Wall Street looks closely at Huaxin

Wall Street looks closely at Huaxin
Published: 05 April 2006

China is the world’s biggest consumer of cement, eating up 40 per cent of global production by volume. Despite government efforts to curb overbuilding, cement will continue to play an important role in the nation’s booming economy.  Yet in a country that consumes a billion metric tons of cement annually, total production capacity is estimated to be 1.3bn tonnes, That disparity sent cement prices plunging to a 10-year low in China last year, and stock analysts don’t see a strong rebound coming soon. Cement makers will continue to face price pressures until the oversupply issue is resolved. So analysts’ advice is to pick your shots and ride the long, slow recovery. 
 
One vehicle they talk about for that ride is Huaxin Cement Co, China’s second-biggest listed cement maker by market capitalization, with shares traded in Shanghai. Although Huaxin’s profits are small and its annual production still is just a fifth of leader Anhui Conch, the No. 2 player appears on a track to get a boost. 
 
Global cement maker Holcim Ltd. of Switzerland, which holds 26.1 per cent of Huaxin in foreign-currency-denominated Class B shares, last month agreed to raise its stake to 50.3 per cent. Holcim has said it will pay about US$125m for 160 million newly issued shares. As part of the deal, Holcim has agreed not to invest in any other Chinese cement makers. If approved by Chinese regulators and Huaxin shareholders, the transaction will make Holcim the first foreign cement-maker to control a big publicly traded Chinese one. 
 
 "Although the spring for cement companies has yet to come, the winter is nearing the end for Huaxin, and investors could take it as a candidate for long-term investment," says Shi Lei, an analyst at Citics China Securities Research. Mr. Shi expects Huaxin’s yuan-denominated Class A shares to rise to seven yuan apiece within 12 months and says it is "safe" for investors to buy the shares at around 5.40 yuan (67 US cents) and to continue accumulating them. His target for the B shares is 75 US cents. Huaxin’s A shares closed in Shanghai yesterday at 6.02 yuan; its B shares closed at 66.8 cents. 
 
The company has high hopes. It predicts that its sales will increase to 4.3 billion yuan this year from 2.6 billion yuan last year. The prediction is predicated on strong growth in fixed-asset investment in its main market, the central province of Hubei, which accounts for about 10 per cent of China’s annual cement consumption. Huaxin expects fixed-asset investment to rise about 30 per cent in Hubei this year, outpacing the 18 per cent national growth target the central government has just set. 
 
 Huaxin plans to use the Holcim investment to build new production lines to increase its annual capacity to 36Mta within two years, from 22Mta currently. The new lines are part of a technological upgrading aimed at reducing pollution and improving efficiency, which analysts say will help Huaxin ride out the industry consolidation.  As it raises production, Huaxin could also use Holcim’s global network to expand its exports, says Li Fan, an analyst at China Merchants Securities.
 
Some of Huaxin’s upside may already be built into the shares. Holcim offered more than a 20 per cent premium over Huaxin’s average share price between Jan. 24 and March 1. Analysts expect Holcim to buy Huaxin’s shares at 6.08 to seven yuan apiece.  "It may take a long time to see Holcim’s investment reflected in Huaxin’s earnings, and profit-taking will surely come in the near term, after Huaxin’s shares rose sharply in the past several weeks," says Fu Meiwang, an analyst at Haitong Securities, who has a "hold" recommendation on the shares. 
 
However,  Holcim will not be a panacea for Huaxin, or for China’s cement industry, where analysts say 5000 cement makers need to be reduced to about 100 over the course of a decade. Hua Xin’s 2005 net profit fell 58 per cent to 62.1 million yuan from 148.6 million yuan in 2004, though its core revenue rose 21 per cent to 2.64 billion yuan. The company cites falling cement prices and rising costs of electricity and coal for the profit performance. For its part, Anhui Conch has warned that its net profit for last year will be more than 50 per cent below the 2004 level. The company will report its 2005 results this month. 
 
Given such profit erosion for the two biggest cement makers, some analysts suggest that investors watch for a 10 per cent price decline before getting into either stock. They say that for investors with a long-term perspective and a belief that construction will remain buoyant in China, Hua Xin is worth watching. 
 
Naito Securities, one of the first Japanese brokers licensed to help individual investors trade Chinese shares, in the 1990s, is the 10th-largest shareholder of Huaxin, with 1.7 million B shares at the end of 2005. Wang Ping, assistant to Naito’s chief representative in Shanghai, says the firm’s Japanese clients started investing in Huaxin’s B shares in 1996 and will continue to accumulate the stock. In 1996, shares of Huaxin traded at about 20 cents – less than one-third the current level. "Our clients are long-term investors," Ms. Wang says. "They are optimistic about China’s economic growth and infrastructure construction development."  (Abstracted from Wall Street Journal Asia).