Positive surprises from our construction value chain visits
Focusing on 2nd derivatives (demand growth/supply constraints), we visited
three cities (Changsha, Tangshan, and Beijing), and met with property
developers, construction machinery producers, steel mills/cement producers to
gauge demand, and coal traders/companies to gauge supply.
Property: Better-than-expected transition from higher sales to increased
construction:
(1) Inventories are falling fast, 40%-50% below the normalized level after 100% ytd
yoy sales growth. Developers are concerned about running out of stock as 2009’s
low supply was due to low construction starts in 2008.
(2) Developers we visited all made major land acquisitions in 3Q, in a magnitude
of 50%-100%, which is in addition to their respective local land banks.
(3) Developers are rushing to start construction given their high gearing and high
land purchase price, in an attempt to benefit from the currently strong market.
(4) Higher property sales usually lead land purchases by 3-4 months, and land
purchases usually lead construction starts by 3-4 months.
(5) Some anecdotal evidence we picked up from the meetings with construction
machinery producers show sharp increases in property sector demand since
Aug., with utilization jumping to 50% in Aug. from the Jan.-July average of 20%.
In some cases demand exceeds capacity with resulting jumps in orderbooks.
(6) Our meetings suggested that steel mill order books for Nov. are in some cases
being filled in two days vs. two weeks previously, strongest momentum ytd.
Infrastructure: Still more to come: Our Hunan industry checks indicated that
only 5-6 highways, out of the 14 announced this year, have started construction.
Upstream: Coal supply constraints support a strong up-cycle:
(1) Shanxi’s small mine consolidation could take two years to complete with a
200mt volume loss; earliest small mine ramp-up potential in 4Q10.
(2) Limited railway infrastructure upgrade in 2010 with emerging bottlenecks.
3 screening criteria: We like steel/coal; d'grade aluminum/cement
(1) Valuation attractiveness – Steel: The only subsector trading at a large
discount to its mid-cycle or close to trough. Our top picks include Baosteel (Buy;
on Conviction Buy List) and Angang (Buy; A share on Conviction Buy List).
(2) Upstream commodity with margin protection – Coal: We upgrade China
Coal (H) to Buy from Neutral, with Shenhua (H) (Buy) as another top pick.
(3) Supply tightness/sustainability – Downgrade Chalco (A and H) and CNBM to
Neutral from Buy due to large idle capacity vs. their mid-cycle valuations. We also
adjust our sector 2009E-11E earnings estimates by -53% to +12%. Key risk to our
target price/investment view includes a sharper-than-expected global slowdown.

Table of contents
Overview: Taking the pulse of the construction value chain; growth accelerating 2
Property channel checks: Higher sales leading to increased construction 9
Infrastructure demand is not only strong, it is holding up well 14
Steel: 2nd derivative improving; valuation attractive 16
Coal: Upstream supply constraints; beginning of a strong up-cycle 24
Aluminum and cement: Supply tightness is the key, downgrade views to Neutral 35
Valuation and summary financials 41
Disclosures