Key points of investment:
? The first coverage gave a buy rating, with a target price of HK$4.80. We covered Asia Cement (China) for the first time and gave it a purchase rating corresponding to the target price of HK$4.80. Asia Cement China is a second-tier leading cement manufacturer in China. By the end of 2012, the company's cement production capacity had reached 18.5 million tons, of which 37%/36%/27% were distributed in Jiangxi/Hubei/Sichuan.
Improved supply and demand relationships in the middle and lower reaches of the Yangtze River increased company profits in 2013. We expect that the cement market in the middle and lower reaches of the Yangtze River (Central and East China, including Jiangxi, Hubei) will see significant marginal improvements in 2013:
The new production capacity in 2013 was about 21 million tons, an increase of 3.4% over the previous year, which is significantly lower than the 6.3/10.2% growth rate in 2011/2012. Production capacity concentration in the Yangtze River Delta region is relatively high: the two leading conch and Chinese building materials have reached a total market share of 65%. When the relationship between supply and demand in the regional cement market improved in 2013, higher market concentration made it easier for leading enterprises to carry out better price coordination and increase the flexibility of regional cement price increases.
Regional integration will bring opportunities for cement prices in Sichuan Since 2008, the Sichuan cement market has been in a state of overcapacity. Cement prices and profit levels are in the middle of a national depression and are in a cost-supported situation. This provides opportunities for leading cement companies to carry out mergers and acquisitions. We expect that by the end of 2013, China Building Materials will acquire more than 70 million tons of cement production capacity in Sichuan through Southwest Cement, thus reaching 40% of the market share. We believe that the increase in cement concentration in the Sichuan market will bring upward opportunities for cement prices in Sichuan.
The expansion of production capacity and the increase in gross profit in 2013 will drive sharp profit growth. Based on our judgment on supply and demand prospects in the middle and lower reaches of the Yangtze River and the Sichuan market, we expect the company's gross profit per ton in 2013 to be 61 yuan per ton, an increase of 16 yuan per ton over the previous year. As two production lines No. 5 and No. 6 with a daily output of 6,000 tons were put into operation in the middle and end of 2013, the company's cement production capacity is expected to increase by 26% in 2013, which will greatly improve the market's impression of the company's slow capacity growth in the past (2011/12 differential energy growth rate was 10/ 0%). In anticipation of gross profit expansion and increased sales, we expect the company's profit to grow 155% in 2013.
The risk-benefit ratio is attractive. Over the past three months, Asia Cement (China) has outperformed two major Yangtze River Basin cement companies, Conch Cement and China Building Materials, by a total of 12/32%. The company is currently trading at a price-earnings ratio of 6.9 times in 2013, which is at an all-time low and 59% lower than Conch Cement. Given the upward margin of profit in '13 and the current valuation level, Asia Cement was given a buying rating of HK$4.80. The target price was HK$4.80, which was calculated from the cash flow discount model, corresponding to 8.4 times the price-earnings ratio in 2013. The off-season decline in cement prices in the first quarter was a potential buying opportunity.