China remains in high gear and despite speculation that the country may come in for a hard landing at some point, we feel that it should be softer than expected. When it comes to Aluminum Corp. of China (ACH) though, it seems like someone forgot to tell this company to get on the expressway of action. Essentially this stock has failed to hold gains for the last two years since it came into the $20 price range back in 2009 given industry weakness.
While going through the last recession and coming out of it, the firm’s financials took a bit of a beating. To say the least, the pre-recession Chalco definitely doesn’t look like post-recession Chalco right now. For the time being, we think it makes sense to rate sickly Chalco a PASS given competitive variables, macro aluminum supply issues and weakened financials.
Domestic Competition Remains High:
When it comes to Chinese aluminum manufacturers, Chalco is definitely the best in breed. The firm has greater economies of scale, better-cost inputs, better access to resources and a few other things going for it. The problem though deals with the fact that there are roughly 100 domestic (Chinese) aluminum-manufacturing companies that Chalco is up against. Further, many of these smaller firms are less concerned with the bottom line and more concerned with trying to gain market share. Part of the reasoning behind this is due to the fact that China is attempting to consolidate its aluminum industry. The net result is smaller companies focusing on volume in an attempt to survive in the industry and undercut larger firms such as Chalco. What this means for Chalco is reduced potential profitability for the immediate period.
Concerning Profitability Trends:
Years | 2008 | 2009 | 2010 |
Operating Margin | 2.38% | -4.67% | 2.81% |
Net Margin | 0.01% | -3.45% | 0.57% |
Return on Equity | 0.02% | -8.81% | 1.53% |
Flooded with Supply:
When looking at aluminum, it’s very easy to find out what it’s exactly pricing at unlike some other commodities. By that same token, in certain ways that means Chalco has very little pricing power. How have we come to this conclusion? What we have consistently seen in the aluminum market over the last few years is that every time the price of aluminum hits a certain price range, the market becomes flooded with inventory. The reason for this deals with the fact that higher cost aluminum smelting operations that have been shut off or set to idle are kicked on once prices sufficiently improve and vice versa. This essentially prohibits aluminum from sustaining higher prices in the market place and prevents Chalco from improving the bottom line.
With the global economy still in recovery mode and growing slowly, we don’t see there being sufficient demand to offset supply pressures. For Chalco this means biting the bullet and having less to look at when it comes to the bottom line.
Poor Liquidity:
Chalco’s financials have been battered by the recession and the weakened aluminum market over the last few years hasn’t helped. In addition, acquiring a large stake in Rio Tinto’s iron ore project in Guinea wasn’t a small price to pay. The net result is a current and quick ratio of .76 and .27, respectively. These numbers do very little to instill confidence on our end. At the same time, we don’t feel that the company is going to go under, but we aren’t going to take unnecessary risk with a company like this when it has other issues as well.
Conclusion:
Chalco could be a great name to buy once things sufficiently improve with the global economy and a new demand level for aluminum is reached. While Alcoa's (AA) most recent earnings did beat top line estimates it failed to surpass earnings estimates which supports our view. Furthermore, it would be nice to see Chalco's liquidity levels improve so this doesn’t have to be an ever-present concern. Until these issues are resolved, Chalco looks sickly and this why we rate a PASS.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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