Published on 12/07/2017 10:01:24 AM | Source: ICICI Securities

Metal Sector Update Chinese illegal capacity - new twist? - ICICI Sec

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Chinese illegal capacity – new twist?

Reason for report: Aluminium sector update

Post our call with AZ China, the client reactions and news flows on Chinese aluminium cuts have been diverse. Since then, the various industry consultants that we have interacted have been sceptical about the strength of the “illegal capacity” cuts out of China. The edict that came out in March, ’17 did not specify that plants have to close if they don’t have the necessary documents, but the edict is now being interpreted that way, following the local government deadline that passed on June 30, 2017. To date, China had closed or is in the process of closing 1.25mnte tons, across 3 smelters, but two of those three also have financial problems (case in point being Hongqiao which secured ~ US$2.95bn of credit line from China CITIC bank). In any case, in a total population of “illegal capacity” of at least 6mnte, the actions so far did not fill us with confidence that the edict would deliver real results. What changes now is the news flow on closure of ~ 1mnte of illegal capacity of Shandong Xinfa as highlighted by our latest interaction with some of the local consultants. These cuts, if implemented, have the following implications.

* Adherence to the edict of March,’17. Shandong Xinfa has about 2.2mnte capacity in Shandong province, so this cut, if it’s true, represents about 45% of Xinfa’s capacity in that province. This is the total of Xinfa’s “illegal” capacity. As per our due diligence, cuts are expected to be implemented in the smelter that the company opened last year, which includes their 660KA pots. It doesn’t mean that they will close this technology however. There’s some further guesses that the company will close their oldest pots first, to a total of 1mnte, so it’s a virtual adherence to the policy, not a literal one. Nevertheless implementation of the same can be crucial.

* Any cuts potentially take out capacity till Mar, ’18. Closing pots is a difficult and dangerous process, and must be limited to a certain number of pots per day (e.g. Xinjiang East Hope is closing ~ 10pots per day and have closed ~ 250kte out of 800kte of total illegal capacity). We therefore expect the process of closing 1mnte will extend into August, ’17. That means that it is extremely unlikely that any closed pots will re-open before the Winter Heating Season period which is finishing on mid-March 2018. These pots will not be able to restart until all the approval documents are in place, but if the company has been told to close, it’s a safe bet they are working very hard to get the paperwork in place as quickly as possible. It’s highly unlikely any stopped pots will be decommissioned. They will be cooled and repaired and will be ready to restart when allowed.

* Can actions by Xinjiang and now Shandong, have cascading impact on other provinces? As highlighted by some of our interactions with the local aluminium consultants, the motivation for forcing this cut on Xinfa can be developments in Xinjiang. Xinjiang’s action to force East Hope to close 800kte, may have nudged Shandong province towards the same. We also believe the Xinjiang and Shandong examples can now be followed by other provinces, notably Inner Mongolia where there are several new projects.

* Potential positive for Hindalco/Vedanta. The move to close all the illegal capacity in China can have positive implications for the metal price and if implemented can have positive implications for Hindalco (where we have currently maintain REDUCE) and Vedanta (ADD). Table 2 highlights the sensitivity of Hindalco to the metal price -- in case action is followed through in the Shandong province as our interactions suggest.

 

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