Investment Planning and Valuation at JSC Kazakhmys Smelting

Aigerim Nagayeva, MSc in Finance, Kazakh British Technical University

Scientific supervisor Kuandyk Tleuzhanuly, PhD

One of the main purposes of investment activities is the realization of company strategy. It covers such aspects as increase of market value of the company, stable and high revenue for shareholders in prospect of the nearest three years, increase of the market share, creation or support of the recognizable trademark, costs reduction and so on.

To reach the investment purpose a company is to elaborate investment policy, on the base of which investment projects are worked out, because investment projects are one of the main approaches to increase company value. It should be mentioned in this connection that broadly speaking there are two types of investments: capital investments and financial investments. Being large-scale, internationally operating company Kazakhmys is engaged in both capital and financial investments. The sphere of interest of the given article covers mainly capital investments in mining industry by the example of Kazakhmys Smelting investment project directed to production of rhenium. Capital investments are elaborated in the form of projects and necessarily presume project documentation such as feasibility study, construction project and business plan.

It is also important that the investment project lies into the strategy of the company. In this case the phenomenon of synergy with other projects and the current activity of the company as a whole takes place, which in its turn enhances the positive effect of the project in terms of profit. Despite the fact that many specialists do not recognize the synergy theory, it still appears to be an argument in favor of investments and M&A’s. According to the synergy theory it is considered that positive synergy creates extra value, while negative synergy can annihilate the value, even if the projects itself are profitable.

Concerning investment activities in mining industry, it should be taken into account that contemporary mining companies are mainly vertically integrated structures. There are two important spheres of activities with different risk degree and time boundaries. The sphere of prospecting, mine workings and extraction is highly risky and requires a lot of time for return on capital investment. The sphere of processing, transportation and sales is less risky; it is more similar to other industries. Among the peculiarities of investments in mining industry the following aspects should be considered: long term character of the investments, capital-intensive projects, high degree of uncertainty on the first stage of investment, permanent variability of prices for resources, high tax burden, and legislative limits.

Kazakhmys investment policy considers long-term investments with payback period of more than one year and short-term investments, which can be realized within one year. But due to the peculiarities of investment activities discussed above, long-term investments prevail among the total flow of investments and especially among capital investments. Despite Kazakhmys’s belonging to mining industry, it should be mentioned that a lot of its investment activities represented by financial ones and directed into subsidiaries and dependent companies (with 20 and more percent of votes but without total control).

Returning to the investment valuation, there are three categories of methods used to make investment analysis: discounted cash flow valuation, comparable or multiples valuation and contingent valuation. The discounted cash flow valuation approach is the basic one, which delivers asset value to the present value of the future cash flows, falling on the given asset. The base of this approach is the present value, which expresses the main principle of finance that a dollar today worth more than a dollar tomorrow, because that same dollar today can be invested to earn some interest immediately. So the present value of delayed payoff can be found by multiplying payoff by discount factor, which is always less than 1.

Comparable or multiples valuation methods are the most widespread to the present day. Its key principle is to find the market price to the similar assets and compare with one to be evaluated. The most difficult here is to find similar company and to convert the prices into standard multiples, in order to compare them and make a reliable analysis. It should be stressed that the reliability of this method is a big issue, so the one who use it has to check the correctness and soundness of the results and used multiples. There are several categories of standard multiples: earnings multiples, revenue multiples, book value multiples and multiples which are specific for a particular industry or field.

And one more valuation approach is contingent claim, which is based on option valuation. Defining the true value of the option, analysts tried to develop a lot of models, which would be suitable for investment valuation. The point here is that some types of investments should be considered as options and correspondingly should not be valued by discounted cash flow method but the way options are valued. The first model of option pricing was introduced by Fisher Black and Myron Sholes and nowadays it is represented in many modified versions. In other words it is a conditional claim, in case if the income is a function of basic asset value, then this asset can be evaluated as option.

Generally to realize investment projects, analysts use a wide range of different models and tools of valuation in order to determine company value, investment opportunities and risks, return on investment, payback period, and the expected profit of the investment project. Talking about investment decision making there are two general rules: rule of NPV and rule of ROR, which are used to make decisions at Kazakhmys Smelting as well. The Net Present Value (NPV) of the project represents the evaluation of the increase in company value or net profit. It is crucial that the NPV as the difference between the invested amount and the amount company is willing to receive by the end of payback period, should be as higher as possible. If the NPV comes out to be negative it means that due to the realization of this investment project company value will decrease, in other words the project is not profitable. Thus the rule says: accept the project is NPV is positive.

Another important criterion is rate of return (ROR) on the investment. In other words it is a ratio of profit to investment, which should exceed the opportunity cost of capital representing the return forgone because of not investing in securities. The rule of ROR says that you should invest if the rate of return exceeds opportunity cost of capital.

Analyzing investment activities and investment projects settlement at Kazakhmys Smelting it can be concluded that most investment projects are evaluated mainly by rather traditional methods of discounted cash flows, without using any multiples approach or even more so contingent method. The process of investment planning is represented as a very complicated, poorly developed field. There is a significant potential that the company can realize via innovations and development in financial and investment sphere.