Chalco 1H18A net profit （after perpetual bond） was Rmb794mn orEPS of Rmb0.048/sh, up 4% YoY. Excluding government subsidy（Rmb593mn） and hedging gain （Rmb70mn）， recurring NP wasRmb276mn, lower than our expectation and Bloomberg consensusdue to lower trading revenue and higher other cost from aluminaand aluminum segments.
Alumina sales volume （excluding chemical grade） was 2.11mnt in1H18A under our estimates, 6% lower YoY. Realized ASP for aluminawas Rmb2,827/t （VAT included） in 1H18, up 7% yoy and mostlyinline with our expectation. Aluminum sales volume was 2.06mnt,up 24% yoy, higher than our expectation. Realized ASP foraluminum was Rmb12,321/t, mostly inline. Unit production costincreased by 9-10% yoy for alumina and aluminum mainly due tohigher raw material prices, mostly in line with our expectation.Operating cash flow was solid at Rmb6.7bn, up 26% YoY. Netgearing declined to 159% versus 191% at the end of 2017. This ismainly due to Chalco’s booking of “capital reserve” by including theproposed new A-share issuance for acquiring minority assets basedon the acquisition agreements signed in January 2018 and theminority asset owners have effectively surrendered their minorityinterest.
We maintain our positive view on the Chinese aluminum sector,driven by supply side improvement on the back of a pause in newline approvals. We see a more balanced outlook for alumina, yetwith potential upside risks to alumina prices given “expanded 2+26”regions hold 24% more share of alumina output versus the “2+26”region. We revised down our SHFE-aluminum price assumption by6% to US$0.86/lb （or 2% to Rmb14,606/t） for 2018E, down 10% toUS$0.87/lb （or 3% to Rmb15,045/t） in 2019E, down 6% to
US$0.90/lb （or flat in Rmb15,654/t） in 2020E, to reflect the slower pace of improvementdue to weaker demand, and new USDCNY exchange rate from 6.3 to 6.8. Our new priceassumption implies a spread of Rmb2,600/t for 2019E （from Rmb3,000/t）， but the sameRmb3,000/t spread for 2020E
We revise down EPS by 33% for 2018E and 18% for 2019E to reflect the loweraluminum spread in 2019E, higher other cost in alumina/aluminum segments from 1H18results and the impact of new shares from the equity exchange agreement. Withbenefits from both aluminum and alumina price improvement, we expect Chalco todeliver ROE of 6.8% in 2019E, from 3.3% in 2017 and 3.1% in 2018E. For everyRmb500/t increase in alumina price, we estimate earnings would improve by 44% （EPSof Rmb0.09/sh） in 2019E, assuming pass-through to aluminum prices. For everyUS$0.05/lb increase in aluminum price, we would expect earnings to improve by 66% in2019E. Our new 12-month target price for Chalco-H is HK$5.6 （from HK$5.9） and Rmb6.0 for Chalco-A （from Rmb 6.5）。 Our target price methodology remains unchanged,based on historical P/B vs. ROE correlation - 2019E P/B of 1.4x/1.8x on ROE of 6.8%（from 1.6x/2.1x with ROE at 9.4%） for H/A. We maintain our Buy rating on both Chalco-Hand Chalco-A.
Key risks include: 1） Aluminum and alumina pricing, which are driven by supply-demand:aluminum and alumina price will directly affect Chalco’s profit. 2） Progress ofrestructuring plan: if the restructuring plan does not get government approval or sees asignificant delay on timetable, minority holdings in certain Chalco subsidiaries willcontinue to be at a high level. 3） Execution of supply-side reforms on shutting downillegal capacity: if the execution is not successful or the shut-down capacity resumesproduction, it will increase market supply and be negative to supply/demand balance.17 August