Credit Suisse Asia Equity Focus Selective buying in China metals and mining ahead of their interim

H1 preview for China metals and mining sector: A mixed bag of results
Steel and metal prices have rebounded in past months after falling sharply on global
de-risking. For instance, the benchmark hot-rolled coil (HRC) and cold-rolled coil
(CRC) price rose 11% and 7% respectively from the low in May. The copper price
also increased by 12% from the recent low. A similar rebound trend also occurred in
other base metals, fuelling renewed interest in China commodity equities, which underperformed the broader market in H1.

Starting next week, China metals and mining companies will begin to report their H1
interim results. Overall, we see the sector reporting mixed results across different
subsectors, with the actual numbers potentially deviating by a wide margin from the
market consensus. On the China steel sector, we expect companies to report a profit turnaround in H1 but a sequential QoQ earnings decline in Q2, as they were impacted by high raw material prices and falling steel demand volume and prices at the start of Q2. In particular, Angang Steel (347 HK, BUY) is more likely to deliver results that are broadly in line with consensus, as the company should benefit from strong exports in H1. On the other hand, we expect Maanshan Iron & Steel (323 HK, HOLD) to report weak Q2 results, as the company has suffered from slowing demand in construction and high material prices. Reflecting the recent share price performance, investor sentiment towards the sector has turned positive, possibly implying that the expected weak Q2 results and perhaps Q3 guidance may have already been priced in after the significant underperformance of the steel sector.

Furthermore, with industry concerns over production cuts, losses at smaller steel mills, inventory destocking and capacity shutdowns well flagged in the marketplace, we believe the sector is approaching a bottom. Conversely, with few signs of an end-demand recovery yet, H2 earnings are likely to show a HoH decline, with Q3 likely
to mark the bottom with a possible recovery in Q4. Hence, we will err on the side of caution regarding the medium-to-long term sector outlook until end-demand starts to show a recovery. Nevertheless, the recent rebound in steel prices reinforces hopes that the sector will bottom. Hence, investors with a high risk appetite may start to look for re-entry positions ahead of the fundamental turnaround.

On China mining stocks, we expect Jiangxi Copper (358 HK, BUY) to report disappointing H1 results, mainly due to the sharp decline in the copper price (–17%) and a contracting smelting margin in Q2. On the base metals outlook, we note that the
copper price found solid support at close to USD 6700/t. We remain positive on the copper fundamentals, given (1) the increasing industrial activity on the back of the macro recovery and (2) the structurally tight supply globally, especially rolling over into 2011. In China, we expect a gradual improvement on the demand side, boosted by the continuing urbanization of third and fourth tier rural villages and counties. We expect the copper price to reach an average price of USD 7280/t by the end of 2010.

On aluminum, the structural overcapacity remains a key concern, even though the aluminum price has improved in recent weeks, rebounding off the low of USD 2030/t. This compares to our average year-end price forecast of USD 2140/t. Potential ETF
issuance on aluminum may stimulate the near-term price rise, but we remain unconvinced about sustained rallies due to the slower response from the supply side, i.e. overcapacity.