T urnaround unlikely in the short term
Fundamentals remain weak
China is a key driver of the global oversupply in zinc and lead. We believe there
could be a severe market surplus in China as it increases production by 14% over
the next three years from the 2007 global production level. The market surplus will
come from mining and smelting capacity expansion, higher imports, and weakerthan-
expected demand growth.
Price weakness could last at least 12 months
Our global mining & metals team forecasts the London Metal Exchange (LME)
zinc price per pound at US¢96.5/98.8/130.0 for 2008/09/10, and the LME lead
price per pound at US¢100.2/90/125 over the same period. Supported by the
marginal cost of US¢95/lb, we estimate the average Shanghai Non-ferrous Metal
Market (SMM) zinc price per tonne would be Rmb16,956/14,927/19,650, and the
lead price per tonne would be Rmb17,437/15,000/18,895 for 2008/09/10.
Risks to our view: substantial reduction in China output
Although unlikely, we think China’s market surplus can be reversed only if
production is lowered by 15%, either by a coordinated/joint move by producers or
by closing down small producers. There are signs that Chinese miners and smelters
are responding to the weak prices.
Our top pick: Shenzhen Zhongjin Lingnan
We initiate coverage of Shenzhen Zhongjin Lingnan (Buy), Western Mining (Buy),
and Yunnan Chihong Zinc & Germanium (Sell). We believe Shenzhen Zhongjin
Lingnan will best weather weak zinc and lead market fundamentals because of its
management expertise, output expansion, and strong by-product prices.
Contents page
Summary and investment case 3
Industry analysis 6
Competitive analysis 22
Industry risks 25
Valuation and comparables 26
Company pages 35
— Western Mining..................................................................................................36
— Investment Thesis........................................................................................37
— Western Mining’s key drivers .................................................................37
— Key catalysts .........................................................................................40
— Risks .....................................................................................................42
— Valuation and basis for our price target..................................................42
— UBS versus consensus..........................................................................42
— Sensitivity analysis.................................................................................42
— Risk analysis..........................................................................................43
— Return on capital ...................................................................................43
— Financials ..............................................................................................44
— Valuation ...............................................................................................47
— Shenzhen Zhongjin Lingnan Nonfemet...............................................................54
— Investment Thesis........................................................................................55
— Shenzhen Zhongjin Lingnan’s key drivers..............................................55
— Key catalysts .........................................................................................57
— Risks .....................................................................................................58
— Valuation and basis for our price target..................................................59
— UBS versus consensus..........................................................................59
— Sensitivity analysis.................................................................................59
— Risk analysis..........................................................................................60
— Return on capital ...................................................................................61
— Financials ..............................................................................................61
— Valuation ...............................................................................................65
— Yunnan Chihong Zinc & Germanium..................................................................71
— Investment Thesis........................................................................................72
— Fundamental weakness in a tough year.................................................72
— Key Catalysts.........................................................................................75
— Risks .....................................................................................................75
— Valuation and basis of our price target...................................................76
— UBS versus consensus..........................................................................76
— Sensitivity analysis.................................................................................76
— Return on capital ...................................................................................77
— Financials ..............................................................................................78
— Valuation ...............................................................................................82
Summary and investment case
We initiate coverage of Shenzhen Zhongjin Lingnan (Zhongjin Lingnan) with a
Buy rating, Western Mining with a Buy rating, and Yunnan Chihong (Chihong)
with a Sell rating. We believe Zhongjin Lingnan will best weather the current
weak zinc and lead market fundamentals and outperform peers, with its
management expertise, mining and smelting capacity expansion and strong byproduct prices.
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