China Cement Sector
SECTOR REVIEW
Stress-testing worst fear
■ The worst fear for Chinese cement sector is demand deceleration,
driven by a potential slowdown in property and industrial expansions,
causing major corrections in share prices. However, we highlight the
supply side story, as well as the start of Sichuan earthquake rebuilding
demand, along with the depressed valuations and implied cement price
outlook from current share prices, would still make the sector our top
pick among Chinese basic materials.
■ In our opinion, small kiln closures and the start of the Sichuan
earthquake permanent rebuilding will counter the demand risks. The
cement market will remain positive unless property/industrial
expansions decelerate by more than 16% (or 43% for the Yangtze river
region). And if history can be of a test, Chinese cement demand growth
has never dropped beyond 5% in the past twenty years, except during
1989-90 and 1997.
■ We see a more positive outlook for cement price in eastern China with
Shandong on top of the list, on most improvement in supply-demand
and the current low profit base. NDRC’s Rmb1000 bn rebuilding
investment plan for Sichuan (that is equivalent to 4% of China’s GDP)
will require 120-140 mn tonnes of cement over 2008-10E, creating 24
mn tonnes of annual shortage in Sichuan, which effectively boosts the
Yangtze region’s cement demand by 5%.
■ While the fundamentals have never been better for the Chinese cement
sector in our opinion, valuations are at the low end of the historical
range. The implied cement price outlook from current share prices is
-8% to 3% up from the current spot – conservative in our opinion. We
maintain OUTPERFORM on Anhui Conch (lowering target price from
HK$75 to HK$60 to reflect market multiple contraction), CNBM, Shanshui,
TCC, Asia Cement. Our top pick is Shanshui.

Stress-testing worst fear
The worst fear of the market on the Chinese cement sector is demand deceleration, driven
by a potential slowdown in the property sector and industrial expansions, causing major
corrections in the share prices. However, we highlight the supply side story as well the
Sichuan rebuilding demand, along with the depressed valuation and conservative implied
cement prices, would still make the sector our top pick among Chinese basic materials.
Demand risk re-assessed
We view that there are two major factors to counter the demand risk: 1) small kiln closures
(net supply growth is expected to be 5-6% in the coming four quarters), and 2) Sichuan
earthquake rebuilding demand to boost the country’s demand by over 3% and the Yangtze
river region’s by 7%, in our conservative estimates. With 1H08 demand growing at 8-9%
and the start of permanent rebuilding in 4Q08, the fundamentals for cement will remain
positive in our opinion, unless the property/industrial expansions decelerate by more than
16% sequentially. Specifically, in the Yangtze River region (supplying Sichuan rebuilding),
a 43% sequential deceleration would be needed before the S/D eases. If history can be of
a test, we highlight that over the past twenty years, Chinese cement demand growth has
never dropped below 5%, except in the trough of 0-3% in 1989-1990 and 1997 (FAI
growth was 0% and 9% respectively). In the long run, we see continued demand growth,
given the high consumption of vertical kiln cement in the past. We estimate that Chinese
cumulative consumption of cement per capita was 2.9 tonnes on dry-kiln cement from
1950 to 1H08, still far from the 7-18 tonnes in other countries before their consumption
peaked.
Higher upside in eastern China
Based on our in-depth analysis on 2007-10 S/D outlook for provinces in eastern, central,
and selected western provinces, we expect stronger improvement in eastern China with
Shandong on the top of the list on aggressive closure of small kilns. The start of Sichuan
earthquake permanent rebuilding demand and the push for infrastructure projects for the
Shanghai Expo should provide additional positive drivers for Yangtze river region in the
coming 12 months. Specifically based on the NDRC proposal on the Sichuan earthquake
rebuilding plan, the total investment for the 2008-10 rebuilding period would reach
Rmb1000 bn, implying 120-140 mn tonnes cement required over the period creating 24
mn tonnes of annual supply shortage in Sichuan for 2008-09E. We believe provinces
along the Yangtze river, including Hunan, Hubei, Anhui, Jiangsu, Zhejiang and Jiangxi,
can leverage the low-cost water transport and the high price premium of Sichuan, boosting
the Yangtze region cement demand by 5% in 2008-10E (if exclude Sichuan).
Improving risk/reward profile
Risk/reward profiles remain attractive for most Chinese cement stocks, in our view,
supported by both valuation and fundamentals. 1) While the fundamentals have never
been better for the Chinese cement sector in our opinion, most Chinese cement stocks are
now trading at 5.4-7.0x EV/EBITDA, versus its historical range of 5-15x, and global peers
historical range of 5.8-8.0x. EV/tonne valuation also implies 0-50% discount to the
replacement of versus historical range of 40% discount to 150% premium. For the Taiwan
listed cement stocks with Chinese exposures, the implied EV/tonne valuations are now at
US$20-35/tonne, all breached below the historical trough as well. 2) The implied cement
price outlook from the current share prices, under the current depressed multiples, is
conservative in our opinion. We estimate that the share prices of Conch and CNBM (key
beneficiary of the rebuilding demand) implies a Rmb3-6/tonne increase in cement prices
versus the current spot – risk remains on the upside in our opinion. our top pick for the
sector is Shanshui, as it is the most under valued stock in our coverage, given its current
share price implies Rmb22/tonne or an 8% decline from the spot, overly bearish in our
opinion.