% to -15%
        SELL – we expect that an investment will bear a loss greater than 15%
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24 February 2009

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