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Morningstar | Anhui Conch’s 2018 Earnings Aided by Robust Selling Price and Sales Volume; Dividend Disappointed

Narrow-moat Anhui Conch Cement’s 2018 net profit rose 88% year over year to CNY 29.9 billion. The results were in line with its previous guidance but beat our expectation, largely attributable to higher sales volume and average selling price, as a result of supply-side reform by the government. The main surprise to us is the lower payout ratio of 30% (from 40% in 2017), which is disappointing. While Anhui has a higher capital expenditure target in 2019, we think the firm is still able to afford a higher payout given its net cash position. After fine-tuning our model and updating our foreign exchange rate assumption, our fair value estimate of HKD 52.00 for the H-share is unchanged but our A-share fair value estimate is reduced to CNY 44.00 from CNY 45.50. We think Anhui is fairly valued at current share price while its near-term performance should be supported by firm cement prices on the back of higher infrastructure spending by the government and continued supply side reform.

Anhui’s sales volume rose 25% year over year to 368 million tons but this was mainly due to a 12-fold increase in trading volume. In order to strengthen its market share, the firm has created trading platforms in some regional markets but the gross margin for this business is dismal at 0.2%. Meanwhile, sales volume growth of self-produced products was stable at 3%, with average selling price rising 32% year over year, more than enough to cover the 10% increase in unit production cost as a result of surging raw materials and labor costs. As a result, the firm’s gross margin improved to 35.6% from 33.9%, a year ago. However, our long-term view on cement demand is bearish as we expect both fixed asset and real estate investments to slow eventually due to China’s transition to a consumer-driven economy. We expect the firm’s average selling price to decline at a moderate pace and we have already factored in slowing growth in Anhui’s earnings.

The firm has guided capital expenditure of CNY 10 billion in 2019 (CNY 5.6 billion in 2018), mainly for overseas projects, environmental and technical upgrade and scouting for merger and acquisition targets. Anhui is active in expanding its overseas business but revenue from this division remains less than 5% of total revenue, and we do not anticipate meaningful earnings contribution in the near term.