Looking for an inflection point
As demand for basic materials has decelerated sharply through 2H08, we believe the
market will be looking for an inflection point in 2009. On a six to 12-month view, with poor
demand visibility in general, we believe the Chinese cement and steel sectors provide the
beta for the potential demand rebound in 2H09, versus coal and non-ferrous metals.
Demand inflection point
We believe the major factors driving demand growth for Chinese basic materials in 2009
are: 1) the government’s stimulus plan, 2) the de-stocking cycle and 3) property
investment. We expect the end of the de-stocking cycles and the full execution of the
government stimulus projects to outpace the negative impact of the property sector,
making mid-2009 a likely inflection point. We also expect sequential acceleration in
demand for most China basic materials in 2H09, in particular, for steel (from -15% YoY in
1H09 to 26% YoY in 2H09), and cement (from 2% in 1H09 to 15% in 2H09). First, we
estimate the government’s stimulus plan, once fully implemented, will boost annual
demand incrementally for cement by 14%, steel by 8% and aluminium by 5%, with upside
risk given the more ambitious local government plans. Second, we believe the aggregated
impact from ongoing de-stocking along the entire value chain will lead to a deep cycle with
an extremely negative growth environment for commodity demand. However, this same
de-stocking cycle could also drive a powerful demand rebound once the inventory
correction comes to end, even without much real demand recovery, in our opinion. Our
channel checks in recent months on inventories of nearly 30 producers for upstream
materials such as coal and iron ore, metal/steel, and downstream products such as
machinery, auto and white goods, suggest signs of inventory correction, ahead of our prior
expectations, a positive leading indicator of improving future demand.
Our beta picks – cement and steel
We view Chinese cement as a proxy of the execution of the government’s stimulus plan,
and the steel sector as the most levered play on the end of de-stocking cycle. We are
neutral on coal and remain cautious on non-ferrous metals. While demand may remain
soft in 1H09, cement is our most favoured sector within the Chinese basic materials space
for 2009, as supply/demand is expected to improve in 2H09. On a six to 12-month view,
we expect net demand growth to improve 11%, while net supply is likely to expand by 9%
(5% if we exclude projects coming at the end of December 2009). The key is timing of the
execution of the stimulus plan, which is likely to surprise the market on the upside, in our
opinion. Our second beta pick is the Chinese steel sector, as the most levered de-stocking
cycle play. We estimate apparent consumption of Chinese steel will improve by 27% HoH
in 2H09, while utilisation is expected to improve from 65% to 83% over the same period,
driven mostly by the end of the de-stocking cycle. As a result, we expect steel’s unit profit
steel to improve from the trough to mid-cycle level or potentially above. Combined with
inexpensive asset-based valuations, we expect a powerful run in Chinese steel stocks in
2Q09. We are neutral on coal and remain cautious on non-ferrous metals.
Top picks – beta and low-cost plays
Our top picks are Anhui Conch, Angang, Baosteel, Chinasteel, and Shenhua, all rated an
OUTPEFORM. Our least favoured stocks are Jiangxi Copper and Panzhihua, both an
UNDERPERFORM. Based on our positive view of China’s cement sector, we maintain our
OUTPERFORM on Anhui Conch, CNBM and Shanshui. We upgrade our ratings on
Chinese steel stocks – Angang, Baosteel, Maanshan and Wuhan – from Neutral to
OUTPERFORM. Our Taiwan team initiated coverage of Chinasteel with OUTPERFORM.
While we believe the worst is over for coal prices and that supply discipline helps stabilise
spot prices, at this point, we prefer to hold steel and cement, as coal is a late cycle play on
a potential demand rebound. We remain highly cautious on aluminium and copper,
especially on current valuations.

Demand inflection point
We believe the major factors driving demand growth for Chinese basic materials in 2009
are: 1) the government’s stimulus plan, 2) the de-stocking cycle, and 3) property
investment. We expect the end of the de-stocking cycles and the full execution of the
government stimulus projects to outpace the negative impact of the property sector,
making mid-2009 a likely inflection point. We expect sequential acceleration in demand of
most China basic materials in 2H09, in particular for steel (from -15% YoY in 1H09 to
26% YoY in 2H09), and cement (from 2% in 1H09 to 15% in 2H09). First, we estimate the
government’s stimulus plan, once fully implemented, will boost annual demand
incrementally for cement by 14%, steel by 8% and aluminium by 5%, with upside risk
given the more ambitious local government plans. Second, we believe the aggregated
impact from the ongoing de-stocking along the entire value chain is driving a deep cycle
with an extremely negative growth environment for commodity demand. However, the
same de-stocking cycle will also lead to a powerful demand rebound once the cycle ends,
even in the absence of a real demand recovery, in our opinion. Our channel checks on
inventories over recent months, through nearly 30 producers for upstream materials such
as coal and iron ore, metal/steel, and downstream products such as machinery, auto and
white goods, suggest signs of inventory correction, ahead of our prior expectations, a
positive leading indicator of improving future demand.
Expect growth to accelerate in 2H09-1H10
We expect apparent consumption growth for basic materials to remain soft in 1H09, due to
deep de-stocking, a time lag in the stimulus plan and a high base in 1H08. However, a
better second half would be supported by completion of the de-stocking process and the
start of peak construction period of the government stimulus plan. We estimate every 10%
change in property investment would swing demand growth for steel and cement by 1-2%,
with the end of the de-stocking cycle possibly adding 20% apparent demand growth for
steel, while full execution of the government stimulus plan is likely to improve demand
growth by 3-14% for cement and steel, based on our estimates
Our base case for bottom-up demand estimates assumes 10% property investment, the
end of de-stocking cycle and full execution of the government stimulus plan starting in mid-
2009, leading to a moderate 2009E demand growth outlook – 6% for steel, 8% for cement,
5% for coal, 4% for copper and 3% for aluminium. Nevertheless, as demand is likely to be
back-loaded, the HoH sequential improvement in demand would be more in focus.