HONG KONG Jiangxi Copper Not quite copper-bottomed We transfer coverage of Jiangxi Copper (JXC) to Matty Zhao with a cautious view (downgrade to Neutral from OP) and price target of HK$15 (from HK$22), 9% downside. We expect copper price to remain weak in 2013-14F due to a worsen supply surplus. It will be hard for JXC to outperform the HSI given its high EPS sensitivity to copper prices, ROE drop from 18% in 2011 to below 7% in 2014E and potential consensus EPS cut (we are 16%/40% below consensus in 2013/14F). It is at 15x 2014E PER, and our PT implies 13.7x 2014PER. 358 HK Neutral Our commodity team expects $6,550/t copper price in 2014 . Supply surplus to worsen in 2014: Given the strong investments in copper Price (at 08:01, 10 May 2013 GMT) HK$16.42 projects in the past few years, our commodity team forecasts 3%/8% mined 12-month target HK$ 15.00 copper supply growth in 2013/14F but 3.5%/4.8% demand growth only. Upside/Downside % -8.6 Valuation HK$ 15.00 . Our commodity team see a worsen surplus in 2014 of 728kt (vs. 221kt in 2013) - Sum of Parts and remain cautious on copper prices with a 6% drop in 2013E to $7,458/t GICS sector Materials Market cap HK$m 56,846 and another 12% in 2014E to $6,550/t. The strong YTD supply growth (8%y-y 30-day avg turnover US$m 38.6 from Chile mines) and high inventory level add more near term concerns. Market cap US$m 7,324 Revenue growth not turning into earnings growth Number shares on issue m 3,462 . Revenue growth mainly driven by low margin business: We expect JXC Investment fundamentals to undertake more copper trading/smelting to boost revenue. Despite a better Year end 31 Dec 2012A 2013E 2014E 2015E TC/RC in 2013/14E, JXC‟s smelting lines may just break even and its trading Revenue bn 158.0 167.6 170.2 175.8 EBIT bn 7.1 5.5 4.2 4.5 segment would deliver 1% profit margin. Thus, while trading/ smelting account EBIT growth % -15.4 -21.8 -24.3 6.7 for over 80% of revenue, they only contribute 10/14% to gross profit in 13/14E. Reported profit bn 5.2 4.1 3.0 3.2 Adjusted profit bn 5.2 4.1 3.0 3.2 . Low cash cost but… We like JXC‟s quality assets and its low C1 cash cost EPS rep Rmb 1.49 1.19 0.87 0.93 EPS rep growth % -21.5 -20.2 -27.3 7.1 at US¢84-85/lb ($1850-1870/t vs. over US$5000/t for high cost producers). EPS adj Rmb 1.49 1.19 0.87 0.93 EPS adj growth % -21.5 -20.2 -27.3 7.1 Our calculated total cost (incl. noncash cost and before netting of by-product PER rep x 8.7 10.9 15.0 14.0 credits) may amount to ~$4700/t in 13-15E, and we see limited management PER adj x 8.7 10.9 15.0 14.0 ROA % 9.7 6.8 4.8 5.0 incentives for cost reduction. ROE % 12.6 9.4 6.5 6.7 EV/EBITDA x 5.6 6.7 7.8 7.3 . Mined copper GPM may drop from 45% in 2012 to 26% in 2014: we expect Net debt/equity % 4.6 12.0 19.4 20.4 P/BV x 1.1 1.0 1.0 0.9 mined copper production to remain stable at 209kt in 2013-15E. Amid weaker copper prices, we see self-mined copper concentrate GPM to drop to 36%/26% Source: FactSet, Macquarie Research, May 2013 in 2013/14F along with a 20/27% EPS drop. A 1% copper price drop leads to (all figures in Rmb unless noted) a 1.7% EPS decline in 2013. DCF value of HK$15 and EV/t reserves value of HK$13-16 . We value JXC‟s mined copper segment using DCF (10.8% WACC) and apply 6x 2014E PER for its trading & smelting business to derive our target price of HK$15 (HK$14.7 from mines and HK$0.3 from trading & smelting). It is at 15x Analyst(s) 2014PER (vs. 12x historical average, 13.8x sector average) and 1x P/B. Our Matty Zhao PT implies 13.7x 2014E PER and 0.9x 2014E PB. +852 3922 1293 [email protected] Ivan Lee . JXC is trading at US¢32/lb EV/t of reserves. Copper M&A deals in 2005-2011 +852 3922 3572 [email protected] Annie Li implied EV/t of reserves ranging from US¢39-75/lb. We think the copper +852 3922 3884 [email protected] supply surplus in 2013/14F is more similar to 2008/09 when average EV/t of 13 May 2013 reserves was US¢40-49/lb. We apply a 20% discount to value JXC (not a bid) Macquarie Capital Securities Limited and the implied value is HK$13-16; and our PT is within the range. Please refer to the important disclosures and analyst certification on page 2 and the inside back cover of this document, or on our website www.macquarie.com/disclosures. [email protected] FIRST LAST 05/14/13 01:21:44 PM Hong Kong Highpower Macquarie Research Jiangxi Copper Inside Jiangxi Copper Not quite copper-bottomed 3 Company profile Valuation unattractive on PE, P/B, . Jiangxi Copper (358 HK, 600362 CH, “JXC”) was listed in HK in June 1997 (40% of the shares), and Shanghai in December 2001 (60%). JXC‟s parent co, EV/t basis 7 Jiangxi Copper Corporation, is its biggest shareholder, which is fully-owned by Earnings drivers and sensitivity 11 SASAC of Jiangxi Province. Supply surplus lead to weak price 13 . Jiangxi Copper integrates copper mining, smelting, copper trading, and by- Solid assets but limited production products (gold/silver/sulphuric acid) business. It owns 6 operating copper growth 15 mines domestically and 2 projects overseas (under development), with combined copper reserves of 17.3mnt (China mines reserves of 10.5mnt) gold Revenue growth =/= earning growth 18 reserves of 340t and silver reserves of 9,664t at the end of 2012. It also owns Key assumptions and financials 22 1 smelter and 7 processing plants. Copper industry – worse 2014 supply . In 2012, copper accounted for 86% of revenue and 67% of gross profit; while surplus 24 by-products made up 14% of revenue and 33% of gross profit. Appendices 36 . JXC produced 1,090kt of copper cathodes in 2012, including mined copper of 211kt (19%) and the remaining ~880kt (81%) from its smelting business, of which JXC purchased copper concentrates from third parties (25%/5% from 358 HK rel HSI performance, & rec history international/China suppliers and 50% from copper scrap & blister market). 1. Mined copper - is the major earnings driver (8% revenue and 68% gross profit) for JXC, given its high GPM (45%) 2. Copper smelting - as JXC‟s mined copper production cannot support its cathode capacity (1mnt), it purchased copper concentrates from third parties and thus only earns TC/RC less smelting &refining cost for this segment. Despite accounting for 37% of revenue in 2012 (by recording all third-party concentrate sales as revenue), it made a loss of RMB700m in 2012 per our calculation. Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. 3. Copper trading: JXC trades copper of 650kt/1,135kt in 2011/12 based Source: FactSet, Macquarie Research, May 2013 (all figures in Rmb unless noted) on our calculation accounting for 37%/41% of revenue. Yet with less than 1% margin, trading only amount to 4%/8% of total gross profit 2011/12F. 4. By-products - During the copper smelting and refining process, JXC obtains by-products of gold/silver/sulphuric acid/rare metals etc. In 2012, by products accounted for 14% of revenue and 33% of gross profit. Fig 1 JXC: 2012 Revenue and gross profit mix of each segment 120% 100% 14% 33% 80% 8% 41% 60% 40% 68% 37% 20% 8% 0% -9% -20% 2012 Revenue mix 2012 Gross profit mix Mined copper Copper smelting Copper trading By products Source: Company data, Macquarie Research, May 2013 13 May 2013 2 [email protected] FIRST LAST 05/14/13 01:21:44 PM Hong Kong Highpower Macquarie Research Jiangxi Copper Not quite copper-bottomed JXC hard to outperform during supply surplus and price decline . We expect 2014 copper price of US$6,550/t: We remain cautious on copper price outlook, expecting a 6% drop this year and another 12% next year, leading to US$6,550/t 2014 average price and expect below US$6,200/t in 3Q14. (Please refer to our commodity team report “Seeking shelter as the stars fall”) Our weaker copper price assumptions are based on: Worsening supply surplus in 2014: high copper prices in the past few years have driven a period of strong investment into copper projects, with a resulting supply surplus since late 2012. Our commodities team expects supply surplus in 2013 and a deteriorating situation in 2014E. We model 3% mined production growth in 2013 and 8% in 2014. YTD copper production growth has also been very strong, led by 8%YoY growth from Chilean mines and 10% from large producers that release results (50% of total copper supply), with copper supply disruptions unusually quiet.