China's aluminium bonanza may have more to offer investors

[SHANGHAI] China's aluminium sector has been oversupplied and unloved by investors for years. The biggest-ever rally in the nation's top smelter is flipping that assumption on its head.

Aluminium Corp of China Ltd, or Chalco, rose a spirited 80 per cent in Hong Kong in November, its best month since its debut almost two decades ago, as equities and metals prices took heart from China's V-shaped economic rebound and euphoria that a vaccine could soon put an end to the pandemic.

But the extra jolt enjoyed by Chalco and its peers suggests a deeper shift in the industry as concerns around overcapacity and high production costs begin to abate. Even after such a sharp advance, some analysts think Chinese aluminium stocks are still worth buying.

"Aluminium stocks are spiking with aluminium prices, which are continuing their ascent amid the economic recovery," Dai Ming, a portfolio manager at Hengsheng Asset Management Co., said last week.

Undoubtedly, producers like Chalco are well-placed to thrive in a recovery where consumption is being driven by spending on infrastructure, property and autos, all of which rely to some degree on the light-weight metal. Global aluminium demand may grow 2 per cent in 2021, led by China, after slipping 3 per cent this year, according to Bloomberg Intelligence.

Beyond that, China's policy of limiting capacity by retiring old plants for new may be starting to bear fruit. While that's not immediately apparent from ever-expanding output in the world's biggest producer of the metal, it does mean smelters are now far more cost-effective.

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Chalco is among the metals stocks, which also include steel and copper producers, favored by Citigroup, according to a note last week. Analyst Jack Shang cited better demand, low stockpiles, slower-than-expected capacity additions and reduced costs.

The bank has raised its 12-month target price to HK$4.37(S$.0.75)from HK$3.25. Over at Morgan Stanley, analyst Rachel Zhang on Sunday upgraded her recommendation to overweight and assigned a target price of HK$3.50. The stock last traded at HK$3.05.

Boffa Bauxite The state-owned smelter's efforts to relocate to lower-cost regions and ramp up feedstock production at its Boffa bauxite mine in Guinea should help profitability, said Citi's Shang.

Margins in the sector broadly have dramatically improved as aluminium prices have risen to a two-year high in London at the same time as the cost of alumina, the metal's intermediate, powdered form, has slumped. Aluminium may rise further in the near term due to strong demand and a supportive macroeconomic backdrop, before falling to better reflect global oversupply, according to a note from Morgan Stanley analysts including Susan Bates.

The industry's profit margin has now exceeded 2,000 yuan (S$407) a ton, a level last seen in 2017 after a national capacity cull, Wu Huayu, an analyst at Guotai Junan Securities Co, said in a report on Nov. 22. High margins should be sustainable given the weakness in alumina, he said.

On Chalco in particular, though, there is some caution. Yang Ruyi, a partner at Ningbo Chasestone Asset Management Co, said she doesn't recommend buying the stock because of valuation risks. The producer's PE ratio based on blended forward earnings has leaped to 35, more than 40 per cent above its five-year average.

Chalco declined to comment on its operations and shares when contacted by Bloomberg News.

Guotai Junan's Wu said he favors Yunnan Aluminium Co, which could have 50 per cent upside on its stock given its location in a province with the abundant hydro-power necessary to run its smelters. Yunnan Aluminum's PE ratio is 25, matching its five-year average.

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