EquityResearch Report Sector / Research Cement Sector Update Re-rating expected given expectations for policies to stabilize growth

CITIC Securities Research 03 Apr 2014

Hao Zeng Youfeng Qiu Tel: 021-20262107 Tel: 021-20262123 Email: [email protected] Email: [email protected] Practicing license: S1010511020001 Practicing license: S1010513080007

Event:

On 2 Apr, Premier Li Keqiang chaired an executive meeting of the State Council to: (i)

study expanding the scope of preferential income tax policies for small/micro enterprises;

/

Construction Material (ii) increase financial institutions’ support for the redevelopment of shantytowns; and (iii) broaden reform of the railway investment and financing systems to accelerate railway construction. On the same day, cement sector logged the second largest gains among all sectors (next only to the real estate), and it also presented consistently robust performance over the past three weeks.

Comments:

 Expectations for policies to stabilize growth will be a core catalyst driving the cement shares to re-rate. Since the cement sector entered the mature period in 2011, correlation between the cement producers’ share price and short to medium-term business fundamentals has been weakening, and the valuation factor gradually took an upper hand, especially in 2013. There are two core factors that affect valuation of the cement stocks: (i) top-down macroeconomics, including liquidity and expectations for fiscal stimulus, and (ii) expectations for medium to long-term supply contraction. The first factor’s impact on cement stocks’ valuation is more obvious. Since 17 Mar, boosted by a string of macro policies such as the Plan for New Urbanization, “stabilizing growth” reiterated at the executive meeting of the State Council, and railway projects approved by NDRC, cement stocks have registered hefty abnormal returns amid the consistent re-rating. Based on our research framework, it was the changes in the expectations for top-down macro fundamentals that boosted re-rating of the cement stocks. Both recent power generation data and the March PMI suggest that China’s economy is still on the decline. Should these data stabilize and pick up, and gradually confirm the trend of macroeconomic improvement, this will deliver a boost to expectations for the cement fundamentals. Meanwhile, consistent decline in relevant data could likely spawn expectations for pro-growth policies, and thus benefit the cement stocks’ valuation.

 Fundamentals are expected to keep enhancing in 2Q14E and full-year supply and demand landscape is to keep improving. At present, shipments and inventory/capacity ratios of cement leaders under our coverage saw a notable improvement, and cement prices have initiated the first round of price hike. Based on information learnt from enterprises, demand from infrastructure and real estate sectors at the downstream are both normal. As East China is expected to put no new capacity into operation in 2014E, the cement supply and demand landscape will

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China Cement Sector Update

improve further in 1H14E. Infrastructure investment is expected to stay high in 2H14E, but real estate investment will likely come under pressure due to declining GFA of new home starts. Yet, demand will largely sustain positive growth against the government’s bottom line thinking, and the marginal supply and demand landscape will thus keep improving. From the perspective of synergy, investors are advised to pay special attention to Anhui Conch Cement (600585). This year, Conch Cement has changed its assessment method from the previous “quantitative” assessment into assessment of both sales volume and profit, so the Company is more willing to cooperate in raising the cement prices through regional synergy.

 Conch Cement’s H shares are trading at a 65% premium relative to its A-share counterparts, hitting a record high. Although its H shares have been trading at a premium relative to its A-share counterparts since 2017, the spread has been widening over the past two years. In our view, it is mainly due to the differences in the investment styles of investors in Chinese mainland and Hong Kong markets: H-share investors focus more on fundamentals, while A-share investors keep a close eye on macro policies in addition to the fundamentals. H-share investors agree to the rationale of cement supply contraction, which, in their views, will boost the sector’s supply-demand landscape to keep improving, and thus buoy up the business climate. However, only a small portion of A-share investors agree with this rationale, and most of the A-share investors believe that due to the pessimistic expectations for macro economy, the pace of demand contraction may outpace that in supply, adding uncertainties to recovery of the sector’s business climate. As more overseas funds (QFII and RQFII) are approved to invest in the A-share markets, arbitrage trade against the record high price premium between the two markets may temporarily boost A-share cement stocks’ valuation somewhat.

 Cement futures may be launched. Zhengzhou Commodity Exchange is preparing for the launch of cement futures. This is of great significance to the cement sector. First, futures price can offer a reference for spot price, and help cement enterprises improve their production management and enhance economic efficiency. Second, risk aversion function of futures can enable cement enterprises to avert from the risk of price fluctuations. Based on history, launch of the domestic deformed steel bar, wire rod, and glass futures has all triggered temporary trading opportunities in relevant sectors. Currently, given that the fundamentals of the cement sector start to pick up gradually, the expectations for cement futures and pro-growth policies could lead to re-rating of the cement stocks.

 1Q14 results of cement companies are worth expectation. Due to the smaller-than- expected decline in cement price in 1Q14, most cement companies are projected to present pleasant earnings. 1Q14E earnings of cement companies in East China, Central China, and South China are expected to more than double.

 Investment strategy: in the short term, the cement sector has entered a traditional peak season. As demand picks up and inventory declines, the cement sector’s fundamentals are expected to stabilize and improve. From the top-down macro perspective, even if the pro-growth measures rolled out against grave downward pressure are merely hedging policy adopted by the government to defend its bottom line, cement share prices could still increase somewhat. Boosted by expectations for pleasant 1Q14E earnings and consistent improvement in the

Please read the disclaimer at the end of the report 1

China Cement Sector Update

sector’s fundamentals, cement stocks are expected to rebound. As for individual shares, investors are suggested to watch for a) Anhui Conch Cement (600585) and Gansu Qilianshan Cement (600720) for their resilient sales volume and price, b) BBMG (601992) and Tangshan (000401) that benefit from “Beijing-Tianjin-Hebei integration”, and c) Xinjiang Tianshan Cement (000877) and Xinjiang Qingsong Building Materials and Chemicals (600425) that are expected to benefit from the theme of the “Silk Road”.

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