“Many of them that in the past were great have become small,” warned the Greek historian Herodotus, “and those that in my time were great previously were small.” He was writing about the war between Persians and Greeks, but his words could just as easily serve as a warning to Chinalco, China’s state-owned aluminium goliath.
The recently humbled metals company was formed in 2001 from the metaphorical ashes of the Ministry of Metallurgy. It was a pedigree that initially gave it serious political clout. And initially Chinalco was the poster-child for successful state-run businesses.
Then came the 2008 financial crisis and changes in the aluminium industry, forcing Chinalco to diversify into other metals in a big way. The company, naturally, portrays the move as a positive step. But some observers are less certain, interpreting it instead as an admission that Chinalco just can’t make money from its core aluminium business.
Perhaps that’s true. Deep pay cuts and thousands of layoffs are now underway at aluminium plants in Shanxi and Henan Provinces, once the jewels in Chinalco’s crown. Company profits collapsed in 2008, to be followed by a more than $1 billion loss in 2009 and only eked out a small profit of $78 million over the first half of this year, according to the Economy and Nation Weekly magazine.
It’s a decline that would have seemed highly improbable just a few years ago. Aluminium, after all, is key to China’s industrial programme, and in 2005 Chinalco produced 90% of China’s aluminium oxide, the metal’s main precursor. The pricing system in place at the time meant that it sold its wares at the (rising) international price without having to worry about competition for domestic bauxite ore.
Today, its share of the market is thought to have collapsed to just 30%, in the face of a rapid expansion of competing smelters (usually backed by provincial governments). They are often selling aluminium at prices below levels that Chinalco can match (the domestic aluminium industry is estimated to have overcapacity of 30% which has led to aggressive discounting to shift excess supply).
The company is also paying the price for earlier strategic missteps. During the fat years it grew too fast, acquiring smelters all over the country in a bid to reinforce its dominant position. Many of these turned out to be out-of-date assets. “Chinalco only increased its volume without improving its competitiveness,” an industry insider told the magazine. Electricity is at the heart of Chinalco’s problems. “Its energy consumption per unit of aluminium is relatively high,” argues the Economic Observer.
Chinalco also funded its expansion by taking on debt, a lot of it. The Economy and Nation Weekly estimates the company has debts amounting to nearly 80% of its assets (versus less than 60% for Alcoa), which makes competing with upstart rivals that much more difficult.
In hindsight, instead of buying up antiquated smelting capacity, the company would have been better off consolidating its hold on China’s shrinking bauxite reserves. Today, although it’s a shareholder in many mines, Chinalco typically has minority stakes – and is being forced to pay market price for its ore.
That means that rising raw material prices are actually a threat to Chinalco. “In expectation of rising China demand, Africa and other regions have been planning to change from the existing contract pricing mechanism of aluminium oxide in favour of a [more expensive] index-linked model,” predicts the Economy and Nation Weekly.
The company’s plan to find a way out of those problems seems to be based on its experience during the financial crisis. In addition to aluminium plants, Chinalco made a few forays into the copper market while the going was good. Those acquisitions turned out to be among the company’s best performers when its aluminium business was leaking cash last year.
Chinalco will hope its latest purchases prove similarly providential, this time shifting focus into iron ore. It paid $1.3 billion for a stake in a Guinean project (with Rio Tinto) earlier this year, as well as a further $1.5 billion for part of a rare earths company in Jiangxi. More deals look likely to follow.
But those acquisitions will take time (and money) before they become profitable. Even in copper, margins may fall if more competitors manage to enter the marketplace.
“Analysts believe that if China’s copper industry was no longer concentrated among a few players, Chinalco’s [copper business] would start to look like its aluminum business,” explains Economy and Nation Weekly. That would leave the company with two ‘problem children’ instead of just one.
Where next in aluminium? Chinalco recently announced it was forming a joint venture with Sapa, a Swedish metals multinational, which specialises in extruded aluminum profiles. “This is like quenching a thirst with poison,” warned the Economy and Nation Weekly, referring to Sapa’s role in a US anti-dumping investigation into Chinese aluminium earlier this year.
But the JV will focus on making high quality railroad steel to take advantage of the governments plans for new track – utilising the Swedish firm’s technical know-how. But the decision not to go it alone in its home market marks a major shift for the company that once aspired to become a standalone force in the metal.
Still, HSBC thinks Chalco (the company’s listed subsidiary) should be profitable this year. That looks more likely if prices go up in response to electricity curbs shutting smelters across the industry.
And of course, Chinalco does retain one crown jewel: the 9% stake in Rio Tinto it acquired in 2008, when Rio was in financial trouble. Now the global miner is doing well, and Chinalco less so. An irony that Herodotus would have well understood.
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