China has used more cement between 2011 and 2013 than the U.S. has consumed in the entire 20th Century, so you can be forgiven for worrying about a glut of the building material in China.
Those fears are exacerbated when Beijing announced today that China’s economy grew at 7.3% in the third quarter, the slowest pace in five years. Cement producers’ major customers are real estate developers, and builders of highways and railways and other infrastructure, so the mounting concerns about China’s debt, pollution and potential housing over-capacity have weighed on cement stocks like, well, so many tons of concrete.
Against that grey backdrop, the third-quarter earnings reported last night by Anhui Conch Cement looked surprisingly uplifting. Analysts fearing the worse had expected per-share earnings to decline, but Anhui Conch ( 914.HK and 600585.CH) reported a 1% growth in earnings compared to levels a year ago. Cement sales volume grew 15% year-over-year, and coal-price weakness helped margins. For the first nine months of the year net profit growth was a much healthier 52% higher than a year ago.
The stock is up just 0.8% Tuesday afternoon, but Anhui certainly can build on that foundation. For a start, much of the bearish assumptions surrounding cement producers have been built into Anhui’s stock price, which has already corrected 17% since July. Bears were quick to pounce on the 7.3% third-quarter GDP growth, but that number was still a bit better than the 7.2% economists were expecting. More important, the country’s urban fixed asset investments also grew 16.5% year on year, up from last month’s reading 16.1%. While it’s clear that Chinese reforms are pointing in the direction of consumption and services and away from construction, fixed asset investments aren’t about to fall off a cliff.
Anhui Conch trades at nine times what it has earned, which seemed more expensive compared to multiples of roughly five times for rivals like China National Building Material’s ( 3323.HK ), six times for BBMG Corp ( 2009.HK ), and eight times for China Resources Cement ( 1313.HK ). But Anhui has a far stronger balance sheet, with total debt to total assets at a strong 24% - compared to 64%, 31% and 38%, respectively, for said rivals.
Then there is Anhui Conch’s market exposure by region. With slightly more than half of its capacity focused on the East China market, it has zero exposure to North and Northeast China, regions that are the targets of pollution controls. The rest of their capacity is spread between Central, Southern and Western China. While CNBM is also diversified across the country, CR Cement has a focus on Southern China and BBMG has its foothold in North China.
Barclays notes that despite market expectations of only moderate cement price rises in the fourth quarter, and probable sluggish demand growth going forward, the “well-controlled production costs and better-positioned local market for Anhui Conch suggest that earnings and cash flows should be sustained in the medium term.” Barclays also believes Anhui Conch’s strong balance sheet puts the company in a good position for “potential consolidation and market expansion”.
But are Anhui Conch’s advantages already priced in? Maybe not. China consumed a lot of cement between 2011 and 2013, as Vaclav Smil pointed out in his book Making the Modern World: Materials and Dematerialization. But building won’t grind to a halt. Already, exports account for nearly 3% of its sales, and the company is building production in Indonesia and is simultaneously looking to expand overseas with potential new operations in other countries such as Vietnam and Myanmar.
With its market cap roughly equal to US$15 billion, Anhui Conch is already nearly the size of the globally diversified players like Holcim (HOLN.Switzerland) from Switzerland and France’s Lafarge (LG.France). Their price earnings ratios attract significantly higher multiples of 18 times and 26 times, respectively. If Anhui Conch can accelerate its overseas business, the stock – and its valuation multiple – are due for a re-rating.
One question for prospective investors in Anhui Conch, for those who currently have the choice, is whether to buy the Shanghai-listed A shares (600585.CH) or the Hong Kong listed H shares ( 914.HK ). Currently, the A share trades at a 14% discount to the H share, but the premium is likely to disappear once the two exchanges are connected in the near future. In other words, the A share is the more solid value.
