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Jiangxi Copper Company Limited (0358.HK) —— Copper price may remain flat, unoptimistic outlook

Thursday, December 11, 2008

5838

Jiangxi Copper Company Limited(358)

Recommendation on 11 December 2008
Recommendation	Sell
Price on Recommendation Date	$6.300
Target Price	$3.060

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Summary

Jiangxi Copper Company Limited (JXCC or Company) is mainly engaged in copper mining, ore dressing and smelting. Affected by recent financial crisis, global copper demand showed apparent decline, JXCC`s profit evidently dropped in Q3.

On future development, against the continuous financial crisis suppression and corrosion on real economy, JXCC`s major products` market outlook is unoptimistic, even the gold price may present favorable momentum, which means little to prevent the performance from sliding.

Based on market instability, we give P/B valuation, meanwhile take reference of JXCC`s historical low 0.4 times valuation, with 12-month target price at HK$ 3.06. We give “Sell” rating.

Q3 performance slid

JXCC`s quarterly bulletin for Q3 showed that from January to September, within the report period, RMB 41.545 billion operating income was achieved, with RMB 3.699 billion net profit, respectively rose 45.45% and 13.74% from a year earlier, and achieved EPS was RMB 1.22.Comparing with 2Q, the operating income in 3Q was basically stable, while net profit sank from RMB 1.257 billion and RMB 1.522 billion for Q1 and Q2 to RMB 919 million in Q3, dropped 40% from a quarter earlier, while in contrast to last year, net profit fell 27%.On profitability, the Company`s gross margin kept decreasing and achieved respectively at 16%, 13% and 10% for the first three quarters. In the forth quarter, copper price further shows steep decline and it is expected that the Company may suffer losses starting from Q4.

Company operation

JXCC is China mainland`s largest integrated copper producer, also the leading enterprise within the industry. The Company`s industrial chain consists of mining, ore dressing and smelting these three links. After the acquisition of parent company`s assets in 2007, JXCC`s copper resources reserves climbed from around 7.4 million tons to almost 9 million tons, which was accounted for around 33% of China mainland`s copper resource reserves.

The Company`s operating income is contributed from copper cathode (including self-produced copper and processed copper). In addition, the gold, sliver and sulfur associated with copper production are also major parts for the company`s operating income. Studying on JXCC`s first half year`s operating income and profit structure, we can see that mines produced copper was still the key resource for operating profit.

As an integrated enterprise with copper mining and ore dressing, smelting and processing, the abundance for resources and reserves` future change will play important roles for the company`s sustained development. At present, JXCC owns Dexing Copper Mine, which is one of China mainland`s largest open-air mines, Yongping Copper Mine and Chengmenshan these three major large open-air mines, except from these, JXCC still owns Wushan Copper Mine and other large-scale pit mines.As of the end of 2007, JXCC`s resources reserves have rose up to 9.12 million tons, within which, there are 260 tons gold, 7,379 tons sliver and 270,000 tons Mo. On future development, the Company is still promoting the projects in Afghanistan and Chile and trying to acquire its parent company`s resources, therefore, JXCC`s copper resources may present sharp increase in the future.

Copper mines self-sufficiency can`t be improved in short time

JXCC`s current copper annual output is around 150,000 tons. Copper production for mining projects under construction is around 60,000 tons, and will be released in coming years.However, something needs to be pointed out is that newly-added copper mine could hardly to have sharp lift on the copper mines` self-sufficiency in a short period of time, therefore, the Company`s profitability is still unoptimistic.

Copper price is expected to remain flat

In the global economy, two factors that boost non-ferrous metals, oil and other bulk commodities prices` rise have showed reversing signs at present. Europe and U.S. subprime mortgage crisis drove the substantial retreat for copper and other metals` prices. With the slowdown world economy growth, global demand on copper is also shrinking, and supply surplus has become a foregone conclusion, which is expected to around hundred of Thousands tons. Weak copper price is expected to be sustained in the coming two years.

Something needs to be notified that, in view of copper price in futures market, which has already dropped around 70.51% from the highest point, and technically consolidated in the over sell zone for a longer period of time, therefore, I think the situation for the first quarter of 2009 is not too disappointing, but may represent rebound in certain extent.

By-products actuality analysis

Besides copper industry, JXCC also operate by-product, like sulfuric acid business, which showed significant rise in the previous two quarters, and reached up to high level of RMB 2,000/ton in Q3, meanwhile contributed gross profit was higher than one third. But from the forth quarter, affected by crude oil`s sharp decline, economy also slid with demand substantially shrank, while the prices returned to around hundreds yuan, even lower than RMB 300. We think that the future market is still unoptimistic, or even has the possibility of loss.

In comparison, JXCC`s other precious metals like gold, sliver are expected achieve output at 13.8 tons and 390 tons, respectively rise 4.6% and 8.3%. On market prices, it has dropped around 30% from previous high level. However, in view of U.S. dollar may depreciate in medium-term, we hold optimistic opinion on gold prices, and its profitability may continually to be strengthened.

While on the entire operation, gold business only accounts for a very small proportion for JXCC`s operation and it could hardly reverse the overall sliding trend for the Company.

Hedge may cause losses

JXCC usually have hedge on 30% of its copper sale. In Q3, the Company recorded RMB 98.9 million hedge losses. While after October, SHFE copper index futures prices dropped 54% from RMB 53,550.ton at the end of September to current RMB 24,686/ton. We think that JXCC may record huge hedge losses in Q4, which is caused by the Company`s long position on copper futures, although the specific amount is not released. Furthermore, sharp copper price decrease will lead into the high prices acquired materials present inventory impairment.

Valuation

We forecast that JXCC`s operating income in Q4 will show almost 50% drop comparing with previous quarter. Turnover for 2008 and 2009 will respectively achieved at RMB 49.2billion and RMB 32.9billion, with net profit at RMB 3.6 billion and RMB 1.3 billion, an apparent decline will be presented in 2009.

On valuation, considering the unstable performance and flat market, we think that the P/B valuation will be more rational. Comparing with international level, JXCC`s valuation still has some advantages. However, in the past, in the year of 2002, JXCC once recorded 0.3 time lowest P/B. As we are pessimistic on future market, therefore give the Company 0.4 x 2009 BVPS, with 12-month target price at HK$ 3.06. We give “Sell” rating.

Financial Date

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