Why the worst is yet to come for China’s cement companies and what that means for their stocks
Chinese cement companies are facing the double whammy of an economic slowdown and falling prices, with analysts saying the worst is yet to come.
Against the backdrop of a sluggish economy with no significant stimulus plans expected to boost infrastructure investment, cement demand is expected to fall further, said Felix Lam, an analyst at China Construction Bank’s investment banking arm CCB International.
Last year cement demand fell 5 per cent, compared with the 8-9 per cent annual growth seen between 2010 and 2014, according to Lam.
Making matters worse, there have been reports of capacity expansion in the industry, which, Lam says, would put greater pressure on the already subdued cement prices.
With demand shrinking and capacity still growing, average cement price nationwide plummeted 26 per cent from 310 yuan per tonne at the end 2014 to 230 yuan at the end of last month.
According to Wei Sim, an analyst at HSBC, national high-grade cement prices are down 0.2 per from the previous week to 247 yuan per tonne.
Lam said dipping prices indicate the price war among China’s leading cement producers will intensify, with severe consequences for earnings. Prices, he said, may hold up in the short term but only in those provinces where demand and supply are in balance.
“Areas that saw price declines include Beijing, Hebei, Shanghai, Jiangxi, and Guangxi,” said Sim. Price increases are concentrated in Shandong, Jinan, and Sichuan, where shipment levels have increased with construction activity.”
However, in the medium term, Lam said he expects prices to fall across the board. He has forecast an intensifying price war to result in the final stage of consolidation, increasing mergers and acquisitions.
Lam believes cement prices in the next few years will be subject to considerably more downside than upside risk. “We believe that company earnings tend to be less sensitive to sales volume,” he said. “We see very little room for sales volume growth in the coming years given the slowdown in capacity expansion and peaking of China cement demand.”
With 70 per cent of China’s cement going into the construction of infrastructure and property projects in urban areas, any changes in projected growth in infrastructure investment and property development would have strong implications for cement sales, he added.
“Should growth in infrastructure investment slow or new floor space starts for property development contract even more than they did in 2014 to 2015, cement demand – and by extension, cement prices – will decline faster than our forecasts for 2016 and beyond.”
But Lam still recommends China Resources Cement and Anhui Conch for portfolio.
“We have upgraded both companies from underperform to outperform owing to their attractive valuations after a sharp decline in their share prices from their peaks in August 2015,” Lam said.
Acquisition opportunities will emerge for China Resources Cement as a likely price war intensifies this year and the next. But these companies’ fairly heavy exposure to non-yuan-denominated debt could imply risks should yuan depreciation steepen.
Sim prefers BBMG Corp as the company stands to benefit from strong Beijing-Tianjin-Hebei demand in the coming years.
CCB International still recommends avoiding China National Building Material (CNBM) due to its unattractive valuation and high debt, which limit its chances of acquisition. It maintains underperform ratings on both CNBM and West China Cement (WCC). Assuming lower cement prices and gradual depreciation of yuan, Lam expects WCC to report net losses for 2015 to 2017.