The Press Metal Effect | the underwriting sides of things

The recent RM150 million claim on machinery breakdown and machinery breakdown loss of profit was another eye opener, especially for the underwriting fraternity and those that involved with reinsurance.
The following are some snapshots that may be of interest to you….

1. Why were there losses due to machinery breakdown in the first place? Accordingly it was the breakdown of the smelting furnace pots caused by the solidification of the molten materials. Of course, the power outages triggered a chain of events resulting in such a damage….

2. This lead us to the question of why didn’t the insured takes immediate steps in the first place, to remove the molten materials from the furnace during that 5 hours from the time the outage occurred….(accordingly the aluminium based melt can withstand against irreversible solidification within 5 hours in the absence of power supply) and this act would have mitigated the losses. Shouldn’t this be a very important part of the policy condition? The second question here is about the brick lining materials used within the furnace pot that now aftermath of things require replacement; brick lining within any furnace such as this is part of the policy exclusion. If this is the case the claim quantum should dip substantially? By the way, there are few hundreds of such pots, or so it seems….

3. With Press Metal’s production capacity hitting past the billion ringgit mark wouldn’t it be wise for Press Metal to have the necessary backup in case of a prolonged power outage? Accordingly this is not easy; the ordinary power generator sets don’t work for such aluminum manufacturing operations; they would probably need at least two 1,000 MW power plant driven generator sets to deal with the molten materials keeping them in their molten state. I am sure this is a very high-end capex for them. They would probably achieve much more if they just sign a special agreement with SESCO or Bakun based power supplier for a guarantee of consistent and uninterrupted supply so that under no circumstances there be an outage that would last beyond two to three hours…. Question…. was there such a power supply agreement with Bakun in the very first place? But surely they cannot just rely on insurer to pay for something that they should had dealt with right from inception given their substantial investment in such an energy sapping operations. On the other hand it is also for underwriters to be prudently skeptical about available backup plan given the substantial amount of molten materials that are being exposed to losses in any event of outages…. Was is just basing on pricing and deductibles being the only thing that makes underwriters accept this risk, or was it a result of being overshadowed by the production budget agenda?

In the absence of any power supply agreement that makes sense to the underwriters I do not think insurance coverage will be easily made available to Press Metal. Without a proper cover and satisfactory power supply agreement, I don’t think it makes sense for such a RM 1.7 billion worth of plant, machinery & equipment to continue operating….unless they had indeed procured the much needed power plant typed generators as backup.

4. Was there a disparity…. where the loss of profit sum insured in respect of loss of profit in the IAR differed (our rather lower) from that of the LOP sum insured under this MBLOP? Why was there a difference?

Here’s the Borneo Post write-up with title, “Press Metal mitigated by insurance” Samalaju ramp-up | by Ronnie Teo, ronnieteo@theborneopost.com.
Posted on July 3, 2013, Wednesday
Press Metal Sarawak’s facilities in Mukah.

At the time of this announcement, Press Metal noted that none of the pots could be salvaged while its management was unable to estimate the full impact and consequences of the incident but will be closing the smelting plant to facilitate major reconstructions works.

Despite Press Metal Bhd’s (Press Metal) Mukah smelting plant being out of commission due to the blackout last week, analysts believe this will not leave much impact for the group in the long term period, partly mitigated by the ramping up of its Samalaju smelter. On Monday, Press Metal announced on Bursa Malaysia that its subsidiary, Press Metal Sarawak Sdn Bhd (Press Metal Ssarawak) suffered a sudden shutdown of its primary aluminium production lines at its Mukah smelting plant due to a major power outage that occured at approximately 5.40pm on June 27, 2013 in Sarawak.The power outage lasted for almost six hours, leading to a significant drop in temperature of the production pots.“Although power has been restored, Press Metal Sarawak was unable to resume metal production as solidification had taken place in the reduction cells of its potline despite its management and staff working tirelessly around the clock to salvage the pot,” the statement highlighted.

At the time of this announcement, Press Metal noted that none of the pots could be salvaged while its management was unable to estimate the full impact and consequences of the incident but will be closing the smelting plant to facilitate major reconstruction works. It is noted that Press Metal Sarawak has in place adequate insurance coverage and has initiated engagement with its insurers to ascertain the damage and the cost of the reconstruction works. Consequently, the subsidiary has issued a notice to its affected customers that a force majeure event had occured at its Mukah smelting plant, thereby impacting the supply of aluminium products to such customers.

RHB Research Institute Sdn Bhd analyst Ng Sem Guan in a note on the group noted that in addition to adequate insurance coverage, the ramping up of its Samalaju smelter – which is 2.66 times larger and way more efficient than its Mukah operation – will also partly mitigate any immediate losses.

“While this incident will dent Press Metal’s earnings in the short term, most of the shortfall will be compensated by insurance, which will then lessen the impact on the stock’s long term discounted cash flow (DCF),” Ng explained. “As we are assuming a six-month halt in Press Metal Sarawak’s operation, which is likely to wipe out its FY13 earnings, we classify its fixed and overhead costs during the period as exceptionals and cut our FY13 core profit forecast by 14.8 per cent,” he added.

“All said, we have decided to be prudent in terms of valuations by raising the discount to our fully diluted conservative DCF from 20 per cent to 30 per cent, from which we derive a new fair value of RM2.90. We urge investors to look beyond this temporary blip and buy into any share price weakness.”

In a separate note, AmResearch Sdn Bhd maintained its earnings forecast and valuations for Press Metal for now, pending further details. We think Press Metal would be able to claim insurance and could utilise its production in Bintulu to deliver products to the affected customers,” it said. “Nevertheless, we have computed the impact of the closure of its Mukah plant for six months, which would reduce its forecast financial year 2013 (FY13F) net profit to RM36.8 million from RM138.4 million previously. “Core fully-diluted earnings per share would also fall to 7.2 sen from 22.2 sen previously. However, the actual shortfall could be less as our rough estimates assume status quo for electricity cost during the period. We maintain our fair value of RM3.60 per share as we have not changed our FY14F forecasts, pending further details from management.”

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7 comments for “The Press Metal Effect | the underwriting sides of things

  1. jan@jose.com
    July 14, 2015 at 14:31

    Can you guys blog something on the latest Press Metal’s loss? Good to know something on the underwriting aspects of dealing wiht the acceptance of such risk involving substantial heat processes?

    • July 15, 2015 at 09:04

      Try to but takes time to digest the underwriting issues that are to be learned.

  2. Anonymous
    September 21, 2013 at 08:03

    generally power supply agreement with power supply has limitation, ie. the first 6 hours is excluded.

  3. Anonymous
    August 6, 2013 at 12:41

    They need a power plant generator set to support power outages? Cool!

    • August 6, 2013 at 14:31

      Yes, the volume of molten materials is huge and substantial energy is required to keep them in the right state….

    • Anonymous
      August 24, 2013 at 21:07

      This is why qualified risk surveyors/engineers are needed to highlight the exposures for the benefit of the underwriters. Unfortunatley the insurance industry under appreciates such expertise.

      • August 24, 2013 at 22:21

        I have browse through the technical survey report, which was fine two or three years back. It appeared the reporting is very limited. … much of the main exposures were never mentioned. Yes, we can agree that technical survey is important but report must be exposure focus rather than merely reporting….

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