metals, mining, coal, steel - kim eng · 9/25/2013 · metals, mining, coal, steel more excitement...

SEE APPENDIX I FOR IMPORTANT DISCLOSURES AND ANALYST CERTIFICATIONS

Regional Initiating Coverage 25 September 2013

Metals, Mining, Coal, Steel More Excitement For This Space In 2014

We initiate coverage of five companies in the coal, metals and steel sectors in China with an overall positive view – three BUY ratings, one HOLD and one SELL. We believe that 2014 may provide some upside on improving global demand and rising political risk for the coal and metals sectors, which have been struggling for most of 2012.

We forecast an improvement in materials prices from the current levels, except for steel whose prices are chasing raw material costs lower. During 2014, we expect nickel, aluminum, copper and coking coal to outperform. Thermal coal price is likely to rise by 5% from the current level by year-end on favourable seasonal factors. We are above consensus on copper, and well below on zinc relative to consensus for 2014.

We see the ban on ore exports from Indonesia as the biggest near-term industry event. This should help boost the nickel price, and over time the alumina, and to a lesser extent aluminum prices. Chinese ore importers in the nickel pig iron and alumina sectors are most exposed.

Our top pick based on total return is Chalco. We admit this is an out-of-consensus call, especially considering our long-term negative view of the company and industry. But we see some encouraging signs of change and the stock valuation seems to have incorporated most of the negatives. Our call hinges on aluminum price upside next year as supply growth slows and demand growth remains in the low teens in China. This is a Speculative BUY given the company’s persistent losses and weak balance sheet.

Our second pick in terms of total return is Jiangxi Copper, which we expect to benefit from our forecast increase in copper price between now and mid-2014, before we see the market moving into oversupply in the second half of 2014 as Chinese refinery production accelerates on the improving availability of copper concentrate and scrap supply.

The thermal coal sector is heading into a slower growth period and returns will be under pressure for companies that cannot lift productivity or find growth. Our stable long-term pick is Shenhua, which we see as the one to own for those seeking long-term exposure to the coal sector. China Coal is a HOLD for those wishing exposure to the seasonal upside in the next few months.

Our one SELL rating is Angang Steel based on our forecast for lower steel prices over the next few months and the weak earnings outlook for the next two reporting half-year periods. We also find that Angang’s earnings quality has decreased as cash flow is not keeping pace with the improvement in net profit. We see continued oversupply in the steel sector keeping a lid on returns until 2015 at the earliest.

Overweight (new) Alexander LATZER [email protected] (852) 2268 0647

25 September 2013 of 70

Metals, Mining, Coal, Steel Sector

Contents

Investment Summary .......................................... 3

Materials Price Forecasts ................................... 4

Coal Outlook ..................................................... 10

Aluminum Outlook ............................................. 14

Copper Outlook ................................................. 19

Steel Outlook .................................................... 23

China Shenhua Energy (1088 HK) ................... 28

China Coal Energy (1898 HK) .......................... 36

Jiangxi Copper (358 HK) ................................... 42

Chalco (2600 HK) ............................................. 51

Angang Steel (347 HK) ..................................... 60



Investment summary: Materials price recovery, not relapse

We initiate coverage of five companies in the coal, metals (copper/ aluminum), and steel sectors in China with an overall positive view – three BUY ratings, one HOLD and one SELL. A summary of our investment recommendations, target prices and total return are summarised in the table below. The company sections at the back of this report provide much more details, including earnings sensitivity analyses. At the end of this section, we provide our earnings estimates and the comparison to consensus.

Figure 1: Summary of ratings, target prices and up/downside return potential

Ticker Price RatingTarget

price %Upside/

(Downside) 2014E

Div. Yld.Total

Return (%)Shenhua 1088 HK 25.50 BUY 29.00 13.7 4.6 18.3China Coal 1898 HK 4.99 HOLD 5.50 10.2 2.7 12.9Chalco 2600 HK 2.79 BUY 3.50 25.4 0.0 25.4Jiangxi Copper 358 HK 16.28 BUY 20.00 22.9 0.9 23.8Angang 347 HK 5.10 SELL 4.25 (16.7) 0.0 (16.7)Source: Maybank Kim Eng estimates

Our recommendations are supported by the companies’ business outlook, including stock valuations, and materials price forecasts (discussed in detail in the next section). We forecast an improvement in materials prices from the current low levels, except for steel prices, which are chasing raw material prices lower. However, towards late 2014 and into 2015, we expect materials prices to trend lower, except for aluminum, as supply overtakes demand.

We foresee a continued challenging outlook for the Chinese corporates. With slower demand growth and lower selling prices, the challenge is to raise productivity to restore profit margins. Not every company is equipped to do this either because of difficult assets, poor industry dynamics or cash flow limitations.

That leads us to our top long-term pick, Shenhua, which we see generating steady growth and cash flows from its mix of assets, supporting healthy dividends with upside from M&A due to its strong balance sheet. The share valuation has recovered from depressed levels but still stacks up well with global materials companies in any sector. We discuss this in more detail in the company section.

On the flip side, we initiate coverage of China Coal with a HOLD rating in anticipation of the upcoming seasonal recovery in coal prices and because our EPS estimates appear to be slightly above consensus. Looking ahead, we find the share valuation a bit full based on our forecasts, and believe the stock may struggle in a slower coal demand growth environment. The company lacks a medium-term growth driver and is ramping up capex in coal/chemicals, which could lead to a deteriorating balance sheet.

Our top pick based on total return is Chalco, which is a reversal of our long-standing negative view of the company and industry. We see some encouraging signs of change at the company and the stock valuation seems to have incorporated most of the negatives. Our call hinges on aluminum price upside next year from slower Chinese supply growth due to rising costs, in part due to the ban on bauxite exports from Indonesia. This is a Speculative BUY given the company’s weak industry position and weak balance sheet.

Our second pick in terms of total return is Jiangxi Copper, which we expect to benefit from our forecast increase in copper prices in mid-2014. This stock has high leverage to the copper price and our strategy is to trade it, given our forecast for a copper market surplus and lower prices later next year. Jiangxi has relatively low returns vs. the global mining peer group and we discuss this in more detail in the company section. Returns could slightly improve if the



company is successful with one of its overseas copper growth projects. Our estimate is in line with the consensus in 2014, but below for 2013 and 2015.

Our one SELL rating is on Angang Steel based on our forecast for lower steel prices over the next few months and the weak earnings outlook for the next two reporting half-year periods. We also find that Angang’s earnings quality appears to have decreased as cash flow is not keeping pace with the improvement in net profit. Its P/BV seems high given an ROE of 2-3.5%, particularly in comparison to its earlier history when its ROE was much higher and P/BV slightly lower. In general, Chinese steel companies are placed last among their global peers in terms of ROE. We include global comparison graphs of steel companies in the Angang section at the end of this report.

Figure 2: Summary of EPS estimates vs. consensus for 2013E-2015E 2013E 2014E 2015E

EPS est. Consensus EPS vs.

Cons. (%) EPS est. ConsensusEPS vs.

Cons. (%) EPS est. ConsensusEPS vs.

Cons. (%)Shenhua 2.33 2.27 2.7 2.36 2.29 3.3 2.42 2.40 1.0 China Coal 0.41 0.39 7.3 0.44 0.39 13.5 0.46 0.47 (2.0)Chalco (0.36) (0.27) 32.7 (0.23) (0.19) 23.6 (0.10) (0.09) 5.6 Jiangxi Copper 0.83 0.90 (8.3) 0.98 0.99 (0.6) 0.86 1.00 (13.4)Angang 0.14 0.13 5.8 0.15 0.17 (10.1) 0.24 0.22 5.5 Source: Bloomberg Consensus, Maybank Kim Eng estimates

Materials price forecasts, rankings – some volatility will return

The following graphs and tables present our materials price forecasts through 2017 (our long-term price assumption year), as well as where we stand relative to consensus. Our price forecasts and the YoY change are shown in the three graphs below. During 2014, we expect nickel, aluminum, copper and coking coal to outperform. Thermal coal price is expected to bottom over the next few months and improve 5% from the current level by year-end on favourable seasonal factors, and then trade slightly higher during 2014 averaging USD85/t, up 2% YoY (Newcastle high CV 6,000kcal price FOB Australia).

Figure 3: Forecast 2013 (YoY chg.) Figure 4: Forecast 2014 (YoY chg.) Figure 5: Forecast 2015 (YoY chg.)

Source: Bloomberg, Maybank Kim Eng Source: Bloomberg, Maybank Kim Eng Source: Bloomberg, Maybank Kim Eng

During 2014, the materials we expect to underperform are iron ore, gold and lead, and later in the year, copper. The zinc price is expected to be an average performer during the period but forecast to outperform lead after underperforming for much of the past year. The materials that are underperforming reflect our forecast for rising supply growth and slowing demand growth. We discuss gold further below.

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Outperforming in 2014 will be nickel, aluminum and coking coal, with copper

rising early but fading later in the year.

Thermal coal price should

benefit from improving seasonal factors by end-

2013 and increase 5% YoY in 2014.



Figure 6: Materials price forecasts (metals USD/lb, gold USD/oz, coal and iron ore USD/tonne)

CIF (63.5%)

Iron ore Contract

Coking coal Market

Thermal coal Copper YoY Aluminum YoY Nickel YoY Zinc YoY Lead YoY Gold YoY Fines YoY HCC YoY Newcastle YoY

2008 3.15 -2% 1.17 -3% 9.57 -43% 0.85 -42% 0.95 -19% 869 25% 149 33% 248 143% 131 97%2009 2.34 -26% 0.76 -35% 6.65 -31% 0.75 -12% 0.78 -18% 974 12% 78 -48% 171 -31% 72 -45%2010 3.42 46% 0.99 30% 9.89 49% 0.98 30% 0.97 25% 1225 26% 141 81% 191 11% 100 39%2011 4.01 17% 1.09 11% 10.40 5% 1.00 2% 1.09 12% 1,572 28% 165 17% 289 51% 120 21%2012 3.61 -10% 0.92 -16% 7.96 -23% 0.88 -11% 0.94 -14% 1,670 6% 128 -22% 214 -26% 94 -22%2013E 3.35 -7% 0.84 -8% 6.85 -14% 0.86 -3% 0.96 3% 1,414 -15% 133 4% 158 -26% 83 -12%2014E 3.50 4% 0.88 5% 7.25 6% 0.85 -1% 0.94 -2% 1,342 -5% 122 -8% 163 3% 85 2%2015E 3.03 -13% 0.95 8% 7.75 7% 0.85 0% 0.90 -4% 1,138 -15% 110 -10% 169 4% 89 4%2016E 2.70 -11% 1.00 5% 7.25 -6% 0.85 0% 0.90 0% 900 -21% 99 -11% 158 -7% 85 -4% long-term 2.65 -2% 0.95 -5% 6.50 -10% 0.80 -6% 0.85 -6% 850 -6% 80 -19% 150 -5% 80 -6%Source: Bloomberg; Maybank Kim Eng forecasts

There is considerable risk in our forecasts for a few materials that rely on political factors. We have been a consistent bear on aluminum for many years as we realised early on how the Chinese have become experts in terms of production, while many others were focused only on China’s rapid consumption growth. Our forecast outperformance of aluminum and nickel is premised on the expected ban by Indonesia of the export of bauxite and nickel ores according to the Mining Law of 2009. It will take an act of Parliament to change the law to delay the ban or allow for exceptions.

We do not expect the law to be strictly enforced for companies that are currently building refining capacity as many are not going to meet the deadline. But based on the current investments in refinery capacity, up to half the ore exports would be subject to the ban unless exceptions are granted. Our forecasts for the price appreciation of aluminum and nickel are modest as we assume that there will be some slippage in Indonesia’s target ban. There has also been a large amount of stockpiling by importers to bridge them through 2014 until either their plants are running or they can procure alternative sources of supply. Therefore the headline risk to prices may precede the actual impact that comes later in 2014.

China continues to ramp up nickel pig iron production, which relies on imported nickel ores, about 85% of which comes from Indonesia. Production during 2013 is expected to reach 450,000t, up 36% YoY, according to Antaike. The material is used to make stainless steel, accounting for nearly two-thirds of the source of nickel units, followed by primary nickel about one-third, and stainless steel scrap the remainder. Stainless steel producers are integrating their operations with nickel pig iron producers to further lower costs as the industry has been under great pressure due to overcapacity.

Our gold price forecast shows some appreciation later this and early next year based on continued instability in the Middle East, and more recently from continued easy monetary policy in the US, which has pushed the dollar down and boosted gold prices. We believe that the fundamental trend remains in place for lower prices due to the eventual end to the Federal Reserve’s bond buying programme, which would lead to rising real interest rates and a firmer US dollar. However, supporting factors to our gold price forecast are continued strong Chinese buying, as well as political and financial instability. Besides the Middle East tensions, high debt levels persist in the developed world and in certain emerging economies as well (India and Indonesia). Were it not for these latter factors, our gold price forecast would be more bearish.

The forecasts that are causing us to lose a bit of sleep are aluminum, copper and thermal coal. Starting from 2H14, we look for the aluminum price to outperform the copper price. For some time, we have been bullish on copper relative to aluminum because demand in China continues to outstrip supply. Starting in late 2014, we look for supply growth in aluminum to begin to slow and in copper to begin to increase. In aluminum, this is due to the adverse impact to costs of the

More than any other time, political risk plays a hand

in our forecasts for nickel, aluminum and gold.

A significant increase in Chinese ore imports

points to active stockpiling before the Indonesian ban.

As a result, the headline risk is likely to occur

earlier in 2014, but the actual impact later in the

year.



disruption to bauxite supply from Indonesia, which should become more apparent later in the year. In terms of the Indonesian export ban, we believe that the event risk is higher for disrupting nickel ores relative to bauxite ores so we are relatively more comfortable in our nickel price outlook.

For copper, we forecast a slower rate of demand growth in China next year, and a change in how it obtains copper units. We expect China to accelerate its copper refinery production capacity with the feed increasing from copper concentrate and scrap imports (new mines, many of which are its own overseas investments). Were it not for a copper scrap shortage in the past year, we believe China’s demand for refined copper would have been lower during 2013F. Where we could be wrong is if China’s 2014 demand growth remains close to 10% as in 2013F vs. our forecast of 6.7% or if supply growth disappoints. All it takes is a strike or two and the market is off to the races. Also, the new supply coming on-stream is in Mongolia, Peru and Africa, countries not without their logistical and political challenges.

With respect to thermal coal, we believe there is no shortage of resource availability and that over time it will lose market share to alternative sources of energy. We tend to favour coking over thermal coal for these reasons. This is reflected in our longer-term coal price forecast and we go into great detail about the changing power generation mix in China over the next seven years in the section on coal. However, over the next few years, much of the region including China and India will continue to rely on coal for power generation. As a result, we have kept out price expectations moderately positive for regional thermal coal, with it increasing 2% YoY in 2014 and 4% YoY in 2015 (Qinhuangdao thermal coal price is forecast to increase 6% YoY and 3% YoY in USD terms, and 5% YoY and 1% YoY in CNY terms, over the same period).

Figure 7: Copper and aluminum monthly price history and forecast

Source: Bloomberg, Maybank Kim Eng forecast.

Figure 8: Nickel and gold price history and forecast Figure 9: Lead and zinc price history and forecast

Source: Bloomberg, Maybank Kim Eng forecast. Source: Bloomberg, Maybank Kim Eng forecast.

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The biggest change in our thinking is our forecast for

the aluminum price to outperform the copper

price in 2014. In the past, we have thrived being

bullish copper and bearish aluminum and nickel.

The ban on ore exports by

Indonesia is expected to be more impactful for

nickel relative to bauxite.

For thermal coal, we see its best days in the past.

Other than our expectation of a seasonal bounce in

4Q, we have kept our expectations low for 2014 and 2015. We continue to

prefer coking over thermal coal longer term due to its

relatively tighter supply availability.



Comparison of price forecasts vs. consensus

The following graphs compare our forecasts vs. the Bloomberg consensus, the forward curve, and current spot prices. For 2014, we are above consensus on copper, and to a lesser extent on gold and iron ore. We are well below the consensus on zinc, and to a lesser extent on nickel, thermal coal and lead. Overall, we see market expectations as high for zinc and low for iron ore. In addition, we think the market could be surprised with copper price volatility next year due to a combination of Chinese imports and supply disruptions.

We are most out of line with respect to zinc, where consensus expectations are high because of a view, advanced by some in the metals industry, of a shortage of capex in new supply growth. We remain doubters on the long-term shortage of zinc supply as the resources are there, and could come to market in a relatively short amount of time with moderate investment. Further, consensus forecasts for zinc market undersupply have considerably decreased over the past year, from over 1 million tonnes (mt) to about 200,000t per annum, to the point that exchange inventories remain ample to meet shortages of supply.

Figure 10: Copper (USD/lb) Figure 11: Aluminum (USD/lb) Figure 12:Nickel (USD/lb)


Figure 13: Zinc (USD/lb) Figure 14: Lead (USD/lb) Figure 15:Gold (USD/oz)


Figure 16: WTI (USD/bbl) Figure 17: Thermal coal (USD/t) Figure 18:Iron Ore (USD/t)


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We are still doubters on the bullish consensus

view on zinc prices, and note the downgrade of

forecasts for a deep market shortage. China is moving to deficit, which is a positive, but inventories

remain ample to meet shortages of supply.



The fallout on materials from credit withdrawal, slower growth

Longer term, growth in China is expected to continue to slow as the economy steers away from the previous energy intensive/industrial growth model. The first step was the severe tightening of credit from late 2011, which reduced aggregate demand growth for materials and created imbalances between supply and demand. While credit policy has since eased somewhat, we look for profit growth to slow under the pressure from slower demand growth and lower selling prices. Thus far in 2013, unit costs have decreased for most materials companies due mainly to lower energy prices. Continuing the trend will be more difficult and require more management to increase asset productivity. The country also has to deal with a strong currency vs. its regional neighbours that will create problems for its exporters and for regional importers who are more accustomed to the deflationary impact of Chinese goods.

Electricity sector provides a good overview of the future trend in demand

The electricity sector provides a good barometer of current demand, as well as the longer-term trend in the rate of growth for materials consumption given roughly 70% of the mix is primary industry. The growth rate of total power capacity installations is expected to slow to a CAGR of 6% over 2012-2020F vs. 16% from 2002-2012. Thermal power capacity, the major source of which is coal, is expected to slow to a CAGR of 4% from 2012-2020 vs. 15% from 2002-2012. Alternative energy sources are stepping up in the period ahead, with nuclear increasing to 26%, up from 14% in the earlier eight-year period, and wind at 14%, solar 29%, and gas 9%.

Hydro installations are expected to remain strong at 6.5% CAGR from 2012-2020, but well below the 14% rate in 2002-2012. Sichuan is China’s top hydropower generating province, running 35.27GW of hydropower units as at end-2012. This year the province is expected to add an extra 11GW in capacity, following massive investment over the past few years. In Sichuan, the Jinping No.1 Hydro Power Plant is expected to commission in Jun 2004 after nine years of construction (2005). Total capacity of the power plant is 3.6GW, comprising six 600MW units at a total cost of CNY23.23b (USD3.80b).

Despite the slowdown in the rate of capacity growth, total power generation capacity is expected to increase by 50% from 1.2 million MW in 2012 (1,200GW) to over 1.8 million MW (1,800GW) in 2020. Thermal capacity is expected to increase 37.5% from 0.8 million MW (800GW) in 2012 to 1.1 million MW (1,100GW) in 2020.

Figure 19: Power generation breakdown Figure 20: Power capacity by source

Source: CEC, Bloomberg, Maybank Kim Eng Source: CEC, Bloomberg, Maybank Kim Eng

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Longer-term growth in alternative energy sources (hydro, wind, nuclear, gas)

will lower the share of thermal power in China’s

total energy mix.

Thermal power generation is expected to increase at

4% CAGR through 2020, down from a 15%rate

earlier and compared to 6% for total power

generation in China.

Corporates face challenges from slower demand growth. Lower unit costs have helped

thus far in 2013, mainly from energy, but further

savings will require more difficult steps to raise

productivity.



The implication is a slowdown in materials consumption

Over the long term, the implication for materials consumption growth in China is positive in aggregate. But to gauge what that means in real terms each year vs. the prior period of strong growth, we have taken a closer look at thermal coal demand from the power segment (about 65% of coal demand). We assume China does need this much power generation capacity, but that power plant operating rates decline from current levels, and that thermal coal-fired plants lose some market share to other sources, such as hydrocarbon, mainly gas, and alternatives (nuclear, wind, solar).

For the eight-year period from 2012 to 2020, we believe China may only need an incremental 650 million tonnes (mt) of raw thermal coal production vs. the 1.7 billion tonnes of raw coal produced for the previous eight years from 2004 to 2012. This implies an annual production requirement of about 100mt from 2014 to 2020, which is about half the rate of 213mt/yr from 2005 to 2012. More aggressive assumptions using lower power plant operating rates result in the production requirement falling to 70mt per annum. The good news is that the adjustment appears to be front-end loaded during 2013F, with low prices forcing closures of marginal coal mines leading us to forecast a 1.0% decrease (36mt) in China’s total raw coal production during 2013.

It is no wonder that several coal companies have mentioned that the “golden age” of thermal coal in China is a thing of the past. Their capex spending also indicates the trend, with a greater share of spending on coal/chemicals (China Coal), and in the case of Shenhua, power generation and infrastructure (rails and ports), and also chemicals. China Coal is moving more towards diversification, and Shenhua towards consolidation (buying coal from others to leverage its infrastructure advantage). For regional coal producers, the near-term adjustment has been painful, but over the longer term, the trend of rising costs in China and appreciating currency bodes well for continued increases in China’s coal imports from regional suppliers.

Supply-side discipline required to stabilise prices for the next upturn

The implication for material prices is more complex. When Chinese growth was rapid and materials prices rising, profit margins were wide and equity valuations expanded. The shift to a slower rate of growth and lower prices will require more rational supply growth and therefore a more careful allocation of capital by mining companies and a focus on productivity gains. Most global materials companies have trimmed production and reduced staff, as well as lowered and redirected their capital allocation to the highest returning projects. China faces challenges in this regard, particularly in sectors plagued by overcapacity such as coal, steel and cement. China’s challenges in these sectors have been the rest of the world’s headache because the surplus has been exported.

Additional capacity in metals/steel coming online at not the best of times

Because mining project lead times are very long (shorter for brownfield than greenfield), there is a queue of new projects coming online this year and next. These were in the works when Chinese growth was more rapid. For greenfield projects, 10 years is quite common from project conception, land acquisition and permitting feasibility studies and construction to first production.

Some of the new projects are world-class in scale and cost, and will at least maintain the competitive position of the company undertaking the development, such as in iron ore and copper. In China, new aluminum and steel capacity continues to come online more than offsetting the curtailment of higher cost capacity. The Chinese government is taking the lead in capital allocation, a role played by managements and shareholders in companies in the developed markets.

China may only need an incremental 650mt of raw

thermal coal production from 2012 to 2020 vs.

the 1.7 billion t from 2004-2012.

This implies an annual production need of about

100mt, which is about half the rate of 213mt/yr in the earlier eight-year period.

Because of long lead times in the sector, new capacity is coming online that may

push the market into oversupply and force out

the competition.

We see aluminum capacity outside China at risk, iron

ore capacity in China at risk, and further cuts to

global steel capacity, particularly in China.



We have seen little evidence that the Chinese government is being effective in this role. The only way forward is a move towards market-based costs and pricing to force the appropriate allocation of capital. Thus far, private companies appear to be reacting most quickly while SOEs, with some exceptions, are being supported at the local and state levels, for example through preferential tax treatment and low-cost loans.

Coal outlook: Setting up for a weak recovery, watch out for policy risk (resource tax and power tariff rate cut)

Our forecasts for coal (thermal and coking coal) in China and the region are in the table below. We forecast that both the Chinese and regional coal markets will see thermal coal prices bottom out during the next three months due to seasonal factors lifting demand (colder weather) and limited supply (rainy season), as well as diminished hydropower availability in China. But in the long term, we forecast lower thermal coal prices, reflecting the outlook for ample supply and importantly, a more competitive energy mix as discussed earlier.

Figure 21: Coal price forecasts (Coal pricing in USD/t) 2010 2011 2012 2013E 2014E 2015E Long-termThermal coal: Newcastle 6,000 kcal FOB Australia 100 120 94 83 85 89 80Chg. 39% 21% -22% -12% 2% 4% -10%Qinhuangdao 5,800 kcal (VAT excl.) 98 119 101 86 90 93 83Chg. 25% 21% -15% -14% 5% 3% -10%Coking coal: Australia prime hard coking coal* 176 294 192 158 163 169 150Chg. 143% 67% -35% -18% 3% 4% -11%Shanxi coking coal price (VAT excl.) 217 241 206 165 173 183 160Chg. 33% 11% -15% -20% 5% 6% -12%**Pricing is FOB Australia and based on weekly spot market for the history and quarterly contract for the forecast period. Source: Bloomberg, McCloskey, Maybank Kim Eng estimates

During the next 12 months, we look for the thermal coal price in China to outperform the regional one due mainly to a relatively better demand growth outlook. Beyond the seasonal factors, the fundamental picture in China is slowly improving based on a bottoming of industrial demand, supply-side cuts in response to lower prices, and inventory de-stocking at power plants. Power demand growth in China is increasing on a YoY basis, though it is likely to materially slow from the pace over the summer. Coking coal prices in both China and the region have increased over 10% from the lows in mid-July due to re-stocking by steel companies, far outperforming thermal coal.

Our biggest concern on the regional front and the biggest source of downside risk to thermal and for that matter coking coal prices in the region is India. The country accounts for just over 10% of global seaborne thermal coal demand but about 20% of the seaborne demand in Asia. Its weakening currency is putting pressure on the already low profit margins of its power producers that rely on thermal coal imports, mainly from Indonesia, but also Africa, to augment lagging domestic coal production. Thus far, the prices of lower quality (calorific) coal have been adversely impacted. In addition, one likely outcome is higher interest rates, which would depress demand in the aggregate and for coal in the country.

In China, while local governments are moving to support large coal companies, the central governmental is likely to roll out policies to control coal usage and increase fees. Industry reports point to plans by the NDRC to control coal use in key cities such as Beijing, Tianjin, Hebei, the Yangtze River Delta, Pearl River Delta and Shandong in response to high pollution levels this past winter. Meanwhile, the Ministry of Finance indicated it will press ahead with the resource tax reform for coal later this year. A resource tax has been rumoured to be in the pipeline for the past few years but has been stalled due to the weak economy

During the next 12 months, we look for the thermal

coal price in China to outperform the regional one due mainly to better demand growth outlook. Our biggest concern is a

further weakening of demand from India.

The biggest risk to our

expectation for coal prices in China to outperform is if

Chinese coal supply growth recovers and

increases to 5% or above per annum.

In China, local governments are moving

to support large coal companies, while the

central government is likely to roll out policies

to control coal usage and increase fees.

The most impactful of

these could be the long-awaited rollout of the

resource tax on the mining sector.



and industry opposition. It may gather momentum in the current environment and given the policy direction of the new government.

Momentum lacking in coal market business and current prices

Thermal coal market fundamentals continue to improve in China but prices remain lacklustre and have underperformed coking coal in both China and the region. The outperformance of coking coal can be attributed to better supply management by regional producers and a burst of buying activity by Chinese steel mills in August. The upside momentum in the coking coal contract price for 4Q13 from USD145/tonne in 3Q13 may have also sparked some advance buying. However, if the recent pullback in iron ore is any guide, the rally may prove to be short-lived.

Figure 22: Qinhuangdao thermal coal price and inventory

Source: Bloomberg, Steelhome

Figure 23: Coking coal prices in China (VAT incl.) and Australia (USD/tonne)

Source: Steelhome, McCloskey

Fundamentals for Chinese thermal coal market slowly improving

China’s thermal coal price premium relative to the similar grade Australia price delivered to southern China has decreased to a slight discount from a 20% premium earlier in 2H12. The comparison is useful as an indicator of relative pricing trends and tells us that Chinese prices are currently well supported, having deflated more in line with those in the region. As a result, China’s thermal coal imports are expected to slow over the next six months as consumers favour domestic supply.

De-stocking by power producers continues with inventory falling by over a third to 18 days in August vs. the high of 30 days in September last year.

Imports are expected to slow during 2H13 vs. the rate in 1H13, which will slightly increase the consumption of domestic coal. In addition, China

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turned higher, finding support from steel mill re-

stocking and well-managed supply. A near-

term pause is likely as demand slows.



imposed a 3% import tax on lignite coal imports (low calorific value, high ash coals) effective at the end of August. This will be a marginal positive for domestic coal prices.

Figure 24: Thermal coal price (5,800kcal) Qinhuangdao vs. Newcastle, and premium (discount) delivered to China

Source: McCloskey, Maybank Kim Eng estimates

The intent of the import tax on low CV coal (lignite) is to help reduce pollution from coal-fired power plants. The tax follows the drafting of a plan by China’s National Energy Agency for an outright ban on low quality coal imports. The ban and import tax are contentious issues for power plants and traders in China, and also violates the ASEAN-China Free Trade Agreement. For China, it will be a slight positive for domestic coal producers and a slight negative for power producers who use this coal for blending. For the region, it will be a slight negative for exporters of low-rank coals, mainly in Indonesia. China imported a total of 36mt of lignite during the first seven months of this year, up 17% YoY, of which 34.8mt, or nearly 97%, was from Indonesia.

China’s total raw coal production decreased 3% YoY in July in both the month and on a YTD basis, indicating the pressure being felt on small- and medium-sized producers from lower prices. The most notable decrease was in Inner Mongolia, the leading coal producer in China, where output was down 12% YTD through July and 9% YoY in the month. Production was up in Shaanxi and largely flat in Shanxi. Small producers are being squeezed while larger (mainly SOE) producers are taking share.

China’s power consumption increased strongly in July, due to higher industrial activity and hot weather. Total consumption was 495b kWh, up 8.8% YoY and 12.9% MoM. Industrial consumption also increased for the fifth straight month to 360.9bn kWh, up 8.1% YoY and 7% MoM.

Looking ahead, maintenance on the Daqin railway, China’s largest coal line by volume (with a capacity of about 440mt) is scheduled for maintenance work during September, which should further tighten supplies at the port. This is largely a shifting of inventory from the port to the mine, but usually provides some support for prices before the seasonal demand reaches higher levels.

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Premium (discount)(USD/t)Qinhuangdao coal price (LHS) Newcastle coal price (LHS)Qinhuangdao premium (discount)The premium of thermal

coal prices in China over those of the region has

turned to a slight discount, which should lead to coal

imports being displaced by domestic coal

consumption in the near term.



Figure 25: China coal days’ inventory at power plants and in total

Source: McCloskey, CCTD, Maybank Kim Eng estimates

Figure 26: China's coal production by province lower YoY (million t) Jul-13 2013 YTD Jul-12 2012 YTDInner Mongolia 76.6 529.5 84.0 601.0YoY chg. -9% -12% Shanxi 71.2 540.0 72.0 534.9YoY chg. -1% 1% Shaanxi 45.9 269.6 40.5 254.4YoY chg. 13% 6% SUB TOTAL 193.8 1,339.1 196.4 1,390.2YoY chg. -1% -4% % share China 65% 65% 63% 65%Other Provinces 106.2 719.9 113.6 742.0YoY chg. -6% -3% TOTAL CHINA 300.0 2,059.0 310.0 2,132.2YoY chg. -3% -3% Source: McCloskey

After a three-and-a-half-year decline from Jan 2010, power generation growth is recovering strongly. Total power generation growth turned strongly positive in April led by a pickup in thermal power, and the trend has continued during the very hot summer period. The improvement is also the result of recovering industrial activity, as well as the seasonal decline of hydropower generation. The data below indicate a 14% increase in total power generation during August, with a 23% rise in the thermal component. We are looking for YoY growth to slow to a more sustainable level in the months ahead once we are past the summer period, a rate that would reveal more about underlying industrial demand growth.

Figure 27: Monthly power generation and pct. change Figure 28: Power generation by source and pct. change

Source: China NBS Source: China NBS

China’s coal imports, both thermal and coking, remain at high levels, though they are down from peaks reached earlier this year after rising strongly in the past few years. We look for imports to stabilise near current lower levels before moving higher again. We forecast continued increases in China’s coal imports longer term, as shown in our supply/demand table in the next section.

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Power plants continue to de-stock with inventory at

18 days in August, down by over a third from the

high of 30 days in September last year.

China’s coal production growth is down 3% YoY

through July, led by a 12% YoY decrease in Inner

Mongolia, the country’s largest coal producer by

province.



Figure 29: China thermal coal trade (mt) Figure 30: China coking coal trade (mt)


China coal industry production/consumption model

The table below summarises our forecast of China’s total raw coal production, consumption, and trade. We look for China’s raw coal production to slow and for imports to continue rising. Coal consumption in aggregate is expected to increase by 2% this year, which would be the slowest rate of growth since the early 1990s, according to our records. The trend of slowing demand growth and inventory de-stocking will require continued consolidation of the supply base in order to support prices.

Figure 31: Chinese coal industry supply/demand – growth rates slowing Raw Coal (million tons) 2005A 2006A 2007A 2008A 2009A 2010A 2011E 2012A 2013E 2014E 2015EProduction 2,113 2,373 2,523 2,716 3,050 3,240 3,519 3,660 3,624 3,733 3,845 Incremental Prod 157 261 150 193 334 190 279 141 -36 109 112 Incremental Prod (%) 8.0% 12.3% 6.3% 7.7% 12.3% 6.2% 8.6% 4.0% -1.0% 3.0% 3.0%Export 72 63 53 45 22 18 15 9 8 6 4 Export Growth (%) -17.2% -11.8% -16.0% -14.7% -50.6% -19.5% -18.7% -37.2% -12.5% -24.8% -33.0%Import 26 38 51 40 125 165 183 289 313 329 346 Import Growth (%) 41.3% 46.5% 32.6% -21.5% 213.6% 32.0% 11.2% 57.7% 8.5% 5.0% 5.0%Net Export (Import) 46 25 2 6 -102 -147 -169 -280 -305 -323 -342 Net Export growth (%) -33% -45% -90% 129% -1958% 43% 15% 66% 9% 6% 6%Inventory (total EOY) 140 144 149 188 172 223 313 347 292 244 204 Inventory change 36 5 5 39 -17 51 91 34 -55 -48 -41 Days of supply (total inv.) 25 23 22 26 20 24 32 32 27 22 18 Domestic Consumption 2,031 2,344 2,516 2,672 3,169 3,336 3,597 3,906 3,984 4,104 4,227 Incremental Cons (Mt) 137 313 173 156 497 166 262 309 78 120 123 Incremental Cons (%) 7.2% 15.4% 7.4% 6.2% 18.6% 5.3% 7.8% 8.6% 2.0% 3.0% 3.0%Note: coking coal approx. 750mts Source: CCTD, Bloomberg, McCloskey, Steelhome, Maybank Kim Eng estimates

Aluminum outlook: Surplus, but price support on rising costs

Our forecasts for the global and Chinese aluminum markets are contained in the table below. We look for the combined market to remain in surplus the next few years due to continued capacity additions in China, which are more than offsetting production curtailments. According to ANZ China, as of July, idle aluminum smelting capacity was 5.5mt, but new capacity additions were 1.5mt, with an additional 5.1mt under construction (23% of forecast 2013 consumption). From 2015, we forecast that China will move closer to a balance between supply and demand, as production growth slows on diminishing industry profitability due to rising costs for raw materials and from regulatory fees. The hole is quite deep though in terms of global annual oversupply and the level of inventory.

The Chinese are very good at funding and building aluminum smelters and power plants – a match made in heaven. The trend in the aluminum market has been to bring on new highly efficient low-cost capacity to replace older, higher-cost ones.

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Coal consumption is expected to increase 2% this year, the slowest on

record, and will require continued consolidation of

supply given our consumption growth

forecast of 3% in 2014 and 2015.

Chinese aluminum supply has been encouraged by

superior returns compared to selling electricity. Lower

coal prices have made power generation more

profitable, which may help reduce the incentive for, and slow the growth of,

aluminum supply.



ANZ-China estimates that at the current Shanghai aluminum price of about USD2,350/t (USD1.07/lb.), roughly half of the smelters in China are operating at a cash loss. The government has been unable to materially alter supply growth, and many of the plants that have been closed were obsolete and not operating. Chinese smelters have been willing to tolerate low or negative profit levels because they have exceeded those from simply generating and selling electricity. Now that power plant profit margins have increased due to lower coal prices and smelter profitability remains low, this trend may change.

So what is going to change the dynamics of the global aluminum industry? The developed world is also adding more capacity and despite the fact that the global surplus lies flatly at China’s door, it too will be forced to do more in terms of capacity closures. In the next section, we lay out some of the key factors that could lead to a reversal of fortune for the aluminum market. Our forecast calls for a decreasing global market surplus, as capacity and production growth slows in China, with prices increasing about 5% from the current spot price during 2013 (up 1.2% YoY), and a further 6% YoY increase during 2015.

Figure 32: Global and China Primary aluminum production/consumption in surplus

Source: Wood Mackenzie, Bloomberg, Maybank Kim Eng estimates

Figure 33: Global and China aluminum production and consumption summary (‘000t) 2011 2012A 2013E 2014E 2015EGlobal prod./cons. Production 46,178 47,919 50,460 54,367 56,151 YoY chg. 9% 4% 5% 8% 3%Consumption 43,909 46,472 49,352 52,613 55,301 YoY chg. 8% 6% 6% 7% 5%Market surplus (deficit) 2,269 1,448 1,108 1,754 850 Total inventories 6,582 6,914 8,022 9,776 10,626 Weeks of supply 7.8 7.7 8.5 9.7 10.0 Price (USD/t) $2,402 $2,022 $1,853 $1,929 $2,094 Price (USD/lb.) $1.09 $0.92 $0.84 $0.88 $0.95 China prod./cons. Capacity 25,670 27,670 30,870 34,370 36,370 YoY chg. 13% 8% 12% 11% 6%Production 19,800 22,220 24,500 26,400 27,800 YoY chg. 14% 12% 10% 8% 5%Operating rate 82% 83% 84% 81% 79%Consumption 19,167 21,043 23,300 25,659 27,322 YoY chg. 16% 10% 11% 10% 6%Surplus (deficit) 427 12 189 50 0 Source: Wood Mackenzie, Bloomberg, Maybank Kim Eng estimates

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The surplus in China is expected to decrease as

supply growth slows due to decreasing industry

profitability. The biggest near-term

upside cost risk is Indonesia’s ban on bauxite

exports in 2014.



Aluminum market conditions and current prices

Chinese aluminum production has increased about 10% thus far in 2013, which is roughly equivalent to our full-year forecast of 10.3%, and slightly below forecast consumption growth of 10.7%. Supply side cuts continued to help aid in the process of de-stocking China’s inventory of aluminum. Inventory on the Shanghai exchange has decreased 38% from the April high this year. However, the stockpile of metal in Shanghai pales in comparison to that on the LME, which reached a new high in mid-July this year.

Aluminum prices on both the LME and Shanghai exchanges peaked in early Sep 2011 at USD2,431/t and USD2,793/t, respectively (the difference largely reflects the 17% VAT in China). The Shanghai price has outperformed the LME price, falling 16% vs. the latter’s 26% decline. The outperformance indicates continued healthy demand growth in China. The graph below depicts the pricing and inventory levels on the LME and Shanghai exchanges.

Figure 34: Aluminum prices and inventories

Source: Bloomberg. Note: the Shanghai price includes the 17% VAT

China’s production of aluminum has increased strongly in line with demand, supported by upstream integration into alumina. The country is now nearly self-sufficient in alumina, utilising domestic and increasingly imported bauxite. Looking ahead, alumina production is likely to take a hit starting in 2014 for those refineries which have not made adequate business recovery plans to procure bauxite in advance of the changes in Indonesia’s raw materials export policy starting next year (more below).

Figure 35: Chinese aluminum production and YoY change Figure 36: Chinese alumina production and YoY change

Source: IAI Source: IAI

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The LME inventory overhang is a negative

factor for the market, particularly as

warehousing rules are reformed, allowing for

more rapid outflows, and carrying costs rise.



What could help lift or lower aluminum prices?

We see four key supporting factors for China’s primary aluminum production growth: ample and cheap raw materials (bauxite and electricity), subsidised demand from the aluminum fabrication sector (exports receive VAT rebates), local government support (subsidies, and low but rising environmental costs), and until recently, cheap financing. For reference, alumina and electricity each contribute roughly a third of aluminum production cost.

China’s bauxite vulnerability. China on average imports about 50% of its bauxite requirement to produce alumina (4t bauxite/2t alumina/1t aluminum), most of which comes from Indonesia. This has fuelled the rapid growth of China’s alumina production to the point where it is nearly self-sufficient. China’s self-sufficiency in both aluminum and alumina production have eliminated the country as an upside catalyst for the global prices of both.

Action. Under the Mining Law of 2009, Indonesia will ban the export of unprocessed ores from Jan 2014. Those exporters within Indonesia who do not have their processing capacity (bauxite to alumina) running in time may be allowed to continue exporting under a quota, but at an export tax of 50%, up from 25% previously, with some exceptions. As mentioned earlier, we anticipate some slippage in the ban/tax increase depending upon the exporter/importer’s progress on adding refining capacity.

Impact. Based on our rough calculations, the increased tax will add 15% and 5% to the production cost of alumina and aluminum respectively, for those refineries/smelters wholly reliant on imported bauxite. Regional bauxite prices will most likely rise to the level of the new tax-inclusive price from Indonesia.

Impact. With respect to the ban, the regional prices of bauxite and alumina will most likely increase depending on how much the Chinese can diversify their import sources (for instance, bauxite from Australia, some from India, Africa, which has great long-term potential). Chinese companies are rapidly building stockpiles in advance of the ban, which should help get them through most of 2014. Chinese bauxite is generally high in silica and, if relied on, will further raise costs. For example, if the Chinese return as large net importers of alumina due to a shortage of bauxite, and regional alumina prices increase by USD100/t to about USD420/t, the cost increase to a Chinese smelter wholly reliant on imported alumina would be approximately 10%.

Conclusion. Some importers of Indonesian bauxite that have not taken steps to build refinery capacity in Indonesia will face higher costs as regional prices increase. Some may import more alumina, favourably impacting prices. The impact on aluminum is positive but less than for bauxite and alumina, depending on how much of the cost can be absorbed by profitable Chinese smelters, but marginal capacity may close. We reflect this trend in our aluminum forecast of a slower rate of growth in China’s production and in higher aluminum prices. The biggest beneficiaries are regional suppliers of bauxite and alumina as prices rise, and Indonesian companies that are moving up the value chain.

Aluminum consumption, mainly from aluminum fabricators in China, is growing very rapidly at about 10% per year, but this is still less than supply growth. Nearly 15% of China’s primary aluminum production is exported through the manufacture of fabricated aluminum products, much to the consternation of its trading partners in Asia. The annualised figure through Jul 2013 is about 3mt, which is about 4x the level in 2005. The increase is due to China putting an export tax on primary aluminum because of its energy intensity, but leaving a loophole in exempting the fabrication



sector. If China is serious about reducing the energy intensity of its economy, it will restrict the exports of fabricated products mainly to only those that are higher value-added and meet the needs of domestic industry. If China’s primary aluminum production falls more rapidly than we forecast and prices rise, aluminum fabrication capacity could enter a period of consolidation or be forced to import more aluminum. The aluminum market would be more balanced, helping to support prices (there is still a large global inventory that would need to be worked down). Chinese fabricators would lose market share to international competitors. China does not need to produce as much primary aluminum as it currently does because a lot of it is being exported via fabricated products.

Electricity vulnerability. The cost of making aluminum is likely to marginally increase. Aluminum is one of the most energy-intensive materials to produce (about 13.5MW/t), with electricity accounting for about 30% of total production costs. In China, the outlook for power availability is quite good, as discussed earlier. If generating electricity ever becomes more profitable than selling aluminum, then production of the latter will slow. This may not happen over the near term. Costs are likely to rise for industry longer term, in line with the government’s plan to restructure the economy.

Local subsidies – slowly diminishing, but exist for a small portion of the aluminum smelters. During times of economic crisis (GFC and the 2012 downturn), local governments have subsidised power costs, waived taxes, and even purchased aluminum to help ease the burden of low prices on the sector and keep the engine of GDP running. This demonstrates the historical tension between the local and central government in China.

Environmental costs –will take years to be rolled into the cost structure of industry but should help restrain supply growth. We are referring to resource taxes, carbon taxes, environmental remediation and other measures to help the environment. Beijing is getting tougher on egregious violations, particularly when exposed by local opposition. The old adage, “build first and permit later”, seems to be rapidly fading as a business practice, as enforcement is stepped up. We also reflect this trend in our estimate of slower rates of capacity and production build.

Government-mandated capacity closures. Our expectations are low, of the order of 1.0-1.25mt (about 3% of total capacity) for 2013. But as mentioned earlier, new capacity is coming in at a higher rate. One regulation on the sector is that pots that operate under 160,000 amps (typical average worldwide is 180,000 amps) will be subject to compulsory shutdowns. But our industry sources indicate that based on a sample of smelters that have closed, most were either already idle or never started operation. Therefore it seems that the impact will be on marginal loss-making smelters who cannot maintain adequate profitability. Where the government can have an impact is on continuing to move the industry to real-world costing over time (energy, environment, health, safety, etc.) to force out marginal producers.

Impact of new warehousing rules on metal premiums. Despite the oversupply of aluminum, global premiums for delivery from warehouses to customers are high. Consumers have complained about the problem and measures are being taken to alleviate the bottleneck, such as the LME accelerating delivery times. The profitable metals warehousing business has attracted financial institutions (large banks) and also traders. The US Congress has put pressure on banks to sell non-core speculative businesses, and a few have sold warehouses. Over time, higher interest rates and an easier flow of material to consumers will lower premiums and bring more off-exchange supply onto the market. This would be a net negative for aluminum prices at some point in the future.



Figure 37: Aluminum ingot trade ('000 mt) – slight exports Figure 38: Aluminum semi trade ('000 mt) – high exports


Figure 39: Alumina trade ('000 mt) – largely self-sufficient Figure 40: Bauxite trade ('000 mt) – stockpiling for 2014


Copper outlook: Upside from improving near-term demand

We look for the copper price to improve over the next six months, in line with the recovery of China’s industrial economy and as supply remains tight. Longer term, increasing copper supply growth is expected to lead to a widening oversupply of refined copper starting in the second half of 2014. Much of the growth in mine supply of copper concentrate is being matched by double-digit increases in China’s copper smelting/refinery capacity, which, in addition to easier scrap availability, should reduce the growth rate of refined copper imports. The global copper market turned to surplus in 2012from a deficit in 2010 and 2011, and we forecast it to remain in moderate surplus through to 2015.

The demand for refined copper has benefitted from strong consumption in China as well as tight scrap availability, which is normally consumed as a less expensive alternative by copper fabricators. In addition, the Chinese customs department has enforced a “green fence policy”, which has led to a build-up of scrap inventories at ports as substandard shipments are returned to the country of origin. Copper scrap accounts for more than half of China’s total copper supply and 85% of its scrap is imported from outside the country, mainly the US and Europe. Primary copper scrap generation and secondary scrap gathering typically slow during manufacturing downturns because of low prices. The gap between primary copper and scrap narrows at the bottom of the economic cycle, and widens during the recovery phase of the cycle.

Chinese refined copper demand has been very strong thus far in 2013, as shown in the graph below. China’s apparent consumption has been supported by inventory de-stocking, as well as a pickup in refined copper imports, from April of this year. As a result, we are assuming very strong consumption growth of 10.5%

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The tight supply of copper concentrate and scrap is expected to ease later in 2014, leading to a slower rate of growth in China’s

refined copper imports.

Copper scrap availability usually tightens during

periods of low prices, and China’s new “green fence policy” has impacted the

import supply as well.



YoY in 2013 vs. our expectation of about 8% earlier. We believe that China’s core refined copper consumption annual growth rate will be in the 5-6% range going forward. The growth rate has often been impacted by speculative refined copper imports (arbitrage of Shanghai vs. LME copper prices). Currently, the arbitrage favours importing copper to China.

Figure 41: China apparent refined copper consumption increasing strongly

Source: China NBS, Bloomberg, Maybank Kim Eng

Were it not for China’s strong re-stocking demand growth this year, our forecast copper market surplus would be higher. For example, if Chinese growth were 8% during 2013 and not 10.5% as we now forecast, the market surplus during 2014 would be 40% higher (758kt vs. 539kt). Despite the surplus, we see the copper prices being supported above the current level until late 2014 by improving economic activity worldwide and in China. This is reflected in our copper supply and demand model, with the surplus becoming more evident during 2H14.

Figure 42: Global refined copper production/consumption – surplus later in 2014

Source: Wood Mackenzie, Bloomberg, Maybank Kim Eng estimates

Our historical analysis of copper inventory and prices shows that unless the market is awash in supply, which is not our assumption, prices will be supported if expectations of global demand growth are positive. In the end, copper prices will take their cue from China’s imports of refined copper, which are the most visible, though not the most accurate, manifestation of its real demand. The table below provides the details of our outlook for the refined copper market worldwide and in China.

The most interesting and perhaps risky call is our forecast for China’s refined copper imports to peak this year before declining in 2014 and 2015. This is a result of the rapid growth in China’s refinery capacity, which will be fed from rising copper mine concentrate supply (domestic and imported), and copper scrap imports. Even with our assumption of declining refined copper imports, the domestic market is in surplus, as shown in the last line of the table. This surplus

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90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12A13E14E15E

('000 t)(USD/t) Market balance (RHS) Copper Price (LHS)

Surplus

Deficit

China’s apparent consumption has been

supported by inventory de-stocking, as well as a

pickup in refined copper imports from April of this

year. As a result we forecast very strong

consumption growth of 10.5% YoY in 2013.

We look for the global copper market to be in

moderate surplus, but for the price to be supported well above USD3.25/lb. as

long as the market has a positive view on economic

growth, and US monetary policy is supportive.

The most risky call is our forecast for China’s

refined copper imports to peak this year and decline

in 2014 and 2015.

The main reason is our expectation of a large

increase in refined copper output in 2014 due to new

capacity and a large increase in mine

concentrate supply.



is needed to support the increasing capacity and need for inventory (working capital) of the copper fabricated products industry. Where we could be wrong is if China’s scrap supply remains tight and/or demand growth remains closer to 10%, compared with our forecast of around 6.5% in 2014 and 2015.

Figure 43: Global and China copper production and consumption summary (‘000t) 2009 2010 2011 2012A 2013E 2014E 2015EGlobal prod./cons. Production 18,271 18,934 19,675 20,131 21,023 22,237 22,939 YoY change % 0.1% 3.6% 3.9% 2.3% 4.4% 5.8% 3.2%Consumption 17,362 19,306 19,747 19,697 20,719 21,698 22,670 YoY change % -3.2% 11.2% 2.3% -0.3% 5.2% 4.7% 4.5%Balance: surplus (deficit) 910 (373) (72) 434 304 539 268 Total inventories 3,214 2,841 2,769 3,203 3,507 4,047 4,315 Weeks of supply 9.6 7.7 7.3 8.5 8.8 9.7 9.9 Price (USD/t) $5,162 $7,536 $8,835 $7,957 $7,385 $7,716 $6,680 Price (USD/lb.) $2.34 $3.42 $4.01 $3.61 $3.35 $3.50 $3.03 China prod./cons. Production 4,109 4,534 5,197 5,828 6,209 8,195 9,645 YoY change % 8.3% 10.3% 14.6% 12.2% 6.5% 32.0% 17.7%Consumption 6,500 7,204 7,815 8,204 9,065 9,677 10,304 YoY change % 27.5% 10.8% 8.5% 5.0% 10.5% 6.7% 6.5%Net exports (imports) (3,165) (2,942) (2,718) (3,181) (3,186) (2,231) (1,561)YoY change % 124.5% -7.0% -7.6% 17.0% 0.2% -30.0% -30.0%Balance (prod. - net exp. - cons.) 773 271 100 806 330 748 901 Source: Wood Mackenzie, Bloomberg, Maybank Kim Eng estimates

Figure 44: China's refined copper production and YoY change

Source: China NBS

Copper market conditions and current prices

The LME copper price has continued to move sideways, in a range of USD3.00-3.30/lb, since April of this year. The price is currently at the upper end of this range, caught in a tug-of-war between those expecting continued US monetary expansion (positive) and those expecting its removal (negative). We think it more likely that fiscal stimulus will be slowly tapered and the economy allowed to stand on its own at some point during the next 12 months. Over the near term, the positive arbitrage favours continued Chinese imports of copper from overseas, based on the lower price of the LME vs. Shanghai copper prices after adjusting for the 17% VAT in China.

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YoY Chg.'000 t Refined Copper YoY Change

We could be wrong if China’s consumption

growth remains close to 10% vs. our assumption of

6.5% for the next few years, or if refined copper

production growth does not accelerate due to

construction delays or disruptions to the feed of copper mine concentrate

or scrap.



Copper price and inventories on the metals exchanges Figure 45: Copper price and inventories

Source: Bloomberg. Note: the Shanghai price includes the 17% VAT

Imports of refined and concentrate copper bottomed out in March of this year and have increased strongly since on consumer re-stocking and arbitrage-driven speculative buying. The refined copper trade is a source of trade finance and has been boosted by those seeking access to cheap credit. This makes interpreting the trade data as much or more about credit flows than the demand for copper.

Figure 46: Refined copper trade ('000 mt) Figure 47: Concentrate copper trade ('000 mt)


Copper scrap imports have not materially improved and remain about 25% below the high in Nov 2012. China’s trade of copper semi-fabricated products remains well balanced, as opposed to aluminum where exports far exceed imports. But over the past eight years China has cut its copper semis imports by half, while its exports have been flat. We look for continued growth in China’s copper fabrication sector to meet growing domestic demand.

Figure 48: Copper scrap trade ('000 mt) Figure 49: Copper semi trade ('000 mt)


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The LME copper price has been range-bound since

April at between USD3-3.30/lb. The arbitrage

continues to favour exporting copper to China after adjusting for the 17%

VAT.



Steel outlook: Woes to continue due to excess capacity

Our forecast calls for the steel sector to remain highly seasonal with steel prices recovering during the first half of the year and falling during the second half. We see this sector as one to trade based on the trend in steel prices and earnings, buying in when losses deepen, and selling out when conditions improve. Capacity additions in the past several years, on top of high raw material costs, have nearly eliminated pricing power and squeezed profit margins. In 2012, the average operating profit margin of the steel sector was 0.04%, the lowest of all industries, with about 40% of the companies in the sector making losses.

We have taken a relatively optimistic view from 2015, forecasting some improvement in industry fundamentals as low profitability, tight credit availability and government restrictions limit the pace of expansion. We forecast capacity growth slowing to about 2% per year from 2014 compared to high single digits in the past several years, with operating rates rising from 78% in 2012 to 82% during 2015 (based on average year-end capacity).

What is likely to change or not in the near term to relieve some of the pressure on the sector?

We are forecasting lower iron ore prices the next few years due to rising new supply amid slowing Chinese demand. The big question is how much of the cost benefit can Chinese mills retain in terms of profit margins. Historically, as profit margins widen, steel production rises. Given the current excess capacity, we see no reason for this to change over the medium term. We have forecast that Chinese steel prices fall slightly less relative to decreasing iron ore prices.

Government restrictions on capacity additions have tightened, but past efforts have had mixed success. From 2006-2012, crude steel capacity was reduced by 76mt mainly from obsolete plants, but new capacity was 440mt. The State Council's cancellation of a batch of approval rights is a positive signal. Future reduction targets are quite ambitious, for example Hebei Province is targeting a 20% reduction in three years.

Chinese steel exports have increased 17% YoY through August and are on track to reach 68mt this year (+22% YoY), very close to the record high. Korea and Latin America were the two largest export destinations. Exports will not have a material impact on the problem of excess capacity in terms of supporting domestic Chinese prices. And already, weaker regional currencies (India, Japan, and Korea) are eroding the cost competitiveness of Chinese steel exports.

M&A at the state level has been active, but overall industry consolidation remains slow and ineffective in consolidating capacity. A large number of local steel mills refuse to be acquired by larger steel companies, state-owned or otherwise. The steel mills are the backbone of local economies, contributing to GDP, providing large-scale employment, and paying taxes. Some progress has been made on agreements to ease the burden locally, such as through transfer payments from the central government.

Hebei local government released its final target for

steelmaking capacity closures the next five years, setting this at

60million metric tonnes or over 20% of existing

capacity. Achieving that target would be

impressive.



Figure 50: Finished steel trade (mt)

Source: China NBS

Steel and raw material price assumptions

The following table shows our forecast for Chinese steel prices and steelmaking raw materials. We have assumed that steel prices fall less than raw material prices. For the correct comparison, note that iron ore makes up only about one-third of steelmaking costs, as does coking coal. So an accurate comparison of the impact of changing raw material prices on the cost of steel would involve taking a third of the iron ore and coking coal price change vs. our steel price forecast, as shown in Figure 52.

Figure 51: Chinese steel and raw materials price assumptions (VAT incl.) Steel price forecast 2010 2011 2012 2013E 2014E 2015E 2016E 2017EFlat steel Benchmark (2.75mm HRC, Rmb/t) 4,413 4,838 4,177 3,836 3,777 3,649 3,447 3,275YoYchg. 16% 10% -14% -8% -2% -3% -6% -5%Benchmark (2.75mm HRC, USD/t) 652 749 662 623 619 608 574 546YoYchg. 17% 15% -12% -6% -1% -2% -6% -5%Long Steel Benchmark (ψ12 rebar, Rmb/t) 4,230 4,783 4,054 3,648 3,501 3,315 3,068 2,914YoYchg. 13% 13% -15% -10% -4% -5% -7% -5%Benchmark (ψ12 rebar, USD/t) 625 740 643 592 574 553 511 486YoYchg. 14% 18% -13% -8% -3% -4% -7% -5% Raw material price forecast ($US/t, VAT not applied): Iron ore fines (62% CIF China) 141 165 128 133 122 110 99 80YoYchg. 81% 17% -22% 4% -8% -10% -11% -19%Hard coking coal contract (FOB Australia) 191 289 214 158 158 155 150 150YoYchg. 11% 51% -26% -26% 0% -2% -3% 0%Source: Custeel, Steelhome, Maybank Kim Eng

Steel prices to make up some ground lost to iron ore prices longer term

Steel prices have failed to keep pace with the volatile cost of steelmaking raw materials (iron ore and coking coal), as shown in the graph below. US steel prices have performed better in this regard than those in China due to consolidation and import duties. US steel companies have suffered volatile swings in earnings, including losses, but not to the extent of Chinese steel companies. The graph shows our forecast for lower raw material prices and a lesser decrease in China’s steel prices longer term. The graph only includes the cost of raw materials (1.6t iron ore and about 0.5t coking coal per tonne of raw steel).

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China’s trade in finished steel shows increasing net

exports. We see this topping out as overseas

market demand slows and weaker regional currencies

erode its export competitiveness.

We forecast a continued decrease in iron ore prices

as supply growth accelerates the next few years. But thus far, steel

companies have not been able to materially expand

profit margins.



Figure 52: Raw material costs (iron, coking coal) vs. US and China HRC prices

Source: AMM, SBB, Custeel, Steelhome, Maybank Kim Eng

Figure 53: China steel supply/demand model (mt) – capacity growth forecast to slow 2010 2011 2012 2013E 2014E 2015E 2016E 2017ECapacity yr. end 800 872 946 1,008 1,033 1,059 1,085 1,101Capacity yr. avg. 760 836 909 977 1,020 1,046 1,072 1,093Utilization 82% 82% 78% 80% 81% 82% 83% 84%Crude steel production* 626 689 711 784 826 857 890 918Finished steel production** 799 881 953 1,051 1,108 1,150 1,193 1,231Flat 362 392 412 456 499 529 549 579Share of total finished prod. 45% 45% 43% 43% 45% 46% 46% 47%Long 437 489 541 595 609 621 644 653Net export (incl. semis) 26 33 42 54 43 44 47 48Import 16 16 14 14 21 25 26 27Export 43 49 56 68 64 70 73 76Apparent cons. (reported)** 773 848 911 997 1,065 1,105 1,146 1,183Apparent cons. (adjusted) 576 626 637 696 747 775 804 830 YoY Change Capacity yr. end 11% 9% 8% 6% 2% 2% 2% 2%*Crude steel production 11% 10% 3% 10% 5% 4% 4% 3%Finished steel production** 16% 10% 8% 10% 5% 4% 4% 3%Apparent consumption** 13% 10% 7% 9% 7% 4% 4% 3%Apparent consumption adjusted*** 11% 9% 2% 9% 7% 4% 4% 3%* Crude steel production in 2011 could be understated by 10-20Mt due to statistical error between parent/subsidiary producers in Hebei Province. **Includes double counted tonnes from downstream processing found in the reported figures ***Adjusted consumption is our estimate excluding the double counting of finished steel from further downstream processing. Source: CEIC, CMIPRI, CBI, Kim Eng forecasts

Figure 54: China’s crude steel production, capacity, and operating rate

Source: CEIC, CMIPRI, CBI, Maybank Kim Eng

China’s steel production surged 33% from Nov 2011 to May 2013 just as credit policy was being tightened to slow the economy. The impact squelched the seasonal 1H rally in prices. This is a pattern that has been repeated over the last several years.

100 150 200 250 300 350 400 450 500 550

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Raw materials cost ex-freight (RHS) China HRC 2.75mm, VAT excl. (LHS)US HRC price (LHS)USD/t USD/t

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m tonnesSteel production (LHS) Steel capacity (LHS) Utilization rate (RHS)

Longer term, we forecast some profit margin

improvement as iron ore and coking coal prices fall

slightly more relative to steel prices, aided by

slowing steel production growth.

If China is successful in at least slowing the rate of

capacity additions, operating rates should

slowly improve over the next few years.



Figure 55: China’s crude steel production growth history and forecast

Source: Custeel; Steelhome, Maybank Kim Eng forecast

Steel market conditions and current prices

Steel prices have been trending lower since the fourth quarter of 2011 when China began its credit tightening. The pace of price declines slowed in the fall of last year, and prices rallied during the seasonally strong late first and early second quarters of this year. Accompanied by lower raw material costs and a seasonal pickup in demand, steel mill profitability improved during the second quarter.

During July, CISA reported that its members returned to profit with average operating profit margins of 0.77%, the highest so far in 2013, and well above the margin of 0.04% for all of 2012. Profits increased to USD474m for the 86 members comprising tier one and two steel mills, from losses of USD114m in June. CISA attributed the improvement to higher demand and prices.

Figure 56: Steel market prices (CNY/t incl. VAT)

Source: Custeel, Steelhome

Since the spring price rally, steel prices have weakened 1-2% due to a flattening out of demand and excess production brought on in response to the improvement in profit margins. Industry sources report that there was no widespread improvement in buying, which was the main reason behind the price corrections. In an attempt to stabilise the market, Baosteel announced that it would keep its September HRC price unchanged, but is eliminating the CNY100/t discount it was offering earlier.

Steel company pricing appears to be out of line with market pricing (the average is being boosted by Baosteel’s pricing), raising the risk that if the market does not improve, steel mills will have to capitulate. The graph below indicates average company and market HRC prices (ex-VAT). The bars illustrate company price premium to the market price, which has widened to over 20% the past few months. Since the GFC, the steel mills, led by Baosteel, have been trying to push

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Monthly crude production (LHS) YoY growth (RHS)

(Est.)

GFC Peak to Trough:-25% from June to

Nov., 2008

GFC Trough to Peak:

+49% from Nov., 2008 to Aug.,

2009

Peak to Trough:-17% from May,

2011 to Nov., 2011

YoY chg.

Trough to Peak:+33% Nov., 2011

to May, 2013

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Rebar ψ12 Plate 20mm HRC 2.75mm

CR sheet 1mm HDG 0.5mm

Steel prices in China staged a seasonal

recovery in 1H13, boosting profits, but a surge in

production and a flattening of demand has pushed

prices lower in September.

Just as China was tightening credit, crude

steel production accelerated, increasing 33% from the Nov 2011

trough to the peak in May 2013. Though slightly off

the peak, production remains at high levels.



market prices higher. This is indicated by the majority of the bars in the graph above the 0% line ever since the GFC vs. more of a balance of bars in the negative/positive territory before.

Figure 57: Market price tension of company vs. market prices

Source: Custeel; Steelhome, Maybank Kim Eng

Inventory levels do not appear excessive

Inventory of long and flat products in China do not appear excessive based on the small sample provided in our data series (source: Steelhome). The data continue to follow a seasonal pattern for long products, which are typically accumulated during 1Q and de-stocked during 2Q. The inventory of HRC (flat products) shows a longer-term trend of de-stocking from the peak in early 2010 and 2011 of just below 6mt to the trough earlier this year of about 3mt. HRC inventory has increased by a third since then.

Figure 58: China flat product inventory at traders/distributors (mt)

Figure 59: China long product inventory at traders/distributors (mt)

Source: Steelhome Source: Steelhome

Figure 60: China non-iron ore steelmaking raw material prices (VAT incl.) USD/t

Source: Custeel, Bloomberg, Steelhome

-15%

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Company vs. market premium

(discount)Prices (Rmb/t)

Co. vs. Market premium (discount); (RHS, bars)Co. avg. HRC price (VAT excl.)Market price (2.75mm, VAT excl.)

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Tangshan cokeShanxi coking coalNanjing scrap (6mm)Newcastle Premium HCC (FOB Australia, VAT not applied)

Company steel prices have moved out of line with

lower market prices, posing the risk of a price

cut during 4Q13.


Hong KongInitiating Coverage 25 September 2013

China Shenhua Energy The One To Own In The Coal Sector Steady growth, strong balance sheet and healthy cash flows. We initiate coverage with a BUY and target price of HKD29. Catalysts are improving macro and seasonal factors, and higher earnings powered by strong coal sales growth. We see upside to consensus EPS in 2013/14.

Anticipating slowing coal consumption in China, Shenhua has ramped up capex spending in 2012 and 2013 to expand its delivery systems (rail, port, shipping), and power plant capacity (supplied 86% with its own coa). Coal mine capex continues, but at a lower rate.

The benefits of this sensible strategy are yet to come, and include rapid sales growth through consolidation of regional coal supply via its delivery network, and raising productivity to offset higher industry costs. We assume volume growth of 5-7% in sales and 3.5% in production in 2014-16. Strong sales volumes YTD support our 2013 target.

We forecast a 5% increase in thermal coal prices by end-2013 from current levels, in line with the average for the same period in 2010-2012, backed by recovering thermal power generation, lower inventory at power plants, and maintenance on China’s largest coal railway in September. We forecast a 5% YoY coal price hike in 2014 and a 2.5% power tariff rate cut later with segmental margins lower thereafter.

We forecast rising cash flows as Shenhua tapers its capex spending from the peak of nearly USD10b in 2013, with the company returning to a net cash position in 2015. The strong balance sheet offers flexibility for future growth and continued strong dividends.

Our valuation is based on a DCF methodology. Our target price of HKD29 represents a 10% discount to our DCF valuation of HKD32/sh (WACC 11.2% and long-term growth 2.75%). Our TP translates to a PBR of 1.4x and EV/EBITDA of 5.1x our 2014 estimates. We see this as fair given Shenhua’s strong industry position, leading profit margins, and cash flows supporting a healthy 39% payout to shareholders.

China Shenhua Energy – Summary Earnings Table FYE Dec (CNYm) 2012A 2013A 2014F 2015FRevenue 250,260 253,986 274,692 292,061 EBITDA 86,401 88,692 90,537 93,022 Recurring Net Profit 48,858 46,362 47,031 48,190 Recurring Basic EPS (CNY) 2.456 2.331 2.365 2.423 EPS growth (%) 6.6 (5.1) 1.4 2.5 DPS (CNY) 0.96 0.91 0.92 0.94 PER (x) 8.4x 8.6x 8.4x 8.1xEV/EBITDA (x) 4.9x 4.8x 4.5x 3.9xDiv. Yield (%) 4.7 4.5 4.6 4.8 P/BV (x) 1.6x 1.4x 1.3x 1.1x Net Gearing (%) 4.5 8.7 2.6 net cashROE (%) 20.2 17.1 15.8 14.7 ROA (%) 11.3 9.8 9.3 8.9 Consensus EPS (CNY) N.A. 2.27 2.29 2.40 Source: Shenhua, Bloomberg Consensus, Maybank Kim Eng

Buy

Share price: HKD25.50 Target price: HKD29.00

Alexander LATZER [email protected] (852) 2268 0647

Stock Information

Description: China Shenhua Energy Company Limited (China Shenhua) is the largest coal producer in China, with production mainly thermal coal totaling 304m tonnes and sales of 464.6m tonnes in 2012. The companyis headquartered in Beijing and is 73.01% owned by the State.Shenhua is fully integrated from coal mining, railway transportation, ports, shipping, and coal-fired power plants. The majority of the company's business is conducted within China. Ticker: 1088 HK Shares Issued (m): 19,889.620 Market Cap (USDm): 65,024 3-mth AvgDaily Turnover (USDm): 64.5 HSI: 23,371.5 Free Float (%): 26.99 Major Shareholders: % JP Morgan 11.35 Blackrock 7.88 Walter Scott Partners 5.20 Vanguard Group Inc. 3.28 Key Indicators (June 30, 2013)

ROE – annualised (%) 19 Net debt (Rmbm): 17,064 NTA/shr (HKD): 19.26 Interest cover (x): 27.8 Historical Chart

Performance: 52-week High/Low (HKD) 35.45/18.10 1-mth 3-mth 6-mth 1-yr YTD Absolute (%) 4.3 15.9 (10.1) (15.1) (24.9) Relative (%) (2.6) (2.0) (15.7) (27.9) (28.0)

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40.0

Sep 12 Nov 12 Jan 13 Mar 13 May 13 Jul 13 Sep 13

PRICE PRICE REL. TO HANG SENG INDEX

Source: Bloomberg


China Shenhua Energy Company Limited

How do we justify our positive view on the shares?

Positive earnings and cash flow growth forecast in 2014/15

We forecast profits to trough in 2013, with moderate increases in 2014/2015 due to slightly higher coal prices and coal sales volumes. The lower ROE in 2013 was mainly driven by lower coal prices and during 2014 is due to our assumption of a power tariff rate cut and higher unit costs. The decrease in ROE is also a direct result of the defensive strategy of the company to adjust the business to the changing market environment.

Figure 61: ROE and net profit and coal volumes

Source: Shenhua, Maybank Kim Eng estimates

Free cash flows are expected to increase on lower capex and rising profitability. Assuming 2013 was the peak in capex spending, we see Shenhua returning to a net cash position in 2015. Its business is highly cash generative, which gives the company the financial flexibility to pursue bolt-on acquisitions and maintain a healthy dividend policy (39% payout). Shenhua indicated during its interim results briefing that capex for 2013 is likely to come in below its earlier forecast of CNY67.45b. Our forecasts assume a cut of 12% from the initial guidance.

The company recently acquired the coal-to-chemicals business of its parentco Shenhua Group. We also think it remains in the running to be part of a consortium to acquire the Tavan Tolgoi East block. With respect to M&A, management has specifically stated that it will stick to its core competencies. It uses a variety of evaluation criteria, including an IRR of greater than or equal to 10%, cash flows of the business, and how it complements the existing asset base.

Figure 62: Free cash flow outlook


19.2% 19.9 20.7 21.2 20.2 17.1 15.8 14.7

CNY 26.6bn 31.7

38.8

45.8 48.9 46.4 47.0 48.2

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CNYb CAPEX Dividends Operating cash flows Free Cash Flows

Shenhua has emerged from a market downturn

with only a forecast 5% fall in net profit for 2013F, and

with capex remaining at high levels to further

improve the business. This shows the strong cash

generating power of the business.



Figure 63: Operating profit by business segment Figure 64: Capital spending by business segment

Source: Shenhua, Maybank Kim Eng estimates Source: Shenhua, Maybank Kim Eng estimates

Business strategy – the right one at this point in the cycle From 2008-2012, Shenhua’s profit grew rapidly due to rising volumes from its own mines, and stable to slightly higher returns as rising coal prices more than offset increasing costs. As the operating environment changed, management rapidly adjusted its business strategy to focus on higher productivity to cope with slower volume growth amid stable coal prices. This is a sensible move at this point in the cycle and one that is possible due to its strategic portfolio of mines, power plants and coal delivery systems (rails, ports and shipping).

During 2013, this strategy paid off. The company saw increased sales volumes from third parties, was able to prioritise higher-margin mines and expanded its coal delivery systems, which helped lower costs (-3% YoY our 2013 estimate) amid significantly lower selling prices (Qinhuangdao -17% YoY and Shenhua average -10% YoY in 2013F in CNY terms). As a result, we forecast the company will experience only a 5% decrease in profitability this year, which is far better than most of its peers in any of the materials sectors.

Looking ahead, we forecast Shenhua’s profitability will grow more slowly coming out of the 2013 trough than in the period before based on our assumptions. During 2014, we have assumed slower market demand growth, higher total unit costs (+4% YoY), a power tariff rate cut (-2.5%), partially offset by higher sales volumes, though with a less profitable product mix (increasing sales of third-party coal vs. self-owned coal). The graph below illustrates our assumptions on costs and selling prices and Figure 61 our assumptions on coal sales volumes.

Figure 65: Average realised coal selling price and unit costs


31 36 39 47 45 38 41 42 3

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Valuation Our valuation is based on an examination of Shenhua’s PBR relative to its ROE, as well as our DCF analysis. Our DCF value is HKD32/sh from the beginning of 2014 to which our target price of HKD29/sh represents a 10% discount. The indicated DCF valuation from the start of 2015 is HKD35/sh, reflecting the winding down of the capex programme and closer to higher cash flows in our forecast period. We are using a WACC of 11.2% and perpetual growth rate of 2.75%. Our terminal year is 2017 in which we have assumed a regional coal price of USD80/t (Newcastle high CV 6,000kcal), up 2% from the current level, and Qinhuangdao of CNY585/t (high CV 5,800kcal), which is flat with the current level. We have assumed Shenhua’s total delivered coal costs rise 3% from 1H13 actual to CNY318/t in 2017 (USD53/t), with coal production of 355mt (+12% vs. 2013F), and coal sales of 592mt (+21% from 2013F).

With respect to the other segments, we have assumed moderate growth in volume of about 3% per year from 2013 to 2017, but have taken down the profit margins. For the power segment, we have assumed a lower profit margin of 18% in 2017 compared to 22% in 2013 and 20% in 2014 (we assume a 2.5% tariff rate cut), which we think is conservative. Our profit margin for the railway segment is down slightly from 47% in 2013F to 45% in 2017, shipping is flat, and ports down from 34% in 2013F to 25% in 2017. Our sustaining capex assumption is CNY28b.

Under this scenario, Shenhua’s earnings would be flat with those estimated in 2013F, and the EBIT margin would be 23%, down from 27%. The company would be generating free cash flow of CNY29b/yr and have accumulated a total cash balance of about HKD9.50/sh (CNY146b) from 2013 to 2017 vs. about HKD2.25/sh (CNY36b) in 2013F. We assume no M&A and the sustaining capital of CNY30b in 2016 and CNY28b in 2017.

The PBR has fallen in line with the ROE and that makes sense, but we see it having bottomed and below the ratio implicit in a Gordon Growth style analysis. The level of the ROE when compared to the required return on capital still implies that a large premium to book value is justified. We compare the ROEs in 2013, 2014 and 2015 to the required return of 11% and arrive at book value premiums of 55%, 45%, and 35%, respectively, which on the year-end book value equates to a share price of HKD28-29/sh.

Our forecast for Shenhua’s 2014F ROE is 15.8%, which is the same level as the latest point in the one-year forward rolling ROE in the graph below. At this level, the market is valuing the shares at 1.3x. This compares to the 1.4x implied in our target price and the 1.2x using the current share price.

Figure 66:Shenhua ROE vs. PBR

Source: Bloomberg, Shenhua, Maybank Kim Eng estimates

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The PBR has fallen in line with the ROE, which we

forecast is bottoming, and remains at a level where a 35-45% premium to book

value should apply.

Our target price is supported by our DCF and an analysis of its PBR and ROE. In addition, there are

few companies in the materials sector

generating comparable returns.



Figure 67:Shenhua PBR bands

Source: Bloomberg, Shenhua, Maybank Kim Eng estimates

Shenhua’s PBR band analysis using one-year forward rolling estimates indicates the shares remain well below the average PBR since 2006, as well as that since 2009. The PBR is actually below that during the trough of the GFC in late 2008 and early 2009. The shares have not only been de-rated due to the falling ROE, but also the China market de-rating. While we do not argue that ROE is falling, we find that Shenhua remains a world-class company supported by its returns, which we point out further below.

What is priced into the shares?

Since early July, Shenhua’s share price has moved much higher as expectations of macro growth in China improved. The shares have pulled back slightly since on industry-specific concerns regarding government policy towards the coal sector. We believe that policy risk is not fully priced in with respect to a potential tariff rate cut and a resource tax, though we have tried to price some of this into our estimates. The market appears to be pricing in a flat coal price and some policy risk based on our analysis below.

We see the tariff rate hike as being more impactful of the two policies and have factored in a 2.5% cut in 2014, and lower power segment profit margins in the out years as well. The resource tax could take many forms but is likely to be on the value of the product rather than the volume produced. This could imply a tax of 1-3% on the price of coal for example, but we don’t know if other taxes at the local level would be deducted. We have also factored in rising total delivered coal costs in future years.

The table below provides a sensitivity analysis of Shenhua’s earnings to changes in power tariffs and coal prices. Our 2014F EPS of CNY2.37/sh (bolded) assumes a 2.5% tariff rate cut and a 5.0% coal price increase (full-year average realided price CNY407/t). The company’s earnings are more sensitive to changes in the coal price than to changes in the power tariff rate.

The consensus 2014 EPS estimate of CNY2.29/sh (MBKE: CNY2.37/sh) appears to be pricing in either a lower coal price increase (2.5% YoY) or the same coal price increase of 5.0% but a 5% tariff rate cut. The market seems to be pricing in 2014 earnings of closer to CNY2.00/sh, assuming the market PBR of 1.2x the current price. This implies the market has priced in flat coal prices in 2014 YoY and a tariff rate cut of about 2.5%.

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The market appears to be pricing in lower than

consensus earnings of about CNY2.00/sh, which would be pricing in a flat

coal price in 2014 YoY and a tariff rate cut of

about 2.5%.

The PBR remains below the GFC low, reflecting in

part a lower ROE, but also a China de-rating.

This seems unjustified as Shenhua’s business and

returns are among the best worldwide among nearly all materials companies.



Figure 68: Shenhua – sensitivity table on 2014 EPS (CNY/sh). Changes YoY

Po

wer

tar

iff

(%)

chan

ge

Yo

Y

Coal price % chg. YoY -10.0 -5.0 -2.5 0.0 +2.5 +5.0 +10.00.0 1.41 1.75 1.92 2.09 2.27 2.45 2.79-2.5 1.32 1.67 1.84 2.01 2.19 2.37 2.70-5.0 1.24 1.59 1.76 1.93 2.11 2.29 2.63-7.5 1.17 1.52 1.69 1.86 2.03 2.21 2.56-10.0 1.10 1.45 1.62 1.79 1.96 2.14 2.48

Source: Maybank Kim Eng. *Base case EPS is CNY2.37/sh, assuming a 2.5% tariff rate cut and a coal price increase of 5.0% (average realised price CNY407/t)

Earnings revisions – trend has bottomed and should improve

The consensus forecast of Shenhua’s 2013 and 2014 earnings has been in a continuous downward trend since late 2011 in line with the Chinese economy and other materials stocks taking the share price with it. We see this trend bottoming and look for the consensus to raise their forecast more in line with ours. We have noticed that the consensus 2013 estimate has moved higher by a few percentage points since late August.

Figure 69: Consensus forecast for Shenhua’s earnings in 2013 and 2014

Source: Bloomberg consensus

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Global coal company valuation graphs Figure 70: Global coal company market capitalisation (USDm)


Figure 71: Global coal companies EV/EBITDA 2014 Figure 72: Global coal companies Dividend Yield 2014

Source: Bloomberg consensus Source: Bloomberg consensus

Figure 73: Global coal companies ROE 2014 Figure 74: Global coal companies PBR 2014


95 227 297 348 372 487 712 774 780 865 995 1,372 1,410 1,880 2,029 2,376 2,400 2,659 2,689 4,848

7,192 7,735 11,145

29,228

0

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3.24.54.7

4.75.15.3

5.9

6.87.47.47.78.28.58.68.9

9.89.810.0

10.713.113.6

18.121.2

0.0 5.0 10.0 15.0 20.0 25.0

Berau CoalHarum Energy

ShenhuaBorneo Lumbung

Fushan EnergyAdaro

Coal IndiaChina Coal

Peabody EnergyBumi Resources

Consol EnergyBanpu Pcl

MechelPT Bukit AsamWalter Energy

Alpha NaturalWhite Haven

Yanzhou CoalArch Coal

Mongolian MiningHidili

SouthgobiWinsway

0.50.6

1.11.41.5

1.71.81.9

2.42.6

3.13.3

3.94.3

4.54.8

5.17.1

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0

WinswayWalter Energy

HidiliWhite Haven

Consol EnergyMechel

Yanzhou CoalPeabody Energy

AdaroArch Coal

China CoalFushan EnergyPT Bukit Asam

Banpu PclShenhua

Harum EnergyCoal India

Borneo Lumbung

(12.8)(12.4)(12.3)

(10.5)(8.5)

(6.7)(4.0)

(1.5)0.9 1.0

2.3 3.2 3.9

5.7 6.5

7.6 8.0

10.0 15.0 15.2 15.3

20.1 22.3 23.3

30.9

(20) (10) 0 10 20 30 40

Tigers RealmAlpha Natural

Walter EnergyArch CoalWinsway

SouthgobiMechel

Mongolian MiningHidili

RaspadskayaWhite Haven

Peabody EnergyYanzhou Coal

Fushan EnergyChina Coal

Consol EnergyBanpu Pcl

AdaroBorneo Lumbung

ShenhuaBayan Resources

Harum EnergyBerau Coal

PT Bukit AsamCoal India

0.30.30.4

0.40.50.50.6

0.60.70.70.7

0.91.01.01.0

1.11.1

1.31.81.9

2.02.92.9

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5

HidiliAlpha Natural

Arch CoalSouthgobi

MechelBorneo Lumbung

WinswayChina Coal

White HavenYanzhou Coal

Fushan EnergyBanpu Pcl

AdaroPeabody Energy

Mongolian MiningWalter Energy

Tigers RealmShenhua

Consol EnergyHarum Energy

Berau CoalPT Bukit Asam

Coal India



INCOME STATEMENT BALANCE SHEET FYE Dec (CNYm) 2012A 2013F 2014F 2015F

FYE Dec (CNYm) 2012A 2013F 2014F 2015F

Revenues 250,260 253,986 274,692 292,061 Cash & equivalents 51,627 29,994 43,747 75,086 Coal 165,989 161,907 178,615 193,020 Time and restricted deposits 10,054 10,000 10,000 10,000 Power 71,096 73,761 76,762 79,449 Inventories 15,171 18,759 20,879 22,588 Others 13,175 18,318 19,314 19,592 Accounts receivable 20,028 24,129 26,096 27,746 COGS (150,957) (156,327) (173,992) (188,232) Other 14,480 20,319 19,228 17,524 Gross Profit 99,303 97,660 100,700 103,829 Total current assets 111,360 103,201 119,950 152,944 SG&A (12,950) (8,593) (9,614) (10,222) PPE 236,048 275,984 291,922 303,564 Other operating expense 48 (376) (549) (584) Construction in progress 61,142 60,000 50,000 40,000 EBITDA 86,401 88,692 90,537 93,022 Other non-current assets 48,817 52,220 58,215 64,254 DD&A (16,797) (19,421) (20,003) (20,203) Total non-current assets 346,007 388,203 400,137 407,818 Operating Profit (EBIT) 69,604 69,271 70,533 72,819 Total Assets 457,367 491,404 520,088 560,762 Net financing cost (2,071) (2,384) (2,090) (1,557) S. term borrowings & current 28,093 28,000 28,000 28,000 Associates 477 500 500 500 Accounts and bills payable 31,072 31,265 34,798 37,646 Other inc. (exp) 1 321 0 0 Other current liabilities 46,392 54,714 52,198 56,470 Pre-tax profit 68,011 67,708 68,944 71,762 Total current liabilities 105,557 113,980 114,996 122,116 Income tax (10,965) (12,475) (12,919) (14,175) Long term borrowings 39,624 33,151 28,151 28,151 Minority interests (8,188) (8,870) (8,963) (9,329) Other non-current liabilities 5,629 5,500 5,500 5,500 Net Profit 48,858 46,362 47,062 48,258 Total non-current liabilities 45,253 38,651 33,651 33,651 EPS 2.46 2.33 2.37 2.43 Total liabilities 150,810 152,631 148,647 155,767 Div/sh 0.96 0.91 0.92 0.95 Minority interests 49,968 54,403 58,882 63,540 Avg. shares out. 19,890 19,890 19,890 19,890 Share capital 19,890 19,890 19,890 19,890 Reserves 236,699 264,480 292,669 321,565 Revenue Growth % 19.6 1.5 8.2 6.3 Shareholders' Equity 256,589 284,370 312,559 341,455 EBITDA Growth (%) 3.4 2.7 2.1 2.7 Total Liabilities & Sh. Equity 457,367 491,404 520,088 560,762 EBIT Growth (%) 1.3 (0.5) 1.8 3.2 Net Profit Growth (%) 6.6 (5.1) 1.5 2.5 Gross Debt/(Cash) 67,717 61,151 56,151 56,151 Tax Rate % 16.1 18.4 18.7 19.8 Net Debt/(Cash) 16,090 31,157 12,404 (18,935) Working Capital 5,803 (10,779) 4,954 30,828 CASH FLOW RATES & RATIOS

FYE Dec (CNYm) 2012A 2013F 2014F 2015F FYE Dec 2012A 2013F 2014F 2015F Profit before taxation 68,011 67,708 68,899 71,660

EBITDA Margin % 34.5 34.9 33.0 31.9 Depreciation 18,150 19,421 20,003 20,203 Op. Profit Margin % 27.8 27.3 25.7 24.9 Net interest expense 3,315 3,177 2,870 2,808 Net Profit Margin % 19.5 18.3 17.1 16.5 Working capital change (1,394) (5,012) (1,980) 5,466 ROE % 20.2 17.1 15.8 14.7 Cash tax paid (14,689) (12,475) (12,910) (14,155) ROA % 11.3 9.8 9.3 8.9 Others (4,338) (1,434) (1,235) (1,648) Dividend Cover (x) 3.6 3.8 3.8 3.9 Cash flow from operations 69,055 71,384 75,646 84,334 Interest Cover (x) 33.6 29.1 33.0 43.9 Capex (52,256) (59,356) (35,942) (31,845) Asset Turnover (x) 0.5 0.5 0.5 0.5 Disposal/(purchase) 220 273 0 0 Asset / Equity (x) 1.8 1.7 1.7 1.6 Others (9,894) (4,366) 0 0 Asset/Debt (x) 6.8 8.0 9.3 10.0 Cash flow from investing (61,930) (63,449) (35,942) (31,845) Receivables Turn (days) 24.5 31.7 33.4 33.6 Debt raised/(repaid) 1,565 (6,566) (5,000) 0 Payables Turn (days) 66.3 72.8 69.3 70.2 Equity raised/(repaid) 0 0 0 0 Inventory Turn (days) 34.0 39.6 41.6 42.1 Dividends (paid) (17,901) (19,094) (18,081) (18,342) Net Gearing % 5.9 9.9 3.8 Net cash Others (incl. int. paid) (817) (3,908) (2,870) (2,808) Gross Debt/ EBITDA (x) 0.8 0.7 0.6 0.6 Cash flow from financing (17,153) (29,568) (25,951) (21,150) Gross Debt/ Market Cap (x) 0.2 0.2 0.1 0.1 Change in cash (10,028) (21,633) 13,753 31,339 PER SHARE DATA

FYE Dec 2012A 2013F 2014F 2015F

EPS 2.46 2.33 2.36 2.42 EBITDA/share 4.34 4.46 4.55 4.68 DPS 0.96 0.91 0.92 0.94 Oper. CFPS 3.47 3.59 3.80 4.24 Free CFPS (0.06) (0.36) 1.09 1.72 BVPS 12.90 14.30 15.71 17.17

Source: Shenhua, Maybank Kim Eng



China Coal Energy Hold For Recovery In Coal Price Leverage to higher coal prices. We recommend holding the shares for the seasonal recovery in coal prices later this and early next year. Looking further ahead, we forecast profitability to flatten out, capex spending to rise, free cash flow to turn negative, and debt levels to increase as the company builds a new growth engine in coal/chemicals.

Coal/chemicals spending to remain high. Management has doubled coke/chemicals business Capex each year since 2010. In 2013, we forecast Capex on the business at CNY17.4b, (53% of the total spend), and remaining high at CNY15b in 2014, and CNY11b in 2015. We look for the business to turn profitable late 2014 and improve thereafter, but remain small vs. coal based on our projections.

Coal business will drive profitability over the medium term. Given the long lead time to ramp up the coal/chemicals business, profitability will still be driven by the coal segment where volumes are growing nicely in the mid-single digits. During 2014, we forecast a 7% increase in EPS to CNY0.44/sh, which is about 10% above consensus.

We forecast a 5% increase in thermal coal prices by end-2013 from the current level, in line with the average of the same period in 2010-2012, supported by recovering thermal power generation, lower inventory at power plants, and maintenance on China’s largest coal railway. During 2014, we assume a 5.5% YoY increase in coal sales volumes mainly due to higher coal production (+4% YoY), a 3% YoY increase in unit costs, and a 5% YoY increase in the coal price.

Our valuation is based on the one-year forward (2014) PBR/ROE. Our target price of HKD5.50 is based on 0.6x PBR, which is in line with the current market multiple, and appears consistent with the discount commensurate with the ROE vs. the required return. On EV/EBITDA, the valuation is 7.8x, a bit high vs. its peers given its low profit margin, indicating to us that the rally in the shares is nearing an end, unless coal prices move materially higher than our forecast.

China Coal – Summary Earnings Table FYE Dec (CNYm) 2012A 2013A 2014F 2015FRevenue 87,292 80,097 87,399 93,013 EBITDA 17,414 14,349 15,806 17,388 Recurring Net Profit 8,842 5,491 5,855 6,149 Recurring Basic EPS (CNY) 0.67 0.41 0.44 0.46 EPS growth (%) (11.2) (37.9) 6.6 5.0 DPS (CNY) 0.21 0.12 0.13 0.14 PER (x) 6.1x 9.5x 8.8x 8.3xEV/EBITDA (x) 4.3x 7.2x 7.5x 7.4xDiv Yield (%) 4.2 2.5 2.7 2.8 P/BV (x) 0.6x 0.6x 0.5x 0.5x Net Gearing (%) 17.2 32.8 37.5 40.4 ROE (%) 8.9 5.3 5.4 5.5 ROA (%) 5.1 2.8 2.7 2.6 Consensus EPS (CNY) N.A. 0.39 0.39 0.47 Source: China Coal, Bloomberg Consensus, Maybank Kim Eng

Hold



Stock Information

Description: China Coal Energy Co. Ltd. (China Coal) mines and markets primarily thermal, but also coking coals. The company also manufactures coal mining equipment and offers coal mine design services. The company, which is 58.2% State held, is headquartered in Beijing, with principal operations located in Shanxi Province in northern China. During 2012, raw coal production totaled 145.4m tonnes,and sales of self-produced coal 111.1m tonnes, of which 98.6% was thermal coal. Ticker: 1898 HK Shares Issued (m): 13,259 Market Cap (USDm): 8,482 3-mth AvgDaily Turnover (USDm): 28.8 HSI: 23,371.5 Free Float (%): 41.8 Major Shareholders: % Blackrock 7.1 JP Morgan 6.6 Citigroup Inc. 4.8 Government of Singapore 4.4 Key Indicators (June 30, 2013)

ROE – annualised (%) 6.3 Net debt (Rmbm): 33,895 NTA/shr (HKD): 9.08 Interest cover (x): 6.9 Historical Chart

Performance: 52-week High/Low 9.04/3.66 1-mth 3-mth 6-mth 1-yr YTD Absolute (%) 13.0 (10.5) (37.2) (29.2) (45.4) Relative (%) 14.2 (7.0) (33.3) (38.9) (41.2)

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PRICE PRICE REL. TO HSI Index

Source: Bloomberg


China Coal Energy Company Limited

How do we justify our view on the shares?

We justify our view by a combination of factors, primarily our forecast for a mild increase in thermal coal prices (5% to year-end and 5% in 2014 YoY), the nearly full valuation, the lack of other growth drivers in the medium term, and the step-up in capex causing negative free cash flow and rising debt levels.

Overall, given our coal price forecast calling for a mid-single digit increase in 2014 YoY, we see the upside as limited, while the business risk is rising if the company spends as much as we have forecast. Based on our earnings forecasts, the valuation appears to offer limited upside longer term. Given the approaching seasonally strong period, we believe it is worth holding current positions to participate, before taking profits.

Figure 75: ROE and net profit and coal volume

Source: China Coal, Maybank Kim Eng estimates

Figure 76: Average realised coal selling price and unit costs

Source: China Coal,Maybank Kim Eng estimates

Looking beyond 2014, we have made some big assumptions on the coke/chemicals business, despite the lack of specific data points from management other than its expressed goal of shifting the focus from coal to coke/chemicals/energy. For example, our capex and profit margin assumptions are likely to change as the business plan is disclosed in more detail. We have kept our assumptions modest in terms of profitability because the segment has been loss making in all but two interim periods from 2H08 through 1H13.

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Source: China Coal, Maybank Kim Eng estimates

All in all, this company will continue to be driven by the coal segment and the ability of management to continue to raise productivity to stabilise returns if coal price volatility remains low on a historical basis, as we forecast.

Figure 78: Operating profit by business segment Figure 79: Capital spending by business segment

Source: China Coal, Maybank Kim Eng estimates Source: China Coal, Maybank Kim Eng estimates

Valuation

We have valued China Coal using PBR and ROE analysis because cash flows remain weak relative to debt levels to generate a meaningful DCF valuation. Our target price of HKD5.50 is based on 0.6x PBR on our 2014 estimates, which is in line with the current market multiple, and appears consistent with the discount commensurate with the ROE vs. the required return. Our forecast for the ROE is about 5.5% the next two years, which is slightly greater than half the required return. The graph below shows the relationship between China Coal’s ROE and PBR ratio on a one-year forward moving average basis.

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Figure 80: China Coal – ROE and PBR chart

Source: Bloomberg, China Coal, Maybank Kim Eng estimates

The PBR is low on a historical basis as well (see graph below), trading at a level similar to that during the GFC. However, our 2014 forecast compared to 2009 calls for EPS 20% lower and ROE about half.

Figure 81: China Coal – PBR bands

Source: Bloomberg, China Coal, Maybank Kim Eng estimates


Based on the table, it appears that the current share price is discounting a zero to 2% increase in the coal price YoY during 2014. As shown, China Coal has high operating leverage to coal prices and as a result, high earnings volatility. If the coal price exceeds our forecast, the shares will move higher, all other factors unchanged. The table below provides an estimate of the impact of the change of the coal price on the earnings, ROE and share price of China Coal. We have derived the share price using the ratio of the ROE to the required return on capital of 9% times the book value.

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While the PBR is low on a historical basis,

profitability is forecast to be worse in 2014 than

during the GFC (2009).

A discount to PBR is justified given the outlook

for profitability (ROE) to remain low.



Figure 82: China Coal – sensitivity table on 2014 EPS (CNY/sh). Changes YoY Coal price(% chg. YoY) EPS (Rmb) ROE (%) Share Price (HKD)

-10.0 0.16 2.0 1.98 -5.0 0.26 3.2 3.13 -2.5 0.30 3.8 3.72 0.0 0.35 4.3 4.32

+2.5 0.40 4.9 4.92 +5.0 0.44 5.4 5.50

+10.0 0.54 6.6 6.74 +20.0 0.72 8.7 9.20

Source: Kim Eng estimates. The share price is generated using the ratio of ROE to the required return times the book value.

Earnings revisions

The momentum in the consensus earnings for China Coal continued to decrease the past month since the company reported a weak interim results, albeit at a slower rate than earlier. The upturn in the share price implies the market sees the earnings stabilising based on the interpretation of recent positive macro-economic data.

We have indicated earlier in our analysis of the coal market that the macro trend turned a corner earlier this year but the coal price continued to remain weak, reflecting ample supply and de-stocking. Projecting the trend would indicate some level of re-stocking in a couple of months by power producers, which we think is largely priced into the shares.

The recent very strong electricity data may be a result of the summer heat wave or a shift higher in sustaining demand. We will know more over the next month or two. Our forecast calls for an improving but historically slower rate of consumption growth and for supply to remain adequate to meet demand compared to the surplus earlier this year. If aluminum output is any guide, China is an electricity intensive economy and more coal supply will be needed ahead.

Figure 83: Consensus forecast for China Coal’s earnings in 2013 and 2014


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INCOME STATEMENT BALANCE SHEET FYE Dec (CNYm) 2012A 2013A 2014F 2015F

FYE Dec (CNYm) 2012A 2013A 2014F 2015F

Revenue 87,292 80,097 87,399 93,013 Cash & equivalents 13,901 6,216 6,745 6,120 COGS (65,291) (61,728) (67,223) (70,974) Time and restricted deposits 9,471 8,650 8,650 8,650 Gross Profit 22,000 18,369 20,176 22,039 Inventories 6,697 7,527 7,909 8,481 SG&A (4,586) (4,020) (4,370) (4,651) Accounts receivable 11,394 12,704 11,160 12,177 EBITDA 17,414 14,349 15,806 17,388 Other 7,918 8,649 9,197 9,862 DD&A (4,697) (5,671) (6,750) (7,750) Total current assets 49,381 43,746 43,661 45,289 Operating profit (EBIT) 12,717 8,679 9,056 9,638 PPE 85,510 108,200 126,594 139,689 Other income (loss) (32) 34 67 71 Mining and land use rights 32,479 33,000 33,000 33,000 Net financing cost (254) (419) (700) (850) Other non-current assets 18,317 23,903 23,577 27,813 Associates 236 250 250 250 Total non-current assets 136,306 165,103 183,171 200,502 Other gains (losses) 122 16 0 0 Total Assets 185,688 208,849 226,832 245,791 Pre-tax profit 12,789 8,560 8,673 9,109 S. term borrowings & current 6,541 7,900 7,900 7,900 Income tax (3,214) (2,141) (2,168) (2,277) Accounts and bills payable 16,102 16,936 15,160 14,843 Minority interests (733) (928) (651) (683) Other current liabilities 11,483 10,199 10,677 11,392 Net Profit 8,842 5,491 5,855 6,149 Total current liabilities 34,126 35,035 33,736 34,134 EPS 0.67 0.41 0.44 0.46 Long term borrowings 40,077 60,447 75,447 86,447 Div/sh 0.21 0.12 0.13 0.14 Other non-current liabilities 10,064 7,500 7,500 10,594 Avg. shares out. 13,259 13,259 13,259 13,259 Total non-current liabilities 50,141 67,947 82,947 97,041 Total liabilities 84,267 102,982 116,683 131,175 Minority interests 14,694 15,750 15,750 15,750 Share capital 13,259 13,259 13,259 13,259 Reserves (incl. ret. earnings) 73,468 76,858 81,141 85,608 Shareholders' Equity 86,726 90,117 94,399 98,866 Revenue Growth % (3.9) (8.2) 9.1 6.4 Total Liabilities & Sh. Equity 185,688 208,849 226,832 245,791 EBITDA Growth (%) (7.3) (17.6) 10.2 10.0 EBIT Growth (%) (9.5) (31.8) 4.3 6.4 Gross Debt/(Cash) 46,619 68,347 83,347 94,347 Net Profit Growth (%) (11.2) (37.9) 6.6 5.0 Net Debt/(Cash) 32,718 62,131 76,602 88,227 Tax Rate % 25.1 25.0 25.0 25.0 Working Capital 15,255 8,711 9,925 11,155

CASH FLOW RATES & RATIOS

FYE Dec (CNYm) 2012A 2013A 2014F 2015F FYE Dec 2012A 2013A 2014F 2015F Profit before taxation 12,789 8,541 8,673 9,109

EBITDA Margin % 19.9 17.9 18.1 18.7 Depreciation 4,697 5,671 6,750 7,750 Op. Profit Margin % 14.6 10.8 10.4 10.4 Net interest expense 1,119 1,650 2,000 2,300 Net Profit Margin % 10.1 6.9 6.7 6.6 Working capital change (2,082) (2,218) (685) (1,856) ROE % 103.2 90.6 94.7 96.3 Cash tax paid (3,502) (2,141) (2,168) (2,277) ROA % 50.2 40.6 40.1 39.4 Others (incl. int. paid) (2,133) (593) (2,250) (2,550) Dividend Cover (x) 4.6 5.3 5.2 5.2 Cash flow from operations 10,888 10,910 12,320 12,476 Interest Cover (x) 50.1 20.7 12.9 11.3 Capex (24,934) (32,889) (25,144) (20,845) Asset Turnover (x) 0.5 0.4 0.4 0.4 Disposal/(purchase) (4,067) 0 0 0 Asset / Equity (x) 2.1 2.3 2.4 2.5 Others (2,889) (1,921) 0 0 Asset/Debt (x) 4.0 3.1 2.7 2.6 Cash flow from investing (31,889) (34,810) (25,144) (20,845) Receivables Turn (days) 40.6 54.9 49.8 45.8 Debt raised/(repaid) 12,272 19,000 15,000 9,500 Payables Turn (days) 75.8 97.7 87.1 77.1 Equity raised/(repaid) 0 0 0 0 Inventory Turn (days) 39.2 42.1 41.9 42.1 Dividends (paid) (3,157) (2,784) (1,647) (1,756) Net Gearing % 27.4 40.8 44.8 47.2 Others (incl. int. paid) 4,196 0 0 0 Gross Debt/ EBITDA (x) 2.7 4.8 5.3 5.4 Cash flow from financing 13,311 16,216 13,353 7,744 Gross Debt/ Market Cap (x) 0.9 1.3 1.6 1.8 Change in cash (7,691) (7,685) 529 (626) PER SHARE DATA

FYE Dec (CNY) 2012A 2013A 2014F 2015F

EPS 0.67 0.41 0.44 0.46 EBITDA/share 1.31 1.08 1.19 1.31 DPS 0.21 0.12 0.13 0.14 Oper. CFPS 0.82 0.82 0.93 0.94 Free CFPS (1.30) (1.87) (1.09) (0.76) BVPS 6.54 6.80 7.12 7.46

Source: China Coal, Maybank Kim Eng



Jiangxi Copper Ride The Copper Price One Last Time

We initiate coverage of Jiangxi with a BUY rating based on our forecast recovery in the copper price over the next six months on improving global demand growth and rising Chinese imports. We forecast EPS to improve from the trough in 1H13 on rising copper prices and metals sales volumes through mid-2014 with full-year 2014 EPS up 19% YoY. We see this as a trading call given our forecast copper price peak in mid-2014 after which supply overtakes demand.

The near-term earnings trend to remain weak, which could later provide an even more attractive entry point. Jiangxi’s 1H13 earnings were weak, down 49% YoY due to lower metals prices and higher raw material costs. The company has warned to expect more of the same in its nine-month results due next month. While our 2013 EPS is below consensus, our 2H13 EPS estimate is up from the 1H13 trough. Our 2014 EPS estimate is in line with consensus, while 2015 is below.

Improving financial flexibility on healthy cash flows and low/negative net debt. Rising cash flows are forecast to drive the company to a net cash position during mid-2014, which should allow for increasing capex to pursue growth initiatives. Jiangxi has a couple of overseas copper projects (Peru and Afghanistan). When more details are provided, we will incorporate them into our model.

Our valuation methodology utilises DCF, to which we apply a premium based on our forecast peak in the copper price above our long-term assumption. Our target price of HKD20/sh is based on a 25% premium to our DCF value of HKD16/sh, reflecting a mid-2014 LME copper price peak of USD8,157/t (USD3.80/lb) compared to our long-term forecast of USD5,842/t (USD2.65/lb). The EPS run rate at our peak copper price is CNY1.22 vs. our 2014 estimate of CNY0.98. Using the current PER of 13x, the peak EPS equals our target of HKD20.

Jiangxi Copper–Summary Earnings Table FYE Dec (CNYm) 2012A 2013A 2014F 2015FRevenue 158,006 180,389 190,047 165,965 EBITDA 6,924 5,157 5,821 5,249 Recurring Net Profit 5,170 2,861 3,402 2,991 Recurring Basic EPS (CNY) 1.49 0.83 0.98 0.86 EPS growth (%) (21.5) (44.7) 18.9 (12.1)DPS (CNY) 0.50 0.12 0.15 0.13 PER (x) 8.8x 15.6x 13.0x 14.5xEV/EBITDA (x) 6.9x 9.0x 7.3x 6.8xDiv Yield (%) 3.1 0.8 0.9 0.8 P/BV (x) 1.1x 1.0x 0.9x 0.9x Net Gearing (%) 4.5 3.7 Net cash Net cashROE (%) 12.6 6.6 7.4 6.2 ROA (%) 7.1 3.5 3.9 3.4 Consensus EPS (CNY) 2.66 0.90 0.99 1.00 Source: Jiangxi Copper, Bloomberg Consensus, Maybank Kim Eng

Buy



Stock Information

Description: Jiangxi Copper Company Limited (Jiangxi) is China's largest copper producer with business activities mainly in the PRC and headquarters in Jiangxi Province. Its ADR shares are listed in New York (JIXAY), and its ordinary shares on the main stock exchanges in Hong Kong and Shanghai. Jiangxi Copper Corp, a Chinese SOE, owns 40.4% of Jiangxi. Jiangxi and its subsidiaries are engaged in copper mining, smelting, refining, and manufacturing, with byproduct output from copper smelting of precious metals and sulphur. It also produces rare earth metals and chemical products. Ticker: 358 HK Shares Issued (m): 3,463 Market Cap (USDm): 7,227 3-mth AvgDaily Turnover (USDm): 29.1 HSI: 23,371.5 Free Float (%): 59.6 Major Shareholders: % Blackrock 6.8 JP Morgan 4.6 Vanguard 2.9 Franklin Resources 2.5 Key Indicators (June 30, 2013)


Performance: 52-week High/Low 21.95/11.52 1-mth 3-mth 6-mth 1-yr YTD Absolute (%) 14.4 (0.5) (18.1) (11.8) (26.1) Relative (%) 15.6 2.9 (14.3) (21.5) (21.9)

0.0

5.0

10.0

15.0

20.0

25.0



Source: Bloomberg


Jiangxi Copper Company Limited

How do we justify our view?

Our BUY rating is predicated on a recovery in the copper price during the seasonally strong periods of 2Q and 3Q of 2014. Jiangxi’s share price is highly correlated with the price, as shown in the graph below. Depicted is our monthly copper price forecast through end-2014 and the expected trend in the share price to our HKD20 target. The share price has underperformed vs. the copper price since earlier this year, reflecting cautious market sentiment on global growth (copper price expected to fall rather than share price rise).

We discussed the copper market in detail earlier in this report and how the growth rate in Chinese apparent copper consumption has exceeded our expectation. The risk to our call is that China effectively re-stocks during 2H13 and “borrows” demand growth from our estimate for 2014. However, we see the copper price moving more on headline macro growth fundamentals, which we see as increasingly positive, while US monetary policy remains accommodative.

Figure 84: Jiangxi Copper share price and LME copper price highly correlated

Source: Bloomberg, Maybank Kim Eng estimates

Our longer-term forecast of LME and Shanghai copper prices is illustrated in the graph below. The copper price in Shanghai (ex-VAT) increased relative to the LME price during 2011, reflecting strong demand growth in China relative to that outside the country. We look for the gap to slightly narrow starting in 2015 as demand growth in China slows on a relative basis.

Figure 85: Copper price history and forecast – LME vs Shanghai (ex. 17% VAT)

Source: Jiangxi Copper, Maybank Kim Eng estimates

Profit outlook forecast to improve on higher prices and sales volumes. Our forecast 19% YoY increase in 2014 profits (CNY3.40b vs. CNY2.86b) is based on a 5% increase in the Shanghai copper price, 3% higher sales volumes and lower costs. Jiangxi mentioned in its interim results not only lower metals prices but

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USD/t HKD/sh Share price (LHS) LME copper price (RHS)

Estimate

5,941

4,412

6,441

7,551 6,801

6,315 6,595

5,700

6,776

5,213

7,435

8,744

7,776 7,468 7,810

6,735

3,000

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9,000

10,000

2008 2009 2010 2011 2012 2013E 2014E 2015E

USD/t LME copper price Shanghai copper price (excl. 17% VAT)

Jiangxi’s share price is highly correlated with the

copper price. We see room for the share price to

increase to catch up with the current and forecast

higher copper price.



also higher input costs. We believe this reflects the tightness in the supply of copper units (concentrate and scrap) during the early part of the year due to disruptions of copper mines and from tight scrap availability.

We look for the supply of the materials that Jiangxi feeds into its smelters (copper scrap and concentrate) to improve during 2014. We also look for tolling and refining rates to improve as the tightness in the copper concentrate market eases. Like most of China’s copper smelters, Jiangxi is long smelting, requiring that it purchase copper units in much greater quantities than it self-supplies from its own mines (copper concentrate).

This is shown in the graph below where copper cathode production from its smelters exceeds the copper concentrate production from its mines. Copper smelting offers lower but more stable returns than that from copper mining. Despite being long smelting capacity, Jiangxi’s earnings are mainly driven by the copper price and to a lesser extent the byproduct gold, other metals, and sulfur credits produced from the smelting of copper. Jiangxi is also China’s largest copper concentrate producer, though other Chinese companies with overseas growth projects are catching up (Chinalco Mining, 3668 HK, HKD1.11, Not Rated).



Looking longer term, we forecast modest volume growth of about 3% per year in Jiangxi’s copper smelting and mine production. A step-up to our assumptions would occur if the Galeno copper project were to come on-stream sometime during late 2014 or 2015. However, the project has repeatedly been pushed back and we refrain from adding it to our numbers until management provides more clarity on the volume and cost.

The only mention of the project in the company’s 2012 annual report is “the development plan for the mine is under demonstration”. We take this to mean that the project is in the test phase of development with construction largely completed. The Galeno project is jointly controlled – 40% share each with China Minmetals Non-ferrous Metals Company Limited – through the 100% equity interest in Northern Peru Copper Corp. The value of the investment is shown in Jiangxi’s annual report at CNY3.25b (USD533m).

Free cash flow has been consistently positive reflecting the favourable copper price the past few years. We look for free cash flow to remain stable in 2014 and improve in 2015, mainly as working capital turns positive to CNY2.4b vs. a negative CNY1.0b during 2014. This reflects our forecast decrease in copper prices during 2015, which will result in lower inventory valuation and sales values. As mentioned above, Jiangxi purchases large volumes of copper concentrate to feed its smelters, resulting in large swings in working capital related to movements in the copper price. We have left our capex forecast stable with prior periods at CNY2.0b (USD330m).

11.7% 10.9%

17.5% 17.9% 12.6%

6.6% 7.4% 6.1%

CNY 2.3bn 2.4bn

5.0bn 6.6bn

5.2bn

2.9bn 3.4bn 3.0bn

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ROE in %;Net Profit in CNY bProduction, '000 t

Copper concentrate productionCopper cathode productionROE

We look for net profit to increase during 2014 on

higher metals prices and sales volumes, as well as

lower input costs of copper units.





Valuation

Our valuation methodology utilizes DCF, to which we apply a premium based on our forecast peak in the copper price above our long-term assumption. Our target price of HKD20/sh is based on a 25% premium to our DCF value of HKD16/sh, reflecting a mid-2014 LME copper price peak of USD8,157/t (USD3.80/lb) compared to our long-term forecast of USD5,842/t (USD2.65/lb).

Our DCF assumptions include a WACC of 11.25% and long-term growth rate of 4.25%, a bit higher than we normally use to make up for the lack of our forecasts including Jiangxi’s overseas growth projects. The EPS run rate at our peak copper price would be about CNY1.22 vs. our 2014 estimate of CNY0.98. Using the current PER of 13x, the peak EPS would equal our target of HKD20.

We illustrate in the graph below Jiangxi’s one-year forward rolling PBR and ROE. Based on our 2014 estimates, the shares are currently trading equal to book value and at an ROE of 7.2% rolling towards our 2014 full-year estimate of 7.4%. The ROE high of 37% in 2006 was due to the impact on net profit of a doubling in the copper price YoY to USD3.02/lb while book value was quite low. Our target price of HKD20/sh represents a PBR of 1.1x, compared to the current 1.0x the book value of HKD17.50/sh we forecast for year-end 2014.

Figure 88: Jiangxi Copper – ROE and PBR chart

Source: Bloomberg, Jiangxi Copper, Maybank Kim Eng estimates

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2008 2009 2010 2011 2012 2013E 2014E 2015E

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OCF excl. chg. WC CAPEX Working Capital (WC)

Dividends Free Cash Flow

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Jiangxi’s shares are trading at the book value

of its assets. Our target price assumes this will

increase to 1.1x.

Cash flow generation has been healthy and stable

since 2011 despite continual buildup of

working capital. As metals prices decrease in 2015,

we look for cash flows to improve as the working

capital requirement decreases despite lower profitability.



Jiangxi’s PBR (one-year forward rolling average) is close to the average for the period post the 2008 peak, and well above the trough of 0.4x in Aug 2008. We forecast the company’s net profit in 2013 to be about 24% higher than in 2008 and 2009, but our ROE estimate is 6.6%, which is well below the 11.7% in 2008 and 10.9% in 2009. Either the market is fixated on the level of earnings rather than that relative to the book value, or the stock price is overreaching. We continue to believe that the copper price drives the share price, but are mindful that the shares will be vulnerable to a sharp correction once copper prices peak.

Figure 89: Jiangxi Copper PBR bands

Source: Bloomberg, Jiangxi Copper, Maybank Kim Eng estimates


In the table below, we have provided a sensitivity analysis with various copper price scenarios and the impact on Jiangxi’s EPS, ROE, EBITDA and hypothetical share price at various PERs. Based on our estimates, the share price appears to be already factoring in a copper price of USD3.50/lb, which is higher than the current market price of USD3.35/lb. In the course of a few weeks from early September, the market has gone from factoring in the current copper price at that time of about USD3.25/lb to factoring in the higher than current price of USD3.50/lb.

This tells us that it will take a higher copper price of USD3.80/lb for the shares to move to our target price. In addition, as the copper price moves higher than USD3.80/lb, the market will increasingly anticipate the peak in EPS based on even higher copper prices and apply a lower PER. Our table factors this in as best as we can estimate for both the upside (PER compression) and the downside in EPS at lower copper price (PER expansion).

We note that Jiangxi’s cost structure appears to have moved materially higher from as recently as 2011, given the higher copper price necessary to generate a similar earnings level based on our estimates. We noted this in our discussion of ROE vs. prior periods as well. This also indicates that the stock will face a hard correction after copper prices peak unless management can restore the level of earnings relative to the copper price from a few years ago.

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0.9x Avg-1SD

The PBR has recovered vs. the GFC low but the ROE

was higher in 2008 and 2009 than in 2013F. We take this to mean either the market is fixated on

PER or the shares will be vulnerable to a sharp

correction once copper prices peak.



Figure 90: Jiangxi Copper 2014 earnings sensitivity to changes in copper price Copper (USD/lb) EPS (Rmb/sh) ROE (%) EBITDA (bn) Shpr (HKD) PER

2.60 (0.28) (2.2) 0.3 3.34 N/A 2.80 0.14 1.1 2.1 5.47 30.0 3.00 0.48 3.7 3.6 10.18 16.5 3.20 0.74 5.6 4.8 13.29 14.0 3.50 0.98 7.4 5.8 16.33 13.0 3.80 1.22 9.1 6.9 20.00 12.8 4.00 1.48 10.9 8.0 22.75 12.0 4.20 1.82 13.3 9.5 24.47 10.5 4.40 2.24 16.1 11.3 27.24 9.5


Earnings revisions

Consensus earnings for 2013 and 2014 have been in a continuous downward trend, particularly after the company’s disappointing 2013 interim profit report. The share price is anticipating that EPS has troughed and will recover on higher copper prices along the lines of what we discussed in the previous section. Our 2013 EPS forecast of CNY0.83/sh is below the consensus of CNY0.90/sh, in line for 2014 at CNY0.98/sh vs. consensus CNY0.99/sh.

Figure 91: Consensus forecasts for Jiangxi’s earnings in 2013 and 2014


0.60.81.01.21.41.61.82.02.22.42.6

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CNYHKD

Share Price (LHS)Consensus EPS adjusted 2013 (RHS)Consensus EPS adjusted 2014 (RHS)



Global metals company valuation graphs

In this section we provide graphs of global metals companies for comparison to those in China (Jiangxi and Chalco).

Figure 92: Global metals company market capitalisation (USDm)


Figure 93: Global metals company EV/EBITDA (x) 2014 Figure 94: Global metals company PBR (x) 2014


1639

177335

480 637 737 883937 9261,2351,3031,3331,3361,355

2,4332,7412,7823,026

3,3173,197

3,3663,506

4,448

4,598

4,876

4,7605,137

5,658

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8,4868,479

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9,43212,149

13,338

13,43715,856

18,63123,927

34,087

35,15335,505

72,28083,122

95,905

173,192

020,00040,00060,00080,000

100,000120,000140,000160,000180,000200,000

2.02.12.1

2.93.3

4.95.05.15.45.45.45.86.06.16.26.36.36.1

6.96.76.96.86.96.96.97.37.37.37.47.68.07.98.2

8.89.79.710.2

10.911.912.3

15.215.716.0

20.8

0 5 10 15 20 25

Sesa GoaChina Vanadium Titano

African MineralsHongqiao

Sterlite Inds.Vedanta

Energy Resource AustraliaVale (Brazil)

Freeport McMoRanAnglo American

AntofagastaRio Tinto

Paladin EnergyPan Aust

Korea ZincBarrick Gold

Teck ResourcesBuenaventura

PT IncoBHP Billiton

MinmetalAlcoa

Nickel AsiaAneka Tambang

HindalcoGlencore XstrataFortescue Metals

Cliffs Natural Res.Norsk Hydro

LynasIluka

PhilexLonmin

Jiangxi CopperMolycorp

Zhaojin MiningZijin Mining

Lingbao GoldAnglo American Platinum

Newcrest MiningUnited Co Rusal

China MolybdenumMitsubishi

Chalco

0.10.40.50.50.60.60.60.60.60.70.70.70.70.70.70.70.70.80.80.80.80.90.90.90.91.01.01.11.01.11.11.21.21.31.31.41.51.6

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3.76.1

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0

HarangaUnited Co Rusal

Sterlite Inds.China Vanadium Titano

Lingbao GoldHindalco

Paladin EnergyCliffs Natural Res.

MinmetalHongqiao

AlcoaSesa GoaMitsubishi

African MineralsGlencore Xstrata

Norsk HydroBuenaventura

ChalcoEnergy Resource Australia

Anglo AmericanLonmin

AluminaTeck Resources

Vale (Brazil)Jiangxi Copper

China MolybdenumMolycorp

Aneka TambangVedanta

Zijin MiningBarrick Gold

LynasPan Aust

Korea ZincPT Inco

Nickel AsiaPhilex

Freeport McMoRanZhaojin MiningNorilsk Nickel

AntofagastaAnglo American Platinum

Newcrest MiningRio Tinto

IlukaBHP Billiton

Fortescue Metals



Figure 95: Global metals company ROE (%) 2014 Figure 96: Global metals company dividend yield (%) 2014


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2.32.3

3.73.84.25.05.05.35.8

7.27.47.47.77.88.28.28.28.58.89.09.29.29.310.010.210.410.710.711.511.611.912.913.213.914.615.016.015.9

18.518.919.520.621.7

32.3

(20) (10) 0 10 20 30 40

Energy Resource AustraliaChalco

HarangaLingbao Gold

AluminaMolycorp

Norsk HydroAlcoa

Cliffs Natural Res.Lonmin

United Co RusalNewcrest MiningTeck Resources

HindalcoJiangxi Copper

Anglo AmericanAnglo American Platinum

Paladin EnergyBuenaventura

NalcoZijin Mining

PT IncoAneka Tambang

MitsubishiChina Molybdenum

Glencore XstrataPan Aust

China Vanadium TitanoPhilex

MinmetalZhaojin Mining

Sterlite Inds.Barrick GoldAntofagasta

VedantaKorea Zinc

Vale (Brazil)Sesa Goa

Freeport McMoRanNickel Asia

IlukaLynas

BHP BillitonAfrican Minerals

Rio TintoNorilsk Nickel

HongqiaoFortescue Metals

0.00.00.00.00.10.10.2

0.50.5

0.81.11.31.41.4

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2.01.9

2.22.32.42.62.72.72.6

3.02.82.83.13.03.13.13.23.23.23.43.53.73.83.93.9

4.34.44.64.8

9.110.3

0 2 4 6 8 10 12

MinmetalChalco

Energy Resource AustraliaUnited Co Rusal

Lingbao GoldAfrican MineralsPaladin Energy

LonminLynas

Newcrest MiningAnglo American Platinum

HindalcoSesa Goa

AlcoaBarrick Gold

Korea ZincPhilex

AluminaZhaojin MiningJiangxi Copper

AntofagastaAneka Tambang

Cliffs Natural Res.Sterlite Inds.

Hindustan ZincBuenaventura

Zijin MiningPT Inco

Teck ResourcesPan Aust

Glencore XstrataMitsubishi

Norsk HydroRio Tinto

NalcoAnglo American

VedantaFreeport McMoRan

BHP BillitonChina Molybdenum

IlukaChina Vanadium Titano

Fortescue MetalsVale (Brazil)Nickel Asia

HongqiaoNorilsk Nickel




FYE Dec (CNYm) 2012A 2013A 2014F 2015F

Revenue 158,006 180,389 190,047 165,965 Cash & equivalents 16,678 16,436 17,893 22,200 COGS (149,280) (173,326) (182,325) (159,056) Time and restricted deposits 3,631 6,500 6,500 6,500 Gross Profit 8,726 7,063 7,722 6,909 Inventories 15,936 12,999 13,674 11,929 SG&A (1,802) (1,906) (1,900) (1,660) Accounts receivable 14,156 20,294 21,380 18,671 EBITDA 6,924 5,157 5,821 5,249 Other 2,053 2,650 2,650 2,650 DD&A (1,290) (1,372) (1,402) (1,436) Total current assets 52,456 58,879 62,098 61,950 Operating profit (EBIT) 5,634 3,785 4,419 3,813 PPE 19,934 20,605 21,243 21,847 Other income (loss) 781 677 700 700 Intangible assets 817 800 800 800 Net financing cost (832) (950) (820) (733) Other non-current assets 4,881 4,913 3,779 3,779 Associates 9 7 (4) (4) Total non-current assets 25,632 26,318 25,822 26,426 Other gains (losses) 682 10 0 0 Total Assets 78,088 85,197 87,920 88,377 Pre-tax profit 6,273 3,530 4,295 3,777 S. term borrowings & current 12,417 14,000 14,000 14,000 Income tax (1,026) (707) (859) (755) Accounts and bills payable 11,647 15,599 16,409 14,315 Minority interests (78) 38 (34) (30) Other current liabilities 3,173 5,150 5,150 5,150 Net Profit 5,170 2,861 3,402 2,991 Total current liabilities 27,238 34,749 35,559 33,465 EPS 1.49 0.83 0.98 0.86 Long term borrowings 6,299 4,150 2,400 650 Div/sh 0.50 0.12 0.15 0.13 Other non-current liabilities 689 864 1,473 3,355 Avg. shares out. 3,463 3,463 3,463 3,463 Total non-current liabilities 6,988 5,014 3,873 4,005 Total liabilities 34,226 39,763 39,432 37,470 Minority interests 1,088 1,100 1,100 1,100 Share capital 3,463 3,463 3,463 3,463 Reserves (incl. ret. earnings) 39,312 40,871 43,925 46,344 Shareholders' Equity 42,775 44,334 47,388 49,807 Revenue Growth % 34.9 14.2 5.4 (12.7) Total Liabilities & Sh. Equity 78,088 85,197 87,920 88,377 EBITDA Growth (%) (20.0) (25.5) 12.9 (9.8) EBIT Growth (%) (24.5) (32.8) 16.8 (13.7) Gross Debt/(Cash) 18,716 18,150 16,400 14,650 Net Profit Growth (%) (21.5) (44.7) 18.9 (12.1) Net Debt/(Cash) 2,038 1,714 (1,493) (7,550) Tax Rate % 16.4 20.0 20.0 20.0 Working Capital 25,218 24,130 26,539 28,485


FYE Dec (CNYm) 2012A 2013A 2014F 2015F FYE Dec 2012A 2013A 2014F 2015F Profit before taxation 6,273 3,530 4,295 3,777

EBITDA Margin % 4.4 2.9 3.1 3.2 Depreciation 1,290 1,372 1,402 1,436 Op. Profit Margin % 3.6 2.1 2.3 2.3 Working capital change (1,290) 752 (952) 2,360 Net Profit Margin % 3.3 1.6 1.8 1.8 Cash tax paid (1,229) (707) (859) (755) ROE % 12.6 6.6 7.4 6.2 Others (incl. int. paid) 271 (109) 0 0 ROA % 7.1 3.5 3.9 3.4 Cash flow from operations 5,316 4,838 3,887 6,818 Dividend Cover (x) 3.3 8.8 8.7 8.5 Capex (2,154) (2,000) (2,000) (2,000) Interest Cover (x) 6.8 4.0 5.4 5.2 Disposal/(purchase) (2,158) (825) 0 0 Asset Turnover (x) 2.0 2.1 2.2 1.9 Others 3,613 (2,343) 0 0 Asset / Equity (x) 1.8 1.9 1.9 1.8 Cash flow from investing (700) (5,167) (2,000) (2,000) Asset/Debt (x) 4.2 4.7 5.4 6.0 Debt raised/(repaid) 3,052 1,315 0 0 Receivables Turn (days) 30.6 34.9 40.0 44.0 Equity raised/(repaid) 0 0 0 0 Payables Turn (days) 25.2 28.7 32.0 35.3 Dividends (paid) (1,731) (1,731) (429) (510) Inventory Turn (days) 36.7 30.5 26.7 29.4 Others (incl. int. paid) (253) 509 0 0 Net Gearing % 4.5 3.7 N.A. N.A. Cash flow from financing 1,067 93 (429) (510) Gross Debt/ EBITDA (x) 2.7 3.5 2.8 2.8 Change in cash 5,684 (237) 1,458 4,307 Gross Debt/ Market Cap (x) 0.4 0.4 0.4 0.3

PER SHARE DATA

FYE Dec (CNY) 2012A 2013A 2014F 2015F

EPS 1.49 0.83 0.98 0.86 EBITDA/share 2.00 1.49 1.68 1.52 DPS 0.50 0.12 0.15 0.13 Oper. CFPS 1.54 1.40 1.12 1.97 Free CFPS 0.41 0.32 0.42 1.24 BVPS 12.35 12.80 13.69 14.38

Source: Jiangxi Copper, Maybank Kim Eng



Chalco Speculative Buy On Aluminum Price Rise We initiate coverage of Chalco with a BUY rating, reflecting our view that the shares represent a low cost option on higher aluminum prices. We forecast a modest recovery in prices next year on the positive impact on market sentiment of Indonesia’s restrictions on bauxite exports from 2014, and as rising raw materials costs result in slowing aluminum supply growth from later in the year in China.

Management is making progress in improving the business. Aluminum costs fell 6% YoY in 1H13 and we look for further improvement as the aluminum business is resized to more profitable facilities. The company is also increasing self-owned energy and bauxite supplies (imported ores account for only 25% of Chalco’s total), and is constructing an alumina refinery with its JV partner in Indonesia.

Despite the improvements, the company will continue to face challenges even with higher forecast prices and lower costs. We forecast losses to decrease from CNY0.36/sh in 2013F (excl. gains) to CNY0.23/sh in 2014F. Borrowing will continue to be necessary to fund the business, assuming capex is largely flat with 2013. Our aluminum price forecast is below consensus (though the rating is non-consensus).

As an SOE, Chalco does not have the same bankruptcy risk as a private company. Nonetheless, the nature of this call makes it a Speculative Buy, suitable for only certain investors. The main risks are continued strong aluminum supply growth in China causing prices to remain low, and increasing funding costs given Chalco’s high gearing.

Our target price of HKD3.50/sh is based on a DCF valuation (WACC 12.3% and LT growth 2.75%) with 2017 our terminal year, and an LME aluminum price of USD0.95/lb (USD2,094/t). Our target price implies a PBR of 1.0x and EV/EBITDA of 10.0x our 2013 estimates vs. 0.8x and 8.1x currently. Chalco’s earnings are sensitive to changes in metals prices. Each USD0.01/lb change in aluminum (USD10/t change in alumina) impacts EPS by CNY0.027/sh (CNY0.032/sh).

Chalco – Summary Earnings Table FYE Dec (CNYm) 2012A 2013F 2014F 2015FRevenue 149,479 144,400 145,792 149,657 EBITDA 825 10,235 16,218 21,070 Recurring Net Profit (8,247) (4,865) (3,093) (1,285)Recurring Basic EPS (CNY) (0.61) (0.36) (0.23) (0.10)EPS growth (%) N.A. N.A. N.A. N.A.DPS (CNY) - - - - PER (x) N.A. N.A. N.A. N.A.EV/EBITDA (x) 151.0x 14.4x 9.4x 7.3xDiv Yield (%) - - - -P/BV (x) 0.7x 0.7x 0.8x 0.8x Net Gearing (%) 68.3 74.2 76.5 77.4 ROE (%) (17.2) (11.5) (7.9) (3.5)ROA (%) (5.0) (2.6) (1.5) (0.6)Consensus EPS (CNY) N.A. (0.27) (0.19) (0.09)Source: Chalco, Bloomberg Consensus, Maybank Kim Eng

Buy



Stock Information

Description: Aluminum Corporation of China Limited (Chalco) is the largest producer of aluminum in China. The company is owned 42% by Chinalco, an SOE, and is headquartered in Beijing, with business activities mainly in the PRC. Its ADR shares are listed in New York (ACH), and its ordinary shares on the main stock exchanges in Hong Kong and Shanghai. The company and its subsidiaries are engaged mainly in the aluminum industry with growing businesses in materials trading and energy. Ticker: 2600 HK Shares Issued (m): 13,524 Market Cap (USDm): 4,838 3-mth AvgDaily Turnover (USDm): 6.1 HSI: 23,371.5 Free Float (%): 55.3 Major Shareholders: % Franklin Resources 31.4 J.P. Morgan 4.7 Blackrock 3.5 Vanguard 3.0 Key Indicators (June 30, 2013)

ROE – annualised (%) (4.0) Net debt (Rmbm): 110,875 NTA/shr (HKD): 9.32 Interest cover (x): (0.3) Historical Chart

Performance: 52-week High/Low 4.21/2.20 1-mth 3-mth 6-mth 1-yr YTD Absolute (%) 5.7 (17.1) (20.9) (15.0) (26.5) Relative (%) 6.8 (13.7) (17.0) (24.7) (22.3)

0.00.51.01.52.02.53.03.54.04.55.0



Source: Bloomberg


Aluminum Corporation of China Limited


We see Chalco shares as a low cost option on higher aluminum prices. We forecast a modest recovery in prices next year on the positive impact on market sentiment of Indonesia’s restrictions on bauxite exports from 2014, and as rising raw materials costs result in slowing aluminum supply growth later in the year in China. We see this as a Speculative Buy recommendation based on the market impact of the changes to export policy in Indonesia.

Chalco is also making progress on addressing competitive weaknesses and to restore profitability medium-term. The impact of its initiatives will take time and as such, we are not long-term buyers of the stock given the challenges and in light of its stretched balance sheet. We will assess its progress as they develop but are keeping our expectations low evident in our earnings projections.

Chalco is making progress to address competitive weaknesses in energy, self-owned bauxite supply, and in the productivity of its plants. We forecast further improvement in productivity based on a resizing of its aluminum production facilities. Management has indicated that loss making plants will be suspended, merged, or the work transferred. We forecast a 5% decrease in aluminum unit operating costs in 2013 and a 3% decrease in 2014 YoY. The company is also increasing its energy exposure through purchasing coal and power plants. In January of this year Chalco purchased a 70.82% equity interest Ningxia Energy with 2.38 billion tonnes of coal and other power assets and is targeting further improvement in self-generated energy requirement from 21% now by 2015.

With respect to bauxite, the company has and continues to expand its self-owned supply, which is currently 50%. The sources of its bauxite and our forecast are shown in the graph below. During 2012, self-owned bauxite production was 17.3mt, up from 13mt in 2010, and should account for 50% of its total requirement by year-end 2013 on a run rate basis. We forecast the run rate of self-supply to increase to 65% at the end of 2014 and 72% at the end of 2015. The company is also diversifying its import sources, but given its increasing alumina capacity both domestic and in Indonesia, we anticipate its total bauxite requirement will decrease. Chalco’s exposure to imported bauxite is only 25%, and we forecast it to reach 14% by year-end 2014.

Figure 97: Chalco's sources of bauxite supply

Source: Chalco, Maybank Kim Eng estimates

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Chalco’s exposure to imported bauxite is only

25% and we forecast it to reach 14% by year-end

2014, and lower thereafter.

Chalco is making progress in adding more self-owned

energy, bauxite, and alumina supply both in

China and in Indonesia.

It is also building up its two new business units in

Energy and Trading to provide a more stable

earnings base. It has also sold its aluminum

fabrication business.

Our forecasts do not include the Simandou iron ore JV in Guinea with Rio

Tinto which has been delayed to 2018.



The push to develop bauxite and alumina capacity has taken on a new urgency with the situation in Indonesia. Chalco disclosed that new taxes on bauxite exports imposed by the Indonesian government caused its cost of alumina in2012 to increase by approximately 4% YoY. The table below provides the sources of Chalco’s bauxite and the costs during the interim periods of 2013, 2012 and 2011. Bauxite costs have increased about 10% on average per year (see table below).

Figure 98: Cost of bauxite

(CNY/t) 1H'13 1H'122013/12%

chg. 1H'112012/11%

chg.Self-operated mines 230 200 15 175 14Domestic purchased 290 280 4 270 4Imports 450 402 12 398 1Blended average 301 277 9 249 11Blended avg. (USD/t) 49 44 11 38 15Source: Chalco

In April this year Chalco acquired a 70% equity interest in PTNP, a company incorporated in Indonesia, which holds several bauxite exploration and development permits at a total cost of CNY32.5m (USD5.25m). The company is also collaborating with an Indonesian company in controlling bauxite resources and accelerated the development of mines and is targeting annual production capacity of 1.80mt.

Chalco is also accelerating the construction of a JV alumina refinery in West Kalimantan, Indonesia, which should be completed by the end of 2015. Total capacity is estimated at about 2mt per annum and we are awaiting further updates once construction begins. Chalco’s alumina cost increased about 10% during 2012 due to higher bauxite and consumables costs, but is expected to decrease 5% in 2013 due to lower energy and consumables costs. During 1H13, Chalco’s cash alumina cost was CNY2,173/t (USD353/t) according to the company.

Figure 99: China alumina price and Chalco's alumina cost


Chalco has made progress in lowering its cost of aluminum thanks to lower energy prices during 2013. During 1H13, its aluminum cash cost was CNY13,143/t (USD2,137/t), approximately 6% lower YoY. For the year as a whole, we forecast a 5% YoY decrease and a further 3% YoY decrease in 2015. The graph below compares the pricing trend in China for aluminum, which fell below Chalco’s costs and led to large losses in its aluminum division in 2012 and 2013. We look for a combination of higher selling prices and lower costs to gradually return the business to breakeven longer term.

A new JV in bauxite, and one in an alumina refinery in Indonesia by the end of

2014 to address supply constraints and rising

costs brought on by new export policies.



Figure 100: China’s aluminum price and Chalco's aluminum cost


Financials: Outlook for profitability and cash flows to improve

We look for Chalco’s profitability to improve the next few years from the trough in 2012 due to higher selling prices and lower operating costs. Our projections for profits, ROE, and sales volumes are all in the graph below. Our profit forecasts deduct non-recurring items, such as the CNY1.741b gain during 1H13. While improvement is evident the net profit remains in the red. Non-cash charges, mainly DD&A, remain high so EBITDA is actually relatively strong. We have forecast lower volumes of alumina and aluminum, reflecting management’s comments that it will rationalise the businesses to improve profitability. The projections are our own and could be subject to change when more details of the plan are disclosed.

Figure 101: ROE and net profit and aluminium/alumina volumes


The graph below details the improvements by business segment with the largest changes simply reducing the losses in aluminum and alumna, which we think can be accomplished by closing underperforming facilities. Business segment data prior to 2010 may be misleading when compared to more recent periods because of the changes in the businesses and changes in financial reporting.

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Stemming the losses in the aluminum business

will take time, but we think the worst from 2012

is in the past.

We have forecast lower metals sales volumes and

lower costs reflecting management targets to

rationalise the businesses to improve profitability.



Figure 102: Operating profit by business segment


Free cash flow is forecast to steadily improve the next few years on improving profitability (operating cash flows), and slightly lower capex. Free cash flow has been on a negative trend since 2010 due to falling profitability and volatile swings in working capital. During 1H13, the draw in working capital was a net negative CNY6.3b, mainly due to a negative CNY4.3b in accounts receivable and a negative CNY9.7b in other assets, partially offset by a positive CNY6.6b in accounts payable. We have assumed a net negative CNY6.6b for the full-year 2013.



(10,000)

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CNY b Aluminum Alumina Fabricated Products Energy Trading

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2008 2009 2010 2011 2012 2013E 2014E 2015E 2016E

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OCF excl. chg. WC CAPEX Working Capital (WC)Dividends Free Cash Flow

Weak operating profits and negative working capital have led to deteriorating

free cash flow. We forecast these measures to turn more favourable ahead.

We forecast business segment profits to improve as losses in aluminum and

alumina decrease and contributions from new

businesses increase.



Valuation

Our target price of HKD3.50/sh is based on a DCF valuation, assuming a WACC of 12.3%, long-term growth rate of 2.75% and 2017 as our terminal year in which we forecast an LME aluminum price of USD0.95/lb (USD2,094/t). Our target price implies a PBR of 1.0x and EV/EBITDA of 10.0x our 2013 estimates vs. 0.8x and 8.1x currently.

The PBR ratio has fallen in line with the ROE and is at the GFC low of 0.8x. The losses have also returned to the GFC low but improved from the blowout loss during 2012. The ROE is much lower (more negative) because the book value has decreased after the period of net losses forecast at a negative 11.5% vs. negative 8.4% during 2009.

We note that the valuation has remained stable at about 0.8-1.0x since late 2011 despite the significant losses over the following period. We believe the valuation fully reflects the negative sentiment and the poor earnings performance. Hence, we see some upside potential in the valuation back to book value on positive news, which we expect as a result of the changes we have forecast.

Figure 104: Chalco – PBR bands

Source: Bloomberg, Chalco, Maybank Kim Eng estimates

Figure 105: Chalco – ROE and P/BVPS chart

Source: Bloomberg, Chalco, Maybank Kim Eng estimates

The PBR and ROE trends are shown in the graph above on a one-year forward rolling basis. Our one-year forward forecast of ROE calls for it to improve from a negative 11.5% in 2013 (-17.2% in 2012) to a negative 7.9% in 2014. This is shown in the graph where the line is moving higher while the current PBR trend remains lower.

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The PBR valuation has been stable at 0.8-1.0x

since late 2011 despite the losses over the ensuing

period indicating that the negative factors are now factored into the shares.

We look for ROE trend to improve and the PBR to

follow on a lag basis.




The table below illustrates Chalco’s earnings sensitivity to changes in the aluminum price and indirectly the alumina price since our model links that latter to the former at a ratio of 17.5% in 2014. We also provide an estimate of the share price but have used book value since PER is not relevant due to the negative EPS. We have assumed the PBR remains at 1.0x though the shares should trade at a PBR discount at lower aluminum prices and a premium at higher prices which we conclude it does. Our estimate is shown bolded in the table.

The table indicates that the current share price is factoring in an aluminum price of between USD0.65-70/lb, which appears low compared to the current market price of USD0.80/lb. Looking at it another way, if we assume the market is using the current aluminum price of USD0.80/lb, then the shares are trading at a 15% discount to book value of HKD3.25/sh. If using the consensus forecast of USD0.92/lb, then the market is applying a 25% discount to book value.

Our view is that the market usually factors a materials price somewhere in between the spot price and consensus. This would imply that the market is discounting the shares by 20% and using an aluminum price of about USD0.85/lb, which is slightly below our forecast of USD0.88/lb on average for 2014. We believe that for the share price to achieve our target, the spot aluminum price needs to reach USD0.95/lb, which we forecast to occur during late 2014.

Figure 106: Chalco – 2014 earnings sensitivity to change in aluminum price Aluminum (USD/lb) EPS (Rmb/sh) ROE (%) EBITDA (bn) Shpr (HKD)* BV (Rmb/sh)

0.65 (0.98) (38.5) (8.9) 2.61 2.05 0.75 (0.64) (23.9) 2.3 3.03 2.38 0.80 (0.48) (17.2) 7.9 3.25 2.55 0.85 (0.31) (10.9) 13.4 3.45 2.71 0.88 (0.23) (7.9) 16.2 3.50 2.80 0.90 (0.15) (4.9) 19.0 3.67 2.88 0.95 0.02 0.7 24.6 3.89 3.05 1.00 0.19 6.0 30.2 4.09 3.21 1.10 0.52 15.8 41.3 4.52 3.55

Source: Maybank Kim Eng estimates. *Share price assumes shares trade at book value in HKD. We also have linked the alumina price to the aluminium price at a ratio of 17.5% for 2014. So the EPS changes include the change shown in the aluminium price and the change in alumina price.

Earnings revisions

The trend in earnings revisions has been downwards on a steel trajectory for both the 2013 and 2014 consensus EPS estimates. More recently, consensus EPS has turned higher for 2013 and 2014. This is a positive indicator and the shares are a bit off the lows as well. We are maintain our cautious outlook on 2014 EPS at a loss of CNY0.23/sh vs. the consensus of CNY0.19/sh, which is based on a higher aluminum price forecast than ours. We forecast the run rate of Chalco’s earnings to materially improve during 2H14 to the consensus figure as profitability is impacted by our forecast higher market prices.

We believe the market is factoring in an aluminum

price of USD0.85/lb, which is halfway between the current market price of

USD0.80/lb and the 2014 consensus.



Figure 107: Consensus forecasts for Chalco’s earnings in 2013 and 2014


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Share Price (LHS)Consensus EPS adjusted 2013 (RHS)Consensus EPS adjusted 2014 (RHS)




FYE Dec (CNYm) 2012A 2013A 2014F 2015F

Revenue 149,479 144,400 145,792 149,657 Cash & equivalents 9,219 9,382 9,441 8,858 Cost of sales (143,493) (134,894) (133,222) (134,543) Time and restricted deposits 1,128 543 543 543 Gross profit 5,985 9,506 12,570 15,115 Inventories 25,596 25,293 24,979 25,227 Selling & dist. exp. (1,968) (1,727) (1,750) (1,796) Accounts receivable 2,616 7,329 7,333 7,482 General & admin. (2,993) (2,576) (2,624) (2,694) Other 10,456 20,234 19,983 20,181 EBITDA 1,024 5,203 8,197 10,625 Total current assets 49,016 62,780 62,280 62,291 DD&A (6,309) (6,701) (7,040) (7,140) PPE 96,248 101,707 103,807 104,807 Research & dev. (199) (170) (175) (180) Intangible assets 4,260 10,700 10,700 10,700 Operating profit (EBIT) (5,484) (1,669) 982 3,305 Other non-current assets 25,493 28,874 28,734 28,594 Net financial expense (4,599) (4,931) (5,562) (5,647) Total non-current assets 126,001 141,280 143,240 144,100 Other income 744 750 750 750 Total Assets 175,017 204,060 205,520 206,391 Gains (losses) (45) 1,741 0 0 S. term borrowings & current 67,915 70,000 70,000 70,000 Associates 292 292 0 0 Accounts and bills payable 7,059 13,489 13,322 13,454 Pre-tax income (9,092) (3,817) (3,830) (1,592) Other current liabilities 8,879 9,443 9,326 9,418 Income tax 448 473 575 239 Total current liabilities 83,853 92,932 92,648 92,872 Profit from continuing ops. (8,644) (3,344) (3,256) (1,353) Long term borrowings 36,636 57,826 62,826 64,826 Profit from discontinued ops. 0 207 0 0 Other non-current liabilities 757 1,100 1,100 1,100 Minority interest (410) (174) (163) (68) Total non-current liabilities 37,392 58,926 63,926 65,926 Net to shareholders (8,234) (2,962) (3,093) (1,285) Total liabilities 121,246 151,858 156,573 158,798 Recurring net from cont. ops. (8,247) (4,865) (3,093) (1,285) Minority interests 9,963 11,287 11,124 11,056

Share capital 13,524 13,524 13,524 13,524 Revenue Growth % 2.5 (3.4) 1.0 2.7 Reserves (incl. ret. earnings) 30,283 27,391 24,298 23,013 EBITDA Growth (%) (88.8) 407.8 57.6 29.6 Shareholders' Equity 43,808 40,916 37,822 36,537 EBIT Growth (%) (274.5) (69.6) (158.8) 236.7 Total Liabilities & Sh. Equity 175,017 204,060 205,520 206,391 Net Profit Growth (%) (3,559.9) (64.0) 4.4 (58.4) Recurring Net Profit Growth (%) 1,793.3 (41.0) (36.4) (58.4) Gross Debt/(Cash) 104,551 127,826 132,826 134,826 Tax Rate % 4.9 12.4 15.0 15.0 Net Debt/(Cash) 95,331 118,444 123,384 125,968 Working Capital (34,837) (30,152) (30,368) (30,581)


FYE Dec (CNYm) 2012A 2013A 2014F 2015F FYE Dec 2012A 2013A 2014F 2015F Profit before taxation (9,092) (3,817) (3,830) (1,592)

EBITDA Margin % 0.7 3.6 5.6 7.1 Depreciation 6,309 6,701 7,040 7,140 Op. Profit Margin % (3.7) (1.2) 0.7 2.2 Net interest expense 4,864 4,931 5,562 5,647 Recurring Net Profit Margin % (5.5) (3.4) (2.1) (0.9) Working capital change (569) (6,567) 276 (370) ROE % (17.2) (11.5) (7.9) (3.5) Cash tax paid (171) 473 575 239 ROA % (5.0) (2.6) (1.5) (0.6) Others (incl. int. paid) (218) (2,261) (5,562) (5,647) Dividend Cover (x) N.A. N.A. N.A. N.A. Cash flow from operations 1,122 (539) 4,060 5,417 Interest Cover (x) (1.2) (0.3) 0.2 0.6 Capex (9,148) (9,000) (9,000) (8,000) Asset Turnover (x) 0.9 0.7 0.7 0.7 Disposal/(purchase) (13,477) (1,080) 0 0 Asset/Equity (x) 4.0 5.0 5.4 5.6 Others (9,676) (10,250) (9,000) (8,000) Asset/Debt (x) 1.7 1.6 1.5 1.5 Cash flow from investing (23,153) (11,331) (9,000) (8,000) Receivables Turn (days) 10.1 12.6 18.4 18.1 Debt raised/(repaid) 21,869 14,588 5,000 2,000 Payables Turn (days) 19.7 27.8 36.7 36.3 Equity raised/(repaid) 0 0 0 0 Inventory Turn (days) 63.2 68.8 68.9 68.1 Dividends (paid) (53) (43) 0 0 Net Gearing % 70.5 75.8 77.8 78.7 Others (incl. int. paid) (1,387) (2,594) 0 0 Gross Debt/ EBITDA (x) 102.1 24.6 16.2 12.7 Cash flow from financing 20,429 11,951 5,000 2,000 Gross Debt/ Market Cap (x) 3.5 4.3 4.5 4.6 Change in cash (1,602) 81 60 (583)

PER SHARE DATA

FYE Dec (CNY) 2012A 2013A 2014F 2015F Shares outstanding 13,524 13,524 13,524 13,524 Reported EPS (0.61) (0.22) (0.23) (0.10) Recurring EPS from cont. ops. (0.61) (0.36) (0.23) (0.10) DPS - - - - EBITDA/share 0.08 0.38 0.61 0.79 Oper. CFPS 0.08 (0.04) 0.30 0.40 Free CFPS (0.60) (0.71) (0.37) (0.19) BVPS 3.24 3.03 2.80 2.70

Source: Chalco, Maybank Kim Eng



Angang Steel Sell Before Fall And Buy In Spring We initiate coverage with a SELL rating based on our forecast for eroding profitability on lower steel prices through year-end 2013 and flat earnings in 2014 YoY. We see the unfolding industry trend as a repeat of prior ones, where modest industry profitability earlier in the year brings on excess supply later in the year eroding prices and margins.

The 1H13 profit improvement could prove illusory. Angang reported a profit in 1H13 after three consecutive HoH losses, boosted by higher selling prices and lower input costs, as well as an accounting change that lowered DD&A. We forecast 2H13 EPS to fall near breakeven based on lower profit margins due a 6% HoH fall in steel prices, eroding earlier cost gains, partially offset by higher sales volumes.

Profitability expected to stall in 2014. We look for flat 2014 EPS YoY (12% below consensus) as lower steel prices erode much of the decrease in input costs. We also note a decline in earnings quality as cash flows lag the profit trend after being boosted in 1H13 by a jump in payables. In 2015, we forecast rising profits as supply side discipline helps margins widen as prices for steel fall less than for raw materials.

Been here before, this time may be a bit different. Bold measures to close capacity have been announced in the past, but in the end have amounted to a few percent at most and been more than offset by new capacity additions. While new targets are more aggressive, we believe it will take a few years to have an impact. In the meantime, as industry profitability remains marginal, we believe steel prices will continue to chase raw material prices downhill while demand growth slows.

Our target price of HKD4.25 is based on a 10% discount to our DCF valuation (12.5% WACC and long-term growth 2.75%) due to the current weak ROE vs. our long-term assumption. Our target price implies 2014F PBR of 0.5x and EV/EBITDA of 4.5x, which appears generous compared to 2000 to mid-2003 when ROE was 2-3x higher.

Angang Steel – Summary Earnings Table FYE Dec (CNYm) 2012A 2012A 2014F 2015FRevenue 77,748 73,735 75,954 75,217 EBITDA 3,265 9,217 9,599 10,428 Recurring Net Profit (4,157) 1,026 1,093 1,709 Recurring Basic EPS (CNY) (0.57) 0.14 0.15 0.24 EPS growth (%) 93.7 N.A. 6.6 56.4 DPS (CNY) - - - 0.12 PER (x) N.A. 28.8x 26.6x 16.7xEV/EBITDA (x) 18.1x 5.1x 4.9x 4.4xDiv Yield (%) - - - 2.3 P/BV (x) 0.6x 0.6x 0.6x 0.6x Net Gearing (%) 38.3 26.6 26.8 25.7 ROE (%) (8.5) 2.2 2.3 3.5 ROA (%) (4.1) 1.0 1.2 1.8 Consensus EPS (CNY) N.A. 0.13 0.17 0.22 Source: Angang Steel, Bloomberg Consensus, Maybank Kim Eng

Sell



Stock Information

Description: Angang Steel Company Limited (Angang Steel) is one of China’s largest steel producers and is based in Anshan in in northeast China. The company mainly produces flat rolled steel, such as hot-rolled sheets, cold-rolled sheets, galvanized steel sheets, color-coated plates, silicon steel and medium plates, as well as wire rods and steel pipes. Its products are widely used in industries such as automobile, construction, ship-building, home electrical appliances, railway construction and the manufacture of pipelines. Ticker: 347 HK Shares Issued (m): 7,235 Market Cap (USDm): 4,731 3-mth AvgDaily Turnover (USDm): 9.2 HSI: 23,371.5 Free Float (%): Major Shareholders: % Citigroup Inc. 5.2 J.P. Morgan 5.1 Government of Singapore 4.9 Wellington Management 4.8 Key Indicators (June 30, 2013)


Performance: 52-week High/Low 6.78/3.49 1-mth 3-mth 6-mth 1-yr YTD Absolute (%) 10.3 9.3 (3.6) 27.4 (14.8) Relative (%) 11.4 12.7 0.3 17.7 (10.6)

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Source: Bloomberg


Angang Steel Company Limited


Our main near-term concern is the weak trend in steel prices and the downside risk to profitability in 2H13. Looking to 2014, we believe that the level of profitability does not support a higher share price, and the trend in EPS could turn negative YoY vs. our flat assumption if steel prices or volumes disappoint. In addition, free cash flow is not improving as rapidly as reported net profit, implying the quality of earnings has decreased, partly due to the accounting change for depreciation (more below), but also the stretching out of payables, which during 1H13 helped fund a reduction in short-term debt and the working capital deficit.

Steel prices have fallen 3% in north China on average the past few weeks and the outlook for further decreases during the fourth quarter due to slowing demand and continued high steel production remains high. Specifically for Angang, we project EPS to decrease during the next two reporting periods (2H13F, 1H14F) relative to 1H13 EPS of CNY0.097/sh. If Angang’s product sales volumes do not increase 4% HoH to offset lower prices, 2H13F EPS could come in near breakeven, which is well below our and the consensus estimates.

In the graph below we have provided Angang’s operating profit/t of finished steel sales vs. the HoH change in unit costs and revenues. Operating profit has significantly decreased from the level in 2006 and 2007 because of a loss of pricing power due to slower demand growth and weak customer profitability. The steel industry and Angang’s losses reached a deep level in 2012 as steel prices fell faster than raw materials cost.

There is some cause for optimism as lower input costs and less volatility should help steel companies and their customers manage profit margins more effectively. However, pricing power remains weak and that is a function of industry overcapacity. Looking at Angang’s profit trend, our two main concerns are can the bump up in 1H13 be sustained, and if it is, then the level of future profitability appears uninspiring due to competitive pressures limiting profit margin expansion.

Figure 108: Angang – operating profit/t and changes in costs and revenues HoH

Source: Angang, Maybank Kim Eng estimates

The graph below shows Angang’s net profit and ROE vs. its crude steel production and finished steel sales volumes. Our steel production growth forecast is 1.5% in 2014 and 2.5% in 2015, while for finished steel sales it is 5% in 2014 and 2.5% in 2015 as Angang works down its inventory after sales weakened this year relative to plan. Angang has not altered its steel volume targets for 2013, at least not publically, so we have assumed a pickup in 2H13 after a weak 1H13. The stronger 2H vs. 1H sales is a typical pattern but this year 1H was a bit weaker relative to production than usual.

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We are concerned by the weak trend in steel prices

and the potential for the same in 2014 pushing our

estimates lower and further below consensus.

In addition, the quality of earnings appears to have

fallen as cash flows lag the recovery in 1H13 profit.

Working capital benefitted from a large increase in

payables in 1H13.




Source: Angang Steel, Maybank Kim Eng estimates

Despite our forecast for a YoY increase in pre-tax profit in 2014 (CNY1.4b vs. CNY1.1b), free cash flow is expected to decrease YoY. This is due to lower operating cash flow and the cash drain from working capital vs. the cash generation in 2013. Angang stretched its accounts payables during 1H13, which increased to CNY10.7b at the end of the period from CNY5.8b at end-2012. This was matched by a similar decrease in short-term debt to CNY9.99b from CNY15.1b. Angang’s balance sheet had become heavy on short-term debt, which was nearly double long-term debt of CNY8.4b at end-2012. The increase in payables also helped reduce the working capital deficit to CNY8b at end-Jun 2013 from CNY17bn at end-2012.


Source: Angang Steel, Maybank Kim Eng estimates

Valuation

Our target price of HKD4.25 is based on a 10% discount to our DCF valuation (12.5% WACC and long-term growth rate of 2.75%) due to the current weak ROE vs. our higher long-term assumption of 6.5%. Our target price implies 2014F PBR of 0.5x and EV/EBITDA of 4.5x, compared to the current value of 0.6x and 5.0x. The graph below shows Angang’s one-year forward rolling PBR and ROE.

The jump in ROE during Nov 2011 reflects the rolling in of our full-year 2013 ROE of 2.2% vs. the negative 8.5% in 2012. Historically, we have seen the PBR

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2.99bn 0.7bn 2.1bn (2.1bn)

(4.2bn)1.0bn 1.1bn 1.7bn

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An increase in payables boosted working capital during 1H13 allowing for

the pay down of short-term debt and funding of the working capital deficit.

We look for the volume of steel sales to outpace

steel production in 2014 to make up for the imbalance

during 2013 as steel demand remained

sluggish. We think Angang may miss its 2013 steel

volume targets.



improve slowly to changes in ROE that were sustained. For example, in 2000, ROE dipped to 5% and then improved over the subsequent two years to over 10% before the PBR followed rising to a high of 1.1x. We believe the current period is different in that the ROE has moved from negative to positive low single digits.

Assuming the improvement in ROE in 1H13 is sustained, the low level we forecast for 2014 of 2.3% and for that matter our optimistic 3.5% in 2015 support at most a PBR of 0.4-0.5x, similar to that during the period from 2000 to mid-2003. It appears the market will not allow the valuation to fall lower, such as to a level of 0.25x PBR unless there is a major economic downturn or earnings collapse, though this level would be more in line with the current ROE.

Figure 111: Angang Steel – ROE and PBR chart

Source: Bloomberg, Angang Steel, Maybank Kim Eng estimates

Figure 112: Angang Steel – PBR bands

Source: Bloomberg, Angang Steel, Maybank Kim Eng estimates


It is difficult to calculate a reasonable sensitivity analysis fixing one variable like steel price while leaving the input costs unchanged. This is because of the linkage between the two ever since the market moved to short term iron ore pricing vs. the previous one-year and then quarterly contract. It is more instructive to look at how earnings are impacted by changes in the profit margin. Suffice it to say that small changes in profit margin lead to large changes in absolute profits because the impact of prices and raw materials costs flow straight through to the bottom line. For example, our forecast 2014 net profit is CNY1.1b (CNY0.15/sh) and net margin is 1.4%. If we were to double our profit margin to 2.8%, Angang’s net profit would also double to CNY2.2b (CNY0.30/sh).

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The PBR bands may no longer be relevant

calculated over a period when the business was

generating a higher ROE.

The bounce in ROE reflects the improvement

from a negative 8.5%to the positive 2.3% we forecast

for 2014.

Despite the improvement, we see no reason why the PBR should be more than 0.4-0.5x equal to or lower

than what it was from 2000 to mid-2003 when the ROE

was significantly higher.



Earnings revisions

The consensus earnings for 2013 and 2014 have been moving sideways since earlier this year, which has helped put a floor under the share price valuation as we discussed earlier looking at the PBR. We see some scope for small downward revisions more in line with our 2014 estimate. Also, the quality of earnings implies that cash flows may not be as strong as the trend in earnings and further funding (debt) may be required, which would raise the interest expense and adversely impact net profit.

Figure 113: Consensus forecasts for Angang’s earnings in 2013 and 2014


Global steel company valuation graphs

In this section we provide graphs of global steel companies for comparison to those in China (Angang, Baosteel, Maanshan, Shougang and Wuhan).

Figure 114: Global steel companies – market capitalisation (USDm)


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462 557 9121,761 2,227

2,5562,884 2,9683,220

3,3463,4673,547

3,703 3,9173,9354,040 4,682

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Figure 115: Steel – EV/EBITDA (x) 2014 Figure 116: Steel – PBR (x) 2014


Figure 117: Steel – ROE (%) 2014 Figure 118: Steel – dividend yield (%) 2014


4.85.15.35.35.45.45.45.45.55.5

5.96.36.36.46.66.97.07.17.4

7.87.98.08.4

8.79.1

0 3 6 9 12 15

JSW SteelAngang

Steel AuthorityTata Steel

Thyssen Krupp (Germany)U.S. Steel

Severstal (Russia)Arcelor Mittal (Luxembourg)

Evraz (London)AK Steel

Jindal Steel & PowerWuhan

BaosteelSteel DynamicsHyundai Hysco

Bluescope SteelPOSCO

JFE HoldingMaanshan

NucorBhushan Steel

Kobe SteelAllengheny Technology

Nippon SteelDongkuk Steel

0.40.50.50.50.50.60.60.60.60.70.70.7

0.70.80.90.90.90.90.90.9

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Dongkuk SteelArcelor Mittal (Luxembourg)

ShougangSteel Authority

MaanshanAngang

Evraz (London)Baosteel

Bluescope SteelPOSCOWuhan

Hyundai SteelTata SteelJSW Steel

JFE HoldingU.S. Steel

Kobe SteelSeverstal (Russia)

Bhushan SteelJindal Steel & Power

Nippon SteelChina Steel

Allengheny TechnologySteel DynamicsHyundai Hysco

NucorThyssen Krupp (Germany)

-4.2-1.0

0.31.6

2.52.62.8

4.14.55.25.75.95.96.1

7.27.2

9.19.29.39.710.0

11.812.513.0

14.414.5

18.4

-6.0 0.0 6.0 12.0 18.0 24.0

ShougangDongkuk Steel

Evraz (London)Maanshan

AngangArcelor Mittal (Luxembourg)

WuhanU.S. Steel

Allengheny TechnologyBluescope Steel

Hyundai SteelPOSCO

China SteelSteel Authority

Kobe SteelBaosteel

Tata SteelJFE Holding

Severstal (Russia)Nippon Steel

JSW SteelSteel Dynamics

NucorBhushan Steel

Jindal Steel & PowerHyundai Hysco

Thyssen Krupp (Germany)

0.00.20.2

0.60.60.60.8

1.01.0

1.31.31.4

1.61.71.8

2.12.22.32.42.42.6

2.93.03.13.1

3.23.9

4.3

0 2 4 6

ShougangBhushan Steel

AK SteelHyundai HyscoHyundai Steel

Jindal Steel & PowerMaanshanU.S. Steel

Evraz (London)Kobe Steel

AngangJSW Steel

Nippon SteelThyssen Krupp (Germany)

Arcelor Mittal (Luxembourg)JFE Holding

Severstal (Russia)Allengheny Technology

POSCOWuhan

Steel DynamicsNucor

Bluescope SteelChina Steel

Dongkuk SteelTata Steel

Steel AuthorityBaosteel




FYE Dec (CNYm) 2012A 2013A 2014F 2015F Revenue 77,748 73,735 75,954 75,217 Cash & equivalents 2,049 3,298 3,695 4,112 COGS (70,105) (59,775) (61,797) (60,276) Inventories 10,642 11,193 10,655 10,309 Gross Profit 7,643 13,960 14,157 14,941 Accounts receivable 2,247 1,841 1,869 1,862 SG&A (4,378) (4,743) (4,557) (4,513) Other 12,051 10,000 10,000 10,000 EBITDA 3,265 9,217 9,599 10,428 Total current assets 26,989 26,332 26,218 26,283 DD&A (5,692) (5,692) (5,635) (5,748) PPE 51,257 50,670 50,803 50,837 Operating profit (EBIT) (2,427) 3,525 3,964 4,680 Construction in progress 9,736 5,500 5,500 5,500 Net financing cost (1,846) (1,452) (1,536) (1,447) Intangible assets 6,677 6,500 6,500 6,500 Associates 412 511 500 500 Other non-current assets 6,578 5,600 5,601 5,601 Other gains (losses) (1,635) (1,530) (1,500) (1,500) Total non-current assets 74,248 68,270 68,403 68,439 Pre-tax profit (5,496) 1,055 1,428 2,234 Total Assets 101,237 94,602 94,621 94,722 Income tax 1,116 (50) (357) (558) S. term borrowings & current 15,130 10,000 10,000 10,000 Minority interests 223 20 22 34 Accounts and bills payable 5,821 9,877 8,324 7,249 Net Profit (4,157) 1,026 1,093 1,709 Other current liabilities 23,004 12,300 12,300 12,300 EPS (0.57) 0.14 0.15 0.24 Total current liabilities 43,955 32,177 30,624 29,549 Div/sh 0.00 0.00 0.00 0.12 Long term borrowings 8,364 9,203 10,203 10,203 Avg. shares out. 7,235 7,235 7,235 7,235 Other non-current liabilities 689 4,138 3,617 3,084 Total non-current liabilities 9,053 13,341 13,820 13,287

Total liabilities 53,008 45,518 44,444 42,835

Minority interests 1,631 1,650 1,650 1,650 Share capital 7,235 7,235 7,235 7,235 Reserves (incl. ret. earnings) 39,363 40,200 41,292 43,002

Shareholders' Equity 46,598 47,435 48,527 50,237 Revenue Growth % (14.0) (5.2) 3.0 (1.0) Total Liabilities & Sh. Equity 101,237 94,602 94,621 94,722 EBITDA Growth (%) (45.7) N.A. 4.1 8.6 EBIT Growth (%) 133.4 N.A. 12.5 18.1 Gross Debt/(Cash) 23,494 19,203 20,203 20,203 Net Profit Growth (%) 93.7 N.A. 6.6 56.4 Net Debt/(Cash) 21,445 15,905 16,508 16,091 Tax Rate % 20.3 4.7 25.0 25.0 Working Capital (16,966) (5,844) (4,406) (3,265)


FYE Dec (CNYm) 2012A 2013A 2014F 2015F FYE Dec 2012A 2013A 2014F 2015F Profit before taxation (5,496) 1,055 1,428 2,234

EBITDA Margin % 3.6 11.9 13.0 13.7 Depreciation 5,692 5,692 5,635 5,748 Op. Profit Margin % (2.7) 4.5 5.4 6.2 Working capital change (928) 3,910 (1,042) (723) Net Profit Margin % (4.6) 1.3 1.5 2.3 Cash tax paid 1,116 (50) (357) (558) ROE % (8.5) 2.2 2.3 3.5 Others (incl. int. paid) 1,069 2,513 (500) (500) ROA % (4.1) 1.0 1.2 1.8 Cash flow from operations 1,453 13,121 5,164 6,200 Dividend Cover (x) N.A. N.A. N.A. 5.5 Capex (2,918) (5,105) (5,768) (5,783) Interest Cover (x) (1.3) 2.4 2.6 3.2 Disposal/(purchase) (106) 0 0 0 Asset Turnover (x) 0.8 0.8 0.8 0.8 Others 272 2,714 0 0 Asset / Equity (x) 2.2 2.0 1.9 1.9 Cash flow from investing (2,752) (2,392) (5,768) (5,783) Asset/Debt (x) 4.3 4.9 4.7 4.7 Debt raised/(repaid) 3,005 (10,521) 1,000 0 Receivables Turn (days) 9.7 10.1 8.9 9.1 Equity raised/(repaid) 0 0 0 0 Payables Turn (days) 27.4 47.9 53.8 47.1 Dividends (paid) 0 0 0 0 Inventory Turn (days) 64.8 66.7 64.5 63.5 Others (incl. int. paid) (1,998) 1,041 0 0 Net Gearing % 33.5 28.8 29.4 28.7 Cash flow from financing 1,007 (9,480) 1,000 0 Gross Debt/ EBITDA (x) 7.2 2.1 2.1 1.9 Change in cash (292) 1,249 397 417 Gross Debt/ Market Cap (x) 0.8 0.7 0.7 0.7 PER SHARE DATA

FYE Dec (CNY) 2012A 2013A 2014F 2015F

EPS (0.57) 0.14 0.15 0.24 EBITDA/share 0.45 1.27 1.33 1.44 DPS 0.00 0.00 0.00 0.12 Oper. CFPS 0.20 1.81 0.71 0.86 Free CFPS (0.20) 1.11 (0.08) 0.06 BVPS 6.44 6.56 6.71 6.94

Source: Angang Steel, Maybank Kim Eng



RESEARCH OFFICES

REGIONAL WONG Chew Hann, CA Regional Head, Institutional Research (603) 2297 8686 [email protected]

Alexander GARTHOFF Institutional Product Manager (852) 2268 0638 [email protected]

ONG Seng Yeow Regional Head, Retail Research (65) 6432 1453 [email protected]

ECONOMICS Suhaimi ILIAS Chief Economist Singapore | Malaysia (603) 2297 8682 [email protected]

Luz LORENZO Philippines (63) 2 849 8836 [email protected]

Tim LEELAHAPHAN Thailand (662) 658 1420 [email protected]

JUNIMANChief Economist, BII Indonesia (62) 21 29228888 ext 29682 [email protected]

Josua PARDEDE Economist / Industry Analyst, BII Indonesia (62) 21 29228888 ext 29695 [email protected]

MALAYSIA WONG Chew Hann, CA Head of Research (603) 2297 8686 [email protected] Strategy Construction & Infrastructure Desmond CH’NG, ACA (603) 2297 8680 [email protected] Banking - Regional LIAW Thong Jung (603) 2297 8688 [email protected] Oil & Gas Automotive Shipping ONG Chee Ting, CA (603) 2297 8678 [email protected] Plantations- Regional Mohshin AZIZ (603) 2297 8692 [email protected] Aviation – Regional Petrochem YIN Shao Yang, CPA (603) 2297 8916 [email protected] Gaming – Regional Media TAN CHI WEI, CFA (603) 2297 8690 [email protected] Power Telcos WONG Wei Sum, CFA (603) 2297 8679 [email protected] Property & REITs LEE Yen Ling (603) 2297 8691 [email protected] Building Materials Manufacturing Technology

LEE Cheng Hooi Head of Retail [email protected] Technicals

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THAILAND Sukit UDOMSIRIKUL Head of Research (66) 2658 6300 ext 5090 [email protected]

Maria LAPIZ Head of Institutional Research Dir (66) 2257 0250 | (66) 2658 6300 ext 1399 [email protected] Consumer/ Big Caps

Mayuree CHOWVIKRAN (66) 2658 6300 ext 1440 [email protected] Strategy Padon Vannarat (66) 2658 6300 ext 1450 [email protected] Strategy Surachai PRAMUALCHAROENKIT (66) 2658 6300 ext 1470 [email protected] Auto Conmat Contractor Steel Suttatip PEERASUB (66) 2658 6300 ext 1430 [email protected] Media Commerce Sutthichai KUMWORACHAI (66) 2658 6300 ext 1400 [email protected] Energy Petrochem Termporn TANTIVIVAT (66) 2658 6300 ext 1520 [email protected] Property Woraphon WIROONSRI (66) 2658 6300 ext 1560 [email protected] Banking & Finance Jaroonpan WATTANAWONG (66) 2658 6300 ext 1404 [email protected] Transportation Small cap. Chatchai JINDARAT (66) 2658 6300 ext 1401 [email protected] Electronics

VIETNAM Michael KOKALARI, CFA Head of Research (84) 838 38 66 47 [email protected] Strategy Nguyen Thi Ngan Tuyen (84) 844 55 58 88 x 8081 [email protected] Food and Beverage Oil and Gas Hang Vu (84) 844 55 58 88 x 8087 [email protected] Banking Trinh Thi Ngoc Diep (84) 844 55 58 88 x 8242 [email protected] Technology Utilities Construction Dang Thi Kim Thoa (84) 844 55 58 88 x 8083 [email protected] Consumer Nguyen Trung Hoa +84 844 55 58 88 x 8088 [email protected] Steel Sugar Resources



APPENDIX I: TERMS FOR PROVISION OF REPORT, DISCLAIMERS AND DISCLOSURES

DISCLAIMERS

This research report is prepared for general circulation and for information purposes only and under no circumstances should it be considered or intended as an offer to sell or a solicitation of an offer to buy the securities referred to herein. Investors should note that values of such securities, if any, may fluctuate and that each security’s price or value may rise or fall. Opinions or recommendations contained herein are in form of technical ratings and fundamental ratings. Technical ratings may differ from fundamental ratings as technical valuations apply different methodologies and are purely based on price and volume-related information extracted from the relevant jurisdiction’s stock exchange in the equity analysis. Accordingly, investors’ returns may be less than the original sum invested. Past performance is not necessarily a guide to future performance. This report is not intended to provide personal investment advice and does not take into account the specific investment objectives, the financial situation and the particular needs of persons who may receive or read this report. Investors should therefore seek financial, legal and other advice regarding the appropriateness of investing in any securities or the investment strategies discussed or recommended in this report.

The information contained herein has been obtained from sources believed to be reliable but such sources have not been independently verified by Maybank Investment Bank Berhad, its subsidiary and affiliates (collectively, “MKE”) and consequently no representation is made as to the accuracy or completeness of this report by MKE and it should not be relied upon as such. Accordingly, MKE and its officers, directors, associates, connected parties and/or employees (collectively, “Representatives”) shall not be liable for any direct, indirect or consequential losses or damages that may arise from the use or reliance of this report. Any information, opinions or recommendations contained herein are subject to change at any time, without prior notice.

This report may contain forward looking statements which are often but not always identified by the use of words such as “anticipate”, “believe”, “estimate”, “intend”, “plan”, “expect”, “forecast”, “predict” and “project” and statements that an event or result “may”, “will”, “can”, “should”, “could” or “might” occur or be achieved and other similar expressions. Such forward looking statements are based on assumptions made and information currently available to us and are subject to certain risks and uncertainties that could cause the actual results to differ materially from those expressed in any forward looking statements. Readers are cautioned not to place undue relevance on these forward-looking statements. MKE expressly disclaims any obligation to update or revise any such forward looking statements to reflect new information, events or circumstances after the date of this publication or to reflect the occurrence of unanticipated events.

MKE and its officers, directors and employees, including persons involved in the preparation or issuance of this report, may, to the extent permitted by law, from time to time participate or invest in financing transactions with the issuer(s) of the securities mentioned in this report, perform services for or solicit business from such issuers, and/or have a position or holding, or other material interest, or effect transactions, in such securities or options thereon, or other investments related thereto. In addition, it may make markets in the securities mentioned in the material presented in this report. MKE may, to the extent permitted by law, act upon or use the information presented herein, or the research or analysis on which they are based, before the material is published. One or more directors, officers and/or employees of MKE may be a director of the issuers of the securities mentioned in this report.

This report is prepared for the use of MKE’s clients and may not be reproduced, altered in any way, transmitted to, copied or distributed to any other party in whole or in part in any form or manner without the prior express written consent of MKE and MKE and its Representatives accepts no liability whatsoever for the actions of third parties in this respect.

This report is not directed to or intended for distribution to or use by any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. This report is for distribution only under such circumstances as may be permitted by applicable law. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Without prejudice to the foregoing, the reader is to note that additional disclaimers, warnings or qualifications may apply based on geographical location of the person or entity receiving this report.

Malaysia

Opinions or recommendations contained herein are in the form of technical ratings and fundamental ratings. Technical ratings may differ from fundamental ratings as technical valuations apply different methodologies and are purely based on price and volume-related information extracted from Bursa Malaysia Securities Berhad in the equity analysis.

Singapore

This report has been produced as of the date hereof and the information herein may be subject to change. Maybank Kim Eng Research Pte. Ltd. (“Maybank KERPL”) in Singapore has no obligation to update such information for any recipient. For distribution in Singapore, recipients of this report are to contact Maybank KERPL in Singapore in respect of any matters arising from, or in connection with, this report. If the recipient of this report is not an accredited investor, expert investor or institutional investor (as defined under Section 4A of the Singapore Securities and Futures Act), Maybank KERPL shall be legally liable for the contents of this report, with such liability being limited to the extent (if any) as permitted by law.

Thailand

The disclosure of the survey result of the Thai Institute of Directors Association (“IOD”) regarding corporate governance is made pursuant to the policy of the Office of the Securities and Exchange Commission. The survey of the IOD is based on the information of a company listed on the Stock Exchange of Thailand and the market for Alternative Investment disclosed to the public and able to be accessed by a general public investor. The result, therefore, is from the perspective of a third party. It is not an evaluation of operation and is not based on inside information. The survey result is as of the date appearing in the Corporate Governance Report of Thai Listed Companies. As a result, the survey may be changed after that date. Maybank Kim Eng Securities (Thailand) Public Company Limited (“MBKET”) does not confirm nor certify the accuracy of such survey result.

Except as specifically permitted, no part of this presentation may be reproduced or distributed in any manner without the prior written permission of MBKET. MBKET accepts no liability whatsoever for the actions of third parties in this respect.

US

This research report prepared by MKE is distributed in the United States (“US”) to Major US Institutional Investors (as defined in Rule 15a-6 under the Securities Exchange Act of 1934, as amended) only by Maybank Kim Eng Securities USA Inc (“Maybank KESUSA”), a broker-dealer registered in the US (registered under Section 15 of the Securities Exchange Act of 1934, as amended). All responsibility for the distribution of this report by Maybank KESUSA in the US shall be borne by Maybank KESUSA. All resulting transactions by a US person or entity should be effected through a registered broker-dealer in the US. This report is not directed at you if MKE is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that Maybank KESUSA is permitted to provide research material concerning investments to you under relevant legislation and regulations.

UK

This document is being distributed by Maybank Kim Eng Securities (London) Ltd (“Maybank KESL”) which is authorized and regulated, by the Financial Services Authority and is for Informational Purposes only. This document is not intended for distribution to anyone defined as a Retail Client under the Financial Services and Markets Act 2000 within the UK. Any inclusion of a third party link is for the recipients convenience only, and that the firm does not take any responsibility for its comments or accuracy, and that access to such links is at the individuals own risk. Nothing in this report should be considered as constituting legal, accounting or tax advice, and that for accurate guidance recipients should consult with their own independent tax advisers.



DISCLOSURES Legal Entities Disclosures

Malaysia: This report is issued and distributed in Malaysia by Maybank Investment Bank Berhad (15938-H) which is a Participating Organization of Bursa Malaysia Berhad and a holder of Capital Markets and Services License issued by the Securities Commission in Malaysia. Singapore: This material is issued and distributed in Singapore by Maybank KERPL (Co. Reg No 197201256N) which is regulated by the Monetary Authority of Singapore. Indonesia: PT Kim Eng Securities (“PTKES”) (Reg. No. KEP-251/PM/1992) is a member of the Indonesia Stock Exchange and is regulated by the BAPEPAM LK. Thailand: MBKET (Reg. No.0107545000314) is a member of the Stock Exchange of Thailand and is regulated by the Ministry of Finance and the Securities and Exchange Commission. Philippines: Maybank ATRKES (Reg. No.01-2004-00019) is a member of the Philippines Stock Exchange and is regulated by the Securities and Exchange Commission. Vietnam: Maybank Kim Eng Securities JSC (License Number: 71/UBCK-GP) is licensed under the State Securities Commission of Vietnam. Hong Kong: KESHK (Central Entity No AAD284) is regulated by the Securities and Futures Commission. India: Kim Eng Securities India Private Limited (“KESI”) is a participant of the National Stock Exchange of India Limited (Reg No: INF/INB 231452435) and the Bombay Stock Exchange (Reg. No. INF/INB 011452431) and is regulated by Securities and Exchange Board of India. KESI is also registered with SEBI as Category 1 Merchant Banker (Reg. No. INM 000011708) US: Maybank KESUSA is a member of/ and is authorized and regulated by the FINRA – Broker ID 27861. UK: Maybank KESL (Reg No 2377538) is authorized and regulated by the Financial Services Authority.

Disclosure of Interest Malaysia: MKE and its Representatives may from time to time have positions or be materially interested in the securities referred to herein and may further act as market maker or may have assumed an underwriting commitment or deal with such securities and may also perform or seek to perform investment banking services, advisory and other services for or relating to those companies.

Singapore: As of 25 September 2013, Maybank KERPL and the covering analyst do not have any interest in any companies recommended in this research report.

Thailand: MBKET may have a business relationship with or may possibly be an issuer of derivative warrants on the securities /companies mentioned in the research report. Therefore, Investors should exercise their own judgment before making any investment decisions. MBKET, its associates, directors, connected parties and/or employees may from time to time have interests and/or underwriting commitments in the securities mentioned in this report.

Hong Kong: KESHK may have financial interests in relation to an issuer or a new listing applicant referred to as defined by the requirements under Paragraph 16.5(a) of the Hong Kong Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.

As of 25 September 2013, KESHK and the authoring analyst do not have any interest in any companies recommended in this research report.

MKE may have, within the last three years, served as manager or co-manager of a public offering of securities for, or currently may make a primary market in issues of, any or all of the entities mentioned in this report or may be providing, or have provided within the previous 12 months, significant advice or investment services in relation to the investment concerned or a related investment and may receive compensation for the services provided from the companies covered in this report.

OTHERS Analyst Certification of Independence

The views expressed in this research report accurately reflect the analyst’s personal views about any and all of the subject securities or issuers; and no part of the research analyst’s compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in the report.

Reminder

Structured securities are complex instruments, typically involve a high degree of risk and are intended for sale only to sophisticated investors who are capable of understanding and assuming the risks involved. The market value of any structured security may be affected by changes in economic, financial and political factors (including, but not limited to, spot and forward interest and exchange rates), time to maturity, market conditions and volatility and the credit quality of any issuer or reference issuer. Any investor interested in purchasing a structured product should conduct its own analysis of the product and consult with its own professional advisers as to the risks involved in making such a purchase.

No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior consent of MKE.

Definition of Ratings

Maybank Kim Eng Research uses the following rating system:

BUY Return is expected to be above 10% in the next 12 months (excluding dividends)

HOLD Return is expected to be between - 10% to +10% in the next 12 months (excluding dividends)

SELL Return is expected to be below -10% in the next 12 months (excluding dividends)

Applicability of Ratings

The respective analyst maintains a coverage universe of stocks, the list of which may be adjusted according to needs. Investment ratings are only applicable to the stocks which form part of the coverage universe. Reports on companies which are not part of the coverage do not carry investment ratings as we do not actively follow developments in these companies.

Some common terms abbreviated in this report (where they appear):

Adex = Advertising Expenditure FCF = Free Cashflow PE = Price Earnings BV = Book Value FV = Fair Value PEG = PE Ratio To Growth CAGR = Compounded Annual Growth Rate FY = Financial Year PER = PE Ratio Capex = Capital Expenditure FYE = Financial Year End QoQ = Quarter-On-Quarter CY = Calendar Year MoM = Month-On-Month ROA = Return On Asset DCF = Discounted Cashflow NAV = Net Asset Value ROE = Return On Equity DPS = Dividend Per Share NTA = Net Tangible Asset ROSF = Return On Shareholders’ Funds EBIT = Earnings Before Interest And Tax P = Price WACC = Weighted Average Cost Of Capital EBITDA = EBIT, Depreciation And Amortisation P.A. = Per Annum YoY = Year-On-Year EPS = Earnings Per Share PAT = Profit After Tax YTD = Year-To-Date EV = Enterprise Value PBT = Profit Before Tax



Malaysia Maybank Investment Bank Berhad (A Participating Organisation of Bursa Malaysia Securities Berhad) 33rd Floor, Menara Maybank, 100 Jalan Tun Perak, 50050 Kuala Lumpur Tel: (603) 2059 1888; Fax: (603) 2078 4194

Singapore Maybank Kim Eng Securities Pte Ltd Maybank Kim Eng Research Pte Ltd 9 Temasek Boulevard #39-00 Suntec Tower 2 Singapore 038989 Tel: (65) 6336 9090 Fax: (65) 6339 6003

London Maybank Kim Eng Securities (London) Ltd 6/F, 20 St. Dunstan’s Hill London EC3R 8HY, UK Tel: (44) 20 7621 9298 Dealers’ Tel: (44) 20 7626 2828 Fax: (44) 20 7283 6674

New York Maybank Kim Eng Securities USA Inc 777 Third Avenue, 21st Floor New York, NY 10017, U.S.A. Tel: (212) 688 8886 Fax: (212) 688 3500

Stockbroking Business: Level 8, Tower C, Dataran Maybank, No.1, Jalan Maarof 59000 Kuala Lumpur Tel: (603) 2297 8888 Fax: (603) 2282 5136

Hong Kong Kim Eng Securities (HK) Ltd Level 30, Three Pacific Place, 1 Queen’s Road East, Hong Kong Tel: (852) 2268 0800 Fax: (852) 2877 0104

Indonesia PT Kim Eng Securities Plaza Bapindo Citibank Tower 17th Floor Jl Jend. Sudirman Kav. 54-55 Jakarta 12190, Indonesia

Tel: (62) 21 2557 1188 Fax: (62) 21 2557 1189

India Kim Eng Securities India Pvt Ltd 2nd Floor, The International 16, Maharishi Karve Road, Churchgate Station, Mumbai City - 400 020, India Tel: (91).22.6623.2600 Fax: (91).22.6623.2604

Philippines Maybank ATR Kim Eng Securities Inc. 17/F, Tower One & Exchange Plaza Ayala Triangle, Ayala Avenue Makati City, Philippines 1200 Tel: (63) 2 849 8888 Fax: (63) 2 848 5738

Thailand Maybank Kim Eng Securities (Thailand) Public Company Limited 999/9 The Offices at Central World, 20th - 21st Floor, Rama 1 Road Pathumwan, Bangkok 10330, Thailand Tel: (66) 2 658 6817 (sales) Tel: (66) 2 658 6801 (research)

Vietnam In association with

Maybank Kim Eng Securities JSC 1st Floor, 255 Tran Hung Dao St. District 1 Ho Chi Minh City, Vietnam Tel : (84) 844 555 888 Fax : (84) 838 38 66 39

Saudi Arabia In association with

Anfaal Capital Villa 47, Tujjar Jeddah Prince Mohammed bin Abdulaziz Street P.O. Box 126575 Jeddah 21352 Tel: (966) 2 6068686 Fax: (966) 26068787

South Asia Sales Trading Kevin FOY [email protected] Tel: (65) 6336-5157 US Toll Free: 1-866-406-7447

North Asia Sales Trading Eddie LAU [email protected] Tel: (852) 2268 0800 US Toll Free: 1 866 598 2267

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metals, mining, coal, steel - kim eng · 9/25/2013 · metals, mining, coal, steel more excitement...

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