Monthly Archives: March 2013

2013 Q1 AZ China Webinar

Written by Paul Adkins

Our second AZ China webinar is available below. This March update takes a look at the recent SRB purchase and all the recent closures we are seeing.

Webinar download link - View the PPT in Slideshow View to hear the audio. Welcome your feedback or topic suggestions for future webinars.

 

 

Eight billion RMB loss could have been a nice profit

Written by Ken Wangdong

Chalco’s staggering 8 billion RMB annual loss surprised most analysts’ forecasts. At AZ China however, we think the focus on last year’s financial results is only scratching the surface. There are more structural challenges facing Chalco. These challenges include higher production costs in primary metal smelting; higher cost in alumina production resulting from the Indonesian bauxite ban, and over-exposure to cyclical downturns.

Comparing to the model

What surprised most forecasts are the additional finance costs from Chalco’s ‘strategic transformation’ which ‘expanded the size of interest-bearing debts’. Here we note the extra finance cost is beneficial to the group’s medium to long run performance, therefore, the rationale for the spending is sound. The real problem remains in its poor gross profit position, as a result of structurally high operating costs combined with cyclical price depression in 2012.

From a segment point of view, the biggest loss contributor is the alumina segment. This raises alarms about the Indonesian bauxite situation, which according to Chalco increased cost of alumina by 4%, and reduced its 2012 production capacity in alumina by 1.7 million tonnes. The alumina division loss highlights a structural problem, which is the on-going reliance on Indonesian bauxite and its impact on Chalco’s alumina business in the future.

Besides alumina, the other problem is in the profitability of primary metal production. The aluminium segment profit was the biggest contributor to Chalco’s 2011 group profit, and it generates more than twice the profit than its alumina division. However, aluminium profitability sank in 2012 and delivered a significant loss to the group. In essence, Chalco needs a profitable aluminium division in order to secure profitability for the whole group.

What could have been a nice profit

We introduce three simple scenarios to demonstrate the structural problem in Chalco’s operation. The first scenario is where we model the income statement with 2011 common-size ratios and apply the real finance cost in 2012; comparing this to the same scenario with a model carrying a lower finance cost figure. The result is Chalco would have made a loss even with higher sales at its 2011 common-size ratio level, due to higher finance cost in 2012. The comparative case of using a lower finance cost figure shows a profit. These results tell an important story, which is Chalco’s 2011 operational level had too high a cost of sales figure; in another word, its costs were already structurally too high in 2011.

The second scenario uses a common-size ratio from a few years ago, which is 2% lower than the 2011 level. Now, we apply the real finance cost to the model and find a nice 2 billion RMB profit for the group. This is evident of the high structural cost that is the main obstacle to the group’s profitability. By lowering costs, the group can improve its position significantly.

The third scenario is when we eliminate the 6,600 Million RMB loss from the primary metal division and apply the real finance cost from 2012; we also eliminate the loss from the alumina division in the calculation. The result is a 961Mn profit for the group. Here we see the combined effect of increased alumina cost and metal production cost to be the primary contributor to the group’s loss.

The above analysis is consistent with the group’s own reports. The current Chalco primary aluminium price is around 15,000RMB/t, a 7% drop. According to Chalco, the metal price was a main force behind the group’s total loss position. Reversing the 7% decline gives a metal price of 16,130RMB/t, which is 5.84Mn RMB of loss per RMB/t decline in metal price. Here we need to re-emphases that an elimination of the 6,600MN RMB loss is not enough for the group to return to profit, because the group would still suffer from high structural costs. Thus, a lowering of cost and a lift in alumina performance are needed, and mere increase in metal price is not enough.

On a cash cost basis

It is possible to find out the extent of pressure that Chalco felt in 2012. Here, we employ AZ China’s cash cost curve model and taking into account the various smelters operated by Chalco in China. The result is consistent with the financial analysis from the group’s financial statements. 60% of Chalco’s capacities are underwater on a cash cost basis; these capacities suffer from structurally high energy costs and they are located in high cost regions. The capacities that are located deep in the North-West do not suffer from a cash loss position.

A simple strategy to remedy Chalco’s position would be to have lower costs. This can be achieved by a migration of the high cost smelters to low cost regions. However, this would require time and significant capital allocation. Meanwhile, Chalco’s plan for diversification to expand upstream businesses is a necessity to maintain the group’s competitiveness in alumina and bauxite. From a cyclical point of view, we also sense a threat from potential price sluggishness in the Chinese aluminium market due to overcapacity and weak demand, which would go on to impair the group’s profitability given its stubborn high costs.

The rating agencies have put Chalco on a negative watch, BBB-. This suggests a worsening of macro conditions would undermine the group’s ability to repay debt. However, there is still a reasonable argument that China can maintain reasonable macro economic growth, which would help Chalco to maintain sales volumes, so we do not expect the rating agencies to move further against Chalco too soon.

Nevertheless, Chalco’s risk is not just low metal price or sluggishness in the economy; it is rather the high structural costs in smelting, and a weaker position in alumina production.

 

AZ China’s CPCX goes live!

Written by Paul Adkins

If you are a buyer or seller of Calcined Petroleum Coke (CPC), this index was made particularly for you; however, others in the industry will no doubt find it useful as well. The index shows actual CPC transaction prices on a weekly, monthly, and quarterly basis for five different grades of CPC within China’s three major CPC regions.

All CPC buyers and sellers who register and input data this month will have a year of free access to the index. Register for a free trial to learn how it works via our website https://az-china.com/CPCX/login.php or contact us with questions at CPCX@az-china.com.

 

如果您需采购或销售煅烧石油焦(CPC),这将是为您量身定做的CPC索引,但其对同行业的其它公司来讲,无疑具备同样的使用价值。此索引显示的是中国三大生产地区五种不同级别的煅烧石油焦周度、月度及季度的实际成交价格。

本月内成功注册并提交记录的用户将获得一年的免费服务,马上点击链接https://az-china.com/CPCX/login.php,开始体验!或咨询CPCX@az-china.com

Bear market for base metals

Written by Paul Adkins

Excerpted from AZ China’s March Aluminium Report:

Money never sleeps: The continuation of liquidity and credit market impotence

Global growth is full of uncertainty, which means there is no bull market for base metals for a while. In terms of inflation, there is a fair chance that inflation is created in the process of global money printing. This may occur when recovery gets a firmer footing, which will “benefit” base metal prices. But it is an artificial benefit – the same total production costs more to buy, but also more to make, especially if inflation causes wage spikes. So no extra demand or supply, only higher costs. That’s hardly a long-term benefit or benefit at all.

 

To read this article in its entirety, sign up for a free trial subscription to this monthly aluminium report enquiries@az-china.com

 

Closures Watch 21st Mar

Written by Ken Wangdong

The latest information on production cuts and closures:

Henan Longxiang which earlier announced the cut of 30Kt, which was half of their production, has increased that volume to stop all of their production of 60Kt. This increases the total amount of production cut/closures to 585Kt, with an additional 50Kt unconfirmed.

The industry needs substantially more production cuts as well as increased demand in order for the price to lift high enough to remove the red ink that has been flowing freely in recent times.

 

China’s impending financial crisis

Written by Ken Wangdong

With heightened concerns over China’s leverage, non-performing loans and property market bubble, the market is anticipating some form of crisis originating from the banking sector.We believe there are increasing risks in the Chinese financial system, however, the risk is not as severe as they were for the US prior to the Global Financial Crisis. A comparison of the US and China appears frequently in the media, but we remind our readers of some differences between the US and China:

  • The key differentiator is financial innovation in the US, which China has not developed to the same extent i.e. structured finance, CDOs, CDs
  • Toxic sub-prime loans, Ponzi finance. We don’t see that in China YET, but China could easily get there
  • The PBOC is much more prudent than prior to the GFC (Global Financial Crisis), and they learned the lesson of Lehmon
  • China is building up leverage, but not as severely as the US
  • The banking sector is backed by the CIC, PBOC, and a government with limited external debt
  • The US relied primarily on debt and consumers with debt, whereas China has an investment, export-led growth model

 

For more in-depth China analysis contact us at enquiries@az-china.com

10% cut

Written by Ken Wangdong

As seen in the article from CNBC: Rusal CEO: ‘Last Act of Drama’ in Commodity Market, oversupply is the word of the day and it begs clarity. One way to look at oversupply is essentially that the growth on the supply side overtakes demand , generating more inventory and price deflation. Behind production growth stands medium term capacity additions which cause structural shifts in the demand to supply balance in the medium term.

The idea of a 10% cut highlights the seriousness of the problem, however, the quantification of “excess” is a more tricky exercise. A 10% cut in global production is implying the cuts in both China and the ROW (rest of the world). We estimate the excess in China is somewhere close to 1.8 to 2Mt; this figure requires one to assume China will slowdown going forward given its structural issues. A 10% cut would mean 2-3 million tonnes of aluminium would come out from ROW, which pulls us back to 2004 levels.

The question is are we back to that level? We tend to believe it overestimates the extent of oversupply in the system. Production growth outside of China has been growing more or less close to world demand growth. The prospect that ROW demand for aluminium has pulled back to a level 8 years ago is daunting; however, it is not entirely dismissible. Deleveraging and global risks are very real dampening factors to world demand; but the amount of growth since 2004 in the ROW has been strong, both inflation and deflation existed and the world grew on the balance.

The answer for where are we now is clear: China and the ROW are both in oversupply. The excess in China requires both cuts and stronger demand side recovery. The ROW does not require as severe of a cut, but it does need demand side recovery. We’re watching closures and cuts in both China and the ROW. Macro risks will also play a big part in 2013. More on this subject in our Monthly Aluminium Report.

SRB purchase price

Written by Ken Wangdong

SRB has finalized its metal purchase price at 15,137RMB/t. This is largely within expectation, a 2-4% price guide above the current spot price on the SHFE.

Does the higher price inspire upward force on price? The answer is yes, but it works hand-in-hand with the purchase at the same time. The two actions provide for a case of upward pressure on price, or at least an attempt to stabilize the price.

We estimate the excess in China is somewhere close to 1.8 to 2Mt.

Closures Watch

Written by Ken Wangdong

Closures of aluminium smelting capacity intensified in recent days. Specific closures include: Henan Xinwang, Henan Longxiang, Guanxi Investment Corp., Jiangsu Datun, Yunan Qujing, totaling 520Kt.

We believe around 1.8-2Mt of excess exists in the market, with more closures to come despite the SRB metal purchases.

AZ China was the only commentator to predict these closures. In our February Aluminium Report, we predicted 500,000t of metal units exiting the market in 2013, being more than 800,000t on an annualized basis. We repeated this prediction during our TMS meetings earlier this month.

You heard it here first. At AZ China.

Dominoes falling? Supply side correction starting

Written by Paul Adkins

Perhaps we are finally seeing the much-needed correction to the supply side of China’s aluminium industry.

In the last 3-4 weeks, at least 4 smelters have announced cuts to production. Total capacity cuts amount to 450,000t on an annualised basis.

It started with less than a trickle. The first to switch off pots was a tiny plant in Henan province. They cut 25,000t, being half their capacity - never mind that such small plants were outlawed several years ago.

But this week, at the same time that the SRB has moved to buy 300,000t, another 3 plants have advised of cuts. Assuming these pots remain cold through the rest of this year, it should equate to just under 300,000t for 2013.

Interestingly, 2 of the 4 plants were receiving subsidies from their local governments, but those have now stopped.

These cuts also come at a time when other new plants are turning on pots, especially up in the north west of the country.

We forecast at least 500,000t of cuts in this year’s envelope. China needs that level of supply side correction just to get the inventory levels down sufficiently. Demand side improvement is unlikely to be strong enough to do all the heavy lifting.

We continue to monitor the situation, and will bring you news of other cuts as soon as we hear of them.