Xinren Aluminum - Solid result with attractive valuation (DBSVickers)

BUY S$0.33 STI : 2,796.22

Price Target : 12-Month S$ 0.73

Reason for Report : 2Q11 Results

Potential Catalyst: Substantial hike in aluminum prices

SV vs Consensus: Sole house covering this counter.

• 2Q11 results were above our estimates thanks to aluminum price hike

• Constructing carbon anode plant will save costs

• Retain BUY call with TP at S$0.73

2Q11 results beat our projection. Xinren Aluminum (XAH SP) registered RMb1,885m revenue(+37% y-o-y), RM256m gross profit(+116% y-o-y) and RMB141m net profit(+454% y-o-y) - exceeding our expectations. We believe this was due to the hike in primary aluminum prices, which enabled the company to gain from holding raw material and product inventories. Gross margin improved to 13.6% in 2Q11 from 10.3% in 1Q11 thanks to ASP hikes, particularly as increase in export sales outpaced the increase in average production cost. Its inventories and receivables increased by 10%, 6% respectively compared to FY10 following the revenue increase. Its net debt also increased by 9% due to capex and working capital.

Less volatile aluminum prices, desirable investment in carbon anodes LME primary aluminum prices rose to US$2,600/ton, up 24% y-o-y and 4% q-o-q, while aluminum prices on the SHFE (Shanghai future exchange market) nudged up 9% y-o-y and 0.4% q-o q in 2Q11. Aluminum prices in China are less volatile thanks to supply surplus, which should result in more stable earnings compared to producers of other metals. The company has decided to construct a production plant for carbon anodes. Capex is estimated at RMB 300m in FY11. When the plant construction is completed, this would lead to cost savings of RMB 400/ton or 2.5% for primary aluminum.

Retain BUY call with S$0.73 TP pegged at 9.7x FY11F PE or 15% discount to the weighted average valuation of its global peers. Factoring in the stronger results, we have revised up FY11F EPS by 2%. However, FY12F EPS revised down by 3.4% following the delay of the fabrication plant in Jiangyin to 3Q12 (from 3Q11) due to late delivery of equipment. The stock is trading at an undemanding 4.4x FY11F PE and 1.1x FY11F P/BV. LME Aluminum prices have dropped by 8% since 1st Aug, while Xinren’s share price has fallen by 13%. We believe consistent earnings delivery should be a catalyst for the stock and remove investors’ skepticism on the counter.