Earnings beat consensus on intensive cost reduction
Chalco released its 1H16 results with NPAT of RMB57m, beating FY16consensus of RMB-737m and generally in-line with DBe of RMB223m, thanksto its comprehensive cost control efforts. Gross margin improved 3ppt YoY asa result of stronger aluminium performance. However, for the first time,alumina recorded operating losses given the subdued price. According to theCFO, the company has achieved its unit cost target set earlier this year but willcontinue to focus on cost control. We maintain Hold on valuation.
Comprehensive cost reduction initiatives
Despite the 10% YoY decrease in ASP and the decrease in output of aluminumand alumina, gross profit increased 19% YoY on effective cost savings,especially in the aluminum segment. Unit cost of aluminum and alumina wasRMB10080/t and RMB1800/t (incl. VAT) in 1H16, decreasing 24%/16% YoY,respectively (detailed cost in page 4). Roughly 50% of the reduction in unit costis attributable to the c.30% YoY decrease in average electricity cost fromRMB0.38/kwh to RMB0.27/kwh. Into 2H16, electricity cost might face pressurefrom the growing coal price, but mgmt. believes the impact will be muted asIPPs currently have a very low utilization rate. Furthermore, Chalco was able toreduce its labor force massively to c.60k, from 100k employees in early 2013.The capex plan is c.RMB10bn this year, with the major focus on bauxite andthe Baotou Huayun project (aluminium alloy 0.5mt and captive power plants).
Higher minority interest might continue, and eased cashflow
The 2Q minority share of NPAT was RMB268m, higher on structural changesin segment profits. Most of the alumina subsidiaries are 100%-owned byChalco (except 50% interest in Huaxing, which also performed quite well), butthe subsidiaries that produce aluminum have more minority interest involved.We expect this trend for minority interest to continue in the second half of theyear, although we don’t expect much downside for the alumina price (close tomajor refineries’ unit cost), but easier restarts make it unlikely to perform aswell. On the other hand, Chalco’s net gearing was still high at 170%, but withlong-term debt representing a big portion and a lower interest rate. Coupledwith eased cashflow, we don’t expect a further increase in net gearing.
Maintaining Hold on valuation; risks
Our target price of HKD2.7 is based on historical P/B of 0.9x (since 2012) and2016E BVPS. Chalco is now trading at 0.9x/0.9x of our 2016/2017E BVPSestimate. We maintain Hold on the fair valuation. Risks include better- orworse-than-expected supply discipline and higher/lower metal prices.