China Pulse Check: Building Materials Sector

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1 Equity Research Sector Watch China Pulse Check: Building Materials Sector Demand recovery in line with expectation, watch for sector opportunities Ou Yafei SFC CE No. BFN GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Contribution from the GF A-share research team: Zou Ge * zouge@gf.com.cn * Please note that Zou Ge is not a registered licensee with the Securities and Futures Commission of Hong Kong and is not allowed to conduct regulated activities in Hong Kong. Short-term shocks in 1Q18 now ended; rebound in production in April in line with expectations, cement production in the south better than in the north NBS data for 4M18 show cement output declined 1.9% YoY during the period to 580m tonnes (3M18: -4.). Output of flat glass reached 270m weight cases, down 1. YoY (3M18: -2.). April monthly cement production grew 3.2% YoY, up significantly compared with growth in March (-15.6% YoY), and up 36. MoM (MoM growth in April 2017 was 9.7%). April flat glass production grew 1.4% YoY, up significantly from March (-5.2% YoY), and up 3.3% MoM, better than seasonal performance (MoM growth in April 2017 was -2.2%). The rebound in April matches with the high-frequency data we track, and was in line with our expectation. We believe the negative growth in production was a result of short-term factors including the weather, CNY and the Two Sessions rather than weak demand. As these short-term factors fade, previously suppressed demand was released in April, leading to a rebound in production data. In terms of regions, cement production in the south was notably better than in the north. Demand from infrastructure declined, while demand from property increased According to NBS data, 4M18 national FAI investment (excluding rural households) grew 7. YoY, down 0.5pp on Jan-March and down 1.9pp on 4M17, while the overall level remained relatively stable. Infrastructure investment (excluding electricity, heat, gas, and water production and supply) grew 12.4% YoY, down 0.6pp on Jan-March and down 10.9pp on 4M17. In the near-term, we are watching whether fine-tuning policy will lead to a stabilization in infrastructure investment. Nationwide investment in property development grew 10.3% YoY, down 0.1pp on Jan-March, and down 1.0pp from 4M17. New starts floor space grew 7.3% YoY, down 1.6pp on Jan-March and down 3.8pp from 4M17. Floor space sold was up 1.3% YoY, down 2.3pp on Jan-March, and down 14.4pp from 4M17. The combination of sales data and new starts area indicated that housing stock remained low, which should be beneficial for new starts construction in the short term. High frequency data including prices and inventory suggest positive demand and supply conditions for cement, while business conditions in the glass industry were less promising in the peak season Since the second half of March, the cement capacity storage ratio has decreased sharply, and was low in absolute value (according to dcement, the national average cement capacity storage ratio was 54%). Cement prices continued to grow MoM. Based on production and demand data, we expect the industry to see stable demand, a supply contraction and to experience promising business conditions. High-frequency data for the glass industry indicated discrepancies. In previous years, glass inventory remained low in 1Q and rebounded in 2Q, while the glass price was strong in 1Q, the traditional low season, but declined from April, the traditional peak season. The difference between the glass and cement price trend is mainly due to supply. As industry conditions this year will likely to see stable demand and limited supply constraints, we will closely follow changes in supply. (Continued on next page ) This is a summary of a report originally written in Chinese. Please contact us for more information of the original report. The Chinese version shall prevail in the event of any discrepancy between the two versions.

2 Investment recommendation Affected by short-term factors, 1Q18 industry demand was below expectations but increased substantially MoM in April. Industry demand has remained stable so far this year (demand from infrastructure declined, while demand from property increased). The most important characteristic of this cycle is divergence in sector performance. Given 1Q18 earnings of listed companies, we think 1) Cement industry fundamentals were better than in the glass industry due to a better supply structure and control of total supply. In terms of regions, regions with supply contractions (rotational production stoppages) are mainly in northern China, which also saw less demand compared with the south. Cement companies in the south therefore posted better earnings than their counterparts in the north. Meanwhile, Conch Cement ( CH), with its low-cost competitive advantages, continued to gain market share. 2) For the upstream real estate industry chain, the engineering segments of quality companies saw increasing demand, significantly better than overall performance for the industry chain. 3) Among sub-sectors, demand for quartz glass from semiconductor companies continued to rise, and demand for high-end glass coating materials rose. Production and sales of glass fiber remained promising, driven by the economic recovery in Europe and the US. Currently, against the backdrop of an improvement in the Chinese economy and earnings in the past two years, we expect the sustainability of fundamentals to be the most important factor to consider when looking for investment opportunities. Our top picks are companies with sustainable high growth. We continue to like Skshu Paint ( CH), Monarch Sanitary Ware ( CH) and Oriental Yuhong Waterproof Technology ( CH), which are likely to benefit from increasing industry concentration, Shandong Pharmaceutical Glass ( CH), Pacific Quartz ( CH) and China Jushi ( CH), given rising high-end demand. We may also see share price rebounds in cement companies with exposure to southern China. We like Conch Cement ( CH), Huaxin Cement ( CH) and Tapai Group ( CH), which are likely to post higher-than-expected earnings in 2Q18. Risks: A further downturn in the economy, volatility in macroeconomic policies such as currency and property policies, new capacity additions beating expectations, rapid growth in raw material costs, quicker-than-expected changes in the energy consumption structure, and company management and operational risks. 2

3 /03 10/07 10/11 11/03 11/07 11/11 12/03 12/07 12/11 13/03 13/07 13/11 14/03 14/07 14/11 15/03 15/07 15/11 16/03 16/07 16/11 17/03 17/07 17/11 18/ Sector report Key data point snapshots Figure 1: 4M18 cumulative cement production down 1.9% YoY Figure 2: 4M18 cumulative glass production down 1. YoY 玻璃产量累计同比 YoY growth in cumulative (%) glass output (%) 水泥产量累计同比增速 (%) YoY growth in cumulative cement output (%) -0.1 Sources: Wind, GF Securities Development & Research Center Sources: Wind, GF Securities Development & Research Center Figure 3: 4M18 cumulative FAI grew 7. YoY YoY 全国固定资产投资累计同比 growth in cumulative FAI (%) (%) 2 1 Figure 4: YoY growth in cumulative FAI in infrastructure (excluding utilities such as electricity) grew 12.4% YoY 2 1 基建投资累计同比增速 YoY growth in cumulative ( FAI 不含电力 infrastructure ) (%) 3

4 Sector report Figure 5: 4M18 cumulative investment in property development grew 10.3% YoY Figure 6: 4M18 cumulative land areas purchased down 2.1% YoY 房地产开发投资累计同比增速 YoY growth in cumulative investment (%) in property development (%) 购置土地面积累计同比增速 YoY growth in cumulative land (%) areas purchased (%) Figure 7: 4M18 cumulative property area sold grew 1.3% YoY Figure 8: 4M18 cumulative floor space of buildings newly started grew 7.3% YoY 商品房销售面积累计同比增速 YoY growth in cumulative property (%) area sold (%) 房屋新开工面积累计同比增速 YoY growth in cumulative floor space (%) of buildings newly started (%) Figure 9: Housing inventory still seeing destocking 350, , , , , ,000 50,000 0 Cumulative floor space of residential buildings 住宅累计 ( 新开工 - 销售 ) 面积 / 万平方米去化周期 Destocking / 月 cycle/month ( 右轴 ) (RHS) (newly started sold)/10k m

5 Figure 10: National cement capacity storage ratio (%) Sources: GF Securities Development & Research Center Figure 11: National flat glass inventory (10k weight box) Sources: GF Securities Development & Research Center 5

6 What else is in the GFS China Pulse Check? * The GFS China Pulse Check series offers speedy updates on industry data and exclusive insights into both short-term and longer-term trends. Its expanding coverage currently includes the following monthly issues. Steel sector update: Supply and demand analysis, raw material prices, steel and iron ore prices, outlook on the coming month. Steel trade data update: Steel product exports, iron ore imports, steel product profitability, outlook on the coming month. Crude steel output update: Monthly and daily crude steel/pig iron output, outlook on the coming month. Coal sector update: Thermal coal, coking coal and anthracite prices; supply and demand analysis; outlook on the coming month. Property sector update: Policy review, property transactions, land supply and sales, liquidity supply for developers and home buyers. Auto sector update: Auto total sales and breakdown, raw material costs. Natural gas market update: Gas consumption and output, LNG prices. Building materials sector update: Cement/glass output and prices, downstream industry (property and infrastructure) sales and investment growth. 6

7 Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months Company ratings Buy Stock expected to outperform benchmark by more than 1 Accumulate Stock expected to outperform benchmark by more than but not more than 1 Hold Expected stock relative performance ranges between - and Underperform Stock expected to underperform benchmark by more than Sector ratings Positive Sector expected to outperform benchmark by more than Neutral Expected sector relative performance ranges between - and Cautious Sector expected to underperform benchmark by more than Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report. 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