Structural investment opportunities

Transcription

1 Sector Research China Construction & Building Materials July 31, 212 Construction & Building Materials Cautious Buy Structural investment opportunities Investment highlights Demand-and-supply conditions are expected to improve in 2H 212. We forecast cement output to grow faster in 2H 212 and increase by 6.2% in 212. New clinker production capacity is estimated to reach around 18 million tonnes in 212. We believe the demand-and-supply conditions will improve gradually given increasing cement demand and limited new cement supply after 3Q Q profit of the cement sector is expected to improve with significantly varied performance among different regions. We forecast the profit of the cement sector to slump by 44% y-o-y in 212. We forecast 3Q profit will remain at a low level. But 4Q profit is expected to rise over 3Q, boosted by the traditional peak season and stimulus measures. The profitability of cement companies operating in north-eastern China are expected to remain high. The profitability of cement producers in eastern and mid-southern China are likely to recover. Cement companies operating in Shaanxi, Gansu and Qianghai may record improved profitability, while those operating in Xinjiang are facing downside risks. Cement manufacturers in south-western China are on course to see profits rebound as the industry concentration improves. We estimate the cement players in northern China to see limited profit improvement. Maintain Cautious Buy rating on the cement sector. We prefer two types of stocks. (1) Cement companies with operations in eastern China and expected profit recovery and growth potential. We suggest paying close attention to Anhui Conch (6585 CH), Jiangxi Wannianqing Cement (789 CH) and Anhui Chaodong Cement (6318 CH). (2) Cement companies operating in western China and poised to benefit from investment stimulus policies. We suggest paying close attention to Gansu Qilianshan Cement (672 CH) and Tangshan Jidong Cement (41 CH). Maintain Neutral rating on the glass sector. Overall, we expect limited downside pressure and upside potential for the flat glass sub-sector given the slow recovery in demand and profits. That said, we believe the uptrend in the deep processing glass sub-sector will be sustainable despite short-term pressure. In the short term, we suggest focusing on the float-glass producers as these are likely to rebound, driven by expectations of policy easing, such as Zhuzhou Kibing (61636 CH), Shandong Jinjing Science & Technology (6586 CH) and CSG (12 CH). We also recommend to wait for long-term investment opportunities when the supply and demand conditions have improved significantly as more producers suspend production and demand has actually increased, boosted by actual policy easing. Analyst Qiu Bo qiubo@guosen.com.cn S Sales Contact Dan Weil Global Head of Institutional Sales and Trading Managing Director dan.weil@guosen.com.hk Chris Berney Managing Director chris.berney@guosen.com.hk Roger Chiman Managing Director roger.chiman@guosen.com.hk Andrew Collier Director andrew.collier@guosen.com.hk Joe Chan Director joe.chan@guosen.com.hk Cancy Kong Vice President cancy.kong@guosen.com.hk Gary Wong Associate gary.wong@guosen.com.hk Ma Ning Associate ma.ning@guosen.com.hk For ratings definitions and other important disclosures, refer to the Information Disclosures at the end of this report.. 1

2 Other sectors: pay attention to the companies with clear growth prospects. We are optimistic about the prospects of Beijing Oriental Yuhong Waterproof (2271 CH), which is poised to benefit from its leading position in the waterproofing industry, expansion of sales channels & networks, and better control of expenses and receivables. We expect Beijing New Building Materials (786 CH) to see sales volume and profit growth, boosted by capacity expansion and increasing demand. We also like China Fibreglass (6176 CH), given its leading position in the fibreglass sector, market prowess, significant costs advantage and the expected rebound in exports. Exhibit 1: Earnings forecasts & ratings Ticker Company Rating Closing price (RMB) Market cap. (RMB mn) EPS (RMB) PE (x) 212E 213E 212E 213E 6585 Anhui Conch Cement Buy Jiangxi Wannianqing Cement Buy Beijing New Building Buy Materials 2271 Beijing Oriental Yuhong Buy Waterproof 6176 China Fibreglass Buy

3 1 Investment strategy for the cement sector 1.1 We are cautiously optimistic about growth in cement demand in 2H 212, and forecast sales to grow by 6.2% y-o-y in 212 China s GDP growth slowed further in 2Q 212 due to adverse impacts from the European debt crisis, weakening economic conditions, domestic economic restructuring and monetary tightening. China s GDP growth slowed from 8.1% in 1Q to 7.6% in 2Q. Exhibit 2: China s GDP growth slowed down 16% 14% 12% 1 8% 6% 4% Mar/3 Mar/4 Mar/5 Mar/6 Mar/7 Mar/8 Mar/9 Mar/1 Mar/11 Mar/1 China s fixed asset investment (FAI) (excluding rural households) amounted to RMB billion in Jan-Apr, representing a 2.2% y-o-y growth, which eased.7 percentage point from 1Q 212. Real estate development investment rose by 18.7% y-o-y to RMB1,583.5 billion during the same period, 4.8 percentage points lower than that in Jan-Mar. The y-o-y growth of value-added in industries above the designated size eased 2.6 percentage points from March to 9.3% in April. China s manufacturing PMI continued to stay above the critical level of 5, slightly up.2% m-o-m to 53.3 in April. Electricity consumption increased by 3.47% y-o-y in April, representing the lowest level since May 29. Exhibit 3: Cumulative amount and y-o-y growth of China s FAI Exhibit 4: Cumulative amount and y-o-y growth of investment in real estate development in China RMB bn 35, 3, 25, 2, 15, 1, 5, 4 35% 3 25% 2 15% 1 5% 7, 6, 5, 4, 3, 2, 1, 45% 4 35% 3 25% 2 15% 1 5% Feb/9 May/9 Aug/9 Nov/9 Feb/1 May/1 Aug/1 Nov/1 Feb/11 Aug/11 Feb/12 Feb/9 May/9 Aug/9 Nov/9 Feb/1 May/1 Aug/1 Nov/1 Feb/11 RMB bn Aug/11 Feb/12 May/12 Cumulative amount of FAI (RMB bn,lhs) Cumulative y-o-y growth of FAI (RHS) Cumulative investment in real estate development (RMB bn,lhs) Cumulative y-o-y growth of investment in real estate development (RHS) 3

4 Exhibit 5: Growth of value-added of industries above designated size 25% Exhibit 6: Growth of electricity consumption % % -1 Jan/6 May/6 Sep/6 Jan/7 May/7 Sep/7 Jan/8 May/8 Sep/8 Jan/9 May/9 Sep/9 Jan/1 May/1 Sep/1 Sep/11 May/12 Jun/9 Aug/9 Oct/9 Dec/9 Feb/1 Apr/1 Jun/1 Aug/1 Oct/1 Dec/1 Feb/11 Apr/11 Jun/11 Aug/11 Oct/11 Dec/11 Feb/12 Apr/12 As stated in Premier Wen Jiabao s government work report, China s 212 GDP growth target is 7.5%. Based on experience in previous years, China s actual GDP growth is usually higher than the government s target. As such, we estimate 212 GDP growth to be 8%. To achieve the GDP growth target, the government is expected to issue policies to stimulate the economy. However, the global economic slowdown is adversely affecting China s exports, while domestic consumption lacks growth momentum in the short run. Under such a scenario, investment might be the best measure for stimulating economic growth. Recently, China released a series of favourable policies for the cement sector to boost cement demand from investments in railway infrastructure projects, public housing construction and rural building material stimulus programme. Exhibit 7: Favourable policies and information for the cement sector Date Source Content Ministry of Railways The Ministry of Railways has received an intended credit line of over RMB2 trillion from banks by the end of last year Ministry of Railways China Securities Journal People s Daily Executive Meeting of the State Council The Ministry of Railways issued the Implementing Opinions on Encouraging and Guiding Private Investment in Railways. The government plans to speed up the approval process for large-scale infrastructure projects, and has asked various parties to submit their project proposals for this year before the end of June. China will take effective measures to increase commodity housing supply and increase the pilot points for the rural building material stimulus programme, Premier Wen Jiabao said in Hubei. According to the requirements of the government, preliminary preparations for the established projects should be accelerated while the projects in progress should be continued to ensure these are completed as scheduled. China encourages private capital to invest in railway, infrastructure, energy, telecommunications, education, and medical sectors. The government will also increase support for public housing construction and renovation of dilapidated houses in rural areas. Source: Ministry of Railways, China Securities Journal, People s Daily Given the side-effects of the RMB4 trillion stimulus package, we believe China will launch much more moderate stimulus policies this time mainly for the purpose of stabilising economic growth and compensating for the adverse impact incurred by declining investment in the real-estate sector. As investment requires financial support, we need to further track the fund allocation in the sector to determine the actual impact of this new round of stimulus measures. 4

5 We estimate 212 FAI growth will be 18% FAI correlates closely with GDP and outstanding loans. Assuming the GDP growth rate is 8%, inflation rate is 4% and new loans amount to RMB8.5 trillion this year, 212 FAI will be RMB32.66 trillion and RMB34.91 trillion based on the linear regression between GDP and FAI, and between outstanding loans and FAI respectively. Given the minor adjustment to FAI statistics standard from 211 and the expectations on government stimulus policy, FAI will be slightly higher than the regression value. Thus, we estimate the FAI to reach RMB36.7 trillion in 212, around 18% up y-o-y. Exhibit 8: Regression analysis on FAI and GAP Exhibit 9: Regression analysis on FAI and outstanding loans 35, 3, 25, y =.647x R² = , 3, 25, y =.568x R² =.982 2, 2, 15, 15, 1, 1, 5, 5, -5, -5, 1, 2, 3, 4, 5, 1, 2, 3, 4, 5, 6, Cement demand is estimated to increase by 6.73% y-o-y to 2.22 billion tonnes in 212, according to FAI-based calculations Cement consumption per RMB1, of FAI has been declining in recent years. Assuming the cement consumption per RMB1, of FAI is.6 tonne and FAI is RMB36.7 trillion in 212, we estimate the total cement consumption (cement output) to increase by 6.73% y-o-y to 2.22 billion tonnes in 212. Exhibit 1: Cement consumption per RMB1, of FAI Cement consumption per RMB1, Cement consumption per RMB1, of urban FAI in Jan-Apr (tonne) of total FAI (tonne) Source: Guosen Securities Economic Research Cement demand is expected to rise by 5.78% y-o-y to billion tonnes in 212, according to calculations based on investments in various sectors China targets railway infrastructure investment of RMB4 billion. Investment in railway infrastructure construction declined by 38% y-o-y to RMB29.1 billion in April 212. Over January to April, investment in railway infrastructure construction plunged by 48% y-o-y to RMB71.7 billion, accounting for about 18% of the total investment target for 212 (almost the same as that of 17% in 29 and 21). Besides, the government has released a series of 5

6 favourable measures to stimulate railway infrastructure investment, such as issuing railway bonds and encouraging private investment in railway construction. As such, we believe that the RMB4 billion railway infrastructure investment target can be achieved this year. Based on past experience, 2 tonnes of cement will be consumed per RMB1, of investment in railway infrastructure. As railway infrastructure investment is expected to fall by RMB61.1 billion in 212 from RMB461.1 billion in 211, we estimate the cement demand from railway investment to decrease by 12.2 million tonnes in 212. Exhibit 11: Cumulative amount and y-o-y growth of investment in railway infrastructure construction Exhibit 12: Monthly amount and y-o-y growth of investment in railway infrastructure construction RMB bn RMB bn Jan/9 Apr/9 Jul/9 Oct/9 Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/12 Jan/9 Apr/9 Jul/9 Oct/9 Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/12 Cumulative investment in railway infrastructure construction (RMB bn,lhs) Cumulative y-o-y growth of investment in railway infrastructure construction (RHS) Source: Ministry of Railways, Guosen Securities Economic Research Monthly investment in railway infrastructure construction (RMB bn,lhs) Y-o-y growth of investment in railway infrastructure construction (RHS) Source: Ministry of Railways, Guosen Securities Economic Research China s completed FAI in transportation dropped by 5.22% y-o-y to RMB285.8 billion over January to April 212 due to financial strain. But we see no further decline in transportation investment growth with the easing of liquidity conditions. However, the growth rate will hover at a low level due to the continuous improvement of highway construction and relatively high investment base caused by the previous stimulus package in 28. As such, we expect FAI in transportation to post zero growth in 212. That is to say, cement demand from transportation FAI will not increase in 212. Exhibit 13: Cumulative amount and y-o-y growth of FAI in transportation Exhibit 14: Monthly amount and y-o-y growth of FAI in transportation RMB bn 1,4 1,2 1, RMB bn Feb/9 May/9 Aug/9 Nov/9 Feb/1 May/1 Aug/1 Nov/1 Feb/11 Aug/11 Feb/12 Feb/9 May/9 Aug/9 Nov/9 Feb/1 May/1 Aug/1 Nov/1 Feb/11 Aug/11 Feb/12 Cumulative FAI in transport (RMB bn,lhs) Cumulative y-o-y growth of FAI in transport (RHS) Source: Ministry of Transport, Guosen Securities Economic Research Monthly FAI in transport (RMB bn,lhs) Y-o-y growth of FAI in transport (RHS) Source: Ministry of Transport, Guosen Securities Economic Research As the government has been attaching increasing importance to water conservancy construction in recent years, we predict that the investment in this area will surge to RMB4 billion in 212 from RMB334.1 billion in the previous year. Past experience 6

7 shows that around 1.4 tonnes of cement will be consumed for every RMB1, investment in water conservancy. Therefore, we forecast cement demand from water conservancy to increase by million tonnes in 212. We estimate the metro, bridge, airport and other public infrastructure construction projects to generate an increase of 2 million tonnes in cement demand in 212. The completed investment in real-estate development rose by 9.22% y-o-y to RMB49.8 billion in April 212. During the first four months of 212, the completed real estate development investment increased by 18.7% y-o-y to RMB billion, newly started GFA fell by 4.2% y-o-y, which was the first negative growth recorded since October 29 as a result of property controls, and GFA under construction and completed GFA jumped by 21.2% and 3.2% y-o-y respectively due to the construction and completion of numerous projects newly started in 21 and 211. We estimate that the growth of real estate development investment is likely to bottom out in June to August as the property control effect fades out. Thus, we forecast the investment in real estate development to grow by 5% this year, which would drive cement demand to increase by around 19.5 million tonnes. Urbanisation is an important driver for cement demand growth. As China plans to raise its urbanisation rate from 47.5% in 21 to 51.5% in 215, we estimate cement demand for urbanisation to grow by about million tonnes or 12% y-o-y in 212. Based on our above calculations, cement demand in 212 is expected to increase by 5.78% y-o-y to about billion tonnes. By taking the average of the cement demand amount calculated based on the above two methods, we estimate that cement demand in 212 to be around billion tonnes, up 6.2% y-o-y. China s cement output grew by 5.47% y-o-y to 592 million tonnes over January to April 212. We believe that the cement demand growth will pick up in May to December due to the improved weather conditions and policy loosening. We estimate the full-year cement demand growth to reach 6.2% in 212. Exhibit 15: Cement output and y-o-y growth mn tonnes 2,5 2, 1,5 1, Jan/9 Mar/9 May/9 Jul/9 Sep/9 Nov/9 Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Mar/11 Sep/11 Mar/12 May/12 Cumulative cement output (mn tonnes,lhs) Cumulative y-o-y growth of cement output (RHS) 7

8 1.2 New cement supply will continue to decrease New clinker production capacity is expected to reach around 18 million tonnes in 212, and decrease after 213 In January to April, the completed investment in the cement sector dropped by 12% y-o-y to RMB28.2 billion. FAI in the cement sector has been posting negative growth for 14 consecutive months since February 211, indicating the control policies for the sector have taken effect. Based on data from Digital Cement, new dry process clinker production capacity reached 25 million tonnes in 211. Given a 12% y-o-y decrease in investment in the cement sector over Jan-Apr this year, we estimate new dry process clinker capacity in 212 to be around 18 million tonnes, equivalent to 234 million tonnes of cement production capacity. New cement production capacity is expected to decline to between 5 million and 8 million tonnes in 213. The 12th Five-Year Plan for the cement sector stresses the control of capacity expansion and acceleration of restructuring and upgrading in the sector. Thus, we believe that China will continue to curb cement overcapacity in the long run. Exhibit 16: Cumulative amount and y-o-y growth of FAI in the cement sector Exhibit 17: Monthly amount and y-o-y growth of FAI in the cement sector RMB bn RMB bn Feb/9 May/9 Aug/9 Nov/9 Feb/1 May/1 Aug/1 Nov/1 Feb/11 Aug/11 Feb/12 Feb/9 May/9 Aug/9 Nov/9 Feb/1 May/1 Aug/1 Nov/1 Feb/11 Aug/11 Feb/12 Monthly FAI in cement sector (RMB bn,lhs) Y-o-y growth of FAI in cement sector (RHS) Cumulative FAI in cement sector (RMB bn,lhs) Cumulative y-o-y growth of FAI in cement sector (RHS) Elimination of obsolete production capacity continues China targets to eliminate 219 million tonnes of obsolete cement production capacity in 212. We estimate that around 8 million tonnes of obsolete capacity to be eliminated will be clinker capacity, while about 14 million tonnes will be grinding capacity. Given the unregulated production and low operation cost, small grinding plants may expand cement capability arbitrarily and disrupt the market price and order. Elimination of small cement grinding plants will be conductive to enhancing cement supply-demand balance and stabilising the cement price. 1.3 We estimate the cement sector to post negative profit growth in 212 Corporate profits are determined by revenues and costs. Revenues of cement players are dependent on cement price and sales, while costs are mainly dependent on the price of coal and electricity, and capacity utilisation rate. 8

9 Cement cost falls slightly as capacity utilisation rate improves As coal price has dipped by around RMB3 per tonne this year, we expect a relatively stable coal price going forward. We see no significant change in electricity price since the price adjustment at the end of last year. As market demand improves, cement output is expected to increase, which may bring down the fixed cost per tonne. Thus, we forecast that cement cost will remain stable, and may fall slightly as coal price drops and capacity utilisation rate improves. Exhibit 18: Coal price in China RMB/tonne Jan/9 Mar/9 May/9 Jul/9 Sep/9 Nov/9 Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Mar/11 Sep/11 Mar/12 May/12 Shanxi qaulity mix FOB Datong quality mix FOB Supply and demand situation is affected by new production capacity We estimate cement demand and supply to reach billion tonnes and billion tonnes respectively in 212. Capacity utilisation rate is expected to fall by 2% y-o-y to 88% in 212 due to higher-than-expected new cement production capacity and slowdown in cement demand growth resulting from tightening policies. Exhibit 19: Supply and demand in the cement sector E Cement demand (billion tonnes) Cement supply (billion tonnes) Capacity utilisation rate 87% 9 91% 9 88% We estimate the profit of the cement sector to slump by 44% y-o-y in 212 Assuming the net profit per tonne is RMB26 in 212, we estimate the profit of the cement sector to slump by 44% y-o-y to RMB57.5 billion in The demand and supply situation in the cement sector has not deteriorated significantly. Based on the capacity utilisation rate in 212, we see no tight supply in 212. In terms of demand, there were relatively few newly started projects in 1H 212, thus exerting some pressure on the market. But we believe that cement demand will recover in 2H 212 with the commencement of more infrastructure projects. 9

10 2. Price alliance and coordination among cement players can improve profitability. Net profit per tonne reached RMB9.5 in January to February 212, representing a slight increase as compared with the same period of 28 or a decrease compared with the same period of 21. Net profit per tonne amounted to RMB2.63 in 28 when cement manufacturers had not formed any price alliance and cement price was fully determined by competition in the market. Price alliance began to take shape in the cement sector in eastern China in late 2H 21. As such, we forecast that net profit per tonne in 212 will be higher than that in 28, but slightly lower than that in 21. Exhibit 2: Profit forecasts for the cement sector Profit of the cement sector (RMB million) y-o-y growth Output (million tonnes) Net profit per tonne (RMB) Dec-3 11, Dec-4 13, % Dec-5 8, % 1, Dec-6 15, % 1, Nov-7 2, % 1, Nov-8 26, % 1, Nov-9 36, , Nov-1 48, % 1, Dec-11 11, % 2, Dec-12 56,992-44% 2, Feb-4 1, Feb-5 (418.9) (4.24) Feb-6 (48.8) (.39) Feb Feb-8 1, Feb-9 1, Feb-1 2, Feb-11 7, Feb-12 2, The above forecast is based on the premises that the economy is undergoing restructuring, cement consumption per RMB1, of FAI drops off and price alliance remains effective. However, we cannot rule out the possibility of increase in state infrastructure investment to stimulate economic growth, rapid economic transformation, broken price alliance, etc. Therefore, we conduct the following analysis in light of various possible extreme scenarios: Exhibit 21: Profit of the cement sector under different scenarios (Unit: RMB billion) Exhibit 22: Profit growth of the cement sector under different scenarios % -54% -52% -51% -49% 24-52% -5-48% -46% -45% 26-48% -46% -44% -42% % -42% -4-38% -36% % -35% -33% -31% 1

11 3Q profit will stay at a low level while 4Q profit may improve over 3Q 3Q is the traditional low season for cement consumption in southern China due to the decline in construction works during the wet season and hot weather. Slowdown in the real estate investment has adversely affected cement demand from the property sector. We estimate the growth of real estate development investment to hit the bottom in June to August. Recent acceleration of infrastructure investment is expected to be reflected in the cement demand in 4Q. The profitability of the cement sector lacks growth momentum and will remain at a low level in 3Q 212, in our view. Exhibit 23: Average price of P.O 42.5 cement stood at low levels Exhibit 24: Profitability of the cement sector fell to historic low RMB/tonne Jan/9 Apr/9 Jul/9 Oct/9 Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/12 Feb/7 Jun/7 Oct/7 Feb/8 Jun/8 Oct/8 Feb/9 Jun/9 Oct/9 Feb/1 Jun/1 Oct/1 Feb/11 Net profit margin of the cement sector Gross profit margin of the cement sector Jun/11 Oct/11 Feb/12 4Q is the traditional peak season for the cement sector. Various local areas will accelerate project construction and the investment projects encouraged by the government will commence construction in 4Q 212, which may lead to an increase in cement demand. As the demand for cement improves, cement price and sales are likely to increase, and 4Q profit is expected to rise over 3Q. 1.4 Cement companies operating in north-eastern China are expected to maintain high profitability, while those operating in eastern, mid-southern and south-western China are expected to see profit recovery The cement sector is highly fragmented with strong regional characteristics. Different supply and demand conditions and market concentration in different areas may result in different cement prices and profit levels. 11

12 Exhibit 25: Supply and demand situations in different regions Total capacity of new dry process (mn tonnes) New cement capacity (mn tonnes) Cement output (mn tonnes) Obsolete capacity eliminated in 211 (mn tonnes) Obsolete capacity with clinker capacity Small grinding plants Impact of new capacity on 212 Y-o-y growth of cement output in Jan-Apr 212 Impact of new capacity on Y-o-y growth of cement output in Jan-Apr 212 Cement output in 211/capacity of new dry process in 211 China % 5% 1 95% Northern region % -3% 28% 93% Beijing % 26% 89% Tianjin % Hebei % -6% 24% 113% Shanxi % 15% 24% 5 Inner Mongolia % 36% 99% North-eastern region % -7% 13% 11 Liaoning % -5% 9% 88% Jilin % 16% 113% Heilongjiang % 7% 1 155% Eastern region % 2% 9% 95% Shanghai % 11% 375% Jiangsu % 5% -1% 146% Zhejiang % -12% 14% 16% Anhui % 13% 12% 48% Fujian % 25% 2% 14% Jiangxi % -3% 16% 83% Shandong % -3% 1 11 Mid-southern region % 9% 13% Henan % 15% -6% 19% Hubei % -9% 13% Hunan % 9% 5% 94% Guangdong % 1% 9% 113% Guangxi % 13% 3% 92% Hainan % 8% 113% South-western region % 12% 12% 78% Chongqing % 22% 61% Sichuan % 9% 6% 99% Guizhou % 3 6% 62% Yunnan % 9% 2 76% Tibet % -74% 61% North-western region % 18% 14% 59% Shaanxi % 26% -12% 65% Gansu % 26% 51% Qinghai % 18% 16% 64% Ningxia % -5% 3 85% Xinjiang % 7% 78% 47% Source: Digital Cement, Wind, Guosen Securities Economic Research 12

13 Exhibit 26: P.O 42.5 cement price in provincial capitals on December 31, RMB/tonne Beijing Tianjin Shijiazhuang Taiyuan Huhhot Shenyang Changchun Harbin Shanghai Nanjing Hangzhou Hefei Fuzhou Nanchang Jinan Zhengzhou Wuhan Changsha Guangzhou Nanning Haikou Chongqing Chengdu Guiyang Kunming Tibet Xi'an Lanzhou Xining Yinchuan Urumqi China China Exhibit 27: P.O 42.5 cement price in provincial capitals on May 25, RMB/tonne Beijing Tianjin Shijiazhuang Taiyuan Huhhot Shenyang Changchun Harbin Shanghai Nanjing Hangzhou Hefei Fuzhou Nanchang Jinan Zhengzhou Wuhan Changsha Guangzhou Nanning Haikou Chongqing Chengdu Guiyang Kunming Tibet Xi'an Lanzhou Xining Yinchuan Urumqi China Exhibit 28: Unit price change of P.O 42.5 cement by regions (year-to-date) 1 RMB/tonne Beijing Tianjin Shijiazhuang Taiyuan Huhhot Shenyang Changchun Harbin Shanghai Nanjing Hangzhou Hefei Fuzhou Nanchang Jinan Zhengzhou Wuhan Changsha Guangzhou Nanning Haikou Chongqing Chengdu Guiyang Kunming Tibet Xi'an Lanzhou Xining Yinchuan Urumqi China 13

14 Exhibit 29: Unit price change of P.O 42.5 cement by regions (year-to-date) (%) Beijing Tianjin Shijiazhuang Taiyuan Huhhot Shenyang Changchun Harbin Shanghai Nanjing Hangzhou Hefei Fuzhou Nanchang Jinan Zhengzhou Wuhan Changsha Guangzhou Nanning Haikou Chongqing Chengdu Guiyang Kunming Tibet Xi'an Lanzhou Xining Yinchuan Urumqi China The above exhibits show that cement price rose in north-eastern China, Shaanxi, Gansu and Qinghai this year. Currently, the cement price in north-eastern China is relatively high, compared with other regions. New cement capacity has been well consumed by demand growth in mid-southern China this year. New dry-process capacity utilisation rate in the north-eastern and mid-southern China was higher than other regions in 211. Cement companies operating in north-eastern China are expected to maintain high profitability. Thanks to the effects of high market concentration and price alliance, cement price in north-eastern China rose at the beginning of this year and stood at a high level in January to April despite the negative growth in cement demand. We believe that price alliance and coordination will enable the cement price in this region to stand at a relatively high level going forward. But the potential for further price hike in this region is limited, as a greater price difference may result in the influx of lower-priced cement from other regions, which would exert pressure on the cement price in this region. Exhibit 3: P.O 42.5 cement price in north-eastern China Exhibit 31: Cement inventory in north-eastern China RMB/tonne Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Mar/11 Sep/11 Mar/12 May/12 Shenyang Dalian Anshan Benxi Changchun Tonghua Harbin Jiamusi Shenyang Changchun Harbin June 1 February 3 Cement enterprises operating in Shaanxi, Gansu and Qianghai are expected to record improved profitability, while those operating in Xinjiang are facing downside risks. Cement price plunged and the majority of cement manufacturers in Shaanxi suffered 14

15 losses last year due to the cut-throat competition in the market, which also dragged down the cement prices in Gansu and Qinghai. As cement supply and demand conditions improve, cement players in Shaanxi have raised the cement price by RMB75/tonne since this year through taking concerted efforts to limit output, thus pushing up the cement prices in Gansu and Qinghai and improving regional profitability. However, cement price in Xinjiang is expected to dip as new capacity surges. Exhibit 32: P.O 42.5 cement price in north-western China Exhibit 33: Cement inventory level in north-western China RMB/tonne Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Mar/11 Sep/11 Mar/12 May/12 Xi'an Baoji Ankang Lanzhou Pingliang Xining Yinchuan Urumqi Aksu Xi'an Lanzhou Xining Yinchuan Xinjiang June 1 February 3 We forecast that the profits of cement producers in eastern and mid-southern China may recover as the market demand improves. Given the release of new production capacity and weakening demand for cement, gross profit per tonne for cement producers in eastern China has fallen from over RMB1 to RMB4-5. Some small producers have even reported losses. We believe that cement price in this region has almost hit bottom and the downside potential will be limited. Cement producers in eastern China will return to profitability once new production capacity has been fully released and cement demand improves, in our view. Exhibit 34: P.O 42.5 cement price in eastern China Exhibit 35: Cement inventory level in eastern China RMB/tonne Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Mar/11 Sep/11 Mar/12 Shanghai Nanjing Hangzhou Hefei Fuzhou Nanchang Jinan May/12 Shanghai Nanjing Wuxi Suzhou Xuzhou Hangzhou Jiaxing Quzhou Shaoxing Ningbo Hefei Chaohu Tongling Wuhu Fuzhou Longyan Nanchang Jiujiang Fuzhou Ganzhou Jinan Zibo Zaozhuang June 1 February 3 15

16 Exhibit 36: P.O 42.5 cement price in mid-southern China Exhibit 37: Cement inventory level in mid-southern China RMB/tonne Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Mar/11 Sep/11 Zhengzhou Wuhan Changsha Guangzhou Nanjing Haikou Mar/12 May/12 Zhengzhou Xinxiang Nanyang Anyang Wuhan Jingmen Huangshi Yichang Changsha Loudi Changde Guangzhou Yingde Yunfu Nanning Guigang Guilin Chongzuo Yulin Haikou June 1 February 3 Cement prices in south-western China have remained at low levels along with the increase in cement capacities incurred by post-quake reconstruction. As the most decentralised cement market in China, market concentration in this region is much lower than other regions. Anhui Conch Cement (6585 CH), China National Building Material, Lafarge, TCC International, etc. are expanding their business scales in south-western China through mergers and acquisitions. We expect the market concentration in this region to improve late this year. It is estimated that the total market share of the top five cement players in the region will exceed 3, which may help boost the cement price in the region through price alliance and coordination. We estimate that the profitability of cement companies in south-western China may improve significantly once bottoming out. Exhibit 38: P.O 42.5 cement price in south-western China Exhibit 39: Cement inventory in south-western China RMB/tonne Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Chongqing Guiyang Mar/11 Sep/11 Chengdu Kunming Mar/12 May/12 Chongqing Chengdu Mianyang Yibin Leshan Guiyang June 1 February 3 Kunming Qujing We predict limited profit improvement of cement makers in northern China, particularly in Hebei, given sluggish demand and overcapacity in this region. Industry integration and elimination of obsolete capacity in the region should be accelerated, in our view. 16

17 Exhibit 4: P.O 42.5 cement price in northern China Exhibit 41: Cement inventory in northern China RMB/tonne Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Mar/11 Sep/11 Beijing Tianjin Shijiazhuang Taiyuan Huhhot Mar/12 May/12 Beijing Tianjin Shijiazhuang Tangshan Handan Xingtai Taiyuan Datong Yuncheng June 1 February 3 Lvliang Huhhot Wuhai Ordos To conclude, we are optimistic about the cement companies operating in north-eastern China with high profitability, cement companies with operations in the eastern, mid-southern and south-western China and opportunities to recover profits as the market demand and industry concentration improve, and the cement companies operating in north-western China with expected profit improvement boosted by increasing demand from infrastructure construction. 1.5 Rating and strategy for the cement sector Maintain Cautions Buy rating on the cement sector Profits of cement players fell sharply in 1H 212 amid weak demand for cement due to macro controls. Given pessimistic market expectations on the cement sector, 212 profitability and valuation of cement companies have been downgraded, and the Cement Index has plunged since July 211. However, cement demand is expected to improve with policy loosening, providing a catalyst for cement stock prices to rise since May. Cement stocks rebounded on the release of the RMB4 trillion stimulus package in November 28, but experienced corrections later, and continued to rise till the stimulus package had actually boosted cement demand and cement players profitability. We estimate that it will take three to six months before policy loosening can actually take effect and stimulate cement demand in the market. Besides, 3Q is the traditional low season for the cement sector. Thus, we expect the cement sector to see increasing demand, growing profits and rising stock prices in 4Q 212. But we still need to track the policy implementation. Two types of stocks to watch: 1. Cement companies with expected profit recovery and high growth potential. Under the pressure of newly added cement production capacity in eastern China in 1H 212, some cement manufacturers in the region had to sell cement at cost, or even reported losses. Cement price in this region is expected to stabilise after all new cement production lines have been put into commercial operation in June. As 17

18 demand gradually increases with policy easing, cement players in eastern China are likely to take concerted action to raise the selling price of cement through collaboration and coordination, thus greatly boosting their profitability. We suggest paying close attention to Anhui Conch (6585 CH), Jiangxi Wannianqing Cement (789 CH) and Anhui Chaodong Cement (6318 CH). 2. Cement companies operating in western China poised to benefit from investment policy stimulus. As China loosens monetary policies, the government is poised to accelerate infrastructure investment in the relatively underdeveloped mid-western region. Cement companies in this region are on course to benefit from the likely investment policy stimulus. Relevant cement stocks in the region may present some trading opportunities. Besides, cement players in Shaanxi and Gansu are expected to return to profit and post better results in 2H 212. We suggest paying close attention to Gansu Qilianshan Cement (672 CH), Tangshan Jidong Cement (41 CH), Xinjiang Qingsong Building Materials and Chemicals (6425 CH), Xinjiang Tianshan Cement (877.CH) and Ningxia Building Materials (6449 CH). 2 Investment strategy for the glass sector 2.1 Profits of the flat glass sub-sector hit bottom Flat glass output increased slightly by.48% y-o-y to million weight cases over January to April 212. The flat glass sub-sector reported a total loss of RMB765 million for 1Q 212. The flat glass inventory of major glass makers totalled million weight cases at the end of April 212, 27% higher than at the beginning of the year, while the average ex-factory price of flat glass decreased by 7.43% y-o-y to RMB27.4 per square metre in April. Exhibit 42: Cumulative output of flat glass in China Exhibit 43: Float glass inventory increased % 2 15% 1 5% -5% -1 Jan/9 Apr/9 Jul/9 Oct/9 mn weight cases Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/ mn weight cases Jan/8 Apr/8 Jul/8 Oct/8 Jan/9 Apr/9 Jul/9 Oct/9 Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/12 Cumulative output of flat glass (mn weight cases,lhs) Cumulative y-o-y growth of flat glass output (RHS) 18

19 Exhibit 44: Flat glass price remained stable Exhibit 45: Profit of the flat glass sub-sector fell to historic low RMB/square metre RMB mn 8, 6, 4, 2, Jan/9 Apr/9 Jul/9 Oct/9 Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/12-2, Jan/9 Mar/9 May/9 Jul/9 Sep/9 Nov/9 Jan/1 Mar/1 May/1 Jul/1 Sep/1 Nov/1 Profits of the flat glass sector (RMB mn,lhs) Y-o-y profit growth of the flat glass sector (RHS) -4 As the weather is warming up and previously suspended projects have been resumed gradually since March 212, demand for flat glass has recovered slowly. But the slowdown in real estate development investment has dragged down the demand recovery. We expect the demand for glass to improve gradually in 2H 212 as the real estate development investment bottoms out around June to August and auto sales rebound. But significant demand growth may be seen upon further implementation of loosening policies. Exhibit 46: Cumulative y-o-y growth of newly started GFA, GFA Exhibit 47: Auto sales, output and growth under construction and completed GFA mn nuits Feb/9 Apr/9 Jun/9 Aug/9 Oct/9 Dec/9 Feb/1 Apr/1 Jun/1 Aug/1 Oct/1 Dec/1 Feb/11 Apr/11 Jun/11 Aug/11 Oct/11 Dec/11 Feb/12 Apr/12 Jan/9 Apr/9 Jul/9 Oct/9 Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/12 Cumulative y-o-y growth of sold GFA Cumulative y-o-y growth of newly started GFA Cumulative y-o-y growth of completed GFA Cumulative auto sales (mn units,lhs) Cumulative auto output (mn units,lhs) Cumulative y-o-y growth of auto sales (RHS) Cumulative y-o-y growth of auto output (RHS) Supply will not improve in the short term As of May 3, 212, there were a total of 27 float glass production lines in China, among which, 198 lines were operating as normal and 72 lines were under cold repair or halted. Glass producers suspended the production of 26.67% of total float glass production lines, reaching a record high. As at May 3, five new float glass production lines have been put into commercial production and 15 float glass production lines have been completed but have not been put into commercial operation yet this year. Once the lines halted or under cold repair resume production or new lines are put into production, it may significantly affect the market supply. But supply pressure will not be eased in the short term due to the increasing m-o-m demand growth. 19

20 Both price downside risk and upside potential are limited We expect a slight increase in flat glass price with improving demand due to seasonal factors and continuing de-stocking. As profits in the sector fell to historic low and many glass manufacturers suffered losses, glass manufacturers began to take joint actions to suspend production to prop up the glass price. As such, we believe the price downside risk is limited. Given the weaker demand growth and sluggish property market, a significant increase in prices is unlikely either, in our view. In terms of costs of raw materials, the price of soda ash is expected to rebound slightly from the bottom, while the price of heavy oil is estimated to remain stable in 2H 212. Exhibit 48: Prices of soda ash and heavy oil 6, 5, RMB/tonne 4, 3, 2, 1, Jan/7 Apr/7 Jul/7 Oct/7 Jan/8 Apr/8 Jul/8 Oct/8 Jan/9 Apr/9 Jul/9 Oct/9 Jan/1 Apr/1 Jul/1 Oct/1 Apr/11 Oct/11 Apr/12 Price of soda ash Price of heavy oil 2.2 The uptrend in the deep processing glass sub-sector will be sustained despite short-term pressure The low-e glass sub-sector is expected to benefit from promotion of construction of energy saving buildings The usage rate of energy-efficient glass is 1 in China, much lower than 5 in Europe, while the penetration rate of low-emissivity (low-e) glass is only 8% in the Chinese market. China has begun to promote the use of low-e glass in public buildings. Low-e glass is likely to be extended to residential use. We expect a broad prospect for the residential use of low-e glass as people s incomes increase and energy conservation and environmental protection policies are further implemented in China. As Vice Premier Li Keqiang said, China s energy consumption in buildings accounts for nearly 4 of total energy consumption in the country, while energy saving buildings account for less than 25% in urban buildings. Renovation of non-energy-saving buildings in urban cities and the ongoing urbanisation are expected to provide tremendous potential for the energy conservation sector. China plans to invest over RMB5 trillion in environment protection during the 12th Five-Year Plan period. As such, we forecast a surge in demand for low-e glass, boosted by the promotion of energy saving buildings. In low-e glass production, offline production lines account for the overwhelming majority, while online production lines account for less than 2 at present. We estimate online low-e glass production lines to increase along with the popularisation of online low-e 2

21 technologies. But we should note that there is massive overcapacity in offline low-e glass production now. The photovoltaic glass sub-sector remains lacklustre Overcapacity, coupled with the US and EU anti-dumping policies, led to the slackening of China s photovoltaic industry. Under such a scenario, photovoltaic-related deep processing glass products, such as ultra clear rolled glass, ultra clear float glass and TCO glass, have been adversely affected. As the photovoltaic industry is unlikely to recover from the bottom in the short term, we estimate the photovoltaic glass market to remain lacklustre. 2.3 Rating and strategy for the glass sector In our view, flat glass price may rise in the short term, driven by the slowly growing demand and continuing de-stocking. But we believe that the upside potential will be limited before any significant improvement in demand. The low-e glass sub-sector is expected to gain significant momentum due to the promising market prospect, while the photovoltaic glass sub-sector will remain lacklustre. As such, we apply a Neutral rating on the glass sector. We suggest paying attention to the float glass producers that are likely to rebound, driven by expectations of policy easing, such as Zhuzhou Kibing (61636 CH), Shandong Jinjing Science & Technology (6586 CH) and CSG (12 CH). We also advise investors to wait for long-term investment opportunities when the supply and demand conditions have improved significantly as more glass producers suspend production to improve the supply and demand conditions, and demand has actually increased as boosted by actual policy easing. 3 Other sectors: pay attention to companies with clear growth prospects 3.1 Beijing Oriental Yuhong Waterproof (2271 CH): a leading player with promising prospect The leading player enjoys rapid growth According to the 12th Five-Year Plan, the waterproof industry will maintain 2-3 rapid growth, and industry concentration will improve during the 12th Five-Year Plan period. As the first listed company in the waterproof industry, Beijing Oriental Yuhong s production capacity for waterproof roll and waterproof paint reached 6 million square metres and 5, tonnes respectively so far. An additional capacity of 7 million square metres of waterproof roll and 16, tonnes of waterproof paint, as well as other wall coating, mortar and rubber sealing projects are under construction or to be built. The company will expand its production bases from Beijing and Shanghai to Hunan, Liaoning, Guangdong, Yunan and Jiangsu. Diversification of sales channels and expansion of sales network support future development As it is hard for the company to sustain high growth by virtue of direct sales channel, the company began to improve its sales models and develop the distributor channel to fuel 21

22 its sales. It has established the sales network in the 1st and 2nd tier cities, and plans to expand the network to county-level cities. The company is on course to control its expenses effectively and improve the collection of receivables The company s expenses-to-sales ratio increased along with its rapid expansion, thus squeezing its profits. We believe that the company s expenses will drop as it plans to tighten management and reduce redundant staff to enhance efficiency and control expenses. Due to a low receivable turnover ratio, the company reported a net outflow of RMB216 million in cash flow from operations in 1Q 212. In order to improve the receivable turnover ratio, the company has included the collection of receivables in the salesman assessment system. Risk factors GDP growth may slump, real estate investment may fall sharply, and asphalt price may surge. Buy rating We are optimistic about the development prospect of the waterproofing industry and the upside potential of the company. However, it will take time to see performance improvement, given the adverse effect of property controls and suspension of some high-speed railway projects in the short term. We apply a Buy rating and estimate the company s EPS to be RMB.43, RMB.58 and RMB.8 for 212, 213 and 213 respectively. 3.2 Beijing New Building Materials (786 CH): capacity expansion boosts profitability The gypsum plasterboard sector is expected to maintain 18% y-o-y growth in the next three to five years The output of gypsum plasterboard grew by 18.3% y-o-y in China in 211. However, as the potential demand for gypsum plasterboards in the residential market has not been fully developed in China, the average gypsum plasterboard consumption per capita in China is only 1.39 square metres, much lower than that in developed countries (8-1 square metres in the U.S. and Canada, and 4-6 square metres in South Korea, France, German and Japan) and the global average. Gypsum plasterboards also meet the policy requirements for environmental protection and energy conservation. As such, the gypsum plasterboard sector is believed to be a fast-growing industry in China. The demand for gypsum plasterboards mainly comes from home decoration. The potential demand for gypsum plasterboards from re-decoration is two times that from decoration so the adverse impact of property controls on the demand for gypsum plasterboards would be eased to some extent. We estimate the gypsum plasterboard industry to maintain 18% growth in the next three to five years. 22