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Morningstar | Jiangxi Copper’s 2018 Earnings Hit by Impairment Losses and Rising Costs; Unexciting Growth Prospect

No-moat Jiangxi Copper’s, or JC’s, 2018 net profit of CNY 2.42 billion, up 46% year over year, was within preliminary guidance but trailed our expectation mainly due to impairment losses on financial assets amounting to CNY 1.37 billion. Stripping these off, JC’s earnings should be largely in line with our expectation. Nonetheless, JC’s core earnings declined year over year due to rising costs with gross margin falling to 3.2% from 4.2%, a year ago. After rolling forward our earnings model, we raise our fair value estimate marginally to HKD 9.50 (CNY 8.20) from HKD 9.30 (CNY 8.10). We think JC is overvalued at current price level as the firm’s forward earnings growth is unexciting given our bearish long-term outlook for metal prices.

JC’s earnings are highly dependent on copper and gold, which together contributed more than 95% of the firm’s 2018 gross profit. While we don’t expect significant downside for the gold price, we think upside is also limited as we forecast a nominal gold price of USD 1,300 per ounce by 2020. On the other hand, our long-term copper price forecast is below consensus; we project the copper price to fall to USD 2.29 per pound in 2021 before a gradual recovery is in place. This is largely due to slowing Chinese demand growth on the back of decelerating fixed-asset investment growth.

The firm has surpassed its output targets in 2018. In 2019, it plans to produce 1.44 million tons of copper cathode (down 1.6% year over year), 1.26 million tons of copper processing products (up 7.5%), 205,800 tons of copper concentrates (down 1.2%), 25 tons of gold (down 2.3%), and 313 tons of silver (down 20.7%). Unlike its peer, Zijin Mining, we can see that mining output for JC is declining while the firm is also plagued by falling mining reserves.

The firm is keen to expand its reserves and output via mergers and acquisitions. Given the firm’s balance sheet strength (net gearing ratio close to zero), funding should not be an issue in our view.

However, we think there are risks that JC may overpay for acquisitions given the urgency for the firm to reverse its falling earnings momentum. For example, the firm announced in March that it will acquire a 30% stake in Shandong Humon Smelting (annual refining capacity: 50 tons of gold and 700 tons of silver), for CNY 2.98 billion. Priced at an estimated 2018 price/earnings ratio of 25 times and 2.3 times price/book, we think the deal is expensive with limited synergy to JC.