In August 2005, China Economic Review decided to invest RMB10,000 in the A-share market. This was the beginning of the Red Dragon Fund, which continues to appear in the magazine every month. During the course of its existence, the fund – currently under the care of fund manager Zhang Zheng – has tripled in value. (Rest assured, it is nothing more than an editorial exercise.)
Now our paymasters have allocated a new pool of cash to invest in the Shanghai market. The new RMB10,000 fund will be known as the Capitalist Roader Fund. Investment decisions will be made by the CER editorial team and our activities can be followed on this blog.
With that out of the way, we’re pleased to announce we’ve jumped right in with 100 shares of Anhui Conch Cement, China’s largest cement-maker, at RMB55.97 a share. We have been looking at solid, basic, infrastructure plays, since there’s still plenty of China to build. Conch was chosen partly thanks to a Citi Investment Research report by Thomas P. Wrigglesworth and Scarlett Y. Chen, which had good things to say about the cement-maker (albeit focusing on the company’s H-shares).
For starters, the report has a HK$87 target price for the stock with a Buy/Medium Risk rating. It ended trading yesterday at HK$66.85. Why so bullish? In the short term, there’s the massive reconstruction effort required as a result of the Sichuan earthquake.
It costs RMB80 to transport a ton of cement to Chongqing and another RMB100 per ton to get it to the quake area. Mr. Guo [Conch executive director] believes Conch could earn a decent margin given the high pricing in Sichuan. He said Conch would still make money even if the transportation cost amounted to RMB300 per ton.
According to Guo, the National Development and Reform Commission is likely to impose price controls on cement – he estimates that cement would cost RMB1,000 a ton if prices are allowed to rise freely. However, Guo believes the controls will be temporary, since cement-makers need to make money to continue to supplying their end product.
But this isn’t just an opportunistic quake play. The company was already moving its supply chain to the western provinces before the quake struck because prices in Sichuan were among the highest in the country, at RMB600 a ton.
The A-shares are trading at around a RMB10 discount to the H-shares, which is the opposite of what usually happens with dual-listed companies. The price-to-earnings ratio on the A-share is around 32, which is rather high for a cement company, but then Conch is in an unusually strong position to exploit China’s ongoing construction boom. As Wrigglesworth and Chen note, its production capacity is equal to the next-four biggest companies’ capacities combined. They also say that Conch hit a gross margin of 42% in 2003, which was the peak of the last industry cycle. By their estimates, the industry hit bottom last year and is on its way up to a 2011 peak.