20090114 Macquarie Chinese cement
All aboard
Event
We review the Chinese cement market and related stocks.
Impact
Both Anhui Conch and CNBM have performed strongly over the past few months, given the market’s focus on infrastructure spending. This performance has also been fuelled by broker upgrades to both earnings and recommendations. We remain positive on the Chinese infrastructure spending story and the role that cement plays, but we think earnings in the market now might now be too high. When we initiated on the sector, our earnings forecasts were ahead of consensus, but they are now 10–20% below the market.
Volumes and prices improve in December, however gross profit margins were under pressure. While prices have been rising slightly and costs have been falling, the full impact has not been felt during 4Q. Gross margins fell to 20% for Conch and CNBM, from +30% earlier in the year. We are likely to see weaker margins in 1Q09.
Execution risk is now the focus for FY09. We continue to think that the cement story will be heavily weighted to the later half of 2009. Our price targets for the cement companies reflects this. Recent stock performance has now largely factored in a recovery in construction into 2H09. The stocks now need to deliver on expectations in order to maintain outperformance.
GP margin guidance per tonne of cement could actually mean some downgrade for Conch. Conch management has continued to guide for a GP per tonne of Rmb50–60. We understand that in 4Q08, the company achieved around Rmb48/t, the lowest for the year (average FY08 GP per tonne was about Rmb60). For FY09, the market is currently forecasting around Rmb77/t, which is higher than our Rmb70/t; both signal downside risk. Our earnings upgrade to CNBM now means it will deliver a GP per tonne of around Rmb60/t, which appears more reasonable.
Outlook
We think both Conch and CNBM will be well placed to pick up large government-related contracts going forward. Earnings will likely be weaker in the 1H09 but we expect they will improve into 2H09. Both stocks now need to deliver on these expectations.
Anhui Conch: We retain our Outperform rating on Conch but we do see a short-term opportunity to take profit. The stock performance in 4Q08 and 1Q09 is likely to be poor, and we think there is downside risk to the market’s earnings forecast for FY09. On an EV/t basis, we continue to feel comfortable with our target price of HK$40 but we think the stock will provide better opportunity below HK$30.
CNBM. We have upgraded our earnings estimate for CNBM to reflect our lower GP per tonne forecast. The stock is still in a period of strategic transition. While execution risk is high in the short term, we still see further upside to the share price performance.