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ANALYSIS: Analysts say cement is risky, but worth it

Despite signs of renewed buying in cement shares — given their low valuations and anticipated hikes in domestic cement prices for the fourth quarter — analysts are mixed about the sector’s outlook in the second half of the year in light of weakening market demand and rising coal costs.

Cement shares have been battered in recent months, with the local bourse’s cement sub-index dropping 37 percent on average since this year’s high on May 19, under-performing a decline of 24 percent on the benchmark TAIEX over the same period.

The latest industrial production data released by the Ministry of Economic Affairs on Monday last week showed that the output reading grew a weaker-than-expected 1.1 percent in July from a year ago. Economists attributed this slowing growth mainly to a 27.12 percent year-on-year contraction in the construction sector.

Furthermore, the Council for Economic Planning and Development reported last Wednesday that building permits by floor area plunged by 28.81 percent month-on-month and 38.64 percent year-on-year to 1.46 million square meters in July, another sign of a slowdown in the sector.

“Investors anticipating a recovery in Taiwan [cement] demand should be prepared for at least a couple more quarters of sluggish market conditions before we see a light at the end of the tunnel,” Jeremy Chen and Yunchen Tsai, analysts at Morgan Stanley Taiwan Ltd, wrote in a client note last Wednesday.

But Andre Chang (張致竑), an analyst at Citi Investment Research, disagreed.

“We still think both the Taiwan and China governments will focus on infrastructure spending as the easiest means to support economic growth, and cement companies are the biggest beneficiaries,” Chang wrote in a research report released last Thursday.

Business for top cement producers such as Taiwan Cement Corp (台灣水泥) and Asia Cement Corp (亞洲水泥) has gone beyond the domestic market because they have been expanding quickly in China, a market they view as the biggest driver in revenue in the coming years.

Taiwan Cement, for example, is expanding its Chinese operations in Guangdong and Jiangsu provinces, as it hopes to boost output there to more than 20 million tonnes over the next two years. The company also holds an 11.62 percent share in Anhui Conch Cement Co (安徽海螺水泥), the largest maker of cement in China.

Asia Cement entered the China market in 1997 and has plants in Jiangxi, Sichuan and Hubei provinces, data provided by the companies showed.

But these Taiwanese makers faced downside risks in China investment as well, analysts said.

As China is in the process of removing small and outdated cement factories from the market in a bid to increase efficiency while reducing industrial pollution, Citigroup said a slower-than-expected industry consolidation would have an adverse impact on the Chinese market.

Apart from industrial consolidation, Beijing’s austerity measures against the property market — such as asking banks to curb lending to real estate projects to avoid loan defaults — will drag down cement consumption there, Josephine Ho, a Lehman Brothers analyst, said in a report last Wednesday.

Ho said more raw materials price hikes would also take a toll on Taiwanese cement producers’ core earnings in the third quarter, as coal accounts for 30 percent to 35 percent of total manufacturing costs, while producers have found it difficult to pass on extra costs to customers because of competition.

Goldman Sachs analysts Jim Huang and Rowena Chang echoed her view, saying in a report dated last Wednesday that rising coal prices would further squeeze cement producers’ gross margins.

Citigroup offered a “buy” rating on Taiwan Cement shares, with a target price of NT$37. It also recommended a “buy” on the stock of Asia Cement, with a target price of NT$42. Goldman Sachs also reiterated “buy” ratings on both Taiwan Cement and Asia Cement, with 12-month target prices of NT$56 and NT$53 respectively.

Taiwan Cement shares closed up NT$0.25 yesterday to NT$31.35 while Asia Cement closed up NT$0.6 to NT$35.7.
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