In our October 2006 issue of Half-Priced Stocks, we discussed the concept of locking in high yields by investing in beaten-up companies with attractive growth prospects and proven dividend histories. Of the select few finalists that met our requirements in that area, Aluminum Corp. of China (NYSE: ACH) stood at the top of the list. At the time, here's what we had to say: 

"This state-owned company, also known as Chalco, is China's leading aluminum producer and the world's second largest supplier of alumina -- a key raw ingredient used to manufacture aluminum. With four manufacturing plants and several smelters, Chalco produces more than one million tons of aluminum and seven million tons of alumina products annually.

"Since going public in 2001, the firm's dividend track record has been nothing short of phenomenal. Its dividend doubled from $0.21 per share to $0.54 per share in 2003, doubled again in 2004, nearly doubled again in 2005, and then zoomed to $5.02 per share this year.

"On the heels of a nearly -50% slide in the stock over the past nine months, ACH now offers a dividend yield of nearly 8%. With more than $1 billion in annual operating income ($8.62 per share), the firm is currently paying out only a little more than half of its earnings.

"The dividend alone is enough to attract attention, but it is by no means the only selling point. Aluminum consumption in China is rabid -- higher than in any other nation on the planet -- and no company is prepared to meet that demand like Chalco. The firm also benefits from cheap labor, and of course, its ties to the Chinese government." 

Back to the Present
Within two weeks of that write-up, ACH reached bottom and began to rebound. In fact, the shares have rocketed more than +70% since then, climbing from a split-adjusted price of $15.93 to about $27.

Part of that advance was attributable to widespread enthusiasm for Chinese stocks, which swept the Shanghai Composite ahead more than +100% last year. It also didn't hurt that robust demand for raw materials pushed the prices of base metals like copper and aluminum through the roof. In fact, aluminum prices on the spot market hit 17-year highs above $1.09 per pound last February.

ACH sits at the confluence of those two powerful global currents.

As a rule, we are highly reluctant to tread in frenzied sectors or regions where speculation is still rampant -- and ACH is square in the middle of both. Not only is the firm based in China, but it is also heavily tied to volatile commodities prices. Even after this rally, though, the shares are still trading below where they were last March -- and at a reasonable 18% discount to our $33 fair value estimate.

An Eye on the Future
Despite the run-up in aluminum prices over the past few years, the long-term story remains compelling. The world's population is rising every day, global trade is expanding, and the rapid industrialization of fast-growing nations like India and China is fueling heavy demand.

According to forecasts, worldwide aluminum consumption is expected to rise nearly +7% this year, possibly outpacing production. Last year, prices soared on a supply/demand imbalance that reached an estimated deficit of 160,000 tons at one point.

ACH is well-positioned to meet that demand. Recent acquisitions have bolstered the company's production capacity several fold, and management plans to purchase three new smelters -- these should boost aluminum production to 3.4 million tons this year.

Regardless of whether or not supplies remain tight, the company has proven quite capable of prospering under challenging conditions. For example, it managed to post a healthy +25% increase in net income in 2001, despite sharp dips in aluminum and alumina prices that year. And looking beyond 2007, commodities prices run in cycles that tend to be secular in nature, and many analysts believe we are still in the relatively early stages of a bull market that could last another ten years.

In any case, Chalco is in an envious spot. The firm has ready access to bauxite mines (one of the key raw materials refined to make alumina), not to mention the open support of the Chinese government -- which has shut down smaller aluminum firms and arranged favorable, zero-interest financing for ACH. More importantly, the company maintains a monopolistic 90% share of the alumina market in China, where consumption is expected to continue racing ahead at a +12% clip over the few years.

Again, ACH is a volatile stock that is best suited for risk-tolerant investors. Adding to the uncertainty is a lack of timely, accurate financial information. Many of the widely-quoted figures found at online media outlets are often spotty, dated and inconsistent. However, the risk is somewhat mitigated by the company's wide economic moat, durable competitive advantages, and hefty 4.6% dividend yield.

All things considered, we think the risks are outweighed by the potential rewards, and aggressive investors seeking exposure to the sustained economic expansion in China might want to consider ACH. 

Thanks for reading!

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