Chalco (2600, $6.71) 6M Target $7.20 HOLD

Becky Yuen–becky.yuen@guoco.com (852) 2218 2872

Event: Chalco came into agreement to acquire 44.7% stake in Rio Tinto's Simandou iron ore project in Guinea.

• Chalco came into an agreement to acquire 44.7% stake in Rio Tinto's Simandou iron ore project in Guinea. The company will invest a total of US$1.35bn progressively in the next 3-5 years for the development of the project. The project, with measured and inferred resources of 2.25bn tonnes of high-grade hematite iron ore, is expected to commence production in 2015 targeting an annual production of 70mn tonnes.
• The deal, while has little earnings impact to Chalco in near-term, marked the shift of company's core business from solely aluminum-related to a more diversified metals approach. We think this is not a bad thing given the dim outlook of aluminum industry in China. Also Chalco is losing its cost advantage and pricing power in the industry as smaller smelters are more flexible in adjusting to market changes. That being said, Chalco's gradual expansion of business scope may trigger a re-rating from investors in long-term.
• As for the aluminum industry, we believe domestic aluminum price has bottomed in 2Q10 and found a strong support at RMB 14,500 level. With aluminum smelters in China starting to cut production as well as China's stronger enforcement to curb capacity growth and eliminate outdated facilities, we believe there is little chance that aluminum price will experience another significant drop again.
• Yet we see limited upside for aluminum price in 3Q10 as overcapacity and high inventory level will place a cap for near-term price rebound. Thus we believe the earnings for Chalco will stay slim in 3Q10 before having a sequential improvement in 4Q10 with more construction projects coming in.
• We have cut our 2010 earnings forecast from RMB 3.2bn (EPS RMB 0.24) to RMB 2.7bn (EPS RMB 0.20) as we factored in the higher than expected production costs amid the removal of preferential power tariffs and the slow progress in the negotiation of direct power purchase with power plants.
• Maintained HOLD but revised our target price to $7.20, representing a 1.5x 2010 book value. We believe Chalco will be range trading in near-term as earnings outlook remained bleak. Meanwhile, Jiangxi Copper (358, $17.52) remained our top-pick in the nonferrous metal universe as supply tightness of copper concentrates in the next 2-3 years will continue to support copper price.

Yanzhou Coal (1171, $16.88) 12M Target $18.40 HOLD

Yunfeng Fan –yunfeng.fan@guoco.com (86 755) 8209 2443

Event: Yanzhou Coal revised earnings estimation for the first half of 2010 based on PRC G AAP.

• Yanzhou Coal announced that, based on PRC GAAP, net profit for the first half of 2010 will increase by 35% yoy versus the previous forecast of 100% mentioned in the first quarter report. The revision was mainly due to translation loss incurred by fluctuations of the exchange rate of AUD to USD. As the exchange rate of AUD to USD depreciated by 5.1% in the first half of 2010, the company is expected to book an exchange loss of RMB 1,114mn.
• However, the exchange rate of AUD to USD has recovered to 0.8950 on July 28 compared with 0.8985 as at 31 December 2009. We believe a write-back of the exchange loss in the second half of the year is very likely.
• After a sharp fall in February and March, Qinhuangdao coal price resumed its uptrend in April. The coal demand has stepped into booming season in the third quarter. However, NDRC has capped the spot coal price by the end of June leading to a slight decline in spot coal price this month. Share price of Yanzhou Coal is highly correlated to spot coal price historically because the company relies coal sales heavily on the spot market. On the other hand, the proposed reform of Australia resource tax also affects its share price performance.
• We believe that net contribution from Felix will be more significant in the second half of the year. We maintain our 2010 earnings forecast at RMB 6.79bn (EPS RMB 1.38), up 65% yoy. Earnings for 2011 will grow 16.6% yoy to RMB7.92bn (EPS RMB 1.61) based on our estimates.
• Traded at 2010 PER of 10.7x and 2011 PER of 9.2x, valuation of Yanzhou Coal is attractive relative to the peers but we see no share price catalyst in near term.
• Downgrade to HOLD from buy with a revised 12-month target price of $18.40 based on 10x 2011 earnings.