The View

Analysts still bullish on China’s big cement producers and banks

While no one knows for sure what mainland officials mean by ‘supply-side reform’, it has come to be associated with the removal of excess capacity

PUBLISHED : Monday, 29 February, 2016, 10:01am
UPDATED : Monday, 29 February, 2016, 10:00am

The top-down tale of China’s industrial supply glut is often told with stunning comparisons – e.g., in the past few years, China produced twice as much cement as the United States consumed in the whole of the 20th century.

The bottom-up story is told with red ink. Overall profits in the Chinese cement industry shrank by 60 per cent in 2015, and according to BOC International estimates, about 40 per cent of cement companies made losses.

Nevertheless, analyst recommendations for the biggest cement companies tilt more bullish than bearish. Consider the case of China Resources Cement. Most brokers have “hold” recommendations, but there are six “buys” against four “sells”, according to consensus data from FT Markets.

Besides operating in an imploding sector, CR Cement is also vulnerable to the weakening yuan. Last year’s fall in the renminbi increased the company’s foreign-currency debt expenses by HK$800 million, whacking at least a quarter off earnings before interest and tax.

BOCI projects another HK$500 million foreign-exchange loss in 2016. Yet the bank has a buy on the shares, noting that CR Cement’s market value is just 23 per cent of its liquidation value. In short, BOCI believes the shares are oversold.

Brokers are betting that either market fundamentals or Chinese state directives will shut down excess capacity in the cement sector

The analyst community is even more bullish on Anhui Conch Cement, with seven “buy” recommendations against just two “sells”. BOCI, which recently released a detailed report on the cement sector, thinks Anhui Conch is also oversold, and as with CR Cement, thinks the H shares could rebound by 40 per cent.

Brokers are betting that either market fundamentals or Chinese state directives will shut down excess capacity in the cement sector. The bigger companies, such as CR Cement and Anhui Conch, are more likely to be left standing, and their margins could begin to rise.

Mainland officials have been throwing around the words “supply-side reform”. While no one knows for sure what officials mean by this phrase, it has come to be associated with the removal of excess capacity in China’s economy.

As one example, recently the State Council warned that industrial companies with three years of profit losses would be shuttered by edict. If this plan were carried out in the cement sector, it could wipe out 40 per cent of capacity, according to BOCI.

Brokers are a bit less sanguine about the steel sector, in part because it is more labour intensive. Thus there might be more province-level attempts to defy the centre and keep local operations open to save jobs.

The State Council, China’s cabinet, recently announced plans to cut 100 million to 150 million tonnes of capacity from the steel sector, with special funding to assist this process. Even so, many brokers think at least 200 million tonnes needs to disappear. To cite a statistic that appeared in the latest edition of The Economist: China’s excess steel capacity is greater than US, Japanese and German production combined.

UBS noted in a report last week that company shares in sectors within industries with overcapacity – mining, metals, chemicals, construction materials and steel – had fallen about 18 per cent so far this year, which may spur China’s leaders to act more decisively.

“Supply-side reform policies could be rolled out at a faster pace, which may become a catalyst for these sectors,” the bank said.

China’s industrial supply glut is also, naturally, weighing on banks – they’re the ones, after all, who bankrolled the fixed-asset bubble. And everyone knows banks have routinely been issuing new loans to troubled companies, which are used to pay back old loans, a practice known as “ever-greening”. This keeps an artificial cap on non-performing loans.

Yet of the more than two dozen broker recommendations collated by FT Markets for major banks such as Industrial and Commercial Bank of China and China Construction Bank, there are zero “sells” and only three “holds”: for ICBC and two for Construction Bank. All the other recommendations are buys.

How is it that so many bottom-up analysts have buys on banks despite the recognition of understated NPLs? One explanation is that China’s banks are highly capitalised, and have deep financial resources, and are trading cheaply on historical valuations.

The other explanation is bailout related. China doesn’t just have the world’s biggest steel or cement or aluminium companies. It also has the world’s biggest banks. They are, it seems, “too big to fail”.

Cathy Holcombe is a Hong Kong-based financial writer