On August 2, Western Cement announced that Yao Bai Special Cement, an indirect wholly-owned subsidiary of the company, signed a stock purchase agreement with Shaanxi Ning Xin and others on July 31 to acquire 97.5% of Kangding Paomashan Cement's shares with 729.4 million yuan in cash.

We believe that the purchase price is quite reasonable. The target of the purchase is one of only two clinker production lines in Ganzi Prefecture, Sichuan. It is expected that it will benefit from the advancement of major projects such as the Sichuan-Tibet Railway and enhance the company's performance in the short to medium term. At the same time, it covers the border area of the four provinces of Sichuan, Yunnan, Tibet, and is expected to benefit the western development strategy in the new era in the long term. We raised the company's net profit forecast for 2020-2022 to $21.6/24.0/2.58 billion (the original forecast was $21.5/22.9/24.1 billion), the corresponding EPS forecast was $0.40/0.44/0.47, and the current price corresponding PE was 3.7x/3.4x/3.1x, based on the 30% dividend rate assuming that the current stock price corresponds to the 2020 dividend rate of 8.0%, maintaining the target price of HK$2.20 (corresponding to 1.0 times PB in 2020) and the “buy” rating.

The target of the acquisition was one of only two clinker production lines in Ganzi Prefecture, Sichuan. The purchase price was relatively reasonable. The target of this acquisition is Kangding Paomashan Cement Co., Ltd., whose 2,500-ton clinker production line was just ignited and put into operation on May 18. It is one of only two clinker production lines currently in operation in Ganzi Prefecture (another production line with a capacity of 2,000 tons per day, and a production line with a daily output of 2,500 tons under construction), with an annual cement production capacity of 1.5 million tons.

Since the production line has just been put into operation, the PE valuation is quite distorted, and 2019 is still under construction. Net assets at the end of 2019 were negative and PB valuation cannot be used. Therefore, we value the tonne EV in this transaction from the perspective of 500 yuan, while the current industry average/western cement ton EV is 541/347 yuan respectively. Considering the industry's current M&A environment, we think the purchase price is relatively reasonable; at the same time, the capital expenditure required for this acquisition is relatively limited compared to the company's own asset situation. We judge that this year's dividend ratio will remain consistent with last year's.

Benefiting from the advancement of major projects such as the Sichuan-Tibet Railway, the company's performance can be enhanced in the short to medium term. 1) On the demand side, the Sichuan-Tibet Railway crosses Ganzi Prefecture, with a total length of 1,838 kilometers and a total investment of 216.6 billion yuan. It is scheduled to be completed in 2028. Furthermore, Ganzi Prefecture is rich in water resources and plans to build a number of major water conservancy projects, water supply reservoirs and water diversion projects. As major projects advance one after another, it is expected that local demand for cement will be greatly boosted; 2) Looking at the supply side, Ganzi Prefecture currently has only two clinker production lines. The production line under construction is expected to be put into operation by the end of 2021. Under scarce supply, the local high-standard bagged tonne price is over 600 yuan all year round. We expect the production line to reach full production in March-June. Considering the large supply and demand gap in the future, we believe that this acquisition will enhance the company's performance in the short to medium term.

Covering the border area of the four provinces of Sichuan, Yunnan, Tibet, and Qinghai, it is expected that it will benefit the western development strategy in the new era in the long term. Under the current domestic cycle as the main body and the construction of a domestic and international dual cycle development pattern, the development of the western region in the new era is an important entry point. Whether undertaking industrial transfer in the east or speeding up urbanization construction in the western region, it is expected that it will bring strong investment and construction demand. The production line is located in the northwestern part of Ganzi Prefecture and can be expanded in three directions, northwest and south, covering the border area of the four provinces of Sichuan, Yunnan, Tibet, and Qing. It is expected that it will benefit the development strategy of the western region in the new era for a long time. Furthermore, there is still a large gap between supply and demand in the Tibet region. In the future, with the gradual improvement of the road network in Ganzi Prefecture and the completion of the Sichuan-Tibet Railway, this production line can further radiate to Tibet, or benefit from Tibet's scarce supply and high sales prices.

Risk factors: The acquisition agreement was terminated; production line production fell short of expectations; Western Construction's investment fell short of expectations.

Investment advice: Considering factors such as the acquisition target meeting the company's performance in the short to medium term after delivery and long-term benefits from the Western development strategy in the new era, we raised the net profit forecast for 2020-2022 to 21.6/24.0/2.58 billion yuan (the original forecast was 2,15/22.9/24.1 billion yuan). The corresponding EPS forecast was 0.40/0.44/0.47, and the current price corresponding to PE was 3.7x/3.4x/3.1x, based on the 30% dividend rate assuming that the current stock price corresponds to the 2020 dividend rate of 8.0%, maintaining the target Price HK$2.20 (corresponding to 1.0 times PB in 2020) and “buy” rating.