BOCI believes Yunnan Aluminum's current stock price is attractive

From the development of pure smelting enterprises to integrated upstream and downstream aluminum production enterprises, the reduction in alumina costs has also led to a substantial reduction in costs, coupled with the current low price-earnings ratio, the current share price of Yunnan Aluminum is attractive.

BOC International recently released the in-depth report of Yunnan Aluminum Corporation. The main contents are as follows:

Analysts expect that Yunnan Aluminum's net profit growth in 2007 could reach approximately 212%. The growth momentum is mainly due to the decrease in alumina costs. It is expected that the average unit cost of alumina in Yunnan Aluminum will drop by approximately 35% year-on-year in 2007. In addition, the production of bauxite and alumina projects and the increase in electrolytic aluminum production will contribute to Yunnan Aluminum's profits in 2008.

Yunnan Aluminum plans to mine the Wenshan bauxite mine and build an alumina plant with an annual production capacity of 800,000 metric tons. Wenshan has abundant bauxite resources and analysts are expected to meet Yunnan Aluminum's demand for bauxite for more than 30 years. Considering the lack of bauxite in China, analysts believe that Yunnan Aluminum's possession of bauxite resources can reduce Yunnan Aluminum's operational risk and will greatly increase the long-term competitiveness of Yunnan Aluminum.

As of the end of September 2006, Yunnan Aluminum's net debt to equity ratio was as high as 104%. Yunnan Aluminum invests approximately RMB 4 billion in bauxite and alumina projects, which will further increase the financial burden of Yunnan Aluminum in the coming years. Analysts therefore expect Yunnan Aluminum to raise funds by issuing new shares to ease the heavy financial burden.

Using the discounted cash flow to value Yunnan Aluminum, the target price is 11.8 yuan, which is equivalent to approximately 7.9 times the 2007 P/E, which is a discount of 9% to 11% over the average of the industry; even if considering To the possible refinancing, under the target price, the 2007 P/E ratio is 9.2 times, which is basically the same as the average level of the industry, which analysts believe is reasonable.

Table 1. Investment summary

Year ending date: December 31 2004 2005 2006E 2007E 2008E

Revenue from principal operations (RMB million) 2,308 4,508 6,566 6,369 7,564

Change (%) 58 95 46 (3) 19

Net income (RMB million) 189 141 263 821 817

Diluted earnings per share (RMB) 0.35 0.26 0.48 1.50 1.50

Change (%) 14.9 (25.3) 86.4 211.9 (0.5)

Price-earnings ratio 21.4 28.6 15.3 4.9 4.9

Cash flow per share (RMB) 0.1 0.6 0.3 2.8 3.1

Stock price per cash flow 94.7 12.0 22.8 2.7 2.4

Corporate Value / EBITDA 15.5 13.8 9.2 5.0 4.9

Dividend per share (RMB) 0.300 0.20 0.34 0.53 0.52

Dividend yield (%) 4.1 2.7 4.6 7.1 7.1

I. Valuation

Discounted cash flow valuation

Yunnan Aluminum is ready to invest in bauxite, and will extend the industrial chain to an upstream company. It will be developed by an electrolytic aluminum smelting enterprise into an upstream and downstream company integrating bauxite mining and aluminum smelting. Therefore, analysts use cash discounts to value the aluminum industry in Yunnan, which results in Yunnan Aluminum's net asset value per share of RMB 11.80, which is used as the analyst's target price.

Table 2. Cash flow discounted valuation assumptions

Risk-free interest rate (%) 2.94

Market risk premium (%) 8.04

Adjusted beta value 1.10

Capital cost (%) 11.78

Debt costs (%) 6.10

Income tax rate (%) 25

Debt to equity ratio (%) 50

Weighted average cost of capital (%) 9.4

Table 3. Discounted Cash Flow Estimates

Core Business Value 9,307

Net debt (2,465)

Affiliate value 7

Minority Interests (407)

Shareholders' Value 6,443

Net asset value per share 11.8

Table 4. Assumptions for electrolytic aluminum and alumina prices (including VAT)

2006 2007 2008

RMB/metric ton 2004 Expected anticipation of long-term expected price in 2005

Electrolytic aluminum 16,242 16,744 20,000 18,600 17,670 15,900

Year-on-year (%) 11 3 19 (7) (5)

Alumina 4,144 4,444 4,612 2,250 2,138 2,500

Year-on-year (%) 45 7 4 (51) (5)

Table 5. Forecast of sales of major products

2006 2007 2008

(thousand metric tons) Expected anticipation for 2005 in 2005

Electrolytic aluminum 183 318 375 385 475

Year-on-year (%) 69 74 18 3 23

Other valuation methods

In addition to cash flow discounted valuations, analysts also use valuation methods such as P/E and P/B ratios as references. At present, the average annual price-earnings ratio of Yunnan Aluminum in the global and Chinese peers is 8.7 and 8.9 times respectively. At a target price of RMB 11.8, Yunnan Aluminum’s 2007 P/E ratio is 7.9 times, which is a discount of 9% to 11% compared to the average level of the global Chinese peers. At the current price, Yunnan Aluminum's P/B ratio in 2007 was 2.8 times, which is higher than the average level of the global and Chinese peers. However, given the tight bauxite resources in China, analysts believe that Yunnan Aluminum's development of upstream mineral resources will help reduce business risks and increase long-term competitiveness. Therefore, analysts believe that the value of Yunnan Aluminum's assets can be higher. Premium.

Due to the huge capital expenditures in the next two years, analysts expect Yunnan Aluminum to raise more funds by issuing new shares. Assuming a financing amount of RMB 1 billion, the issuance of new shares in early 2007, the issue price of RMB 7.4, and the issuance of new stocks of 135 million, the total share capital of Yunnan Aluminum will increase by approximately 25%, and 2007 earnings per share will be diluted to RMB 1.28. Under the analyst's target price of 11.8 yuan, the corresponding 2007 P/E ratio is 9.2 times, which is basically the same as the average price-earnings ratio of China's peers. Therefore, analysts believe that even considering the refinancing factor, analysts believe that the target price is still reasonable.

Table 6. Comparison of global peers in China

P/E (fold) P/B (fold) Return on equity (%)

Company name currency 2006E 2007E 2006E 2007E 2006

The main international aluminum company

Indian Industry Rupiah 8.8 8.6 1.7 1.4 19.7

National Indian Aluminum Rupee 6.8 7.9 1.8 1.6 26.4

Alcoa U.S. Dollar 9.5 9.5 1.6 1.4 16.6

Alcan Dollar USD 8.6 8.7 1.5 1.3 17.6

Global average 8.4 8.7 1.7 1.4 20.1

H-share listed aluminum company

China Aluminum HK 6.3 12.5 1.5 1.5 23.7

A-share listed aluminum company

Lanzhou Aluminum RMB 21.1 12.6 1.6 1.5 7.8

Jiaozuo Wanfang Renminbi 12.0 6.5 3.1 2.2 25.5

Guan Al shares 15.9 8.2 1.7 1.4 10.4

Zhongfu Industrial Co., Ltd. RMB 13.0 9.8 1.8 1.6 13.8

Baotou Aluminum RMB 9.2 8.1 2.0 1.7 21.5

Nanshan shares RMB 28.7 7.8 1.0 0.9 3.6

Average 16.7 8.9 1.9 1.6 13.8

Yun aluminum shares RMB 15.3 4.9 2.2 1.7 14.6

Table 7. Assume the impact of issuing new shares

07 Earnings per share 08 Earnings per share 07 Target P/E

(RMB) (RMB) (times)

Unissued new shares 1.50 1.50 7.9

Issuance of new shares refinancing * 1.28 1.28 9.2

*: Assuming a financing amount of RMB 1 billion, the total share capital will increase by 25%

Second, earnings outlook

Analysts believe that the decline in alumina costs is the main driving force for Yunnan Aluminum's earnings growth in 2007. In addition, the production of bauxite and alumina projects and the increase in electrolytic aluminum production will contribute to Yunnan Aluminum's profits in 2008. Analysts expect Yunnan Aluminum's net profit in 2007 will increase significantly from 260 million yuan in 2006 to 820 million yuan, an increase of 212%.

Alumina prices drop

Alumina is the main raw material for the production of electrolytic aluminum and accounts for approximately 50% of the total production cost of Yunnan Aluminum. In 2005, about 70% of the alumina needed for Yunnan Aluminum production had a long-term supply contract; in 2006, the proportion of long-term supply contracts fell to about 50%, and in 2007, the proportion of long-term supply contracts will further decline to about 30%. Correspondingly, with the reduction of the proportion of long-term contracts, the proportion of aluminum oxide required by Yunnan Aluminum to purchase from the off-shore spot market in China will increase from approximately 30% in 2005 to approximately 50% in 2006, and further increase to approximately 70%.

In 2006, the alumina production capacity in China rapidly increased, which put heavy pressure on alumina prices. China's alumina prices have fallen by more than 50% since May 2006. In the next two years, China's alumina production capacity will continue to maintain rapid growth, and further pressure will be placed on alumina prices. Analysts expect that the average alumina spot price in China in 2007 will fall by about 51% compared with 2006. The aluminum oxide supplied by Yunnan Aluminum in accordance with the long-term contract mainly comes from imports, and is priced at 17-22% of the three-month aluminium futures price of the London Metal Exchange, and the price is relatively stable. Therefore, analysts expect the alumina spot price will be significantly lower than the long-term contract price in the next two years. Analysts believe that Yunnan Aluminum's reduction in the proportion of long-term supply contracts will greatly reduce Yunnan Aluminum's 2007 production costs. Analysts expect the unit cost of alumina in Yunnan Aluminum to drop by approximately 35% year-on-year in 2007.

The change in alumina prices has a great impact on Yunnan Aluminum's earnings. Analysts' sensitivity analysis showed that alumina prices were below analysts' expectations of 1%, which could increase Yunnan Aluminum's earnings by nearly 2% in 2007. Therefore, the decline in alumina prices will become the main driver of Yunnan Aluminum's earnings growth.

Invest in Wenshan Bauxite Mine

Yunnan Aluminum plans to mine Wenshan Bauxite Mine by increasing its capital Wenshan Aluminum Yunnan Aluminum (55% share in Yunnan Aluminum) and build an alumina plant with an annual production capacity of 800,000 metric tons. Wenshan is also located in Yunnan Province and has abundant bauxite resources. The preliminary proved reserves are currently 33.85 million metric tons. Analysts estimate that the final proved reserves should be much larger than this number. According to the production scale of aluminum oxide planned by Yunnan Aluminum, analysts expect Wenshan Mine to meet the aluminum industry demand for Yunnan Bauxite for more than 30 years. Considering the lack of bauxite in China, analysts believe that Yunnan Aluminum's possession of bauxite resources can reduce Yunnan Aluminum's operational risk and will greatly increase the long-term competitiveness of Yunnan Aluminum.

The first phase of the alumina project (400,000 metric tons of capacity) is expected to be completed by the end of 2007. The second phase (an additional 400,000 metric tons of capacity) is expected to be completed by the end of 08. Analysts expect Yunnan Aluminum's alumina self-sufficiency rate will reach more than 80% after the Yunnan Aluminum alumina project is fully put into production in 2009 (now it has no self-produced alumina). Analysts expect that the total investment for bauxite and alumina projects will be as high as 4 billion yuan.

As the Wenshan bauxite mine is close to the surface and the grade is also higher than the Chinese average, analysts believe that the production cost in the future may not be higher than the Chinese average. The average production cost of alumina in China (owned bauxite) is only 1,800 metric tons, which is far below the spot market price of alumina, which is currently nearly 2,500 metric tons (excluding tax). Analysts believe that with the gradual commencement of production of bauxite and alumina projects after 2008, Yunnan Aluminum's production costs can be further reduced.

Increased production of electrolytic aluminum

Yunnan Aluminum purchased Yongxin Aluminum and Runxin Aluminum at the end of 2005, thereby increasing Yunnan Aluminum's annual electrolytic aluminum production capacity from 300,000 metric tons per year to 400,000 metric tons, an increase of approximately 30%. Therefore, analysts expect Yunnan Aluminum's aluminum production in 2006 will reach about 375,000 metric tons, an increase of 18%.

At the same time, Yunnan Aluminum plans to expand the electrolytic aluminum production capacity of Runxin Aluminum, as Runxin Aluminum has the advantage of small hydropower. Analysts believe that this will increase the output of electrolytic aluminium in Yunnan Aluminum in 2008.

Third, risk analysis

Electrolytic aluminum price changes

The change in electrolytic aluminum prices is an important factor affecting the profitability of Yunnan Aluminum. Analysts assume that Yunnan Aluminum's average selling price of electrolytic aluminum was 20,000 metric tons (including VAT) in 2006, and RMB 18,600 metric tons in 2007. If the actual electrolytic aluminum price is lower than the analyst's assumption of 1%, analysts' estimates of Yunnan Aluminum's earnings in 2006 and 2007 will also be reduced by 6% and 5%, respectively.

Electricity price changes

Electricity costs are another major expense of electrolytic aluminum production, accounting for about 36% of total production costs. Analysts assume that Yunnan Aluminum's average electricity price was 0.37 kWh (excluding value-added tax) in 2006, and 0.39 kWh in 2007. If the actual electricity price is higher than the analyst's assumption of 1%, then Yunnan Aluminum's earnings forecast for 2006 and 2007 will also be reduced by 4% and 3% accordingly. In the past two years, electricity shortages have occurred in Yunnan, but since the second half of 2006, electricity supply in Yunnan Province has become surplus. Therefore, analysts believe that there is limited room for further growth in Yunnan's aluminum electricity prices.

Increased debt burden

As of the end of September 2006, Yunnan Aluminum's net debt to equity ratio was as high as 104%. Analysts expect Yunnan Aluminum's huge investment in bauxite projects and alumina production lines (nearly 4 billion yuan) will further aggravate Yunnan Aluminum's financial burden in the coming years. Analysts expect Yunnan Aluminum's net debt to increase to 137% in 2007 and further increase to 163% in 2008. Analysts expect Yunnan Aluminum's annual financial expenses will rise sharply from 82 million yuan in 2005 to more than 200 million yuan in 2007, which will greatly increase Yunnan Aluminum's financial burden. Analysts therefore expect Yunnan Aluminum to raise funds by issuing new shares to ease the heavy financial burden. At the same time, Yunnan Aluminum's 2007 earnings per share will be diluted.

IV. Yunnan Aluminum Industry Background

Yunnan Aluminum Co., Ltd. Yunnan Aluminum (Yunnan Aluminum) was founded in March 1998, issued 72 million A shares in April 1998 and listed on the Shenzhen Stock Exchange.

The main business of Yunnan Aluminum is the production of electrolytic aluminum and downstream aluminum processing products. Currently, the annual production capacity of electrolytic aluminum is about 400,000 metric tons. From January to August 2006, Yunnan Aluminum produced 18.4 million metric tons of electrolytic aluminum, which accounted for 3.1% of China’s total electrolytic aluminum production and ranked fifth among the national electrolytic aluminum producers.