Aluminum Corporation of China Ltd (ACH): Accumulate Between $16.3-$18.95

 Aluminum Corporation of China Limited (Chalco or ACH: 19.99, -0.68), the largest producer of alumina, primary aluminum and aluminum fabrication products in the People's Republic of China (PRC) closed yesterday at $20.67, down by $0.23 or 1.1% over the previous day's closing price. So far the stock has hit a 52-week low of $18.03 and 52-week high of $34.27. The stock was downgraded to Hold from Buy at Deutsche Bank. I would rather suggest the stock sell at the earliest opportunity. In fact the consensus one year target for the stock is at $8.27.

One might be tempted to buy the stock as: 1) ACH returned to profits in the first quarter, and 2) some analysts suggest that major aluminum producers are positioned to profit in 2010.

ACH did turn profitable in Jan-Mar 2010 quarter. Chalco posted a Q1-2010 net profit of CNY627.25 million versus a year-earlier loss of CNY1.89 billion, short of an average forecast for a CNY1.2 billion profit by two analysts. Reported Q1 EPS was CNY0.0464. This amounts to EADR (earnings per ADR) of CNY1.16 or $0.17. Assuming the company maintains earnings at this rate in the reminder of the year (annualizing), the company's EADR for 2010 would be $0.68. Assuming a conservative forward P/E of 12, we arrive at a one year target price of $8.17. Assuming (my) the best case scenario of quarterly earnings expanding at a CAGR of 10% in the remaining three quarters and also assuming P/E expansion to 18, we arrive at a target price of $16.3. Whereas, the stock is currently trading at $20.67 while analysts polled by Factset have set a one year average target price of $25.95. Buying the stock with the hope of stock reaching this target price is just too very optimistic.

One could argue that, last year (2008) the company generated annual EADR of $2.86 and even with a conservative P/E of 8, would equate to a one year target price of $22.89. So the stock is trading at a discount of 10%. This is surely the right case if indeed profitability pans out that way. And, this depends on aluminum price outlook.

Aluminum price recap and outlook

Due to the global economic slowdown and a plummeted demand amidst the global financial crisis in early 2009, the price of aluminum lingered at low levels. Both prices of spot aluminum at the London Metal Exchange (LME) and Shanghai Futures Exchange of the PRC (SHFE) tumbled as low as $1,288 per tonne and RMB11,405 per tonne, respectively. Following the introduction of stimulus packages worldwide and China's collection and storage of non-ferrous metals since March, the economy has bottomed out, consumption has been gradually picking up and the aluminum price fluctuated upward. Prices of spot aluminum on the LME and SHFE surged as high as $2,265 per tonne and RMB16,850 per tonne, respectively.

The average price of spot aluminum quoted by LME in 2009 was $1,664 per tonne, representing a decrease of 35.3% over the corresponding period last year, while that of SHFE was RMB13,617 per tonne, representing a decrease of 21.5% over the corresponding period last year.

Primary aluminum prices have regained their 2009 losses in 2010. However, euphoria over aluminum prices which peaked at $2450 per tonne in April is now down as three month forward price of aluminum is at $2000 per tonne. So aluminum prices do look good. However, cost of production is also going up hand-in-hand. For instance, in the first quarter of 2010, ACH's revenue jumped 109% year-on-year, mainly due to the surge in selling price and increase in sales volume. However, the company's operating costs increased by 69% year-on-year, mainly due to the increase in unit production cost resulting from the increase in sales volume and raw and ancillary materials price; selling and distribution expenses increased by 59% year-on-year, mainly due to the increase in transportation and packaging expenses corresponding to the increase in sales volume.

At the start of this month, ACH announced, for the first time this year, a reduction of spot sales price of alumina by RMB150, or 5%, from RMB3,000 per tonne to RMB2,850 per tonne. This is an indication that inventories are not clearing at the rate the company would have liked.  I guess in the second half of 2010, price realization will decline further while costs (especially electricity) will increase for aluminum companies including ACH.

Closing note

This is definitely a good time to buy shares of metal companies as there are nearly 11 companies that have a relative strength at or above 80. However, we need to watch out for some cues on ACH.

The long-term debt for ACH is $1,289.0 million, while the net current assets are $505.1 million. However, this may not be a major problem as the company plans to sell RMB5 billion worth of one-year bills on the interbank market. If the company is able to raise funds at reasonable rates then ACH is a stock to buy.

The company dispelled market rumors of exiting the Queensland project. But it is comparing different proposals, and the proposed tax in Australia was a factor under consideration. This is another cue that investors have to watch out. However, the final confirmation would be when the company declares dividends.

Currently, the stock is neither overbought nor oversold, so odds equally favor long and short trades. Upside trade possibilities are low compared to downside. So, accumulate the stock between $16.3 and $18.95 for a two year horizon. There is support for the stock at $19.39 ± $0.43. If the support is broken and stock falls below $16.3 then sell it at the nearest opportunity.

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