In transition: 1st derivative strength to 2nd derivative pickup
China commodity equities have remained range bound since late July on
concerns over demand strength (1st derivative) and demand growth slowdown/
supply response pickup (2nd derivative), which is consistent with the signs of a
mid-cycle correction. Our latest channel checks with traders, industry contacts,
and downstream users (property developers) indicate that demand is strong and
that there are some initial signs of improvement in 2nd derivatives.
Latest channel checks positive takeaways on 1st/2nd derivatives:
(1) Overall end-demand level is strong. Our coal trader contacts continue to
highlight potential emerging railway bottlenecks, as evidenced by Daqin Railway
approaching full 400mt capacity vs. 68% utilization at the beginning of the year.
Aluminum extrusion products ytd yoy production is up 15% while exports have
declined 40% over the same period, indicating strong domestic demand.
(2) On demand 2nd derivative, initial positive signs yet small in scale:
-- Cement prices have risen 5%-7% over the past 2 months in South/East China.
-- Just released September newly constructed property is up 56% yoy and 24%
mom (after turning positive in June), traditionally a slow period.
-- More importantly, credit expansion, leading steel price by one/two months,
has risen for two consecutive months since its July low.
(3) Sustainability of the two key demand drivers remain high:
-- Tracking spending of two-year infrastructure stimulus reaches 33% ytd.
-- Our meeting with Beijing property developers shows strong demand if the
price is reasonable. For the two recent projects launched, demand is so strong
that developers have had to resort to a “lottery” system to allocate sales. National
property sales surprised on the upside post China’s national holiday.
(4) On supply 2nd derivative, we are pleasantly surprised.
-- Steel industry consultant Mysteel indicates the number of steel mills (77
surveyed) cutting production reached 16% in October vs. 5% in September.
-- Shanxi small mine restarts are much fewer than expected, according to coal
traders, due to the complexity in small mine consolidation and safety issues.
-- Coal traders indicate the reason for one of the key met coal transport railways –
the Houyue Line – to cut its shipment target by 18% this year is because of the
exhaustion of met coal resources in Southern Shanxi/Shaanxi.
(5) Three stock screening criteria: supply constraints, emerging supply
tightness, and undemanding valuations. Top picks: Baosteel (Buy, CL), Angang
(Buy, A share is on CL), and Shenhua (Buy). We also adjust our 2009E-2011E
earnings estimates by -12% to +8% to reflect recent commodity price movements
as well as some forecast changes from our global commodities team.