20140416-美银美林-Capacity_cut_comes_in_earlier_than_expected__Reiterate_U_P_12页_637kb_637kb

Summary of Chalco's Capacity Cut and Investment Outlook

Core Content

This document provides an analysis of Chalco's recent decision to temporarily shut down a portion of its aluminum and alumina production capacity, as well as the implications for its financial performance and valuation. The report highlights the company's ongoing challenges in the aluminum industry and reiterates a negative investment outlook.

Key Information

• Company: Chalco (Aluminum Corp. of China)
• Date: April 16, 2014
• Investment Rating: Underperform (U/P)
• Price Objective (PO): HK$1.9
• Current Share Price: HK$2.94
• Downside Potential: 40%
• Valuation Metric: EV-to-Assets ratio of 75%
• Impairment Loss Estimate: RMB1,340 million

Main Points

Capacity Cut

• Chalco announced the temporary shutdown of 600kt aluminum and 800kt alumina capacity.
• This accounts for 16% and 6% of its total aluminum and alumina capacity, respectively.
• The scale and timing of the capacity cut are worse than expected.
• The capacity cut is not a net reduction in domestic capacity due to the replacement of high-cost capacities with low-cost ones from northwestern China.

Impairment Loss

• The impairment loss is estimated to reach RMB1,340 million.
• Based on 2013 data, each ton of aluminum capacity had unit assets of RMB12,948/t and net assets of RMB6,113/t.
• Each ton of alumina capacity had unit assets of RMB5,249/t and net assets of RMB2,368/t.
• Assuming unit impairment losses of RMB1,500/t for aluminum and RMB550/t for alumina, the total impairment loss is RMB1,340 million.

Aluminum Price

• The aluminum price fell by RMB20/t to RMB12,950.
• This is the first drop since the bottom out on March 25, 2014.
• The current price is still 9% lower than the FY13 average price and the FY14 estimate of RMB13,221.

Investment Thesis

• Chalco is expected to have a tough 2014 due to weak aluminum prices and deteriorating profitability.
• The company's valuation is not justified by fundamentals, with a high EV-to-Assets ratio.
• The price-to-book (P/B) method fails to capture the company's high leverage ratio.
• The recent share price rally was driven by the expectation of A-H share price convergence, which has deviated from fundamentals.

Valuation & Sensitivity Analysis

• The current share price is not justified by the company's fundamentals.
• The PO of HK$1.9 is based on a 0.55x P/B ratio, implying a 69% EV-to-Assets ratio.
• The sensitivity analysis shows that the EV-to-Assets ratio decreases as the share price declines.

Catalysts for De-Rating

• Disappointing Q1 results
• Potential significant impairment losses due to capacity closure
• Highly leveraged balance sheet that may negatively impact long-term profitability

Key Financial Data (Dec)

Income Statement

Item	2012A	2013A	2014E	2015E	2016E
Net Income (Adjusted - mn)	(8,234)	975	(6,646)	(2,780)	50
EPS	(0.609)	0.072	(0.491)	(0.206)	0.004
EPS Change (YoY)	NM	NM	NM	58.2%	NM
Free Cash Flow / Share	(0.593)	(0.017)	(0.169)	0.077	0.352

Valuation

Metric	2012A	2013A	2014E	2015E	2016E
P/E	NM	31.83x	NM	NM	644.01x
EV / EBITDA	73.21x	12.55x	43.47x	16.07x	10.97x
Free Cash Flow Yield	-25.16%	-0.737%	-7.17%	3.27%	14.92%

Balance Sheet

Item	2012A	2013A	2014E	2015E	2016E
Property, Plant & Equipment	96,248	100,606	103,385	105,715	107,597
Total Assets	175,017	199,507	198,134	201,257	205,815
Long-Term Debt	36,636	46,295	46,295	46,295	46,295
Net Debt	94,359	107,217	115,537	120,901	122,734
Net Debt-to-Equity Ratio	175.5%	199.7%	247.4%	276.2%	280.0%

Peer Comparison

Company	Ticker	Industry	EV-to-Assets	ROE	Mkt Cap (US$M)	PE	PB	EV/EBITDA
Chalco	2600 HK	Aluminum	75%	2%	5,127	NM	4.9x	43.5x
Maanshan	323 HK	Steel	48%	1%	1,807	NM	7.1x	16.1x
China Coal	1898 HK	Coal	56%	6%	7,506	NM	7.9x	16.0x
Nanshan	600219 CH	Aluminum	63%	5%	3,926	NM	5.5x	14.5x
Angang	347 HK	Steel	52%	2%	4,655	NM	6.4x	13.7x

Key Metrics

• ROE (2014E): -16.2%
• Net Debt to Equity (Dec-2013A): 199.7%
• Est. 5-Yr EPS / DPS Growth: 29.4% / NA
• Free Float: 0.6%
• Stock Data:
  • Price: HK$2.94
  • Price Objective: HK$1.90
  • 52-Week Range: HK$2.20-HK$3.32
  • Market Value (mn): HK$39,762
  • Average Daily Volume: 16,275,300
  • Volatility Risk: HIGH

Conclusion

Chalco's capacity reduction is not expected to support aluminum prices due to the replacement of high-cost with low-cost production. The company's valuation is seen as overinflated, and the recent price rise is attributed to share price convergence expectations rather than fundamental improvements. The report reiterates an Underperform rating and a price objective of HK$1.9, suggesting a 40% downside potential. The high leverage and expected impairment losses are viewed as key factors that will continue to negatively impact the company's profitability.