Chalco: Third-Quarter Results Overshadowed By Policy Headwinds

Summary

• Chalco's recent quarterly results were good, as the company delivered strong top line and bottom line growth in Q3 2021.
• But Chalco's Q3 results are overshadowed by policy headwinds in China, which could have a negative impact on the company's future financial performance.
• Chalco is valued by the market consensus forward FY 2021 and FY 2022 normalized P/E multiples of 10.3 times and 9.4 times, respectively.
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Elevator Pitch

I maintain a Hold or Neutral rating for Aluminum Corporation Of China Limited (ACH) [2600:HK] or Chalco. My prior write-up on Chalco was published four and a half months ago on June 18, 2021.

Chalco's stock price dropped by more than -10% after the company reported its recent Q3 2021 financial results. This suggests that the market is looking beyond Chalco's revenue & earnings growth in the recent quarter, and focusing on the negatives associated with the Chinese government's price control over commodities and the restriction of electricity use in certain parts of the country due to power shortages.

With the recent share price correction, Chalco's shares are valued around 10 times forward P/E, which appears to be attractive at first glance. But there is too much uncertainty associated with the short-term aluminum price outlook and future production output against the backdrop of power shortage in China to justify a Bullish or Buy rating. Instead, I decide to continue to rate Chalco's shares as Neutral.

Good Set Of Results For 3Q 2021

Chalco released the company's most recent financial results for the third quarter of 2021 on October 26, 2021 last week. The company's revenue expanded by +51% YoY and +9% QoQ to RMB74.2 billion in Q3 2021. Chalco's net income attributable to shareholders grew by +430% YoY and +6% QoQ to RMB2.2 billion in the recent quarter.

Notably, it also recognized "provisions for impairment on assets" amounting to RMB816 million in the third quarter of 2021, as per a separate company announcement issued on the same day as the financial results. If the RMB816 million asset impairment charge was excluded, Chalco's adjusted net income attributable to shareholders would have been approximately RMB3.0 billion, which represents a +31% growth on a QoQ basis. In my earlier March 30, 2021 article for the company, I noted that Chalco had guided that there should not be such significant impairment charges for specific long-term assets & receivables by the next fiscal year (FY 2022).

In a nutshell, Chalco's financial performance in the third quarter was pretty good, and the key driver was high aluminum prices. A recent October 29, 2021 South China Morning Post news article highlighted that "China’s aluminum supply shortage keeps prices near 13-year high with little sign of easing amid power cuts, emission targets." In the case of Chalco, the company's average selling price of electrolytic aluminum increased by +11% QoQ to approximately RMB20,529 per metric ton in Q3 2021 based on my estimates, which helped to support the company's robust revenue & earnings growth.

But the market did not respond to the company's Q3 2021 financial results in a positive manner as one would expect, and I will discuss this in greater depth in the next section of the current article.

Policy Headwinds Are A Major Concern

Chalco's stock price declined by -11% from $16.80 as of October 26, 2021 (date of Q3 2021 results release) to $15.00 as of October 29, 2021. In fact, Chalco's shares have corrected by -37% as compared to the stock's 52-week high of $23.90 registered during intra-day trading on September 13, 2021.

Policy headwinds are the key reasons for Chalco's poor share price performance post-results and in the recent two months.

An October 27, 2021 Seeking Alpha news article mentioned that "aluminum prices fall sharply", as "China's state planner wants coal-producing provinces to probe illegal storage sites and crack down on hoarding" to "curb rising coal prices." Another article published by Bloomberg on October 29, 2021 quoted a sell-side analyst from Citigroup (C) saying that "if the (Chinese) government is determined to enforce price control, it would most likely be able to do so"; this certainly applies to coal, and other commodities like aluminum as well.

The writing has been on the wall for some time.

In my previous June 18, 2021 article for Chalco, I discussed about government intervention in the aluminum market, more specifically, the release of state reserves into the market to increase supply and cool aluminum prices. The company also disclosed earlier in 1H 2021 interim financial report that there have been "joint talks among the five departments under the Chinese government and key manufacturing enterprises of iron ore, steel products, copper and aluminum industries" with regards to "the policy of stabilizing prices."

Chalco's policy headwinds are not merely restricted to the potential downward pressure on aluminum price as a result of intervention by the Chinese government.

It was reported that "Southern Power Grid in Guizhou province (in China) ordered electricity curbs on local aluminum producers, effective from Tuesday October 19", according to a late-October article published by commodity research firm, Fastmarkets on its Metal Bulletin website. Notably, Chalco's Guizhou Huaren and Zunyi Aluminum plants located in the Guizhou province accounted for 17% of the company's production capacity as of the end of fiscal 2020.

There is no certainty whether Chalco's production plants located in the other provinces of China will also be affected by similar policies in the future. This implies that there is a significant risk that Chalco's Q4 2021 production volumes might fall short of market expectations.

Valuation And Risk Factors

The market values Chalco at 10.3 times consensus forward fiscal 2021 normalized P/E and 9.4 times consensus forward fiscal 2022 normalized P/E, according to the company's last traded price of $15.00 as of October 29, 2021.

Although Chalco's forward P/E multiples don't seem demanding, the company's future earnings are heavily dependent on aluminum prices and production volume. As I highlighted in the previous section of this article, Chalco faces policy headwinds despite a good set of results in Q3 2021. The Chinese government is likely to exercise greater control over aluminum prices, and a significant part of Chalco's production could potentially be disrupted by restrictions of the use of electricity in certain parts of China.

ACH's key risk factors include a significant drop in aluminum prices in the near future, and lower-than-expected production output going forward.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.