Shanshui Cement (691, $3.77) 6M Target Price $5.90 BUY

Garrett Tse – garrett.tse@guoco.com (852) 2218 2873

Event: Shanshui Cement rose 4.7% yesterday with heavy turnover of 23.4mn shares vs 3-month daily average of 9.1mn shares.

• Cement plays like Shanshui Cement outperformed HSI in past one week and the increasing trading liquidity signals that investors have started to turn their focus to undervalued cement producers. Traded at 11.5x 2010 PER on average, cement stocks' valuation is far below the historical valuation level during mid-to-peak industry cycle. We believe undemanding valuation is the cornerstone of recent rebound while following catalysts might be attracting investors' attention:

1. Industry demand in 2H10 might be better than expectation: Investors expected a slowdown in property sector would reduce cement demand and they have less confidence on offsetting effect brought by increasing demand from economic housing. Yet, recent news flow hinted the determination of government in enforcing local government to achieve the annual target of economic housing development. This shall lift up investors' expectation on cement demand in 2H10.

2. Oversupply concern might be relieved as policy ahead: Our channel checks suggest that closure of obsolete capacity is likely to be faster than market expectation. Besides, there is rumour that the government has been drafting industry guidance of which obsolete capacity is a key issue. Should this guidance be materialized, it would reduce investors' worry on oversupply and a re-rating of the sector is likely.

• Backed by the said catalysts, we like Shanshui Cement (691) given its stronger than industry average earnings growth (29% vs 19%) and being a major beneficiary from the obsolete capacity elimination policy. Shandong Province, the major market of Shanshui (86.0% of 2009 revenue), has over 40% of obsolete capacity compared the national average of 30%.
• We maintained our 2010 earnings estimate of RMB 1.1bn, up 57% yoy with EPS of RMB 0.4, assuming 10% ASP hike, 30% sales volume growth and 20% coal price hike. We noticed that current level of coal price is a bit higher than our assumption. However, we believe the impact would be less than 5% to our earning forecast. We tentatively maintained the forecast of 20% yoy increment of coal price until release of 1H10 result.
• Management guided that capital expenditure for 2010 would be at RMB 5bn, and we believe this will boost capacity and volume growth in 2011.
• Rising coal price is the key downside risk while ASP increment and roll out of favorable government policies are upside catalysts.
• Traded at 8.3x 2010 PER and 6.9x 2011 PER with 2-year EPS growth CAGR of 39%, valuation of the counter is not demanding.
• We rate Shanshui Cement a BUY with six-month target price of $5.90, equivalent to 13x 2010 PER.