As China clamps down on c.10% of its aluminium production, Press Metal Aluminium (PMETAL) is poised to reap the benefits as aluminum price jump to 3-year high. We conservatively up our FY18E aluminium price to USD1,900/MT, increasing our FY17-18E CNPs by 0-7%. Reiterate OUTPERFORM with higher TP of RM4.05 at higher Fwd. PER of 18.0x on aluminium price re-rating factor.

China clampdown. Bloomberg reported that China “called for the closure of 3.21m tons (MT) of illegal aluminium capacity by end July” in Shandong on 24 July, higher than analysts’ expectations. Shandong is a key aluminium production hub in China, and the target makes up c.10% of China’s total production of 31.6m MT in 2016. The news led to a price spike of +7% to USD2,017/MT, the first time prices have traded over USD2,000/MT since end-2014. PMETAL prices similarly rallied, jumping 22% to RM3.27 over the same period.

Positive news… as tightening supply provides good short-run support for aluminium prices. While higher prices may trigger new starts, the commissioning process requires a ramp-up of c.6 months, which could lead to supply tightness up to 2H18. Furthermore, China noted that “all new capacity should replace capacity that has already exited the market” via “Replacement Permits” which are in tight supply at c.2m MT, compared to the “illegal” capacity of c.6m MT. We remain optimistic on short-term price prospects as the Chinese government signals its intent to shut down excess capacity for “blue skies” over the winter months. Since then, aluminium prices have been on a consistent uptrend, and we think that with the environmental deadline looming, further shutdowns should propel prices over the next quarter.

… with caveats. Although producers are facing potentially significant shutdowns over “illegal” capacity, Reuters notes that legality issues might be a “stretchable and negotiable concept”, illustrated by a plant shutdown of 540k MT, which only made up half its “unauthorised capacity”. Without apparent physical dismantling, restarting the plants could merely be a matter of securing permits. Meanwhile, China production numbers indicate an uptrend since Feb-17, and 1H17 production actually increased 11% annually to 16.7m MT. Given these factors, we maintain a conservative price outlook until actual numbers are released in 4Q17-1Q18 to provide better clarity on the long-term sustainability of prices over USD2,000/MT. Thus, we advocate for investors to consider a trading position in the short term to capitalise on aluminium price gains, but adopt a “seeing is believing” perspective when considering prices in the longer run, especially beyond 2H18.

Upgrade FY17-18E CNPs by 0-7% to RM648-877m. In view of tightening supply, we upgrade our FY18E aluminium price assumption by 6% to USD1,900/MT. While our latest assumption is lower than current prices, we believe the conservative estimate is fair considering the lack of actual production figures from China demonstrating that the production cuts have started to kick in. Meanwhile, our FY17E estimate is unchanged as the company’s forward selling policy of >50% of its upcoming production may limit the immediate upside coming from the recent round of aluminium price appreciation.

Maintain OUTPERFORM with higher TP of RM4.05 (previously RM3.15) post upgrade, and roll forward our base year to FY18E, from average FY17-18E for higher EPS of 22.5 sen, (from 18.5 sen). We also up our applied PER to 18.0x, an increase of 1.0x PER, to reflect the re-rating of international aluminium counters in response to the aluminium price surge. Should aluminum prices correct closer to our assumptions, we would consider reverting to our capacity-based PER of 16.0-17.0x Fwd. PER. Nevertheless, we remain strongly positive on PMETAL’s short-term price prospects as aluminium prices hit fresh 3- year high, while long-run earnings outlook is supported by continued cost efficiencies and higher proportion of high-margin products.

Source: Kenanga Research - 10 Aug 2017