2008 Cement Industry Research Report

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From 2008 to 2010, the annual growth rate of China’s cement production is expected to remain around 10%. Since it is necessary to first phase out outdated production capacity and then establish new capacity, the growth rate of new production capacity will slow down, which may lead to temporary shortages of cement supply in regional markets. Driven by factors such as the supply and demand structure and rising costs of coal-fired power, the average comprehensive price of cement will rise steadily. Endogenous growth enables the industry to achieve stable operational results. 　　By 2010, 250 million tons of outdated cement production capacity was to be phased out compulsorily, accelerating industry restructuring and consolidation; market shares and industry profits would concentrate in the hands of the more competitive companies. Therefore, exogenous growth characterized by market integration brings about value in industry restructuring. An ‘Recommended’ investment rating is assigned. 　　Endogenous growth ensures stable performance. As China’s industrialization and urbanization progress, the accelerated development of industry will continue to increase demand for cement. It is expected that GDP growth rates will exceed 10% from 2008 to 2010, while the growth rate of fixed asset investment will remain at 25%. Affected by rising domestic cement prices and the abolition of export tax rebates for cement goods on July 1, 2007, cement exports declined significantly in the second half of the year, dropping by more than 10% on a year-on-year basis. The impact of the policy to abolish export tax rebates lasted only half a year in 2007; starting from 2008, this policy had an effect throughout the entire year. We expect net cement exports to remain at around 40 million tons from 2008 to 2010. Taking into account domestic cement demand and exports, it is expected that cement demand will remain stable at a growth rate of around 10% during the period 2008–2010. 　　The increase in supply will decline. We expect the cement industry to complete approximately 54 billion yuan in fixed asset investment for the whole of 2007. Driven by factors such as an accelerated adjustment in the cement industry structure, increased efforts to phase out outdated technologies, and rising pressure to save energy and reduce emissions, the growth rate of investment in the cement manufacturing sector in 2007 increased, with projections indicating a rate of 7.78%. 　　Given the institutional requirement that new capacity for dry-process cement must be established after the elimination of existing capacity, the growth rate of such capacity between 2008 and 2010 is expected to be 10%, 9%, and 8% respectively. As a result of the phasing out of outdated production capacity, there will be periodic shortages in cement supply in various regional markets. From 2008 to 2010, as 250 million tons of outdated production capacity were phased out, the supply-demand imbalance in the cement industry will tend to even out. 　　Looking at the history of cement development abroad, the average production scale of cement companies is over 600,000 tons. The concentration rate of the top five international cement groups, excluding China Cement, reaches 42%. Based on the development trends in the cement industry, when it comes to cement products with distinct regional characteristics, leading cement companies can play a role in stabilizing regional prices only if they hold a market share of over 60% in those regions. 　　Currently, the production concentration among the world’s top 50 cement giants has reached over 60%. The low concentration level in our country is the main reason for increased price volatility in the cement market as well as for low-level price competition, whereas an excessively small average production capacity hinders the effective realization of scale effects in this industry. With increased efforts to mandatorily phase out outdated production capacity, through endogenous new expansions and exogenous mergers and restructurings, the concentration level of China’s cement industry will further rise during 2008–2009, with projections of 18.1% and 19.6% respectively. 　　Increased industry concentration will bring about economies of scale that lead to lower product costs. The increase in concentration in the cement industry will bring economies of scale to its development. Firstly, as industry policy requirements become stricter, the trend toward larger-scale and domestically produced cement equipment in China will enhance the operational efficiency of new cement production lines that meet certain size standards. Additionally, the improvement in domestic production capabilities has led to a significant reduction in the cost of cement equipment. The reduction in costs leads to a decrease in the fixed costs per ton of cement, which in turn reduces the overall costs of the enterprise and lowers the break-even point ； Secondly, the increase in industrial concentration enhances leading companies’ bargaining power with upstream suppliers and their control over downstream customers, thereby expanding the companies’ profit margins. 　　Integration creates value through restructuring. China’s cement market is a highly competitive market, with cement being a product that is quite homogeneous. When the workforce and technical capabilities are comparable, competition mainly takes the form of price competition. The homogenization trend in the cement industry means that expanding scale is an inherent driving force for cement companies; therefore, scaling up is the main way to achieve a favorable competitive position. Starting from Chizhou in Anhui Province, Conch Cement expanded beyond the Yangtze River basin and across the whole country. What began as Ningguo Cement Plant, with an annual clinker production capacity of over 2 million tons in 1996, evolved into a company with a clinker production capacity of 59 million tons and a cement production capacity of 65 million tons by 2006 – all thanks to continuous mergers and reorganizations that enabled it to expand its scale and achieve dominance in China’s cement industry. In the first 11 months of 2007, Conch Cement sold a total of 78.8 million tons of cement, generating sales revenue of 16.4 billion yuan. It is estimated that 86 million tons of cement will be sold throughout 2007, generating sales revenue of 18.1 billion yuan. Currently, the company’s production and sales volume have ranked first in the country for 10 consecutive years; it has become Asia’s largest supplier of cement and clinker, and ranks fourth in the global cement industry. 　　Forcing the elimination of outdated production capacity will effectively increase industry concentration. The scale limits set by industrial policy effectively promoted the expansion of individual production capacities, laying a technical foundation for increased industry concentration. There is a requirement to phase out 250 million tons of outdated cement by 2010, which will further accelerate industry consolidation; as a result, the concentration level in the cement industry is expected to rise more rapidly. 　　Although it is difficult to determine precisely the specific targets, plans, and timing of mergers and acquisitions, it can be expected that the reshuffling in the cement industry will accelerate in the future. Regional leaders will strengthen their positions within the industry, and mergers and acquisitions in this sector will become more frequent. In the future, mergers and reorganizations in the cement industry will primarily focus on creating regional leading enterprises. On the one hand, capable domestic cement companies form multi-level \"alliances\" with smaller cement enterprises in the areas surrounding their target markets, in an effort to become the leading cement players in those regions ； On the other hand, foreign cement giants are actively establishing operations in the domestic cement market, putting pressure on local cement companies and accelerating the pace of further mergers among the leading enterprises in these regions. Due to the low level of concentration in China’s cement industry, it will take some time to achieve a reasonable level of market concentration, and the benefits resulting from such consolidation will persist from 2008 to 2010. Therefore, market integration will make a significant contribution to industry performance each year. There is still room for further increases in valuations. When compared with similar companies abroad, China’s key cement enterprises no longer have a valuation advantage. The data shows that the average expected price-earnings ratio for key companies in our country is 27.54 times, with a compound annual growth rate of EPS (from 2007 to 2009) of 56.94% ； The average expected price-earnings ratio for foreign companies, excluding Taiwanese cement firms, is 10 times, with a compound annual growth rate of EPS (2007–2009) of 18.75%. Similar to other industries, companies in our country generally exhibit characteristics of high valuations and high growth. However, from the perspective of earnings growth, China’s key cement companies offer attractive valuation prospects. 　　Looking at the development of the cement industry in developed countries, there is always a period of rapid growth in this industry; once the per capita cumulative cement consumption reaches around 20 tons, cement consumption either stabilizes or starts to decline. The development trajectories of the cement industries in Japan and Taiwan, China are very similar: both experienced a period of rapid growth, followed by steady development or a decline. The domestic cement industry will also maintain a golden period of rapid growth for 3–5 years. 　　In comparison, the valuation levels of China’s key cement companies are relatively high, which is related to the current excess liquidity in the RMB market and the limited range of investment options available in the domestic stock market, resulting in a certain degree of \"bubble\" in stock prices. Not only are cement stocks overvalued, but most stocks are also overvalued to some extent. However, from the perspective of investment value, this also reflects to some extent that the market does acknowledge the investment value of the cement industry. 　　On the basis of the inherent growth within the cement industry, external growth through mergers and acquisitions will drive leading companies to expand their operations in a pulse-like manner, thereby increasing industry concentration and raising the gross profit margin of the industry through economies of scale. As the gross margin level in this industry increases, the valuation of the cement industry will rise further; it is expected that this type of periodic growth will continue throughout the years 2007–2009. The total profits of the cement industry from 2007 to 2009 were 23 billion yuan, 30 billion yuan, and 39.6 billion yuan respectively ； The profit per ton of cement was 17.0 yuan, 20.0 yuan, and 24.0 yuan respectively. 　　The forced withdrawal of outdated production capacity is a catalyst that demonstrates the investment value of the industry. We believe that this will be put into practical effect in 2008, with the notable outcomes being a decline in costs within the cement industry and an increase in activities related to restructuring and mergers. Consequently, investment opportunities in the cement industry will arise. Given the high growth potential of these key companies and the improvement in shareholder returns, we assign them a P/E ratio of 30 for 2008 and an EV/EBITDA valuation multiple of 15.