Equity, Bottom-up Analyst, Investics Research

Sameer Taneja

Equity, Bottom-up Analyst

Kelusa Asia Focus Funds

Equity Bottom-Up

Now that the deal of <a href="https://www.smartkarma.com/entities/9423" target="_blank" data-smartkarma-citation="entities:9423:1">West China Cement Ltd (2233 HK)</a> (WCC) with <a href="https://www.smartkarma.com/entities/159" target="_blank" data-smartkarma-citation="entities:159:1">Anhui Conch Cement Co Ltd H (914 HK)</a> (Conch) is off, is WCC standalone a good investment?  Obviously, the stock  looks inexpensive from an EV/ton perspective, but over the last four years, the sector itself has become cheap owing to weakening cement prices nationwide.  This I believe strongly, is structural in nature. Most regions in China are plagued with oversupply. Shaanxi the region which WCC operates in is no different. Summary of what I will touch upon with brief observations: <ol><li>The backdrop on why the deal broke: There are many reasons so it's hard to pick one as the neither Conch or WCC has been very clear. My personal take is Conch saw no value at this price, especially since its own stock price is cheap on an EV/ton basis.</li><li>WCC Margins and Cashflows: WCC margins have been weakening over the last four years and the cash flow while high is subject to very volatile working capital changes; higher receivable days and lower payable days being the major reasons. </li><li>WCC debt: At what level of gross profit does it get difficult to service debt? whilst I don't think at current levels of GP it's a major problem, what happens at lower levels?  The fact that it carries USD400mm of debt in USD is an additional concern. We can do the math with a depreciating USDCNY cross.</li><li>Is EV/ton or P/B the right metric to look at WCC? Peers too are cheap on an EV/ton basis and almost all of them will generate decent cashflow as and when they cease expansions. Buying <a href="https://www.smartkarma.com/entities/5483" target="_blank" data-smartkarma-citation="entities:5483:1">China Shanshui Cement Group (691 HK)</a>  was a case where buying a company that was cheap on an EV/ton basis was not really a great investment. Three major cement companies had taken major stakes in Shanshui (<a href="https://www.smartkarma.com/entities/184" target="_blank" data-smartkarma-citation="entities:184:1">China National Building Material Co Ltd (3323 HK)</a> , <a href="https://www.smartkarma.com/entities/14115" target="_blank" data-smartkarma-citation="entities:14115:1">China Tianrui Group Cement Co Ltd (1252 HK)</a>  and <a href="https://www.smartkarma.com/entities/3374" target="_blank" data-smartkarma-citation="entities:3374:1">Asia Cement China Holdings (743 HK)</a>  prior to them defaulting on their interest payment.</li><li>Cooperation, has it worked in the past? Quite simply, No. The big case of the SOE , CNBM that attempted consolidation is a prime example. It grew from a player with 7.5 mnt of cement production in 2005 to 279 mnt in 2015. But the company is now heavily geared (over 230% net debt / equity) and has no profits to show for it. Will it work in the future? Maybe, maybe not. What's the chance it happens in an environment where demand is faltering at a rate that surprises all? </li></ol>

Now that the deal of West China Cement Ltd (2233 HK) (WCC) with Anhui Conch Cement Co Ltd H (914 HK) (Conch) is off, is WCC standalone a good investment?  Obviously, the stock  looks inexpensive from an EV/ton perspective, but over the last four years, the sector itself has become cheap owing to weakening cement prices nationwide.  This I believe strongly, is structural in nature. Most regions in China are plagued with oversupply. Shaanxi the region which WCC operates in is no different. Summary of what I will touch upon with brief observations: The backdrop on why the deal broke: There are many reasons so it's hard to pick one as the neither Conch or WCC has been very clear. My personal take is Conch saw no value at this price, especially since its own stock price is cheap on an EV/ton basis.WCC Margins and Cashflows: WCC margins have been weakening over the last four years and the cash flow while high is subject to very volatile working capital changes; higher receivable days and lower payable days being the major reasons. WCC debt: At what level of gross profit does it get difficult to service debt? whilst I don't think at current levels of GP it's a major problem, what happens at lower levels?  The fact that it carries USD400mm of debt in USD is an additional concern. We can do the math with a depreciating USDCNY cross.Is EV/ton or P/B the right metric to look at WCC? Peers too are cheap on an EV/ton basis and almost all of them will generate decent cashflow as and when they cease expansions. Buying China Shanshui Cement Group (691 HK)  was a case where buying a company that was cheap on an EV/ton basis was not really a great investment. Three major cement companies had taken major stakes in Shanshui (China National Building Material Co Ltd (3323 HK) , China Tianrui Group Cement Co Ltd (1252 HK)  and Asia Cement China Holdings (743 HK)  prior to them defaulting on their interest payment.Cooperation, has it worked in the past? Quite simply, No. The big case of the SOE , CNBM that attempted consolidation is a prime example. It grew from a player with 7.5 mnt of cement production in 2005 to 279 mnt in 2015. But the company is now heavily geared (over 230% net debt / equity) and has no profits to show for it. Will it work in the future? Maybe, maybe not. What's the chance it happens in an environment where demand is faltering at a rate that surprises all? 

West China Cement - Where Do We Go from Here?

China

Asia Cement China Holdings Corporation manufactures cement in China. The Company excavates the raw materials for, and produces, clinker and different types of cement.

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Asia Cement China (743 HK)

West China Cement - Where Do We Go from Here?

Now that the deal of West China Cement Ltd (2233 HK) (WCC) with Anhui Conch Cement Co Ltd H (914 HK) (Conch) is off, is WCC standalone a good...

Sameer Taneja

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