Tuesday, March 13, 2007
Results Brief: Chalco (2600)
Chalco reported earnings of more than RMB11b on strong sales on alumina and recovery of the aluminum market. On the face of it p/e is now only 8x which suggests cheapness but can it be sustained?
For those not familiar with Chalco and its attraction to me can visit my past post. (http://abaci-investing.blogspot.com/2007/01/buy-china-buy-chalco.html) This post is more about the latest results.
I'll start off with the aluminum business because that's where Chalco has been expanding in order to lessen its reliance on the more volatile upstream alumina market. Aluminum is an essential construction and industrial material (in my view it's better than steel for its lighter weight and better strength) with uses in construction (think buildings), transportation (think cars and parts), packaging (think consumer goods), aviation, aerospace. These sectors will all grow with China even over the long run. I think these all you already know.
Figures wise, capacity was up 65% to 2.5m tonnes and production volume was up 84% to 1.93m tonnes (vs national output of 9.35m tonnes). National demand was slightly lower estimated at 8.67m tonnes but did show faster growth than supply. Management's 2007 target previously stated was 3.4m tonnes or 1/3 of the domestic aluminum market.
I'm not particularly worried about the supply/demand situation of the downstream market, for now, because last year was only the 1st year of recovery when everyone started making money again. Operating margin (before interest & tax) of Chalco was 13.5% vs 1.6% in 2005. And a 13.5% margin did not strike me as being excessive. I don't think a new round of price war will be near the top of the agenda for most smelters.
Figures wise, Chalco's smelters made operating profit of 4.5b, 20x better than in 2005 but still only 1/3 of the upstream alumina business.
I couldn't help but notice the downstream smelters were bought cheap, at only perhaps 4x p/e and discount to the fair value. These bargains might have come as the result of luck as Chalco happened to buy when the industry was at a bottom, or the result of government policy which forced smaller smelters to merge into bigger ones. Though these new businesses only contributed 5% of the net profit last year, it's a good start and I'd like to see this trend of 'cheap' acquisition to continue.
The alumina business contributed 3 quarters of the operating profit, or 13.3b. There isn't much to analyze about this market as so far no one can quite predict the pricing. There was a series of price cut in the 2nd half of last year but then a sudden 50% spike this year. This coupled with Chalco selling forward too making it even harder to understand. So I'd leave this task to the specialist and I offer you no comfort on the stability of the alumina price. But it's worthwhile to note the national supply, though grew by 61% and reached 13.7m tonnes (Chalco produced 8.8m tonnes), still fell behind of the national demand of 19m tonnes. Internal consumption ratio of alumina also grew to 40%, and increasing, which should provide more stable earnings stream.
On capax, Chalco spent 8.7b last year and 8.4b in 2005, proportion spent on downstream increased to 50% from 33%. Management mentioned 3 major alumina projects with combined capacity of 2.8m tonnes, and some expansion of smelters, nearly all located in central/southwest China (opportunities?). These would probably be financed by further bond issues as financially Chalco was very strong with net debt of 6b (against equity of 44b) and interest expense was insignificant at 800m.
Last year's result was exceptional and could be hard to repeat. In a normal year, I'd expect Chalco to earn maybe 8b a year, with equal contribution from upstream and downstream, and a potential to earn up to say 10b as downstream business further expanded. I wouldn't attach too much hope on the alumina business just to be conservative and to save myself from any future embarrassment (but I do assume selling price will not drop by more than 20% from 2006 average of 3,600 per ton). But I do believe it shouldn't be too risky when one is buying the largest vertically integrated production chain of aluminum in China, for China is far from done in building its dynasty.
In terms of valuation anywhere between 10-12x p/e would be fair, that translates to a price range between roughly HK$7-10, though one can never correctly gauge the appetite of the market at any one time, and judging from past observations large over-shooting in either way does seem to occur frequently.
DISCLOSURE: I hold 2600 at time of writing.
For those not familiar with Chalco and its attraction to me can visit my past post. (http://abaci-investing.blogspot.com/2007/01/buy-china-buy-chalco.html) This post is more about the latest results.
I'll start off with the aluminum business because that's where Chalco has been expanding in order to lessen its reliance on the more volatile upstream alumina market. Aluminum is an essential construction and industrial material (in my view it's better than steel for its lighter weight and better strength) with uses in construction (think buildings), transportation (think cars and parts), packaging (think consumer goods), aviation, aerospace. These sectors will all grow with China even over the long run. I think these all you already know.
Figures wise, capacity was up 65% to 2.5m tonnes and production volume was up 84% to 1.93m tonnes (vs national output of 9.35m tonnes). National demand was slightly lower estimated at 8.67m tonnes but did show faster growth than supply. Management's 2007 target previously stated was 3.4m tonnes or 1/3 of the domestic aluminum market.
I'm not particularly worried about the supply/demand situation of the downstream market, for now, because last year was only the 1st year of recovery when everyone started making money again. Operating margin (before interest & tax) of Chalco was 13.5% vs 1.6% in 2005. And a 13.5% margin did not strike me as being excessive. I don't think a new round of price war will be near the top of the agenda for most smelters.
Figures wise, Chalco's smelters made operating profit of 4.5b, 20x better than in 2005 but still only 1/3 of the upstream alumina business.
I couldn't help but notice the downstream smelters were bought cheap, at only perhaps 4x p/e and discount to the fair value. These bargains might have come as the result of luck as Chalco happened to buy when the industry was at a bottom, or the result of government policy which forced smaller smelters to merge into bigger ones. Though these new businesses only contributed 5% of the net profit last year, it's a good start and I'd like to see this trend of 'cheap' acquisition to continue.
The alumina business contributed 3 quarters of the operating profit, or 13.3b. There isn't much to analyze about this market as so far no one can quite predict the pricing. There was a series of price cut in the 2nd half of last year but then a sudden 50% spike this year. This coupled with Chalco selling forward too making it even harder to understand. So I'd leave this task to the specialist and I offer you no comfort on the stability of the alumina price. But it's worthwhile to note the national supply, though grew by 61% and reached 13.7m tonnes (Chalco produced 8.8m tonnes), still fell behind of the national demand of 19m tonnes. Internal consumption ratio of alumina also grew to 40%, and increasing, which should provide more stable earnings stream.
On capax, Chalco spent 8.7b last year and 8.4b in 2005, proportion spent on downstream increased to 50% from 33%. Management mentioned 3 major alumina projects with combined capacity of 2.8m tonnes, and some expansion of smelters, nearly all located in central/southwest China (opportunities?). These would probably be financed by further bond issues as financially Chalco was very strong with net debt of 6b (against equity of 44b) and interest expense was insignificant at 800m.
Last year's result was exceptional and could be hard to repeat. In a normal year, I'd expect Chalco to earn maybe 8b a year, with equal contribution from upstream and downstream, and a potential to earn up to say 10b as downstream business further expanded. I wouldn't attach too much hope on the alumina business just to be conservative and to save myself from any future embarrassment (but I do assume selling price will not drop by more than 20% from 2006 average of 3,600 per ton). But I do believe it shouldn't be too risky when one is buying the largest vertically integrated production chain of aluminum in China, for China is far from done in building its dynasty.
In terms of valuation anywhere between 10-12x p/e would be fair, that translates to a price range between roughly HK$7-10, though one can never correctly gauge the appetite of the market at any one time, and judging from past observations large over-shooting in either way does seem to occur frequently.
DISCLOSURE: I hold 2600 at time of writing.
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