october looking good for felix, page-6

From ABN Amro:
Meetings with various government bodies in Beijing last week highlighted expectations of lower producer prices into 2Q/3Q09. We concur, as demand and price recovery will take time to materialise. We recommend investors stay underweight steel and non-ferrous metals, and overweight coal producers.

Producer prices unlikely to recover soon
Our Head of China Research Wendy Liu recently organised a series of small group meetings with various government agencies/researchers in Beijing. Our key takeaway from the meetings was that producer prices could fall a further 10% and bottom mid-2009 to 3Q09.

Weak prices to weigh on profitability of metals producers
The near-term demand outlook certainly appears bleak with high expectations for any stimulus measures that the Chinese government might introduce. We believe that these may not occur as quickly as the market is hoping and that demand and hence price recovery could take time to materialise. In the interim, the slide in steel and base metal prices has occurred at an alarming pace, which has likely put producers' profits under severe pressure.

Coal profits look safe, even if prices remain flat
One view expressed in the meetings was that contract thermal coal prices may be flat to down in 2009, against our expectation of a 5% increase. We believe the coal producers will remain profitable and will enjoy robust margins even with no price increase. We note that their balance sheets are much healthier than those of the metal producers.

Underweight metals producers and overweight coal
With little clarity on the timing of a recovery, we prefer exposure to stocks with more defensive qualities. We believe the coal companies offer greater earnings clarity and stronger financial positions. We remain Buyers of China Shenhua and China Coal. We believe the metals producers face greater risks to their profitability. Although valuations are close to historical lows, the near-term uncertainties may lead to stock prices falling below our target prices. We would stay underweight metals, with Chalco, Baosteel and Maanshan as our top Sells