It is a classic problem for most industries making the transition from communism to capitalism. The region is littered with Soviet-era dinosaurs that have some great underlying assets like oilfields and gold mines, but the challenge for new owners has been to transform dilapidated facilities into modern ones. On occasions it has not been worth the effort. Kazakhmys, a leading Soviet-era copper producer that still holds massive reserves, was in just such a situation.

Over the last decade, the Kazakh company was busy building new modern mines, but the problem management faced was that the old unproductive facilities were dragging down its profitability, which was hurting the share price. So in the summer of 2014, Kazakhmys announced a major restructuring to create two separate companies. This is proving to be beneficial for profitability, which turned positive in 2015, but investors are still being punished for low metals prices and sluggish global demand.

Management decided to split the London-listed company into two: KAZ Minerals would be a holding company for the new operations and keep the stock market listing, with ‘spun-out Kazakhmys the repository for the legacy operations.

KAZ Minerals shrank by 70% in size, but kept the higher grade, lower cost eastern region assets plus the Bozymchak gold mine in Kyrgyzstan, the two growth projects of Bozshakol and Aktogay, and a new asset Koksay. The rump of high-cost mature assets in the Central and Zhezkazgan regions were spun off into a new entity to be controlled by Kazakhmys’ major shareholder, Vladimir Kim. The two entities will cooperate on smelting and sales.

Separating the company killed two birds with one stone: it solved both economic and political issues at a stroke. “After KAZ Minerals was reorganised as a separate entity with profitable assets and Kazakhmys retained unprofitable assets, KAZ Minerals’ deposits are showing generally good production results... and the development of KAZ Minerals as a separate company is quite good at the moment” Nurlan Ashinov, an analyst at the Almaty-based BCC Invest brokerage, explains to bne IntelliNews, though adds that in the current environment of low prices the profitability of those assets has decreased considerably.

The separation into two companies has also dealt with a nasty image problem. As well as accidents with casualties and labour relations at some of its ageing mines, Kazakhmys got entangled in the scandal surrounding another Kazakh miner ENRC, in which it held a 26% stake before selling it in 2013 after repeated write-downs worth billions of dollars in the value of its stake. ENRC, controlled by a trio of oligarchs – Alexander Machkevitch, Patokh Chodiev and Alijan Ibragimov, none of them a native of Kazakhstan – had to delist from the London Stock Exchange (LSE) in 2013 as a result of boardroom disputes and an investigation by the UK’s Serious Fraud Office.

The brouhaha meant ENRC provided one of the worst ever returns for shareholders on the LSE of about minus 54% since its 2007 listing, according to Thomson Reuters. Kazakhmys’ association with ENRC meant its stock followed the trajectory of ENRC, losing over 85% of its value from the historical highs of 1,660p hit in 2011 to just 238p on November 25, 2013, when ENRC finally delisted.

Deep mining

Despite all these changes, KAZ Minerals shares have continued on a stomach-churning rollercoaster ride for investors. From a high of 343p reached in July 2014 on the back of the announcement of the reorganisation, the stock plunged nearly 79% to 72.7p when the price of copper fell to below $5,000 a tonne – just $100 above the level it reached in 2009 in the wake of the financial crisis.

Although the Kazakh government’s August 20 announcement of a free floating exchange regime for the tenge gave a very short-lived (one-day) boost of 21% to the stock (177.4p), the ensuing depreciation of the tenge has failed to reverse the downward trend: KAZ Minerals shares have lost over 47% since August 20, closing at 89.9p on November 25.

BCC Invest estimates that 60% of KAZ Minerals’ costs are borne in tenge, while almost all revenue is in dollars, so the devaluation of the tenge by about 60% since August 20 should have been positive for the company. Therefore, BCC Invest’s Ashinov says the big fall following the devaluation of the tenge was linked to metals prices and market conditions, rather than specific problems related to the company. “This assumption is supported by the fact that the weakening continued following the initial [August 20] devaluation, despite the positive effects of the devaluation on the company.”

To illustrate the point, Ashinov cited the behaviour of the stock in the past 12 months followed the market rather than the tenge or company financials: the correlation between KAZ Minerals shares and Glencore Xstrata shares is 93%, and between the shares and copper prices is 82%.

Silver lining

BCC Invest believes that the current price of KAZ Minerals shares makes them undervalued and attractive compared to its peers. The brokerage took 16 global copper and other metal companies and compared their current enterprise value to forecasted 2016 Ebitda. The analysis produced the average of 6.65x for the sector, whereas this ratio stands at 4.53x for KAZ Minerals at the moment. “This means on this indicator KAZ Minerals is more attractive compared to similar companies, trading with a discount of [at least] 32%.”

Indeed, on November 18, Deutsche Bank hung a ‘Buy’ rating on KAZ Minerals, setting a price target of 240p on the stock, a potential upside of 163% from its opening price that day.

Looking at the company fundamentals, despite low global prices for metals KAZ Minerals has maintained its core production in the first three quarters of 2015, producing 66,500 tonnes of copper in concentrate against 66,400 tonnes in the same period of 2014 and 28,200 ounces of gold bars against 23,300 ounces.

Revenue was 20% down on year to $341mn in the first half of 2015 due to lower prices and volumes for the key metals of copper, silver and gold. At the same time, sales costs increased to $228mn from $220mn. Cost improvements helped the company to deliver Ebitda before special items of $88mn and eke out a pre-tax profit of $2mn against losses worth $104mn in the same period of last year. Free cash flow before interest was $30mn, reflecting lower commodity prices in the first half of 2015, partially offset by reduced costs.

Retained assets

The assets KAZ Minerals retained from Kazakhmys comprise four operating mines, three concentrators, the Bozymchak gold mine and a concentrator in Kyrgyzstan and major growth projects, two of which – Bozshakol and Aktogay – are under construction. These assets are focused on mining and concentrating, without captive power or smelting and refining facilities. The retained assets contain proved and probable ore reserves of 46.5mn tonnes with contained copper of 0.9mn tonnes at a grade of 1.8%, and measured and indicated mineral resources of 2,624mn tonnes with contained copper of 10.4mn tonnes at a grade of 0.4% as of December 31, 2014.

In the 2013 financial year, the retained assets mined approximately 4.4mn tonnes of ore at a copper grade of 2.41%, and produced 87,000 tonnes of copper in concentrate. These assets contributed sales revenue of around $931mn and Ebitda (excluding special items) of $389mn before the mineral extraction tax of $94mn. Sustaining capital expenditure on the retained assets totalled $72mn.

The assets held by the new Kazakhmys include 12 copper mines (containing proved and probable ore reserves of 326.6mn tonnes with contained copper of 3.3mn tonnes at a grade of 1.03% and measured and indicated mineral resources of 2.7bn tonnes with contained copper of 17.2mn tonnes at a grade of 0.64%), mine development opportunities, four concentrators, two smelters, two coal mines, and three captive heat and power stations.

These mines produced 228,000 tonnes of copper in concentrate in 2013. The assets’ sales stood at $2.3bn and Ebitda (excluding special items) of $342mn before the mineral extraction tax of $148mn. Sustaining capital expenditure on the disposal assets $415mn, while they were valued at $2.8bn as at December 31, 2013. The mines and other facilities of the disposal assets employed 43,000 full-time employees or 81% of the group’s total.

Who is Vladimir Kim?

Vladimir Kim, 54, is Kazakhstan’s fifth richest man with a fortune of $1.8bn in 2015, according to Forbes Kazakhstan. He owns 33.4% of London-listed KAZ Minerals and is a co-owner of the now privately-held Kazakhmys together with another Kazakh oligarch, Eduard Ogay. The co-owners haven’t disclosed their respective stakes in Kazakhmys.