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Metals frenzy has China bond buyers flocking to smokestack debt

[SHANGHAI] China's so-called old-economy companies are enjoying a renaissance in the debt market, bouncing back from a beating on Beijing's quest to modernize growth.

Pressured to reduce capacity and tackle emissions since the end of 2015, coal and metal companies are now seeing some payoff, with a surge in raw materials prices contributing to buoyant earnings - making their credits a hot commodity. Market pariahs a year ago, when their debt lost money for investors, these companies have staged a turnaround.

Coal bonds have returned 5.74 percent in the past six months, the second-best performance in China after electronics. They're followed by the 5.5 per cent returned on notes issued by iron and steel firms. Companies are boosting supply to meet the demand, with 41 billion yuan (S$8.37 billion) of AAA rated onshore bonds already sold this quarter.

"The overcapacity curbs have eased competitiveness" said Xu Hua, deputy head of research at Colight Asset Management in Shanghai, which has about 30 billion yuan under management. "Upstream industries like coal, steel and petroleum refining have the strongest profitability." China is trying to pivot its economy toward newer, high-tech industries, while also making the old ones that have fueled growth for decades leaner and more resilient to potential shocks. That belt tightening has made metals rock-star commodities this year, with reduced output from Chinese producers boosting prices for aluminum to gold. Coking coal, used in steelmaking, has also recovered from a mid-year slump, surging to 2017 highs in China.

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The price boost has translated into profit gains, with Aluminum Corp of China Ltd, the top state-owned smelter, posting an 11-fold increase in first-half earnings, and Hesteel Co, the nation's second-biggest steelmaker, predicting net income could almost triple in the first six months of 2017.

In fact, the 179 China-listed companies in the metals, mining and coal industries reported a total 26.1 billion yuan in profit in the first quarter, compared with a loss of 1.7 billion yuan in the same period of 2016, data compiled Bloomberg show.

The government's supply-side reform initiative has been good for sectors that have struggled with overcapacity, says Patrick Song, a portfolio manager for CSOP Asset Management in Hong Kong.

"For China onshore credit, we continue to prefer those leading companies in overcapacity industries," he said. "We have seen some consolidation, there will be more consolidation - their profitability has improved significantly." Demand has seen debt costs slide. Aluminum Corp., known as Chalco, saw yields of as much as 5.6 per cent on its AAA rated debt due 2018 last year. In 2017, the yield has dropped 11 basis points to 4.83 per cent, according to Chinabond data. Similarly, yields have retreated for steelmakers and coal companies.