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2014 Materials Sector Outlook Summary

Core Content

This report provides an analysis of the materials sector in China for 2014, focusing on coal, metals (nickel, aluminum, copper), and steel. It outlines investment recommendations, price forecasts, and key factors influencing sector performance, including political risk, supply dynamics, and demand trends.

Investment Recommendations

Main Points

1. Overall Outlook

• The report initiates coverage of five companies in the coal, metals, and steel sectors with an overall positive view.
• Three companies are rated as BUY, one as HOLD, and one as SELL.
• The outlook for 2014 is driven by improving global demand and rising political risk, particularly in the nickel and aluminum sectors.

2. Materials Price Forecasts

• Outperforming Materials: Nickel, aluminum, and coking coal are expected to outperform in 2014.
• Thermal Coal: Prices are forecasted to rise by 5% by year-end due to favorable seasonal factors.
• Underperforming Materials: Iron ore, gold, and lead are expected to underperform, while copper will fade later in the year.
• Long-term Trends: Prices for most materials are expected to trend lower from late 2014 onwards, except for aluminum, which is forecasted to outperform copper due to slowing supply growth.

3. Key Drivers

• Indonesian Ore Export Ban: Expected to significantly impact nickel prices, with less effect on bauxite. This is a key near-term event.
• China's Demand and Supply Dynamics: China's demand growth for copper is expected to slow, and the company's ability to obtain copper units will change due to increased concentrate and scrap imports.
• Productivity and Cost Management: Companies need to improve productivity to restore profit margins as demand growth slows and selling prices fall.

4. Company-Specific Insights

• Shenhua (1088 HK): A long-term BUY with steady growth and cash flows. It is a preferred long-term exposure to the coal sector.
• China Coal (1898 HK): A HOLD due to its slightly above consensus EPS estimates and potential for seasonal recovery.
• Chalco (2600 HK): A Speculative BUY based on expected aluminum price upside. Despite its weak balance sheet, the stock valuation has incorporated most negatives.
• Jiangxi Copper (358 HK): A BUY with high leverage to copper prices. Expected to benefit from a mid-2014 copper price increase before facing oversupply in the second half.
• Angang Steel (347 HK): A SELL due to forecasted lower steel prices, weak earnings outlook, and declining earnings quality.

5. Political and Economic Risks

• Political risk, especially from Indonesia's export ban, is a major factor in nickel and aluminum price forecasts.
• The US Federal Reserve's bond buying program is expected to eventually lead to rising real interest rates and a stronger dollar, which could negatively impact gold prices.
• There is a risk of copper price volatility due to supply disruptions and Chinese demand patterns.

6. Sector Adjustments

• The electricity sector is a key indicator of materials demand trends, showing a slowdown in growth.
• Thermal coal demand is expected to decrease due to the rise of alternative energy sources like hydro, wind, and nuclear.
• Coal companies are adjusting by closing marginal mines and shifting towards consolidation or diversification.

7. Global Comparisons

• Chinese steel companies lag behind global peers in ROE.
• Global comparisons of earnings and price forecasts are provided for all sectors.

Key Information

• The report emphasizes the importance of supply-side discipline and productivity gains to stabilize prices.
• The Indonesian export ban is a pivotal event for nickel and aluminum.
• There is a shift in the power generation mix in China towards alternative energy sources, affecting coal demand.
• The outlook for 2014 is cautiously optimistic, with some materials expected to outperform while others face headwinds.
• The report highlights the speculative nature of some recommendations due to weak balance sheets and industry challenges.