base metal smelting industry [email protected]...

Mizuho Securities Equity Research3 September 2012Nonferrous MetalsIndustry Overview

Base metal smelting industryBullish on copper; neutral on nickel and zinc

Senior Analyst:Akifumi Hayashi, CFA+81 3 6202 [email protected]

SummaryWe hereby initiate our coverage of the three major Japanese base metalsmelting companies. We are neutral on the base metal smelting industryoverall, in light of the significant disparities that exist within it, which stem fromuncertainty in short-term base metal price trends and from the supply/demandbalances for the various metals, which are less than universally favorable.While these companies have thus far successfully developed their businesseson a custom smelter model, the limits of this model are gradually becomingapparent. We therefore favor companies with prospects for accelerated growththrough evolution of their business models, such as in expansion in upstreammining operations. We are initiating coverage on Sumitomo Metal Mining witha Buy rating, on Pacific Metals with a Neutral rating, and on Toho Zinc witha Neutral rating.

Base metal prices and implicationsWhile we expect the short-term supply/demand balance for one of the basemetals, namely copper, to be comparatively tight, we expect this balance toremain loose for nickel, another base metal. Although we expect the coppersupply/demand balance to loosen going forward, it will likely remain tightrelative to those of other metals, as supply constraints are likely to limit theamount of surplus. Zinc is currently plagued by oversupply, however, and itappears likely to have the tightest supply/demand conditions over the longterm as older mines are depleted. For nickel, we expect a persistent supplyglut in light of the number of large-scale development projects planned. Forthis reason, we are more bullish on copper-related companies and have morecautious views on nickel- and zinc-related companies.

Share price drivers and valuationsWe see base metal price trends and reforms to company business modelsas the main factors determining share price performance for the basemetal smelting companies. The shares of these three base metal smeltingcompanies are currently trading at PBRs of around 0.5x–0.7x, and their shareprices tend to fluctuate in tandem with base metal prices most heavily weightedin each company’s business structure. Sumitomo Metal Mining is also tradingat a PER roughly on par with that of global competitors. Nevertheless, ouroutlook for copper prices suggests leeway for upward movement in valuations,which deteriorated alongside the drop in nickel prices, and theoretical PBRbased on the relationship between capital costs and ROE also implies upside.

Share price catalysts/risk factorsIn terms of base metal prices, any phenomena that could cause declines insupply could act as catalysts for sector share prices. For individual companies,catalysts include business model reforms involving growth in productionvolume in upstream resource business. Risks to sector share prices include alarger-than-expected drop in base metal prices and unsuccessful developmentprojects.

Figure 1. Investment rating and valuationsCode Rating Share price Price objective Rate of deviation Price objective PER PBR Dividend yield

(¥) (¥) calculationPacific Metals 5541 Neutral 251 250 -0% BPS x roughly 0.5x - 0.4x 0.0%Toho Zinc 5707 Neutral 265 280 6% BPS x roughly 0.7x - 0.6x 2.6%Sumitomo Metal Mining 5713 Buy 808 1,060 31% BPS x roughly 0.9x 8.8x 0.6x 3.5%Note: Share prices are as of 31 August. PER, PBR, and dividend yield data are based on our FY3/13 forecasts.Source: Mizuho Securities Equity Research

Please refer to pages 48 - 49 of this report for important disclosure and analyst certification information.

Mizuho Securities Co., Ltd.

Table of contents Executive summary .................................................................................................. 3

POSITIVE ON SHIFT AWAY FROM CUSTOM SMELTING BUSINESS MODEL ........................ 3

KEY INVESTMENT POINTS ......................................................................................... 3

Valuations .................................................................................................................. 4

BASE METAL PRICES AND KEY SHARE PRICE CHARACTERISTICS .................................. 4

COMPARISON WITH GLOBAL COMPETITORS................................................................ 6

Base metal price forecasts ....................................................................................... 8

(1) COPPER PRICE FORECAST .................................................................................. 8

(2) NICKEL PRICE OUTLOOK .................................................................................... 14

(3) ZINC PRICE OUTLOOK ....................................................................................... 20

Pacific Metals (5541) Taking on challenges in ferronickel business ................. 25

INVESTMENT RATING AND VALUATIONS .................................................................... 25

Toho Zinc (5707) Transition to an integrated mining and smelting business ................................ 33

INVESTMENT RATING AND VALUATION ...................................................................... 33

Sumitomo Metal Mining (5713) New sprouts augur the rise of a new major Japanese base metal company ... 40

INVESTMENT RATINGS AND VALUATION .................................................................... 40

Base metal smelting industry 2


3 September 2012

Executive summary Positive on shift away from custom smelting business model

The Japanese base metal smelting companies have thus far successfully developed

their businesses as custom smelters. However, with the maturing of domestic

demand and shifts in global ore supply/demand conditions, they are now

approaching the limits of growth under a custom smelting business model. The base

metal smelting companies are responding to this state of affairs through such means

as expansion into upstream mining business, technological advances in smelting

methods, and enhancement and diversification in downstream business. We believe

these efforts will be the key to future growth for these companies.

We see Sumitomo Metal Mining’s copper and nickel mining businesses and Toho

Zinc’s zinc mining business as growth drivers. We take a positive view of Sumitomo

Metal Mining’s investment in honing its competitive advantages in upstream

resource development through technological advances in smelting, such as in wet

smelting technology for lower-grade nickel ore. We are focusing on the extent to

which companies will be able to develop new mines for copper and zinc, the

development opportunities for which appear likely to decline over the long term.

Such development will depend on these companies’ efforts in exploration operations,

and the potential of the mining sites in which the companies hold rights will also be

crucial. In this area as well, we believe Sumitomo Metal Mining has advantages in its

annual exploration budget of roughly ¥7b and its wealth of exploration projects. We

also believe there is potential for further expansion in resource volumes in Toho

Zinc’s Rasp mine, as mineralization in its ore deposits seems to extend further to the

north.

Key investment points

Share price performance for the base metal smelting companies fluctuates based on

base metal prices. While we expect the short-term supply/demand balance for

copper to be comparatively tight, supply/demand for nickel appears likely to remain

loose. We therefore view copper-related companies as attractive. Factors apart from

market prices that affect share price performance for individual stocks include trends

in upstream mining business. Sumitomo Metal Mining appears attractive both in

terms of the outlook for base metal prices and in terms of individual factors, and we

are therefore initiating our coverage of the company with a Buy rating. While Pacific

Metals faces a number of issues in terms of both market prices and individual

factors, we believe these have been largely priced in, and we are therefore initiating

our coverage of the company with a Neutral rating. Although we look positively on

Toho Zinc’s progress in upstream mining business, we see a risk that short-term

earnings could fall below the market’s expectations, and we are therefore initiating

our coverage of the company with a Neutral rating.

We believe investment opportunities for the sector as a whole will arise when the

various factors that have thus far necessitated a cautious stance move toward

resolution or at least improvement, widening the selection of attractive stocks

beyond those focused on copper. From this standpoint, we intend to closely monitor

trends at the nickel- and zinc-related companies.

Evolution away from custom

smelting business model will

be the key to future success

Focus on Sumitomo Metal

Mining and Toho Zinc’s

efforts in upstream mining

business

Sumitomo Metal Mining

attractive both in terms of the

outlook for base metal prices

and for individual factors

A widening in the range of

attractive stocks could mark a

turning point for the sector



3 September 2012

Valuations Base metal prices and key share price characteristics

The share prices of base metal smelting companies tend to be closely linked to base

metal prices. In looking at the correlation between base metal prices and the share

prices relative to TOPIX of the three companies on which we are initiating coverage

(Sumitomo Metal Mining, Toho Zinc, and Pacific Metals), we note that the share

price for Sumitomo Metal Mining shows the strongest correlation with gold and

copper prices, while the correlation with nickel prices is strongest with Pacific Metals

and the correlation with zinc is strongest with Toho Zinc. Accordingly, valuations are

also closely linked with market prices for these base metals. In other words, while

valuations can improve on the back of higher base metal prices, valuations can

deteriorate on lower base metal prices. Valuations since 2010 have generally shown

a link with base metal prices, though we note slight differences as a result of unique

factors.

Figure 2. Correlation between base metal prices and share prices of base metal and trading companies relative to TOPIX (2005 onwards)

Pacific Metals Toho Zinc Sumitomo Metal

Mining

Itochu Marubeni Mitsui Sumitomo Mitsubishi

Copper 0.3 0.2 0.6 0.8 0.7 0.7 0.6 0.7

Nickel 0.8 0.7 0.7 0.6 0.5 0.6 0.7 0.3

Zinc 0.6 0.9 0.5 0.5 0.4 0.4 0.6 0.2

Gold -0.1 -0.4 0.2 0.5 0.3 0.3 0.3 0.3

¥/US$ 0.4 0.6 0.1 -0.2 -0.0 0.0 0.0 -0.1

Note: Correlation of trading company share prices relative to TOPIX is highlighted when the correlation is higher than at other trading companies and the company has upstream rights on relevant products.

Source: Mizuho Securities Equity Research

Share price performance, as noted above, appears reasonable when factoring in the

direct impact of base metal prices on performance at the base metal smelting

companies. We estimate the earnings contribution ratio for gold, copper and nickel

at Sumitomo Metal Mining to be roughly 1:1:1. While the decline in nickel prices

contributed to an earnings deterioration in the nickel business at Pacific Metals to

near the break-even point, nickel also appears to be almost the only factor

contributing to fluctuating earnings at the company. Similarly, the fluctuation in

earnings at Toho Zinc was due almost entirely to lower prices on zinc, because the

company is more strongly weighted in zinc than in non-zinc operations, where

earnings were more stable. Looking back to FY3/11, before base metal company

earnings deteriorated to near the break-even point, we see that nickel accounted for

99% of earnings at Pacific Metals, while zinc accounted for about two-thirds of

earnings at Toho Zinc. The earnings contribution ratio for Sumitomo Metal Mining

now appears to be about the same as it was in FY3/12.

In the same manner as the base metal smelting companies, there is a strong

correlation between share price performance at trading companies and commodity

prices for the mainstay products of those companies. While trading company shares

are even more closely linked to the price of copper than Sumitomo Metal Mining, the

copper business accounts for no more than 10% of total earnings, even at leader

Mitsubishi. The share price of Pacific Metals shows a stronger correlation with the

price of nickel than do the share prices of the trading companies, which are

generally in line with the structure of the business at each company. The correlation

Base metal prices as a share

price and valuations driver

Earnings drivers and

comparison with trading

companies



3 September 2012

with the price of zinc is stronger at Toho Zinc than at the trading companies, and a

comparison of operating structure shows no significant difference. Accordingly,

selection based on exposure to zinc and nickel reveals a potential investment

opportunity for base metal companies exceeding that for the trading companies.

Figure 3. Estimated earnings by product at base metal and trading companies (FY3/12)

Pacific Metals Toho Zinc Sumitomo Metal

Mining

Itochu Marubeni Mitsui Sumitomo Mitsubishi

Copper 0% 0% 42% 0% 7% 2% 6% 9%

Nickel 71% 0% 37% 0% 0% 0% 0% 0%

Zinc 0% 8% 0% 0% 0% 0% 6% 0%

Gold 0% 0% 48% 0% 1% 0% 1% 0%

Elimination & others 29% 92% -27% 100% 91% 98% 86% 91%

Note: NP breakdown for trading companies, OP for Toho Zinc, and RP for Sumitomo Metal Mining and Pacific Metals. Includes by-product credit. Earnings on base metal products through indirect equity interest at Mitsui’s Vale excluded. Figures show Mizuho estimates for mining earnings at Mitsubishi, Antamina by-product credit included in copper earnings.


In looking at valuations on an absolute basis, share prices are trading at a PBR of

0.6x for Sumitomo Metal Mining, 0.6x for Toho Zinc and 0.4x for Pacific Metals

based on our FY3/13 estimates. Factoring beta values of 1.2 at Sumitomo Metal

Mining, 1.5 at Toho Zinc, and 1.4 at Pacific Metals, based on a risk-free rate of 1.3%

and an equity risk premium of 6.0%, we calculate a cost of capital of 8.5% at

Sumitomo Metal Mining, 10.3% at Toho Zinc, and 9.7% at Pacific Metals. Based on

a comparison of the cost of capital and ROE, the difference between theoretical

PBR and actual PBR signals upside potential for Sumitomo Metal Mining’s shares,

but downside potential for Pacific Metals’ shares. Valuations on this basis appear to

be roughly on par for Toho Zinc. Nevertheless, we stress the importance of base

metal price trends for share price performance.

Figure 4. Base metal company capital costs and ROE

Pacific Metals Toho Zinc Sumitomo Metal Mining

PBR (FY3/13 Mizuho estimate) (x) 0.4 0.6 0.6

Rf (%) 1.3% 1.3% 1.3%

Beta 1.4 1.5 1.2

Equity risk premium (%) 6.0% 6.0% 6.0%

Cost of capital (%) 9.7% 10.3% 8.5%

ROE (FY3/13 Mizuho estimate) (%) - - 8%

ROE (FY3/14 Mizuho estimate) (%) 1% 6% 8%

Note: Financial figures based on end-term balance sheets. Share prices as of 31 August. Source: Mizuho Securities Equity Research

We are assigning price objectives based on the aforementioned share-price

characteristics and our short-term forecasts for base metal prices. In light of rising

copper prices, we view a PBR of about 1x as the upper limit for Sumitomo Metal

Mining. On the other hand, the share price has fallen in line with the decline in nickel

prices and PBR appears relatively attractive against the current level of copper

prices. We expect nickel prices to bottom near their current level and believe the

basis for valuations could shift to copper prices. Given these assumptions, we are

setting a price objective based on a PBR of roughly 0.9x and our end-of-FY3/13

BPS estimate. We believe the PBR at Pacific Metals could fall below 0.5x should the

trend toward weak nickel prices continue, but our price objective is based on a PBR

of roughly 0.5x and our end-of-FY3/13 BPS estimate as we expect nickel prices to


shows upside based on

profitability comparison

Setting our price objectives



3 September 2012

bottom near their current level. We expect zinc prices to maintain their current level,

and our price objective for Toho Zinc is thus based on a PBR of roughly 0.7x and our

end-of-FY3/13 BPS estimate.

Comparison with global competitors

When comparing valuations for the three base metal smelting companies to global

competitors, we note that share prices for overseas copper mining companies are

trading at PER levels of about 11x, generally in line with those at the copper

smelting companies. Share prices for overseas nickel companies are trading at an

average PER of about 12x, and the mining and smelting business models for

Sumitomo Metal Mining accordingly do not appear overvalued in comparison. In zinc

operations, mining company PERs are low while smelting company PERs seem

high. This appears to reflect depressed profitability at smelting companies. Against

the global competitors, Pacific Metals and Toho Zinc do not necessarily appear

attractive, given the slump in earnings. However, companies such as Toho Zinc

appear likely to show an improvement heading into FY3/14.

Figure 5. Copper price trends and the copper company share price index

0

100

200

300

400

500

600

Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012

Copper company share price index Sumitomo Metal Mining stock price index

Copper price (¢/lb)

(Index: end of 2004 = 100)

Note: Copper company share price index: 100 = end-2004 average for Xstrata, Freeport-McMoran Copper & Gold,

Grupo Mexico, Antofagasta, Teck Resources Source: Mizuho Securities Equity Research


attractive even when

compared to global

competitors



3 September 2012

Figure 6. Base metal company valuations

Market cap Share price PER PBR ROE

Dividend

yield

Dividend

payout ratio

($m) Currency (x) (x) (%) (%) (%)

Copper-related

Xstrata Mining 45,366 952 GBp 11 0.9 8 2.7 31

Freeport-McMoran Mining 34,276 36 USD 11 2.0 18 3.4 36

Grupo Mexico Mining 23,088 39 MXN 10 2.6 25 4.1 43

Antofagasta Mining 17,317 1,107 GBp 12 2.3 19 2.8 35

Teck Resources Mining 15,972 28 USD 9 0.9 9 2.9 27

Copper mine average 11 1.7 16 3.2 34

Jiangxi Copper Refining 6,422 20 CNY 10 1.5 15 2.2 21

Sumitomo Metal Mining Mining, refining 5,793 808 JPY 9 0.6 8 3.5 30

Nickel-related

Norilsk Nickel Mining 29,200 153 USD 8 2.0 25 3.9 31

Eramet Mining 2,933 88 EUR 19 0.8 4 1.8 35

Vale Indonesia Mining 2,393 2,300 IDR 11 1.3 12 6.6 73

Aneka Tambang Persero Mining 1,239 1,240 IDR 8 1.0 13 5.0 39

Nickel Asia Corp. Mining 529 17 PHP 12 1.9 16 4.0 47

Nickel mine average 12 1.4 14 4.3 45

Sumitomo Metal Mining Mining, refining 5,793 808 JPY 9 0.6 8 3.5 30

Pacific Metals Refining 625 251 JPY - 0.4 -1 0.0 -

Zinc-related

Vedanta Resources Mining 4,087 868 GBp 5 0.7 13 4.2 21

Perilya Mining 210 0.27 AUD 6 0.5 9 0.0 0

Zinc mine average 6 0.6 11 2.1 11

Nyrstar Refining 819 3.83 EUR 50 0.5 1 3.9 192

Korea Zinc Refining 6,819 409,000 KRW 11 1.9 18 1.1 12

Zinc ore refining average 30 1.2 9 2.5 102

Toho Zinc Mining, refining 459 265 JPY - 0.6 -2 2.6 -

Note: Share prices as of 31 August 2012. FY12 basis. Consensus forecast by Bloomberg. Figures for Japanese companies are Mizuho estimates. Source: Mizuho Securities Equity Research



3 September 2012

Base metal price forecasts (1) Copper price forecast

We expect the price of copper to trend gradually downward over the medium term,

but see significant latent potential for wide price swings in the event of even minor

changes in supply or demand, as we expect the copper price to remain relatively

high (despite trending downward) and expect supply and demand to remain fairly

evenly matched. We expect the long-term equilibrium price to remain fairly high by

historical standards, with the chief determinants being the limited quantity of new

supply sources and the high development costs involved.

Outlook for supply and demand in China

Our forecasts assume a temporary weakening in demand in China in 2012,

particularly from power cable producers, generally a mainstay source of demand.

However, we expect demand to resume stable growth in 2013. We estimate current

annual per-capita copper consumption in China at roughly 5.5kg, and expect this to

rise to 7.5kg over the long term, with China’s annual copper consumption increasing

at an annual rate of around 5%.

Limits on copper mine output

Copper output is coming up against significant downward pressure, some of which

appears to be structural. The copper grade of the world’s major mines is declining;

this is a structural restriction on supply that is part and parcel with the increasing age

of the mines in operation. Worker strikes and other such disruptions of production

also have a substantial impact, with subsequent recoveries in production falling

short of expectations in some cases even when the ostensible issues have been

resolved.

Copper price forecasts

Figure 7. Global supply/demand balance and copper prices

2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

Production:

Mine MT 15.6 15.7 15.9 16.1 16.3 17.2 18.3 19.4 20.4 21.4

Refined MT 18.0 18.5 18.6 19.2 19.9 20.0 21.1 22.0 22.8 23.7

Consumption MT 18.1 18.2 18.2 19.3 19.5 19.9 20.9 21.6 22.4 23.3

Refined balance MT -0.0 0.3 0.4 -0.2 0.4 0.1 0.2 0.3 0.4 0.4

LME price $/lb 3.2 3.2 2.3 3.4 4.0 3.6 3.5 3.3 3.2 3.0

Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research, based on Bloomberg data

We expect the global balance of supply and demand for copper metal to gradually

ease over the medium term. We do not expect to see shortages emerge, assuming

that slowed growth in nominal consumption in China has an impact on the

supply/demand situation in 2012, and that worker strikes and other temporary

disruptions of production at the world’s major copper mines die down over the

medium term. However, we expect any surplus to be quite limited, especially over

the next few years, and therefore believe that even small swings in supply and/or

demand could potentially result in shortages. These conditions are conducive to

keeping the price of copper consistently high. Our forecasts for supply and demand

Supply/demand balance set

to ease—albeit gradually—

barring any disruptions of

production



3 September 2012

for copper in the world’s major economies with the exception of China are based on

the GDP growth forecasts included in the IMF’s World Economic Outlook Database

of April 2012.

We expect supply and demand for copper to balance out near the equilibrium point

over the long term as well, and therefore expect the long-term equilibrium price to be

underpinned by marginal producers’ cost of production. We have therefore set our

long-term price assumption at $3/lb, which is the price that would correspond to a

required return of 10% assuming a cash cost of $1.4/lb and new mine development

costs of $17,500 per annual metric ton of output.

China copper supply/demand forecasts

Figure 8. Copper supply/demand forecasts for China

2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

Chinese supply/demand

Refined copper output MT 3.5 3.8 4.1 4.5 5.2 5.1 5.6 5.8 6.1 6.4

Net refined import MT 1.4 1.4 3.1 2.9 2.7 3.0 3.2 3.3 3.5 3.7

Apparent refined consumption MT 4.9 5.2 7.2 7.4 7.9 8.1 8.8 9.2 9.6 10.1

Concentrate import MT 4.5 5.2 6.1 6.5 6.4 7.0 8.2 8.5 8.9 9.1

Concentrate production 0.9 1.1 1.0 1.2 1.3 1.4 1.5 1.7 1.9 2.0

Copper demand:

Power MT 2.1 2.5 3.1 3.6 3.6 3.8 3.8 3.7 3.6

Air conditioners MT 0.8 0.8 1.0 1.3 1.3 1.4 1.6 1.8 1.9

Transportation MT 0.5 0.6 0.7 0.8 0.8 0.9 1.0 1.1 1.2

Electronics MT 0.4 0.4 0.5 0.6 0.6 0.7 0.7 0.8 0.9

Building & construction MT 0.4 0.5 0.6 0.8 0.8 0.9 1.0 1.1 1.2

Others MT 0.6 0.7 0.8 0.8 0.9 1.0 1.1 1.2 1.3

Total MT 4.9 5.4 6.8 7.9 8.1 8.8 9.2 9.6 10.1

Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research, based on data from Bloomberg and Antaike

China is the world’s largest consumer of copper, accounting for nearly 30% of the

world’s copper metal consumption, and its effect on the balance of supply and

demand is therefore substantial. According to Antaike, nearly half (46%) of China’s

demand for copper in 2010 was for use in the electric power sector, with air

conditioner and refrigerator production accounting for 15%, automobile production

accounting for 11%, construction accounting for 9%, electronic component

production accounting for 8%, and all other applications together accounting for 11%.

Demand from the electric power sector stems mainly from the production of power

cables for short-distance power distribution and transformers. Power cable

production in China is generally trending upward in tandem with the country’s

electric power output, but we expect to see almost no YoY change in 2012. We also

expect demand for copper for air conditioners and in construction applications to be

fairly weak, but expect growth in demand for other applications to parallel growth in

GDP. Overall, then, we expect China’s demand for copper to increase by around 3%

YoY in 2012. Over the medium term, we expect China’s demand for copper to

bounce back in 2013 with an 8% increase as the demand segments that were

sluggish in 2012 stage recoveries, and we expect YoY growth in demand to stabilize

at 5% in 2014. However, per-capita copper consumption in China stood at only

around 5.5kg in 2010, leaving significant room for consumption to increase over the

long term as the economy expands.

Copper demand in China

stagnant in 2012 but set to

resume growth in 2013



3 September 2012

Figure 9. Chinese copper demand by application (2010) (%)

Electric power46%

Air conditioners15%

Automobile11%

Eletroniccomponents

8%

Building &construction

9%

Others11%

Source: Mizuho Securities Equity Research, based on data from Antaike

Figure 10. Per-capita annual copper consumption by country

0

5

10

15

20

25

0 10,000 20,000 30,000 40,000 50,000

US China Japan South Korea GermanyGDP ($/person)

(kg/person)

Source: Mizuho Securities Equity Research, based on data from JOGMEC

China’s apparent copper consumption in 2011 came to roughly 7.9m MT, with

around 5.2m MT of this being refined copper production and the other 2.7m MT

corresponding to the country’s net imports of copper metal. For the refined copper

production, only around 1.3m MT of the copper ore used came from domestic mines,

with the rest coming as copper ore imports (approximately 6.4m MT) or scrap

imports (approximately 4.7m MT). We therefore estimate that China’s self-sufficiency

ratio for copper metal is less than 20%, indicating a heavy reliance on imports.

According to data from Antaike, China’s copper reserves as of the end of 2009

totaled roughly 30m MT, which does not appear sufficient to allow the country to

increase its self-sufficiency ratio to any great extent. We therefore expect the

balance of supply and demand in China to continue having a significant and direct

impact on the world’s balance of supply and demand.

World copper mine output forecasts

Chile is the world’s largest copper producer, accounting for roughly one-third of

global output. In 2011, the country produced approximately 5.3m MT. We expect this

figure to rise to around 6.8m MT in 2016, assuming a 500,000MT increase in annual

output from the Escondida mine and the added contributions of operations starting

at the Antucoya mine (annual capacity of 80,000MT), the Caserones mine

(150,000MT), and the Sierra Gorda mine (110,000MT). Outside of Chile, other

mines scheduled to commence operations include Peru’s Antapaccay mine (in 2H

2012; annual capacity of 160,000MT), Brazil’s Salobo mine (in 2012–2013; annual

capacity of 200,000MT), Mongolia’s Oyu Tolgoi mine (targeted for 2013; annual

capacity of 430,000MT), and Peru’s Las Bambas mine (targeted for 2014; annual

capacity of 400,000MT). Over the medium term, then, we expect worldwide copper

mine output to increase by around 6% annually.

China relies heavily on

imports

South America the driving

force behind copper mine

production worldwide



3 September 2012

Figure 11. Production capacity forecasts for major copper mines (vs. 2011) (m MT)

0.0

0.5

1.0

1.5

2.0

2.5

2012 2013 2014 2015 2016

Antapaccay Caserones Salobo Oyu Tolgoi Sierra GordaAntucoya Las Bambas Escondida

Source: Mizuho Securities Equity Research, based on company data

Figure 12. Production capacity and development costs per unit at major copper mines

0

5,000

10,000

15,000

20,000

25,000

2011 2012 2013 2014 2015 2016 2017 Note: Development costs per unit calculated by dividing the development cost

by the annual production capacity; given in $/MT. Development cost for Escondida includes only OGP1 and OLAP. Each bubble’s size corresponds to relative annual production capacity.


Fundamentals

Here we look at factors that may have a significant impact on the short-term balance

of supply and demand for copper. China is a tremendous presence on the demand

side, but its consumption and imports tend to follow a seasonal pattern, with much of

the activity concentrated in the first half of the year. We therefore expect China’s

consumption and imports to slow in 2H 2012. Other factors as well point to a

slowdown in 2H, including the correlation between power cable production and

copper consumption and that between electrical transformer production and copper

consumption. Among the industry segments that constitute the chief sources of

demand for copper, the electric power sector (the largest source of demand) saw a

20% YoY increase in power cable production in June, with a 5% decline in

transformer production, and a 1% decline in electric power output. In other demand

segments, air conditioner production fell by 30%, refrigerator production fell by 3%,

and automobile production rose by 14%. Overall, then, these YoY changes suggest

weakening demand, with downstream demand seemingly doing little to drive growth

in copper consumption.

China’s copper consumption

may slow in 2H, following

seasonal pattern



3 September 2012

Figure 13. China’s copper metal production, consumption, and import volumes

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012

(m MT)

Refined production Refined consumption Refined net import Source: Mizuho Securities Equity Research, based on Bloomberg data

Figure 14. China’s power cable production and electric power output

0.0

1.0

2.0

3.0

4.0

5.0


(m km)

0

100

200

300

400

500

600

(b kwh)

Power cable output Power generation (RHS) Source: Mizuho Securities Equity Research, based on Bloomberg data

Figure 15. China’s copper metal consumption vs. power cable production

0.0

0.2

0.4

0.6

0.8

1.0


(m MT)

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

(m km)

Refined consumption Power cable output (RHS) Source: Mizuho Securities Equity Research, based on Bloomberg data

Figure 16. China’s copper metal consumption vs. transformer production

0.0

0.2

0.4

0.6

0.8

1.0


(m MT)

-50

0

50

100

150

200

250

(b volts)

Refined consumption Transformer output (RHS) Source: Mizuho Securities Equity Research, based on Bloomberg data

Figure 17. China’s air conditioner and refrigerator production (YoY)

-40%

-20%

0%

20%

40%

60%

80%


Air conditioner production (YoY) Refrigerator production (YoY) Source: Mizuho Securities Equity Research, based on data from the National

Bureau of Statistics of China

Figure 18. China’s automobile production vs. electric power output (YoY)

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%


Automotive production (YoY) Power generation (YoY) Source: Mizuho Securities Equity Research, based on data from the National

Bureau of Statistics of China



3 September 2012

On the supply side, meanwhile, disruptions of mine production tend to lead to a

tighter supple/demand balance. According to data from Codelco, the average copper

grade coming out of the world’s mines has been falling off markedly almost across

the board since 2000. Presumably, this is at least in part due to the structural

problem of having to dig for ever-deeper ore clusters as mines age. This decline in

copper grade has a surprisingly powerful impact on supply. Again according to

Codelco, the average copper grade has fallen by around 0.02ppt annually for the

past 10 years, which, when set against the world’s current average grade of roughly

0.77%, implies a negative impact on supply of around 2% per year, essentially

canceling out the demand that gets freed up as some copper consumers switch to

alternative metals (BHP Billiton estimates that this demand substitution effect came

to approximately 2% in 2011).

Other disruptions of production have a significant impact as well. At the Grasberg

mine, which was the world’s third largest in 2010 in terms of output (roughly

550,000MT, for a 3% share of worldwide copper production), there was a large-scale

workers’ strike in September–December 2011 that dragged down 4Q 2011 copper

production to around 30,000MT. Freeport, the operator of the mine, issued estimates

in January calling for sales of roughly 420,000MT in 2012, thereby pointing to an

early resolution of the dispute. However, production was again impeded in 1Q 2012,

and copper production was held to just 60,000MT, forcing Freeport to revise down its

2012 sales estimate to approximately 370,000MT. This was followed by another

downward revision, to roughly 340,000MT, in 2Q.

Figure 19. Copper production and copper grade at the Escondida mine (thou MT)

0.0%

0.5%

1.0%

1.5%

2.0%

2008 2009 2010 2011 2012

0

50

100

150

200

250

300

350

400

Escondida production (RHS) Copper grade Source: Mizuho Securities Equity Research, based on data from BHP Billiton

Figure 20. Copper production at the Grasberg mine (thou MT)

0

50

100

150

200

2008 2009 2010 2011 2012 Source: Mizuho Securities Equity Research, based on data from Freeport

Disruptions of mine output

have a substantial impact on

production volumes



3 September 2012

(2) Nickel price outlook

We expect nickel prices to remain range-bound over the medium term. Given the

large number of new projects in the works, we expect the growth in nickel supply to

outstrip rising demand, and expect to see a relatively large supply surplus compared

with other base metals. Considering the high cost of producing nickel pig iron (NPI),

a marginal source of nickel, we expect to see an ongoing tug of war between loose

supply/demand conditions and high production costs. Meanwhile, we expect a

relatively large nickel supply surplus to remain in place over the long term as well,

and believe that the long-term equilibrium price is likely to fall below the level

needed to make new projects economically viable.

Nickel demand outlook for China

We expect Chinese stainless steel production (a major source of nickel demand) to

temporarily slow to 6% YoY growth in 2012, but expect production volumes to return

to a normal growth rate of 8% in 2013. We expect Chinese nickel demand to

increase 7% in 2012 and 8% in 2013, more or less tracking stainless steel

production volumes. We expect per-capita nickel consumption in China to increase

from the current level of roughly 0.5kg per year to around 0.7kg over the long term,

and look for Chinese nickel consumption to grow at an annual rate of around 6%.

Excess nickel supply

There are a large number of new major nickel supply projects in the works. Many of

these projects involve using high pressure acid leach (HPAL) technology to process

low-grade ores, and hence it is becoming increasingly difficult to develop nickel

resources. We therefore assume that it will take roughly 4–5 years for these projects

to reach full capacity, but even then, we estimate a nickel supply glut. Some of these

new projects are facing difficulties starting up beyond those factored into our

conservative assumptions, and this has the potential to push down nickel supply

volumes.

Nickel price forecasts

Figure 21. Global nickel supply/demand balance and nickel prices

2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

World MT 27.8 25.9 24.6 30.7 32.1 33.1 34.9 36.7 38.6 40.2

Production:

Mine MT 1.570 1.496 1.363 1.541 1.825 1.923 2.062 2.183 2.326 2.471

Refined MT 1.454 1.399 1.358 1.433 1.661 1.735 1.846 1.935 2.040 2.142

Consumption MT 1.354 1.333 1.306 1.424 1.655 1.708 1.801 1.895 1.994 2.080

Refined balance MT 0.100 0.066 0.051 0.009 0.007 0.027 0.045 0.040 0.046 0.061

LME price $/lb 16.9 9.6 6.7 9.9 10.4 8.0 7.5 7.5 7.5 7.5

Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research, based on ISSF and Bloomberg data

We expect the global nickel metal supply/demand balance to continue to loosen

over the medium term. Based on the May 2012 Demand Index of the International

Stainless Steel Forum (ISSF), we expect global stainless steel production volume to

continue to see relatively high annual growth at around 5%, and we therefore

assume that nickel demand will also see firm growth. On the other hand, a number

of new major nickel projects were launched in 2011 or are being launched in 2012,

and with capacity utilization at these projects gradually ramping up over four to five

Supply/demand conditions

loosening given abundance

of new major nickel supply

projects



3 September 2012

years, we expect to continue to see additional nickel supply volumes becoming

available in 2013 and beyond. With that said, there are variables involved, namely

the possibility that the supply/demand balance could improve given the difficulties

involved with the major projects, and the possibility of lower-than-expected capacity

utilization at new projects.

We expect the supply/demand balance to remain relatively loose over the long term

as well, and therefore expect the long-term equilibrium price to be lower than the

price needed (we estimate $11.00/lb) to meet the 10% returns required to make new

projects economically viable, and we expect the price to approach the cash cost

(around $7.00–$10.00) of the marginal nickel supply source (NPI). We therefore

assume a long-term equilibrium price of $7.50/lb.

Nickel supply/demand outlook for China

Figure 22. Nickel supply/demand outlook for China

2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

Stainless steel production MT 7.206 6.943 8.805 11.256 12.592 13.348 14.402 15.453 16.580 17.452

Nickel mine production MT 0.066 0.079 0.085 0.080 0.090 0.092 0.095 0.098 0.101 0.104

NPI production MT 0.074 0.078 0.096 0.163 0.200 0.210 0.230 0.240 0.245 0.250

Refined nickel MT 0.145 0.127 0.173 0.151 0.280 0.332 0.366 0.409 0.461 0.499

Refined total production MT 0.219 0.205 0.269 0.314 0.480 0.542 0.596 0.649 0.706 0.749

Refined nickel import MT 0.103 0.117 0.265 0.181 0.212 0.219 0.225 0.232 0.239 0.246

Refined consumption MT 0.327 0.339 0.564 0.489 0.713 0.761 0.821 0.881 0.945 0.995

Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research, based on ISSF, Bloomberg, and Brook Hunt data

As the world’s largest consumer of nickel, accounting for roughly 40% of

consumption, China has a substantial impact on the global supply/demand balance.

According to Antaike, just under 80% of China’s nickel demand in 2010 was for use

in stainless steel. This percentage is relatively high considering that stainless steel

accounts for roughly 60% of global nickel consumption. China’s stainless steel

production volumes have risen at a sharp annual rate of 20% over the past 10 years,

but stainless steel currently equates to just under 2% of China’s crude steel

production volumes, and considering that stainless steel equates to just under 3% of

crude steel production volumes in Japan, we still see substantial room for growth.

Figure 23. Breakdown of Nickel demand in China

Stainless steel78%

Alloy and foundry8%

Plating9%

Batteries4%

Others1%

Source: Mizuho Securities Equity Research, based on Antaike data

Figure 24. Breakdown of global Nickel demand

Batteries& others

7%

Stainless steel60%

Alloy steel7%

Ni base10%

Cu base1%

Plating14%

Foundry3%

Source: Mizuho Securities Equity Research, based on INSG data

Chinese nickel demand

supported by growing

stainless steel production

volumes



3 September 2012

According to INSG data, metal products account for 31% of nickel end demand in

China, while construction and engineering applications account for 20% and 15% of

end demand, respectively. This demand is mainly for stainless steel products, with

the metal products category including stainless steel tableware, the construction

category including elevators, escalators, and air conditioners, and the engineering

category including products such as heat exchangers. We expect China’s stainless

steel production to grow by just 6% YoY in 2012, but expect production to return to

8% growth in 2013. We expect Chinese nickel consumption to grow by 7% in 2012

and 8% in 2013, with the main source of demand coming from growth in stainless

steel production. Per-capita nickel consumption in China amounted to roughly 0.5kg

in 2010, and we see substantial room for growth over the long term as a result of

improvements in living standards.

Figure 25. Nickel consumption in China by end-use application

Others4%Tubular

products7%

Electroniccomponents

11%

Automobiles12%

Engineering15%

Building &construction

20%

Metal products31%

Source: Mizuho Securities Equity Research, based on INSG data

Figure 26. Per-capita nickel consumption by country

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0 10,000 20,000 30,000 40,000 50,000

US China Japan South Korea Germany GDP ($/person)

(kg/person)

Source: Mizuho Securities Equity Research, based on JOGMEC data

China’s nickel consumption amounted to roughly 710,000MT in 2011, with refined

nickel production accounting for roughly 280,000MT, NPI production accounting for

roughly 200,000MT, and nickel metal imports accounting for roughly 210,000MT.

China began producing NPI in 2006, and has been able to accomplish this by

importing low-grade nickel ore. The cost of producing NPI is high, so while this

marginal supply source expands when nickel prices are high, the producers are

unable to compete when nickel prices fall. According to Antaike, the cost of

producing NPI was just over $10.00/lb as of July 2011, with ore accounting for just

under half of the production cost. Meanwhile, Brook Hunt estimates that the cost of

producing NPI was $7.00/lb–$9.00/lb in 2010. Although in the past we saw a sharp

rise in NPI production, we assume that it will be difficult for producers to increase

NPI production volumes at the current nickel price, and we therefore expect 2012

NPI production to remain roughly flat YoY at 210,000MT, while we expect nickel

metal production to continue to grow to 330,000MT. We expect Chinese nickel

production to rise 13% YoY in 2012 and 10% in 2013.

Chinese stainless steel

demand supported by

improvements in living

standards

NPI is the marginal nickel

supply source



3 September 2012

Figure 27. Nickel production volumes in China (m MT)

0.0

0.1

0.2

0.3

0.4

0.5

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Refined nickel NPI Source: Mizuho Securities Equity Research, based on Bloomberg and Brook

Hunt data

Figure 28. NPI cost breakdown ($/lb)

Nickel ore48%

Electric power27%

Coke6%

Auxiliary material4%

Lime2%

Others12%

Source: Mizuho Securities Equity Research, based on Antaike data

Supply outlook for global nickel mining projects

There are a number of new major nickel supply projects in the works. Several of

these projects launched production in 2011, namely the Vale New Caledonia (VNC)

Nickel project (formerly known as Goro, annual production capacity of 60,000MT),

the Onca Puma nickel project (58,000MT), and the Barro Alto project (36,000MT).

Meanwhile, the Ambatovy (60,000MT) and Koniambo (60,000MT) projects are

expected to launch in 2012; the Long Harbour (50,000MT), and Taganito

(30,000MT) projects are expected to launch in 2013; and the Kabanga nickel project

(45,000MT) is expected to launch in 2014. These projects have a total annual

production capacity of 400,000MT, or roughly one-quarter of the global nickel

demand in 2011. However, given the drop off in undeveloped sources of high-grade

ore in recent years, major nickel projects have had to shift to the use of HPAL

technologies, and hence it is becoming increasingly difficult to develop nickel

resources. There are some concerns about producers’ abilities to achieve their

production plans considering the uncertainties of using HPAL technology on a large-

scale commercial basis and the potential for issues with non-HPAL processes in

large-scale operations. We estimate that it will take the new large nickel projects

roughly 4–5 years to achieve their stated production capacities.

Indonesia—the number two global producer of nickel ore behind Russia—produces

just over 10% of the world’s nickel ore, and is working to ban exports of

unprocessed ores from 2014. It is unclear whether the country will be able to fully

enforce the ban given the short time before it would go into effect. If Indonesia were

to implement an export ban, there is a possibility that the impact on the overall

global nickel supply/demand balance would be limited if refining is carried out in

Indonesia. This could, however, tighten up the supply/demand balance for ore and

lead to increased competition for overseas smelters, who are dependent on

Indonesia for ore imports. This mainly applies to NPI and ferronickel smelters, and

we believe there would be a limited impact on overseas smelters using intermediate

products.

While there are a large

number of new nickel mining

projects planned, it is

becoming increasingly

difficult to develop nickel

resources

Indonesian ban on nickel ore

exports could have

detrimental effect on

overseas ferronickel smelters



3 September 2012

Figure 29. Production outlook for new nickel projects (thou MT)

0

100

200

300

400

2011 2012 2013 2014 2015 2016 2017 2018

Goro Onca-Puma Barro Alto AmbatovyKoniambo Kabanga Long Harbour Taganito

Source: Mizuho Securities Equity Research, based on company materials and Brook Hunt data

Figure 30. Production capacity and development unit costs at major nickel mines

0

20,000

40,000

60,000

80,000

100,000

120,000

2010 2011 2012 2013 2014 2015 Note: Development unit costs are development costs divided by annual

production capacity and shown in $/MT. Bubble sizes denote annual production capacity. Development costs for Kabanga nickel project estimated by Mizuho Securities.

Source: Mizuho Securities Equity Research based on company materials

Fundamentals

We have reviewed factors that are likely to have a major impact on the short-term

nickel supply/demand balance. On the demand side, China is a major factor. There

is somewhat of a seasonal pattern to China’s nickel consumption and nickel ore

imports. Stainless steel production, the largest source of China’s nickel demand,

tends to be more heavily concentrated in the first half of the year (1H). As a result,

the production and importing of nickel, a raw material used in stainless steel

production, tends to be concentrated in the latter half of the preceding year (2H). In

light of this seasonal pattern, we expect volumes to pick up as we head into the

latter half of the year. However, given the concerns over Indonesia’s ban on ore

exports, it appears that China has imported large quantities of nickel ore in advance

of this ban, and we expect this to have a negative impact on nickel ore import

volumes from here.

Figure 31. Stainless steel and nickel production volumes in China

0

200

400

600

800

1,000

1,200

1,400


(m MT)

0

10

20

30

40

50

60

70

80

(thou MT)

Refined nickel production (RHS) Refined nickel imports (RHS)China stainless steel production Nickel ore production (RHS)

Source: Mizuho Securities Equity Research, based on Bloomberg data

Figure 32. China’s nickel ore import volume

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000


(thou MT)

China nickel ore imports (Indonesia) China nickel ore imports (Philippines)

China nickel ore imports (total)


Seasonal patterns suggest

that Chinese nickel

consumption will rise heading

into 2H, but frontloaded

imports likely to push down

imports



3 September 2012

In China, which accounts for roughly 40% of global stainless steel production,

production was up just 2% YoY in June. Industrialized nations make up the bulk of

the world’s remaining stainless steel production. In Japan, which is the largest of

these other stainless steel producers, production is currently weak (down 5% in

June), and we do not expect the inventory cycle to lend major support given that

major cyclical swings are unlikely.

Figure 33. YoY comparison of Chinese stainless steel production volumes

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%


China crude steel production (YoY) China stainless steel production (YoY) Source: Mizuho Securities Equity Research from Bloomberg data

Figure 34. YoY comparison of Japanese stainless steel production and inventory volumes (%)

-50%

0%

50%

100%

Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Production (YoY) Inventory (YoY) Inventory (weeks of production) (RHS) Source: Mizuho Securities Equity Research from Bloomberg data

With stainless steel fundamentals lacking strength, it is difficult to take a bullish

stance on nickel demand. There are, however, a number of factors supporting nickel

supply. Of the new major nickel projects, three (VNC, Onca Puma, and Barro Alto)

started production in 2011, and two (Ambatovy and Koniambo) are scheduled to

start production in 2012. Although VNC produced 5,000MT in 2011, production was

halted in May due to issues at its sulfuric acid plant, and production is scheduled to

restart in 4Q 2012 once repairs are completed. Onca Puma produced 7,000MT of

nickel in 2011, but issues with its ferronickel furnaces shut down both of its furnaces

in May and June 2012.

Expect stainless steel cycle

to have neutral impact

Several of the new nickel

projects having difficulties

with startups



3 September 2012

(3) Zinc price outlook

We expect zinc prices to strengthen over the medium term. Many existing mines are

expected to close, and the current supply surplus appears likely to be diminished

even as new mines come on line. Over the long term, we therefore forecast a

tightening in the supply/demand balance. In such an environment, we expect the

long-term equilibrium price to remain high enough for marginal producers to

maintain economic viability.

Chinese zinc demand outlook

Chinese production of galvanized steel sheets is one of the primary sources of

zinc demand, and we forecast a temporary slowdown in growth in galvanized steel

sheet production volume in 2012 to roughly 6% YoY. However, we expect a

subsequent return to stable growth, with a volume increase of roughly 9% in 2013.

We expect Chinese demand for zinc metal to move roughly in tandem with

galvanized steel sheet production, rising 4% in 2012 and 9% in 2013. Over the

long term, we expect Chinese per-capita zinc consumption to increase from the

current roughly 4kg to around 6kg per year, and we forecast annualized growth of

roughly 6% in Chinese zinc consumption volume.

Zinc supply tightening

Over the next five years, zinc mines with combined production capacity of over 1m

MT are expected to close mining operations in the five largest zinc-producing

countries and regions outside of China. It appears unlikely that the new mines

coming on line will be able to compensate for this drop in production capacity, and

we therefore forecast tighter supply conditions for zinc.

Zinc price forecasts

Figure 35. Global supply/demand balance and zinc prices

2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

Production:

Mine MT 11.1 11.8 11.5 12.4 12.8 13.2 13.6 14.3 15.0 15.5

Refined MT 11.4 11.7 11.3 12.9 13.1 13.5 14.0 14.7 15.4 15.9

Consumption MT 11.3 11.5 11.1 12.5 12.5 13.0 13.6 14.3 15.1 15.9

Refined balance MT 0.1 0.2 0.2 0.4 0.5 0.6 0.3 0.4 0.2 -0.1

LME price $/lb 1.5 0.9 0.8 1.0 1.0 0.9 0.9 1.0 1.1 1.0

Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research, based on Bloomberg data

Over the medium term, we expect a gradual reduction in the current global supply

surplus for zinc metal. We forecast global annualized growth in zinc demand of

roughly 5% and global annual mining production volume growth of only roughly 4%

as a result of major mine closures. As a result, we expect the supply/demand

balance to improve. Our assumptions for zinc demand in major countries and

regions outside of China during the period covered by our forecasts are based on

the GDP growth forecasts in the IMF’s April 2012 World Economic Outlook Database.

Supply/demand balance

should improve following

major mine closures



3 September 2012

As we expect the supply surplus to wind down over the long term, we forecast long-

term equilibrium prices to remain high enough for marginal producers to maintain

economic viability. We have therefore set our long-term price assumption at just over

$1/lb, which is the price that would correspond to a required return of 10% assuming a

cash cost for marginal producers of slightly under 70¢/lb and development costs of

$2,900 per annual metric ton of output for the new mines coming on line in 2013 or

thereafter.

Chinese zinc supply/demand outlook

Figure 36. Chinese zinc supply/demand outlook

2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

Refined zinc output MT 3.7 4.0 4.3 5.2 5.2 5.4 5.9 6.4 7.0 7.7

Refined zinc imports MT 0.0 0.2 0.7 0.3 0.3 0.4 0.4 0.4 0.4 0.4

Refined zinc exports MT 0.0 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Net refined imports MT 0.0 0.1 0.6 0.3 0.3 0.4 0.4 0.4 0.4 0.4

Apparent refined consumption MT 3.7 4.2 4.9 5.5 5.5 5.7 6.3 6.8 7.4 8.0

Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research, based on data from Bloomberg

China is the world’s largest consumer of zinc, accounting for just over 40% of global

zinc consumption, and therefore has a substantial impact on the global

supply/demand balance. According to JOGMEC (Japan Oil, Gas, and Metals

National Corporation), roughly 55% of China’s zinc demand in 2010 was for use in

galvanizing (coating steel or iron with zinc), followed by die cast alloys (15%), oxides

(10%), brass (9%), and batteries (9%). The main applications of galvanizing are

steel sheets and structural materials. Chinese production of galvanized steel sheets

currently equates to roughly 5% of Chinese crude steel production volume.

Considering that galvanized steel sheet production volume accounts for more than

10% of crude steel production volume in Japan, we see significant room for growth.

We believe this low ratio is partially the result of the limited adoption in China of

galvanized steel sheets for automotive bodies, a major source of demand for

galvanizing.

Figure 37. Breakdown of Chinese zinc demand

Galvanized55%

Batteries9%

Oxides10%

Brass9%

Die cast alloys15%

Others2%


Figure 38. Chinese galvanized steel sheet production volume and crude steel production volume (thou MT)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0


0%

1%

2%

3%

4%

5%

6%

7%

China galvanized sheet production Galvanized sheet/Crude steel production (RHS) Source: Mizuho Securities Equity Research, based on Bloomberg data

Chinese zinc demand

bolstered by increased

galvanized steel sheet

production volume



3 September 2012

We forecast a temporary slowdown in growth in Chinese galvanized steel sheet

production volume in 2012 at 6% YoY, but expect a recovery to 9% growth in 2013.

We forecast 4% growth in Chinese zinc consumption in 2012 and 9% growth in 2013,

mainly driven by expanded production of galvanized steel sheets. Per-capita zinc

consumption was roughly 4kg in 2010, and we believe there is significant potential

for long-term expansion as standards of living improve.

China’s overall zinc consumption was roughly 5.5m MT in 2011, produced from

roughly 4.3m MT in domestically mined ore, roughly 2.9m in imported ore, and

roughly 800,000MT in net imports of zinc metal and unprocessed alloy. As it appears

that Chinese domestic zinc ore represents ore concentrate, we believe China is

highly dependent on zinc imports.

Figure 39. Per-capita zinc consumption by country

0

2

4

6

8

10

12

0 10,000 20,000 30,000 40,000 50,000

US China Japan South Korea GermanyGDP ($/person)

(kg/person)

Source: Mizuho Securities Equity Research from JOGMEC data

Figure 40. Chinese zinc ore and zinc metal production and import volume (m MT)

0

100

200

300

400

500

600

700

800

900


China zinc ore production China zinc ore importChina refined zinc net imports China zinc slab productionChina zinc slab consumption


Global zinc mining supply outlook

Zinc production volume at currently operating mines is expected to decline sharply

as many of these mines close. In the five years through 2016, we estimate a loss of

1.15m MT in production volume, or 13% of total mining production volume in 2011.

Among mines scheduled to end operations are the Perseverance and Brunswick

mines in 2013 (annual production capacity of 135,000MT and 209,000MT,

respectively), the Lisheen and Angas mines in 2014 (42,000MT and 40,000MT), the

Golden Grove and Duck Pond mines in 2015 (71,000MT and 34,000MT), and the

Century, Skorpion, and Myra Falls mines in 2016 (497,000MT, 53,000MT, and

45,000MT).

During the same period, however, we expect an additional annual production

capacity of 540,000MT from new mines. New mines scheduled to come on line in

2013 include the Bracemac-McLeod mine (with production capacity of 90,000MT),

the Lalor mine (70,000MT), and an expansion of the Mount Isa mine (180,000MT).

In 2014, the Dugald River mine is scheduled to come on line with capacity of

200,000MT. As we expect an accelerated decline in production volume at currently

operating mines, we forecast a tightening in zinc supply/demand conditions even

after factoring in the additional capacity from new mines.

China highly dependent on

zinc imports

Decline in production volume

at existing mines likely to

accelerate



3 September 2012

Figure 41. Combined production capacity of zinc mines ending mining operations (m MT)

-1.5

-1.0

-0.5

0.0

2012E 2013E 2014E 2015E 2016E


Figure 42. Production forecasts for major zinc mines (m MT)

3.0

3.5

4.0

4.5

5.0

5.5

2011 2012E 2013E 2014E 2015E 2016E

Existing Mines New Mines Note: Major zinc mines include mines in Peru, Oceania, India, the US, and

Canada. Source: Mizuho Securities Equity Research, based on company and Bloomberg data

Fundamentals

Here we look at factors that may have a significant impact on the short-term

supply/demand balance for zinc. China is a tremendous presence on the demand

side, and Chinese galvanized steel sheet production volume tends to move roughly

in tandem with crude steel production. For this reason, galvanized steel sheet

production momentum tends to follow a seasonal pattern, with much of the activity

concentrated in the first half of the year. Raw material zinc metal consumption

volume and production volume could be said to move nearly in tandem with or

slightly ahead of galvanized steel sheet production volume. Chinese zinc

consumption has been falling through June, when it declined 2% YoY, in advance of

galvanized steel sheet production, which rose 28% in June, and we expect zinc

consumption to be bolstered in 2H by procurement in preparation for galvanized

steel sheet production in 1H 2013.

Figure 43. Chinese galvanized steel sheet and crude steel production (m MT)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0


0

10

20

30

40

50

60

70

China galvanized production China crude steel production (RHS) Source: Mizuho Securities Equity Research, based on Bloomberg data

Figure 44. Chinese galvanized steel sheet and zinc metal production volume

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0


(m MT)

0

100

200

300

400

500

600(thou MT)

China galvanized production China zinc slab consumption (RHS)

China zinc slab production (RHS) Source: Mizuho Securities Equity Research, based on Bloomberg data

Chinese zinc metal

consumption volume easing

ahead of galvanized steel

sheet production



3 September 2012

Looking at the galvanized steel sheet cycle elsewhere, we turn to Japan, the world’s

fourth-largest consumer of zinc metal. In Japan, galvanized steel sheets account for

roughly half of zinc metal demand, and galvanized steel sheet production volume

tends to parallel trends in automobile production. The galvanized steel sheet

shipment/inventory cycle is nearing peak momentum along with a recovery in

production and shipments and a decline in inventories, and we therefore expect

momentum to wane. We nevertheless believe a major drop in galvanized steel sheet

production volume is unlikely considering that galvanized steel sheet production was

subdued compared to automobile production during the recent recovery phase.

Figure 45. Japanese automobile production volume and galvanized steel sheet production

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6


Automotive production (m vehicles) Galvanized sheet production (m MT) Source: Mizuho Securities Equity Research, based on Japan Automobile

Manufacturers Association and Bloomberg data

Figure 46. YoY growth in production of Japanese automobiles, galvanized steel sheets, and zinc metal

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%


Automotive production (YoY) Galvanized production (YoY)Refined zinc production (YoY)

Source: Mizuho Securities Equity Research, based on Japan Automobile Manufacturers Association, Ministry of Economy, Trade and Industry, and Bloomberg data

Japanese galvanized steel

plate cycle near peak, but

cyclical swings narrowing



3 September 2012

Pacific Metals (5541) Taking on challenges in ferronickel business

Investment rating and valuations

We determined our ¥250 price objective for Pacific Metals by applying a PBR of

approximately 0.5x to our FY3/13 BPS forecast of ¥559. Since the company’s share

price tends to be correlated with market trends (mainly nickel prices), we have set

our price objective with reference to our short- to medium-term market forecasts.

Since the price objective is 0% below the current share price, we are initiating

coverage with a Neutral rating.

Investment thesis

The company has several difficult problems to overcome in terms of the business

environment for ferronickel. These include pressure on production volume from

lower ore grades, and the ban on ore exports from Indonesia expected to be

introduced in 2014. Given the recent share price performance, we believe several of

these factors have already been priced in. However, the business environment is

also affected by several structural factors, and we do not see much chance of any

dramatic improvement. Given the characteristics of the share price, we also see the

company’s high exposure to the nickel market, where we believe fundamentals are

relatively weak, as a negative. We expect earnings to continue at low levels close to

the break-even point over the medium term, and we believe this has negative

implications for share price valuations.

Earnings outlook

We forecast FY3/13 RP of ¥1.5b (down 57% YoY), close to the break-even point.

This is slightly below the company’s new downwardly revised RP forecast (¥2.8b),

announced on 3 August, and the Quick consensus forecast (¥2.0b). The reason we

expect a ¥2.0b YoY reduction in profit is that we expect a ¥7.0b negative impact

from nickel prices, partly made up for by a roughly ¥4.0b positive impact from higher

ferronickel volumes. The reason for setting our forecast around ¥1.3b below the

company forecast is that we expect the impact of nickel prices to be ¥900m worse

than the company assumes.

We forecast FY3/14 RP of ¥2.4b (up 60% YoY), continuing at close to the break-

even point as in FY3/13. This is below the Quick consensus forecast (¥4.5b). The

reason we expect a ¥900m increase in profits is that we expect an increased impact

from cost cutting to more than make up for a roughly ¥1.0b negative impact from

nickel price changes.

Share price catalysts and risks

There are three main potential catalysts: 1) reductions in supply stemming from

difficulties with new nickel development projects; 2) the withdrawal of proposed

measures prohibiting ore exports from Indonesia; and 3) the commercialization of

wet smelting. The main risks are an unexpected decline in market prices and

downward pressure on production volume as a result of a drop in ore grades.



3 September 2012

Focus points and summary

Market exposure

Share price performance at the base metals companies tends to be closely

correlated with price movements in the resources in which each company has the

highest weighting. Accordingly, movements in base metals prices and the

fundamentals in these markets tend to have a major impact on share price

performance. An examination of the performance relative to TOPIX indicates that the

share price of Sumitomo Metal Mining tends to be more closely correlated with

copper and gold prices than those of its competitors, and also closely correlated to

the nickel price. At Pacific Metals, the share price is more closely correlated to nickel

prices than at any of its competitors, while at Toho Zinc the share price is closely

correlated with zinc prices. These correlations are in line with the differences in the

structure of the business at each company.

Figure 47. Relative share price performance of base metals companies against TOPIX and correlation with metal prices (2005 onwards)


Copper 0.3 0.2 0.6

Nickel 0.8 0.7 0.7

Zinc 0.6 0.9 0.5

Gold -0.1 -0.4 0.2

¥/US$ 0.4 0.6 0.1

Source: Mizuho Securities Equity Research, from Bloomberg data

Over the short to medium term, we are most optimistic about copper prices, followed

by zinc and nickel, while for the long term we are most optimistic about zinc,

followed by copper and nickel. The reason for our short- to medium-term

preferences is that the short-term supply/demand balance for copper is the tightest

in relative terms, at close to equilibrium, while the balance for nickel is currently the

slackest. An examination of the current physical premium also shows that zinc is

relatively strong, closely followed by copper. However, there is only a small physical

premium for nickel, and we believe this supports our view. Our long-term outlook is

based on our forecasts for the long-term equilibrium price.

Share price performance

closely correlated with metals

prices

Preferences for short to

medium term: copper, zinc,

and nickel, in that order



3 September 2012

Figure 48. Nickel prices and the nickel premium

0

2

4

6

8

10

12

14

Jan 2010 Jan 2011 Jan 2012

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Nickel price ($/lb) Nickel premium (Europe) ($/MT)

Nickel premium (Shanghai) ($/MT) Nickel premium (US) ($/lb) (RHS)


The key characteristic of Pacific Metals’ share price is that when nickel prices are

rising, it is possible to target a PBR of close to 0.8x, but when nickel prices are

falling the lower bound of the valuation range tends to be a PBR of below 0.5x.

Figure 49. Nickel price and PBR at Pacific Metals

0

200

400

600

800

1,000

1,200

1,400

Jan 2010 Jan 2011 Jan 2012

0.0

0.5

1.0

1.5

Nickel PBR (RHS)

(¢/lb) (x)




3 September 2012

Business environment becoming increasingly difficult

Fall in ferronickel ore grades

Ferronickel is a raw material for stainless steel, and it accounts for just over 20% of

world nickel production. Pacific Metals is in the second tier of the world’s top 10 in

terms of contained nickel production, but it is one of the world’s leading producers of

ferronickel, after Eramet and BHPB. The company can theoretically produce around

40,000MT of nickel per year at three of the world’s largest electrical furnaces, but

currently the limit of real production capacity appears to be around 36,000MT. The

main reason is that, given the recent decline in ore grade, the amount of nickel which

can be produced from a given volume of ore is falling. According to the Japan Mining

Industry Association, if we index the grade of nickel at 100% in FY90, the grade of

ferronickel ore had fallen by 10.8% through FY09, and is expected to fall further. In

terms of ore from the Philippines (which accounts for just under half of the ore the

company purchases), saprolite, which is used as a raw material for ferronickel

production, has seen a particularly marked deterioration in grade over the last few

years, especially ore from Rio Tuba Nickel Mining (RTNM). Accordingly, there is now a

structural impediment to a recovery in the company’s ferronickel production volumes in

the form of deterioration in the quality of saprolite, which is suitable for dry smelting.

Figure 50. Global ferronickel production trends (thou MT)

0

50

100

150

200

250

300

350

2006 2007 2008 2009 2010

Eramet BHPB Pacific Metals Xstrata SMM Nippon Yakin Others Source: Mizuho Securities Equity Research, from Pacific Metals data

Figure 51. Saprolite ore grades for Japanese shipments of saprolite from RTNM

1.6%

1.8%

2.0%

2.2%

2009 2010 2011 Source: Mizuho Securities Equity Research, from NAC data

Expecting to see global tightness in supply/demand balance for

ferronickel raw materials

Indonesia plans to impose a prohibition on ore exports from 2014, but if we assume

that the ore will be smelted at new facilities in Indonesia itself, the new measures

should make little difference to the global supply/demand balance for nickel. Since

the new regulations will only apply to unprocessed ore, we expect intermediate

products, such as nickel matte, which is used as a raw material for electrical nickel,

to be exempt as long as its grade complies with the terms of the new regulations.

Accordingly, we believe the main potential problem will be at overseas smelters

which rely heavily on unprocessed ore from Indonesia. Since unprocessed nickel

ore is mainly used as a raw material in the production of ferronickel and nickel pig

iron (NPI), we expect to see the supply/demand balance for this raw material ore

tighten.

The grade of raw materials

suitable for dry smelting

operations is falling

Impact of ban on Indonesian

exports of unprocessed ore

on ferronickel raw materials



3 September 2012

In 2011, Pacific Metals purchased 49% of its raw materials from Indonesia, 35%

from the Philippines, and 16% from New Caledonia. Its long-term procurement

contract with Indonesia expires in May 2014. Accordingly, finding an alternate source

of ore instead of Indonesia is a key issue for the company. Indonesia exported

around 200,000MT of nickel ore per year until 2011, giving it a global market share

of just over 10%, and if all of the importing countries have to find an alternate source

at once, then we expect to see a considerable tightening in the supply/demand

balance.

Ahead of the introduction of prohibitions on the export of ore from 2014, Indonesia

imposed a 20% tax on ore exports starting in May 2012, but so far we believe this

has had only a limited impact on ferronickel smelters. The basic price for ore, which

was decided on 1 June, was $41.52/MT (on a wet volume basis) for nickel ore with a

content of more than 2% used as a raw material for ferronickel. Assuming a nickel

grade of 2%, we assume the price of contained nickel is around $0.90/lb. The

imposition of a 20% tax on this price results in a cost increase of around $0.20/lb if

all of the cost is borne by the buyer. Even if the company sources 49% of its nickel

ore in Indonesia, we calculate the impact on OP as limited, at only around ¥600m

per year.

Figure 52. Pacific Metals: nickel ore procurement breakdown (2011) (%)

New Caledonia16%

Philippines35%

Indonesia49%

Source: Mizuho Securities Equity Research, from Pacific Metals data

Impact of ban on Indonesian

ore exports should be limited



3 September 2012

Figure 53. Plans for Indonesian nickel smelting plants

Company Location Type Capacity Capex Startup

ktpa $m

Antam East Halmahera FeNi 27 1,600 2014

Antam Pomalaa 12 490 2014

Antam Mandiodo NPI 12 400 2015

PT Barong Barajas Energy Sulawesi

PT Billy Indonesia Kendal 100

Solway Group East Halmahera FeNi 400 3,000

Risingsun Mining & Mineral FeNi

Jien Nickel Ni matte 160

Dafeng Port Group Kendari FeNi 200 600

E United Group 330

Source: Mizuho Securities Equity Research, from JOGMEC, Antam, and Xinhua data

Move towards wet smelting method

The company now needs to respond to the problem of the ore supply/demand

balance and is starting to move towards wet smelting. Specifically, the company is

considering using a normal pressure leaching process at the mine to improve the

grade of low-grade ores which are difficult to process through dry smelting, making

an intermediate product in the form of concentrated nickel hydroxide and then using

this in the dry smelting process at Hachinohe. It completed construction of a pilot

plant in March 2010 with an investment of ¥8.8b, and ran the plant on a test basis

until March 2011. This demonstrated that it would be possible to use the

intermediate product in nickel smelting. Currently, the plant is preparing for the

commercialization of this intermediate material and refining its normal temperature

leaching technology. However, we believe it is still too early to determine whether or

not this initiative will prove successful.

In December 2011, the company purchased a roughly 3% interest in the Indonesian

Weda Bay project, which uses the same normal pressure leaching process for wet

smelting, at a cost of ¥3b. This project is scheduled to eventually produce 65,000MT

of nickel per year, and the final investment decision (FID) is scheduled for the

beginning of 2013.

Move to wet smelting to help

resolve problems, but

outcome still uncertain



3 September 2012

Figure 54. Assumptions underlying our earnings forecasts

FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E

1Q 2Q 3Q 4Q Full-year 1Q 2Q E 3Q E 4Q E Full-year E

Copper ¢/lb 3.5 4.4 4.2 4.1 3.5 4.1 3.8 3.6 3.4 3.4 3.6 3.5 3.3

Nickel ¢/lb 10.8 12.6 11.5 10.4 8.6 10.8 9.2 8.0 7.4 7.4 8.0 7.5 7.5

Zinc ¢/lb 1.0 1.1 1.1 1.1 0.9 1.1 1.0 1.0 0.8 0.8 0.9 0.9 1.0

Lead ¢/lb 1.0 1.2 1.2 1.2 1.0 1.1 1.0 1.0 0.8 0.8 0.9 0.9 1.0

Gold $/oz 1,226 1,388 1,508 1,662 1,683 1,560 1,691 1,612 1,600 1,600 1,626 1,550 1,450

Silver $/oz 20 32 38 38 32 35 33 29 28 28 30 28 27

Forex ¥/US$ 86 82 78 77 79 79 80 80 80 80 80 80 80


Figure 55. Consolidated profit/loss statements (¥b)

FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E

1Q 2Q 3Q 4Q Full-year 1Q 2QE 3QE 4QE Full-yearE

Sales 74.8 2.0 14.7 13.8 17.8 48.3 14.6 11.7 10.7 10.6 47.5 43.4 43.4

GP 24.0 0.1 2.2 0.0 2.0 4.3 1.5 1.1 1.2 1.4 5.2 6.4 6.4

SG&A expenses 5.5 0.4 0.8 1.5 1.5 4.2 1.5 1.5 1.5 1.5 5.9 6.0 6.0

OP 18.5 -0.3 1.4 -1.5 0.5 0.2 0.0 -0.4 -0.3 -0.0 -0.7 0.4 0.4

Dividend income 0.1 0.0 0.0 0.0 0.0 0.1 0.1 0.0 0.0 0.0 0.1 0.0 0.0

Equity-method gain/loss 2.1 0.8 1.2 1.0 0.3 3.3 0.6 0.5 0.5 0.5 2.0 2.0 2.1

Interest 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Non-operatiing profit 0.1 -0.0 -0.0 -0.1 0.2 -0.0 0.0 0.0 0.0 0.0 0.1 -0.1 -0.1

RP 20.8 0.5 2.6 -0.5 1.0 3.5 0.7 0.1 0.2 0.5 1.5 2.4 2.5

Extraordinary income & loss -3.3 -1.6 -1.5 0.6 -0.3 -2.8 0.4 0.0 0.0 0.0 0.4 0.0 0.0

Pretax profit 17.4 -1.1 1.1 0.1 0.7 0.7 1.2 0.1 0.2 0.5 2.0 2.4 2.5

Corporate tax 6.2 -0.6 0.1 -0.0 0.1 -0.5 3.2 0.1 0.1 0.2 3.5 0.8 0.9

Minority interest gain 0.0 -0.0 0.0 -0.0 0.0 -0.0

NP 11.3 -0.4 0.9 0.1 0.6 1.2 -2.0 0.1 0.1 0.3 -1.5 1.6 1.6

Corporate tax rate 35% 57% 12% -49% 9% -68% 266% 39% 39% 39% 174% 34% 34%

EBITDA 26.1 9.8 7.8 9.4 9.7

Note: EBITDA = OP + equity method profits + depreciation expenses. E = Mizuho Securities estimates. Source: Mizuho Securities Equity Research

Figure 56. Segment profits (¥b)

FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E


Nickel 18.4 -0.3 1.3 -1.5 0.5 -0.0 0.1 -0.4 -0.3 -0.1 -0.8 0.3 0.3

Wholesale power supply 0.2 0.0 -0.0 0.0 0.3 0.3 0.0 0.1 0.1 0.1 0.2 0.2 0.2

Others -0.1 -0.1 0.1 0.0 -0.2 -0.1 -0.1 -0.0 -0.0 -0.0 -0.1 -0.1 -0.1

Consolidated 18.5 -0.3 1.4 -1.5 0.5 0.2 0.0 -0.4 -0.3 -0.0 -0.7 0.4 0.4

Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research



3 September 2012

Figure 57. Consolidated balance sheet (¥b)

FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

Cash and deposits 41.5 30.9 31.0 31.0 31.0

Other short-term assets 18.7 17.7 12.7 12.8 12.8

Current assets 60.1 48.5 43.7 43.8 43.8

Fixed assets 49.9 52.1 54.0 55.0 56.1

Other long-term assets 16.5 23.3 24.2 24.8 25.8

Total assets 126.5 123.9 121.8 123.6 125.7

Interest-bearing debt 0.9 0.6 0.3 0.4 1.1

Other debt 15.2 12.4 12.4 12.7 12.8

Shareholders' equity 110.5 109.8 108.3 109.7 110.9

Other comprehensive income -0.1 1.1 0.8 0.8 0.8

Net assets 110.5 110.9 109.1 110.5 111.7


Figure 58. Consolidated cash flow statements (¥b)

FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

NP before tax 17.4 0.7 2.0 2.4 2.5

Depreciation 5.5 6.4 6.4 7.0 7.2

Change in working capital -1.8 -8.5 1.5 -1.0 -0.9

Operating cash flow 21.2 -1.5 10.0 8.4 8.8

Investment cash flow -24.6 9.4 -9.1 -8.5 -9.1

Free cash flows -3.4 7.9 0.9 -0.1 -0.3

Financing cash flow -3.9 -1.9 -0.7 0.1 0.3


Figure 59. Valuations and financial indicators

FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

Common shares (m) 195 195 195 195 195

Per share:

Dividends (¥) 17.0 2.0 0.0 1.0 2.0

Dividend payout ratio 29% 33% 0% 12% 24%

EPS (¥) 58 6 -8 8 8

BPS (¥) 565 568 559 566 572

PER (x) - - - 30.6 30.6

PBR (x) - - 0.4 0.4 0.4

ROA 9% 1% -1% 1% 1%

ROE 10% 1% -1% 1% 1%

Net D/E -37% -27% -28% -28% -27%

Note: Financial analysis indicators based on term-end balance sheets. ROA based on NP. Share prices as of 31 August close. E = Mizuho Securities estimates.




3 September 2012

Toho Zinc (5707) Transition to an integrated mining and smelting business

Investment rating and valuation

We are setting our price objective for Toho Zinc at ¥280, based on applying a PBR

of approximately 0.7x to our FY3/13 BPS forecast of ¥430. Since the share price

tends to be highly positively correlated with metal prices (particularly zinc prices), we

have used this level to reflect our short- to medium-term metal price forecasts and

the risk that short-term earnings could fall below the company's forecasts. Since the

price objective is 6% above the current share price, we are initiating our coverage

with a Neutral rating.

Investment thesis

The company’s zinc business is currently in the process of transformation from the

previous smelting business to a more integrated mining and smelting business that

also involves mining operations and the commencement of operations at new mines.

As a result, we believe the business is becoming less subject to the influence of any

tightening in the ore supply/demand balance. We expect these factors to underpin

the share price over the medium to long term. In addition, we believe the

characteristics of the share price mean that the company’s high exposure to zinc,

where we forecast a relatively tight supply/demand balance over the long term, will

also act as a support for the share price. However, given the current share price

trend and the level of consensus forecasts, we believe it is still too early to conclude

that the market has fully priced in concerns about a downward revision to the

company’s FY3/13 earnings forecasts. We expect this to present a risk in the short

term.

Earnings outlook

For FY3/13, we forecast a recurring loss of ¥1.9b (following RP of ¥2.9b in FY3/12).

This is below the company’s forecast for full-year RP (¥4.7b) and the Quick

consensus RP forecast (¥2.5b). The main reasons we expect a ¥4.8b YoY decline in

profits are the drop in zinc prices (with a negative profit impact of around ¥2.0b), the

drop in lead prices (around ¥1.5b), and a negative impact from foreign exchange

translation losses (around ¥1.0b).

The main reason we expect profits to be ¥6.6b below company forecasts is that we

have been cautious in our cost assumptions for the aging Endeavor mine, where we

expect to see a loss (accounting for roughly ¥3b of the difference between the

company's forecasts and ours). The difference in zinc price assumptions has a

roughly ¥1b negative impact on forecasts, and we also expect to see a ¥2b loss on

inventory valuations.

For FY3/14, we forecast a turn to the black, with RP of ¥5.3b. Although we forecast

a major improvement compared to FY3/13, we still expect profits to come in below

the Quick consensus forecast (¥7.7b). The reason we expect a ¥7.2b YoY earnings

increase is that we expect the operating rate at the Rasp mine, which will start

operations in 2H 2012, to be more than 80% in FY3/14, and expect it to turn

profitable, with a positive profit impact of around ¥4.0b. In addition, we expect the

impact of inventory valuation profits and losses in the smelting segment to turn

positive, with an impact of around ¥2.0b, and also expect a ¥1.0b positive impact

from the absence of the previous year’s forex translation losses.



3 September 2012


There are two main potential catalysts: 1) a reduction in supply as a result of zinc

mine closures; and 2) the establishment of an integrated operating system for

mining and smelting as the company grows volumes in its upstream resource

operations. The main risks are an unexpected fall in market prices and the potential

failure of some business development plans.


Market exposure









prices than those of any of its competitors, while at Toho Zinc the share price is

closely correlated with zinc prices. These correlations are in line with the differences

in the structure of the business at each company.



Copper 0.3 0.2 0.6

Nickel 0.8 0.7 0.7

Zinc 0.6 0.9 0.5

Gold -0.1 -0.4 0.2

¥/US$ 0.4 0.6 0.1





preferences is that the short-term supply/demand balance for copper is the tightest

in relative terms, at close to equilibrium, while the balance for nickel is currently the

slackest. An examination of the current physical premium also shows that zinc is

relatively strong, closely followed by copper. However, there is only a small physical

premium for nickel, and we believe this supports our view. Our long-term forecasts

are based on our forecasts for the long-term equilibrium price.

Tendency for relative share

price performance to be

closely correlated with market

prices

Preferences for short to

medium term: copper, zinc,




3 September 2012

Figure 61. Zinc prices and the zinc premium

0

20

40

60

80

100

120

140

Jan 2010 Jan 2011 Jan 2012Zinc price (¢/lb)Zinc premium (Shanghai) (monthly average) ($/MT)Zinc premium (Rotterdam) ($/MT)Zinc premium (New Orleans) ($/MT)Zinc premium (Shanghai) ($/MT)


One of the key characteristics of the share price at Toho Zinc is that when zinc

prices are rising it is possible to target a PBR of close to 0.9x, but when zinc prices

are falling the valuation tends to fall to a PBR of below 0.6x.

Figure 62. Zinc prices and Toho Zinc PBR

0

50

100

150

Jan 2010 Jan 2011 Jan 2012

0.0

0.5

1.0

1.5

Zinc PBR (RHS)

(¢/lb) (x)




3 September 2012

Transformation from custom smelting to integrated mining and

smelting business

Zinc smelting business

Toho Zinc makes refined zinc at Annaka Smelting (100% owned) and Hachinohe

Smelting (10.48% owned). On an equity basis, the company has around 100,000MT

of zinc production capacity (giving it a domestic market share of around 20%).

Earnings in the company’s custom smelting business come mostly from treatment

charges (TCs) + price escalators + free metal. TCs are set in line with the actual

supply/demand balance for ore, and dropped to $191/MT in 2012 compared to

$229/MT in 2011. Price escalators show the additional percentage gained by the

smelter when LME price changes against the fixed base price. In 2011, the escalator

was 6% compared with a standard price of $2,500/MT, while the de-escalator was

4%. In 2012, the escalator has been 2%–5% against a standard price of $2,000/MT,

while the de-escalator has been 2%. Ore buying conditions worsened on a YoY

comparison in 2012, but we expect the supply/demand balance for ore to trend

tighter over the long term, and believe it is unlikely we will see a significant

improvement in ore buying conditions. The free metal indicates the difference

between the amount of metal content paid for at the time of ore buying and the

actual smelting yield. According to Nyrstar, the difference in the amount actually

obtained is more than 10%, and this is a major source of income for custom

smelters, on a par with treatment charges.

Figure 63. Japanese companies’ zinc mining and smelting production stakes by equity holding (2010) (thou MT)

Zinc mines 2010 Actual Zinc ore refining 2010 Actual

1 Sumitomo 226 1 MMS 214

2 Mitsubishi 43 2 Dowa Holdings 154

3 MMS 30 3 Toho Zinc 97

4 Toho Zinc 30 4 SMM 97

5 Dowa Holdings 12 5 Mitsubishi Material 10

6 Mitsui 7 6 Nisso Metallochemical 4

Japan total 348 Japan total 575


Figure 64. Trends in zinc ore buying purchase conditions

2008 2009 2010 2011 2012

Base TC $/MT 300 195 273 229 191

Basis price $/MT 2,000 1,250 2,500 2,500 2,000

De-escalator % -7% -10% -4% -4% -2%

Escalator % 7% 13% 9% 6% 2%–5%

Source: Mizuho Securities Equity Research, from Nyrstar data

Tightening of ore

supply/demand balance

leaves little room for

improvement in zinc ore

purchase conditions



3 September 2012

Zinc mining business

Toho Zinc purchased Australian zinc mining affiliate CBH Resources (CBH) in

September 2010 for a consideration of ¥23b and turned it into a fully owned

subsidiary. CBH already operated the Endeavor mine, and is developing the new

Rasp mine, which is scheduled to commence production in 2012. Annual production

capacity at the Endeavor mine is 44,000MT, and the life of the mine is estimated at

six years. However, according to CBH, it appears the mine can be expanded further.

The Rasp mine was completed in April 2012, and normal production is planned to

start in 3Q. The company plans to produce 40,000MT of conatined zinc in

concentrate in the third year of operations, and it estimates the life of the mine at

more than 15 years.

Once the Rasp mine (developed at an initial investment of ¥13b) reaches full

production, we expect the cover ratio showing the company’s equity share of zinc

production against the amount of ore needed by its zinc smelting business (i.e., the

self-sufficiency ratio) to rise from just over 10% immediately prior to the

transformation of CBH into a fully owned subsidiary to around 70%, and the shift to

an integrated model of operations covering mining to custom smelting will mean that

the company is much less exposed to shifts in the supply/demand balance for zinc

ore. This will represent a significantly different business model compared to the

other Japanese companies, which are mainly in custom smelting business. The

Rasp mine has reserves not only of zinc, but also of lead and silver, and this should

make it even more competitive as a result of by-product credit. Our earnings

forecasts are based on average levels of cash costs for global zinc mining

operations after taking by-product credit into account. According to JOGMEC,

mineralization in the ore deposits at the Rasp mine extends further to the north, and

we believe that over the long term there is still further upside for resource volumes.

Figure 65. Toho Zinc product sales volume trends (thou MT)

0

20

40

60

80

100

120

140

FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E FY3/16E FY3/17E

0%

20%

40%

60%

80%

100%

Zinc sales volume Proprietary mine weighting (RHS) Note: The self-sufficiency ratio is based on Mizuho estimates, calculated as

estimated equity interest in mining production divided by product sales in smelting operations. E = Mizuho Securities estimates.

Source: Mizuho Securities Equity Research, from Toho Zinc data

Figure 66. Estimated production at Toho Zinc's zinc mine interests (thou MT)

0

20

40

60

80

100

FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E FY3/16E FY3/17E

Endeavor Rasp Note: E = Mizuho Securities estimates Source: Mizuho Securities Equity Research

New Rasp mine to start

production in 2012, leading to

sharp increase in self-

sufficiency ratio once it

reaches full production and

allowing shift to integrated

mining and smelting business

model



3 September 2012


FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E


Copper ¢/lb 3.5 4.4 4.2 4.1 3.5 4.1 3.8 3.6 3.4 3.4 3.6 3.5 3.3

Nickel ¢/lb 10.8 12.6 11.5 10.4 8.6 10.8 9.2 8.0 7.4 7.4 8.0 7.5 7.5

Zinc ¢/lb 1.0 1.1 1.1 1.1 0.9 1.1 1.0 1.0 0.8 0.8 0.9 0.9 1.0

Lead ¢/lb 1.0 1.2 1.2 1.2 1.0 1.1 1.0 1.0 0.8 0.8 0.9 0.9 1.0

Gold $/oz 1,226 1,388 1,508 1,662 1,683 1,560 1,691 1,612 1,600 1,600 1,626 1,550 1,450

Silver $/oz 20 32 38 38 32 35 33 29 28 28 30 28 27

Forex ¥/US$ 86 82 78 77 79 79 80 80 80 80 80 80 80



FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E


Sales 103.6 24.5 26.5 28.4 26.4 105.9 23.7 21.9 22.3 22.6 90.4 95.7 100.6

GP 16.0 2.0 3.0 1.6 4.0 10.5 0.5 1.5 2.6 2.7 7.3 13.7 15.8

SG&A expenses 7.5 1.6 2.1 2.1 1.9 7.7 1.9 2.0 2.0 2.0 7.9 8.0 8.0

OP 8.5 0.4 0.9 -0.5 2.0 2.8 -1.5 -0.5 0.6 0.7 -0.6 5.7 7.8

Dividend income 0.1 0.1 0.0 0.0 0.0 0.1 0.0 0.0 0.0 0.0 0.1 0.1 0.1

Equity-method gain/loss -0.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Interest -0.6 -0.1 -0.1 -0.1 -0.1 -0.4 -0.1 -0.1 -0.1 -0.1 -0.5 -0.4 -0.4

Non-operating profit 0.8 0.2 -1.2 0.4 0.9 0.3 -0.9 0.0 0.0 0.0 -0.9 0.0 0.0

RP 8.7 0.6 -0.4 -0.2 2.8 2.9 -2.4 -0.6 0.5 0.6 -1.9 5.3 7.5

Extraordinary income & loss 3.8 0.2 0.0 -0.1 -0.1 0.1 -0.1 0.0 0.0 0.0 -0.1 0.0 0.0

Pretax profit 12.5 0.8 -0.3 -0.2 2.8 3.0 -2.5 -0.6 0.5 0.6 -2.0 5.3 7.5

Corporate tax 4.9 0.7 -0.2 0.2 1.3 2.0 -0.8 -0.2 0.2 0.2 -0.7 1.8 2.5

NP 7.5 0.1 -0.1 -0.5 1.5 1.0 -1.6 -0.4 0.3 0.4 -1.3 3.5 4.9

Corporate tax rate 40% 84% 64% -105% 47% 67% 34% 34% 34% 34% 34% 34% 34%

EBITDA 12.5 8.9 5.7 13.2 15.6

Note: EBITDA = OP + equity method profits + depreciation expenses. E = Mizuho Securities estimates. Source: Mizuho Securities Equity Research

Figure 69. Profit by segment (¥b)

FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E


Smelting & refining 5.7 0.0 0.0 -0.9 1.9 1.1 -1.7 -0.6 0.3 0.1 -1.9 0.7 1.1

Mineral resources -0.3 -0.3 0.3 -0.0 -0.8 -0.8 -0.3 -0.5 -0.3 -0.0 -1.2 2.7 4.4

Electric materials 1.1 0.2 0.2 0.2 0.2 0.9 0.2 0.2 0.2 0.2 0.9 0.9 0.9

Environmental recycling 1.0 0.0 0.1 0.0 0.1 0.3 0.1 0.1 0.1 0.1 0.6 0.6 0.6

Other 1.0 0.3 0.3 0.2 0.6 1.4 0.2 0.2 0.2 0.2 1.0 0.8 0.8

Consolidated 8.5 0.4 0.9 -0.5 2.0 2.8 -1.5 -0.5 0.6 0.7 -0.6 5.7 7.8




3 September 2012


FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

Cash and deposits 12.7 16.6 17.0 17.0 17.0

Other short-term assets 49.3 50.9 44.1 44.0 44.6

Current assets 62.1 67.5 61.1 61.0 61.6

Fixed assets 45.9 51.9 58.0 60.0 60.0

Other long-term assets 33.1 30.5 32.0 32.0 32.0

Total assets 141.0 149.8 151.1 153.0 153.6

Interest-bearing debt 44.4 61.1 64.5 63.5 59.9

Other debt 36.6 27.8 28.2 28.5 28.7

Shareholders' equity 52.2 52.3 50.0 52.6 56.6

Other comprehensive income 7.9 8.6 8.4 8.4 8.4

Net assets 60.1 60.9 58.4 61.0 65.0



FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

NP before tax 12.5 3.0 -2.0 5.3 7.5

Depreciation 4.2 6.1 6.3 7.5 7.8

Change in working capital -1.7 -9.3 7.5 -1.7 -3.2

Operating cash flow 15.0 -0.2 11.9 11.2 12.1

Investment cash flow -24.1 -11.0 -13.9 -9.2 -7.5

Free cash flows -9.1 -11.2 -2.0 2.0 4.6

Financing cash flow 9.4 15.2 2.4 -2.0 -4.6



FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

Common shares (m) 136 136 136 136 136

Per share:

Dividends (¥) 7.0 7.0 7.0 7.0 7.0

Dividend payout ratio 13% 95% - 27% 19%

EPS (¥) 56 7 -10 26 36

BPS (¥) 443 448 430 449 479

PER (x) - - - 10.3 7.3

PBR (x) - - 0.6 0.6 0.6

ROA 5% 1% -1% 2% 3%

ROE 13% 2% -2% 6% 8%

Net D/E 53% 73% 81% 76% 66%

Note: Financial analysis indicators based on term-end balance sheets. ROA based on NP. Share prices as of 31 August close. E = Mizuho Securities estimates.




3 September 2012

Sumitomo Metal Mining (5713) New sprouts augur the rise of a new major Japanese base metal company

Investment ratings and valuation

We determined our ¥1,060 price objective for Sumitomo Metal Mining by applying a

PBR of approximately roughly 0.9x to our FY3/13 BPS forecast of ¥1,249. Since the

company’s share price tends to be correlated with market price trends (mainly

copper and nickel prices), we have set our price objective with reference to our

short- to medium-term market forecasts. As our price objective is 31% above the

current share price, we are initiating our coverage with a Buy rating.

Investment thesis

The company has a number of strong growth options within the resource business,

and we expect to see it emerge as a major base metal supplier. In the copper mining

business, we expect to see the company’s equity stake in mining production volume

grow by 80% as new and expanded projects make an increasing contribution. We

also expect to see a 50% increase in production volume in the nickel business as

new and expanded projects start to contribute. We expect this volume growth to act

as a key driver of relative share price performance, and since we expect

fundamentals to remain relatively tight in the short to medium term, we believe the

company’s high exposure to the copper business will be beneficial given the key

characteristics of the share price.

Earnings outlook

We forecast FY3/13 RP of ¥75.0b (down 31% YoY). This is below the company’s

full-year RP forecast (¥92.0b) but in line with the IFIS consensus forecast (¥74.4b).

We expect the main reasons for the ¥33.8b YoY reduction in profits to be a negative

impact of around ¥30.0b from the nickel price and ¥10.0b from the copper price,

partly made up for by positive impacts of roughly ¥3.0b from higher gold prices,

¥2.0b from improvement at VNC, and ¥1.0b from forex changes.

The reason we expect profits to be ¥17b below company forecasts is that we expect

an inventory valuation difference of around ¥7b, a ¥6b negative from lower

assumptions for copper prices, a ¥2b negative from deterioration at VNC, a ¥1b

impact from lower assumptions for gold prices and a forex translation loss.

We forecast FY3/14 RP of ¥82.0b (up 9% YoY). This is just below the IFIS

consensus (¥86.9b). The reason we expect a ¥7.0b YoY increase in profits is that

we expect improvements of around ¥6.0b in inventory valuation profits and losses,

around ¥3.0b from profit improvement at VNC, around ¥3.0b in the materials

business, ¥3.0b in forex translation gains, and ¥3.0b on the back of higher volumes

in the overseas mining operations. These positives should make up for a ¥6.0b

negative impact from lower nickel prices, a ¥4.0b impact from lower gold prices, and

a ¥1.0b impact from lower copper prices.



3 September 2012


There are three main catalysts: 1) the emergence of supply constraints, such as a

deterioration in the grade of copper ore and supply issues; 2) a reduction in supply

owing to problems with commissioning new nickel projects; and 3) the

transformation of the company into a major base metal supplier as a result of

volume growth in the high-grade resource field. The main risks are an unexpected

fall in market prices and failure to implement segment business development plans.


Market exposure and trends









prices than those of any of its competitors, while at Toho Zinc the share price is

closely correlated with zinc prices. These correlations are in line with the differences

in the structure of the business at each company.



Copper 0.3 0.2 0.6

Nickel 0.8 0.7 0.7

Zinc 0.6 0.9 0.5

Gold -0.1 -0.4 0.2

¥/US$ 0.4 0.6 0.1





preferences is that the short-term supply/demand balance for copper is the tightest,

at close to equilibrium, while the balance for nickel is currently the slackest. An

examination of the current physical premium also shows that zinc is relatively strong,

closely followed by copper. However, there is only a small physical premium for zinc,

and we believe this supports our view. Our long-term forecasts are based on our

forecasts for the long-term equilibrium price.

Tendency for relative share

price performance to be

closely correlated with market

prices

Short- to medium-term

preferences: copper, zinc,




3 September 2012

Figure 74. Copper prices and the copper premium

0

100

200

300

400

500

Jan 2010 Jan 2011 Jan 2012

0

20

40

60

80

100

120

140

160

Copper price Copper premium (Shanghai) (RHS)

Copper premium (US) (RHS) Copper premium (Europe) (RHS)

($/MT)(¢/lb)


Figure 75. Zinc prices and the zinc premium

0

20

40

60

80

100

120

140

Jan 2010 Jan 2011 Jan 2012Zinc price (¢/lb)Zinc premium (Shanghai) (monthly average) ($/MT)Zinc premium (Rotterdam) ($/MT)Zinc premium (New Orleans) ($/MT)Zinc premium (Shanghai) ($/MT)


Figure 76. Nickel prices and the nickel premium

0

2

4

6

8

10

12

14

Jan 2010 Jan 2011 Jan 2012

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Nickel price ($/lb) Nickel premium (Europe) ($/MT)

Nickel premium (Shanghai) ($/MT) Nickel premium (US) ($/lb) (RHS) Source: Mizuho Securities Equity Research, from Bloomberg data

Figure 77. Gold prices ($/oz)

1,000

1,500

2,000

Jan 2010 Jan 2011 Jan 2012 Source: Mizuho Securities Equity Research, from Bloomberg data

The key characteristic of Sumitomo Metal Mining’s share price is that when copper

prices are rising, it is possible to target a PBR of close to 1x, but when nickel prices

are falling the lower bound of the valuation range tends to be a PBR of around 0.5x.

The correlation of the share price with the gold price is lower than with either copper

or nickel prices, and for the past few years since 2010 we have not observed any

marked correlation.

Accordingly, since the share price has recently fallen in line with the reduction in the

nickel price, the PBR now looks relatively undervalued compared to the current level

of the copper price. We expect nickel prices to bottom out at around the current level,

and if there is no further fall in the nickel price we believe there is scope to move to a

valuation based on the copper price. For these reasons, we set a valuation PBR of

roughly 0.9x.

For reference, the company is currently trading at a PBR of 0.6x, and we believe

that the difference between this and our theoretical PBR based on the relationship

between ROE and the current level signals significant upside for Sumitomo Metal

Mining’s shares. We determined our theoretical PBR using a cost of capital of 8.5%

(assuming a risk free rate of 1.3%, an equity risk premium of 6.0%, and a beta of

1.2), set against an ROE forecast of 8% for both FY313 and FY3/14.

As the nickel price bottoms

we expect valuations to move

in line with copper prices



3 September 2012

Figure 78. Copper prices and PBR at Sumitomo Metal Mining

0

100

200

300

400

500

Jan 2010 Jan 2011 Jan 2012

0.0

0.5

1.0

1.5

Copper PBR (RHS)

(¢/lb) (x)


Figure 79. Nickel prices and PBR at Sumitomo Metal Mining

0

200

400

600

800

1,000

1,200

1,400

Jan 2010 Jan 2011 Jan 2012

0.0

0.5

1.0

1.5

Nickel PBR (RHS)

(¢/lb) (x)


Figure 80. Gold prices and PBR at Sumitomo Metal Mining

1,000

1,500

2,000

Jan 2010 Jan 2011 Jan 2012

0.0

0.5

1.0

1.5

Gold PBR (RHS)

($/oz) (x)


Signs that a new Japanese base metals major is emerging

Copper mining business

In 2011 Sumitomo Metal Mining had an equity copper production volume of around

125,000MT, second among the Japanese companies only to Mitsubishi, which

acquired a 24.5% stake in Anglo American Sur in the same year for $5.39b.

However, gaining a place within the top 15 producers worldwide requires interests of

more than 200,000MT, and currently there is still a significant gap between

Sumitomo Metal Mining and the base metals majors. However, the company has a

number of growth options, including the expansion of the Morenci mine (in which it

has a 12.0% stake) in 2014, the start-up of the Sierra Gorda mine (in which it has a

31.5% stake) in 2014, and the expansion of the Cerro Verde mine (in which it has a

16.8% stake) in 2016. Accordingly, over the next five years we expect it to expand its

equity copper production volume to 230,000MT. If the company realizes its growth

options, we expect to see it emerge as one of the base metals majors.

Realization of growth options

could push company into

ranks of global copper majors

in terms of share of

production volume



3 September 2012

Figure 81. Copper mining production share by company (2011)

KGHM3% Antofagasta

3%Teck Resources2%

Vale2% Norilsk Nickel

2%

Anglo American4%

GrupoMexico*5%

Rio Tinto5%

Xstrata5%

BHPB6%

Freeport8%

CODELCO11%

Kazakhmys2%

First Quantum2%

Barrick Gold1%

Others39%

Source: Mizuho Securities Equity Research, from JOGMEC, Bloomberg and

company data

Figure 82. Sumitomo Metal Mining: copper mining production allocation by volume (thou MT)

0

50

100

150

200

250

2011 Morenci expansion Sierra Gorda Cerro Verdeexpansion

Existing Morenci expansion Sierra Gorda Cerro Verde expansion Source: Mizuho Securities Equity Research, from various company data

Figure 83. Japanese companies: copper mining production allocation by volume (thou MT)

2011 Actual 2017 E

1 Mitsubishi* 138 1 Mitsubishi 271

2 SMM 125 2 SMM 230

3 JX 94 3 Marubeni 213

4 Marubeni 93 4 JX 162

5 MMS 70 5 Mitsui 130

6 Mitsui 59 6 MMS 115

7 Sumitomo 59 7 Sumitomo 93

8 Mitsubishi Materials 69 8 Mitsubishi Materials 69

9 Nittetsu Mining 15 9 Nittetsu Mining 15

10 Sojitz 8 10 Sojitz 8

11 Furukawa Metals 6 11 Furukawa Metals 6

12 Dowa Holdings 4 12 Dowa Holdings 4

Japan total 740 Japan total 1,317

Note: *Includes Mitsubishi’s 25% stake in annual production at Anglo American Sur. E = Mizuho Securities estimates. Source: Mizuho Securities Equity Research, from various company data

Nickel business

We estimate that in 2011 Sumitomo Metal Mining had an equity nickel production

volume of around 63,000MT, including electrical nickel, ferronickel, nickel matte, and

other products. This scale of production already puts it among the major companies

in the world. In terms of technology, we believe the company’s strong know-how

related to the wet smelting method is also an important factor in the potential future

growth of the nickel business. For producing electrical nickel, the company uses the

matte chlorine leaching electrowinning (MCLE) method. Since unexploited nickel

reserves worldwide are increasingly of lower quality, there is increasing demand for

commercial production of nickel from low-grade ores which could not previously be

processed, using the high pressure acid leaching process (HPAL) method, a form of

wet smelting. The company has already achieved high productivity at Coral Bay

Nickel (in which it has a 54% stake) through the use of HPAL technology, and

excluding the impact of the drought, it has also achieved a more or less vertical

start-up curve for the second line, which commenced operation in 2009.

Emerging as one of global

nickel majors by leveraging

advantages of wet nickel

smelting technology



3 September 2012

Future growth options include the company’s second HPAL plant at Taganito (in

which it has a 62.5% stake) in 2013, expansion of PT Inco (20.1% stake) in 2013,

and the move to full production at VNC (previously Goro, 11.0% stake). As a result,

we believe the company’s equity nickel production could potentially rise to around

90,000MT in the future. In the Solomon Islands, where the company is currently

promoting mining operations, it now appears to be close to starting extraction, and

we believe this could provide further upside to nickel mining growth. Over the long

term, we expect Sumitomo Metal Mining to become one of the global nickel majors.

Figure 84. Nickel mining production share by company (2011)

Others28%

Nickel Asia Corp*1%

St. Miniere duSud Pacifique*

1%Votorantim*

1%

Norilsk Nickel17%

Vale13%

BHPB8%

PT Antam*7%

Xstrata6%

SMM3%

SurigaoIntegrated

Resources*3%

Pacific Metals2%

Anglo American2%

Glencore2%

Eramet3%

Jinchuan*3%

Note: * indicates 2009 production Source: Mizuho Securities Equity Research, from company and JOGMEC data

Figure 85. Sumitomo Metal Mining: nickel mining production volume (thou MT)

0

20

40

60

80

100

2011 Taganito PT Incoexpansion

ENi 65ktexpansion

VNC (Goro)

2011 Taganito PT Inco expansion ENi 65kt expansion VNC (Goro) Source: Mizuho Securities Equity Research, from various company data

Figure 86. Japanese companies: nickel mining production volumes (thou MT)

2011 Actual 2017 E

1 SMM 63 1 SMM 92

2 Pacific Metals 31 2 Pacific Metals 38

3 Mitsui 16 3 Mitsui 33

4 Nippon Yakin* 9 4 Mitsubishi 18

5 Sojitz 4 5 Sumitomo 17

6 6 Nippon Yakin* 9

7 7 Sojitz** 4

8

Japan total 123 Japan total 210

Note: * indicates 2010 results, ** indicates 2011 results; E = Mizuho Securities estimates; production volumes for Japanese companies are for shares of pure nickel production including smelting but exclude NAC’s share of production at Sumitomo Metal Mining; figures for Hyuga Smelting are sales volume for its interests.

Source: Mizuho Securities Equity Research, from various company materials



3 September 2012


FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E


Copper ¢/lb 3.5 4.4 4.2 4.1 3.5 4.1 3.8 3.6 3.4 3.4 3.6 3.5 3.3

Nickel ¢/lb 10.8 12.6 11.5 10.4 8.6 10.8 9.2 8.0 7.4 7.4 8.0 7.5 7.5

Zinc ¢/lb 1.0 1.1 1.1 1.1 0.9 1.1 1.0 1.0 0.8 0.8 0.9 0.9 1.0

Lead ¢/lb 1.0 1.2 1.2 1.2 1.0 1.1 1.0 1.0 0.8 0.8 0.9 0.9 1.0

Gold $/oz 1,226 1,388 1,508 1,662 1,683 1,560 1,691 1,612 1,600 1,600 1,626 1,550 1,450

Silver $/oz 20 32 38 38 32 35 33 29 28 28 30 28 27

Forex ¥/US$ 86 82 78 77 79 79 80 80 80 80 80 80 80



FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E


Sales 864 213 221 208 206 848 205 180 163 187 737 765 774

GP 139 38 28 28 38 132 31 26 29 31 117 117 121

SG&A expenses 43 10 11 11 12 44 11 11 11 11 44 44 44

OP 96 28 17 17 26 88 20 15 18 20 73 73 77

Dividend income 2 1 0 1 2 3 1 0 1 1 2 2 2

Equity-method gain/loss 35 11 11 4 -3 23 3 1 -0 1 5 10 16

Interest -2 -0 -1 -1 -0 -2 -1 -1 -1 -1 -3 -4 -4

Non-operating profit -7 -2 -4 -0 2 -4 -3 0 0 0 -3 0 0

RP 124 38 24 20 27 109 21 15 17 21 75 82 92

Extraordinary income & loss -0 0 -12 -5 -4 -21 -0 0 0 0 -0 0 0

Pretax profit 123 38 12 16 23 88 21 15 17 21 75 82 92

Corporate tax 31 7 -1 5 8 19 4 4 4 5 17 17 18

Minority interest gain 9 4 2 1 -3 3 0 0 0 0 2 2 2

NP 84 26 11 9 18 65 17 11 13 15 56 63 73

Corporate tax rate 25% 20% -10% 34% 34% 22% 17% 24% 25% 24% 22% 21% 20%

EBITDA 165 143 112 123 137

Note: EBITDA = OP + equity method products + depreciation expenses. E = Mizuho Securities estimates. Source: Mizuho Securities Equity Research

Figure 89. Segment profits (¥b)

FY3/11 FY3/12 FY3/13 FY3/14E FY3/15E


Mineral resources 70 23 24 16 18 81 20 15 14 14 63 62 58

Smelting & Refining 50 15 3 1 7 26 -0 -4 -2 0 -6 1 14

Materials 5 1 -1 -1 0 -0 -0 1 1 2 3 6 8

Other -2 -2 -2 5 1 3 2 4 4 5 14 13 12

Consolidated 124 38 24 20 27 109 21 15 17 21 75 82 92

Assumptions for NP by product

Copper 44 13 15 10 9 46 11 9 8 8 35 36 37

Nickel 58 15 10 10 7 41 4 1 0 1 7 7 18

Gold 42 12 14 12 13 52 16 13 13 13 54 48 44

Other -20 -3 -14 -11 -1 -30 -11 -8 -3 -1 -21 -10 -7




3 September 2012


FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

Cash and deposits 92 76 80 85 85

Other current assets 381 423 401 384 384

Current assets 473 499 481 469 469

Fixed assets 265 290 330 363 396

Other long-term assets 315 356 392 430 468

Total assets 1,052 1,146 1,203 1,262 1,332

Interest-bearing debt 211 266 280 290 300

Other liabilities 157 154 151 152 156

Shareholders' equity 682 730 770 818 874

Other comprehensive income -52 -70 -68 -68 -68

Minority interest 54 66 70 70 70

Net assets 684 726 772 820 876



FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

NP before tax 123 88 75 82 92

Depreciation 35 31 34 40 44

Change in working capital -56 26 4 -2 -20

Operating cash flow 102 145 113 120 116

Investment cash flow -76 -136 -108 -109 -110

Free cash flows 27 9 4 11 6

Financing cash flow 7 50 -1 -6 -6



FY3/11 FY3/12 FY3/13E FY3/14E FY3/15E

Common shares (m) 562 562 562 562 562

Common shares (m) (diluted) 613 611 611 611 611

Per share:

Dividends (¥) 32 28 28 28 28

Dividend payout ratio 23% 26% 31% 27% 23%

EPS (¥) (diluted basis) 137 107 92 103 120

BPS (¥) 1,121 1,173 1,249 1,334 1,434

PER (x) - - 8.8 7.8 6.8

PBR (x) - - 0.6 0.6 0.6

ROA 8% 6% 5% 5% 5%

ROE 13% 10% 8% 8% 9%

Net D/E 19% 29% 28% 27% 27%

Note: Financial analysis indicators based on term-end balance sheets. ROA based on net profits. Share prices as of 31 August close. E = Mizuho Securities estimates.




3 September 2012

| Companies Mentioned in this Report

Code Company Name Rating Share Price 8/31

5541 Pacific Metals Neutral ¥2515707 Toho Zinc Neutral ¥2655713 Sumitomo Metal Mining Buy ¥808Note: NR = Not RatedSource: Mizuho Securities Equity Research

Important Disclosure Information

■ Mizuho Securities Co., Ltd. and / or its affiliate(s) received compensation in the past 12 months, or expects to receive or intends to seek compensationin the next 3 months for investment banking services from: Pacific Metals, Toho Zinc, Sumitomo Metal Mining.



3 September 2012

Mizuho Securities RatingsMizuho Securities investment ratings are based on the following definitions.

Ratings and price objectives are based on returns expected over the next 6 -12 months.Buy : Stocks for which our price objective, as of the date it is set, exceeds the share price by 10% or more and which are not classified

as "Underperform" under the guidelines for distribution of ratings detailed below.Neutral : Stocks for which our price objective, as of the date it is set, is within 10% of the share price (either above or below) and which are

not classified as "Underperform" under the guidelines for distribution of ratings detailed below.Underperform : Stocks for which our price objective, as of the date it is set, falls below the share price by 10% or more or stocks classified as

"Underperform" under the guidelines for distribution of ratings detailed below.RS : Rating Suspended - rating and price objective temporarily suspended.NR : No rating - not covered, and therefore not assigned a rating.Guidelines for distribution of ratings: When fewer than 10% of the companies within a defined coverage universe (composed of companies withcommon attributes, covered by one or more analysts) have "Underperform" ratings, "Underperform" ratings are applied to 10% of the companies,rounded to the nearest whole number, beginning with those with the lowest implied upside. (These relative distribution guidelines apply only whenthe coverage universe is composed of six or more companies. There may be periods when the number of companies with “Underperform” ratingstemporarily does not meet these guidelines.)

Information can be found on the Mizuho Securities Equity Research website (MizuhoResearchWEB™) under “Disclosure Data” as to the proportion of all research ratings published duringthe last quarter that were in rating categories “Buy”, “Neutral”, and “Underperform”, and information on the proportion of companies within each category to which Mizuho Securities providedinvestment banking services during the last 12 months.

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Base metal smelting industry3 September 2012

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