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Basic Material Ideas
China Commodities feedback
Event
Last week, our team was in China seeing companies and we also had a
number of companies reporting 3Q10 results. When it comes to the China
Commodities trip, the amount of new information was not large but the
following key themes continue to emerge:
⇒ Most agree that the Chinese economy is heading into a period of
more consolidated growth. The government is likely to pursue
efficiencies as opposed to just pushing growth for growth’s sake. This
should be positive for copper and coking coal going forward.
⇒ When it comes to the thermal coal market, most agreed there was
upside in the short term to prices while medium-term supply looked
to be more of an issue. These medium-term views were based on fairly
conservative demand growth rates.
Impact
Commodity stocks appear to be in a period of consolidation. Most are now
searching for more evidence that demand is going to be strong into FY11.
We have made a few changes to our stock picks – Shenhua is now a key
Outperform and Ambuja Cement is a key Underperform, while we have
highlighted the recent rally in China Moly as a potential opportunity to exit the
stock.
Focus topic – feedback from the China Commodities Conf
There was a consensus from the tour that China’s growth would be a little
slower in 2011, although nothing particularly alarming, with most assuming GDP
growth of 8.5–9.0%. There was some concern about policy risk surrounding
resilient property prices, and property market sales were expected to be down
YoY (~–10%) in 4Q10 before rebounding in 2011 by ~10% YoY.
Key focus for the week
Last week, we held our China Commodities tour in China. The overall tone of the conference was
relatively benign but some key themes were re-emphasised.
Most of the presenters in China agreed that growth in the Chinese economy was
consolidating. This does not mean that growth is slowing or will stop but that the government is
searching for more sensible growth options as opposed to growth for growth’s sake. Efficient
usage of materials will continue to be a focus and as such we think raw materials like
copper and coking coal will be direct beneficiaries. The usage of copper in power generation
and appliances will continue to drive demand for the commodity, while the installation of more
efficient and taller blast furnaces means that higher quality coking coal will be required.
Commodities likely to suffer under this sort of regime will be aluminium and maybe even
thermal coal on a longer-term basis (more efficient energy usage equals lower consumption of
coal). We think the thermal coal story remains strong over the next three years, so we see no real
reason to change our views on the sector.
When it comes to key picks across the region, the major changes are as follows:
⇒ We have moved Shenhua into our top Chinese coal picks and we have also added Ambuja
Cements out of India as one of our key Underperform picks. One stock that has rallied
aggressively and can be looked at is China Moly – we think the rally is overdone now.
Top performers across the region
There were some relatively large movements in some of the stocks across the region last week.
One stock that has seen some large increases is China Moly. The stock was up over 20% last
week on the back of reports that molybdenum would be included in the Rare Earths debate and
that mining as well as export of the material might be limited going forward. Molybdenum prices
themselves have not moved at all in recent weeks and demand appears quite stable. The
movement in the stock price appears overdone in our view, and we also believe the fundamentals
of the company do not support such a rapid movement in the stock price. We would suggest to
investors that some profit taking at the moment may make sense.
In most other cases, the rapid movement in stock prices seems to have slowed down. The
cement sector for example did not see much of an increase last week but there was some profit
taking around the region. We think the most recent movement in stocks highlights the fact that
investors are starting to try and work out the next direction in terms of commodity prices and
underlying demand.
If we take iron ore as an example, the increase in prices has slowed down and we are now seeing
very stable prices at around US$150/t in China. It would appear as though the restocking of the
material is now largely over so the rapid increases are probably behind us when it comes to
demand-led pricing. There tends to be risks in relation to supply side issues, but these are difficult
to forecast. We would be getting slightly more cautious on the iron ore names after the recent
rally, but we also acknowledge that the stage has been set for a stronger 1Q11 and 2Q11. Hence,
we believe there is no reason to go completely underweight.
The Chinese steel sector – a quick look
Reports last week suggested that steel production continued to be weak in October. There were
reports in the market that steel production for the second 10 days of October might have been as
low as 570–580mtpa, down from the 594mtpa achieved in September.
The slowdown in production appears to be driven by some further energy related production cuts,
but it also appears that there are some soft spots in terms of demand in the end market in China.
Channel checks with local mills reveal that profitability is still an issue and that there is some
inventory is the system. Both these factors will impact production rates in China and it probably
does not come as a surprise that production has been down. The data is not always accurate, so
there might be some changes to the official numbers, but when you look at the results of Angang
(347 HK, HK$12.18, Neutral, TP: HK$13.00), Baoshan (600019 CH, Rmb7.29, OP, TP: Rmb7.60)
and Maanshan, it is clear that conditions are still very challenging.
We have largely moved to an underweight call on the Chinese steel sector given the profitability
concerns in the market place. We prefer to invest in Korea at the moment, along with India – both
these markets offer lower cost options or integrated options.
China Commodities tour feedback
There was a consensus from the tour that China’s growth would be a little slower in 2011,
although nothing particularly alarming, with most assuming GDP growth of 8.5–9.0%. There was
some concern about policy risk surrounding resilient property prices, and property market sales
were expected to be down YoY (~-10%) in 4Q10 before rebounding by ~10% YoY in 2011.
One of the key themes was the government's desire to increase efficiency. The noise out of
Beijing is clearly that growth for growth’s sake is less of a priority over the next five years. The
presentations suggested this should be bullish for copper (high efficiency motors, consumer
appliances) and hard coking coal demand (as steel mills become larger) but bearish for aluminium
supply (aluminium costs in China set to rise and aluminium’s main inputs are domestic-based
energy, so little benefit from a rising renminbi in terms of import cost reduction).
Broadly speaking, the feedback this week gave us confidence on the bullish outlook for copper.
There was little to suggest demand growth would be any weaker than our expectation of 6% in
2011, which is likely to be conservative, although substitution may impact the market at the margin
when prices get higher. We visit the largest copper cable producer in Asia on Friday.
The presentations also suggested a strong medium- to long-term outlook for aluminium demand.
The rising cost structure and healthy demand outlook from key sectors like autos and ultra-high
voltage transmission should tighten these markets. Government policy could discourage high cost
aluminium capacity, which together with higher power tariffs is set to result in China moving to
being a net importer by 2013–15. Notably, a higher RMB/USD does not benefit aluminium
producers as much as steel producers as most aluminium inputs (ie, energy) are domestically
generated. The eventual unwind of a large stock overhang provides some caution beforehand.
The medium- to long-term outlook for Chinese bauxite and alumina prices was also bullish as
Chinese bauxite mine grades become less and less suitable for refining using the Bayer process
(the Chinese bauxite ore has high alumina but increasing silica content). Methods are being
developed to lower silica content to maintain or grow domestic supply over the medium to long
term, but this will add to the cost of bauxite output.
We came away bullish on thermal coal in the near term, with very limited downside risk and
upside potential of weather and infrastructure bottlenecks. The medium-term outlook was one of a
balanced market within China in the next 3–5 years, although conservative demand assumptions
and a problem-free return to increasing supply underpinned these views. Coal will remain the
primary source for power generation growth.
In steel, we heard a wide range of views on the outlook for production, with forecasts ranging
between 650 and 700mt for 2011. In iron ore, the feedback was that prices should pull back from
their current levels over the next 1–3 months, perhaps by $5–12/t from $142/t for 62% material
owing to an expectation of higher supply of Indian material after the monsoon and an end to restocking
by steel mills in China. Presenters were very bullish on hard coking coal, but more
cautious on the prospects for other coking coals owing in large part to the prospect of higher
Chinese output of the latter coal types.
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