Fitch Ratings has affirmed Aluminum Corporation of China Limited's (Chalco) Long-Term Foreign Currency (FC) Issuer Default Rating (IDR) at 'BBB+' with Stable Outlook and Long-Term Local Currency (LC) IDR at 'A-' with Negative Outlook. The Short-Term FC and LC IDRs have been affirmed at 'F2'.
Chalco is rated at three notches below China's ratings (FC IDR 'A+'/Stable; LC IDR 'AA-'/Negative) based on Fitch's application of the top-down approach in its Parent and Subsidiary Rating Linkage criteria. This reflects Chalco's and its parent Aluminium Corporation of China's (Chinalco) strategic importance to the government in developing the Chinese base metal industry and overseas resources.
Base metals like aluminium are important to China's development of its aerospace and defence industries. Chalco and Chinalco, the latter of which is a major producer in copper and other rare metals, are the largest metal group owned by the state-owned Assets Supervision and Administration Commission (SASAC) of the State Council.
The group's investment in natural resources has expanded following Chinalco's acquisition of a 12% stake in Rio Tinto Plc ('A-'/Stable) in 2008. In 2010, Chalco joined Rio Tinto in the development of Simandou iron ore mine in Guinea and in 2012, made a bid for SouthGobi Resources Ltd, a Mongolian coal company. Domestically, Chalco started developing a domestic coal mine in Gansu Province in 2010. Fitch notes that the company continues to receive strong support from banks in funding these investments, as well as rapid government approval for rail capacity in shipping coal from the China-Mongolia borders.
Chalco's financial leverage, as measured by net adjusted debt/EBITDAR, was weak at 8.1x in 2011, while that for Chinalco was even weaker at 13.5x for the nine months ended September 2011. However, Chalco's interest coverage ratio of 2.1x reflects its continued ability to service its debt and its implied interest cost of funds of 4.5% in 2011 remains lower than China's base lending rate. Fitch expects Chalco's available banking facilities to be sufficient for meeting its future capex and investment needs.
Improved profitability due to increased self-sufficiency in resources and contributions from its iron ore and coal operations may see Chalco's debt peak in 2014. Fitch believes Chalco's aluminium operations have troughed after its operating EBITDAR margin fell to 6.6% in 2011 from 26.4% in 2007 due to weaker selling prices and escalating costs. The agency expects alumina price - the material used for aluminium production - to rise following changes to Indonesia's minerals export regulation, including a curb on the quantity of and a tax on bauxite - a raw material used for alumina refining. Since Indonesia supplies 80% of China's imported bauxite, this will increase the cost of alumina production and consequently constrain output in China. However, Fitch believes Chalco will as a result enjoy higher profitability as it is 50% self sufficient in bauxite, and also because the company sells 36% of the alumina it produces.
Given the linkages between Chalco and the sovereign, any rating action on the latter will result in a similar action on the company. However, any evidence of diminishing strategic importance of Chalco to the state may result in a change to a bottom-up rating approach which could result in a multiple-notch downgrade. Conversely, any evidence of an increase in strategic importance of Chalco to the state may lead to an upgrade by reducing the notching differential between Chalco's and the sovereign's ratings.
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