Asia Cement (China)Æs clinker and cement production facilities are located in the provinces of Jiangxi and Hubei in the central Yangtze River region and in Sichuan in the western part of the country, where the demand growth for cement and fixed-asset investments are above the national average.
However, valuations will likely be as important as company fundamentals, given the number of Hong Kong IPOs that have been pulled this year and the fact that three of the six companies that went public in the first quarter are still trading below their respective issue prices. Asia Cement (China) comes hot on the heels of Maoye Department StoreÆs accelerated offering that was priced on Friday at HK$3.10 per share, or 20 HK cents above the bottom of the price range, for a total deal size of $343 million. The company will start trading on May 5 û the same day that Asia Cement (China)Æs retail offering will open. If the debut is positive, it could give investors û both retail and institutions û added confidence to commit money to this deal as well.
Further guidance will come from E-Land Fashion China Holdings, the fifth largest womenÆs apparel company in China, which is also currently in the market and is due to price its IPO of at least $242 million on May 7. Asia Cement (China)Æs retail offering will close on May 8, while the institutional book will stay open until the May 9. The trading debut is scheduled for May 20.
According to sources, the cement producer has set a price range between HK$4.85 and HK$6.45, which translates into a 2008 price-to-earnings ratio of 15 to 20 times, based on consensus syndicate estimates. The bottom end of the range is essentially determined by the valuation of the Taiwan-listed parent company, which is currently trading at about 14-15 times this yearÆs earnings. Because the Chinese business has a much higher growth profile than the parent, investors generally agree that it makes sense for it to trade at a higher valuation.
The top end of the range currently represents a discount of about 20% to sector leader Anhui Conch Cement which based on Bloomberg estimates was quoted at a 2008 P/E ratio of 25 times on Friday after reaching 26.5 times on Thursday. However, that stock has been quite volatile recently and has moved up from a multiple of about 20 times when Asia Cement (China) launched pre-marketing two weeks ago. Sources note that when the parent, which is part of TaiwanÆs Far Eastern Group, first started to think about a spin-off six to nine months ago, the China comps were on average trading at P/E multiples in the low 30s while its own valuation was closer to 10 times, suggesting the possibility of a significant valuation pick-up.
Since then, however, the valuation gap has narrowed significantly. The parent has gained 15% this year, partly in anticipation of improved cross-strait relations after the expected election in March of Ma Ying-jeou of the opposition Kuomintang party as the countryÆs next president. His election win confirmed, investors have remained positive towards companies with businesses in the mainland, especially those, like Asia Cement, which would like to expand those businesses if allowed.
Meanwhile, Hong Kong-listed cement players like Anhui Conch Cement and China National Building Materials have fallen 3.3% and 37% respectively. On average, the Chinese comps are now trading at P/E multiples in the low 20s and CNBM, which derives about 80% of its revenues from cement production, is quoted at about 24 times. This has reduced the valuation premium in Hong Kong to a level where the benefits of a separate listing of the groupÆs Chinese operations are no longer that obvious. And more importantly, from the investorsÆ point of view, the discount offered at the top of the range may not be considered enough to convince them to put money into a market newcomer. Anhui Conch has a market cap about 10 times the size of Asia Cement (China), while CNBM is about 4.5 times the size.
However, the reasons the company is pursuing a listing are primarily strategic as it doesnÆt really need the money. It has aggressive capital expenditure plans, but with a gearing of only about 40%, it has other means to finance these plans. However, the parent company will no doubt welcome the possibility to raise cash offshore as Taiwanese companies are still only allowed to invest 40% of their capital in mainland China. That cap is expected to be either raised or removed with the election of Ma as president, but it could take some time still.
ôExpansion is the most important way to grow for cement companies and many of the local players doesnÆt have the cash to expand,ö says one observer. However, he notes that Anhui Conch should have no problem financing its earlier announced expansion plans.
The company is offering 375 million new shares, or 25% of the company through joint bookrunners ABN AMRO and BNP Paribas. Ten percent will be set aside for retail investors and standard clawback triggers apply. The deal also carries a 15% greenshoe that could increase the total proceeds to as much as $357 million.
A large portion of the net proceeds will go towards an expansion of the Asia Cement (China)Æs annual clinker capacity to 12.5 million tonnes by 2010 from 5.5 million tonnes at the end of last year, representing a compound annual growth rate of about 30%. The company currently has four production bases for clinker, which is the material used to produce cement. These are all conveniently located in terms of transport û either near the Yangtze River or close to its key market in Chengdu. The company also has about 13 million tonnes of grinding capacity to make the final cement product and operating rights at limestone mines in connection to all its production facilities that will ensure a stable supply of this key raw material for between 16 and 64 years.
Together with an expected improvement in cement prices in the provinces where it operates û partly due to a government-induced closure of small cement plants using outdated production techniques û this should result in a net profit CAGR of close to 37% in 2007-2010, according to syndicate research report. By comparison, Anhui Conch is forecast to grow at a CAGR below 30%. The estimates for capacity and earnings expansion are based on organic growth, but sources note that Asia Cement (China) will also pursue further acquisitions as the sector continues to consolidate. About 20% of the IPO proceeds will be earmarked for this purpose.
Among the key risks for investors to consider are the rising costs of coal and electricity, which are needed to keep its kilns burning and its plants going. Energy costs made up between 43% and 48% of the companyÆs total costs in the past three years and this ratio is expected to continue to increase. The syndicate research report estimates that a 5% increase in coal prices will translated into a profit decline of 6%-9% (or vice versa), while 5% higher electricity prices could result in a 3%-4% lower bottom line in the coming three years.
Some of the electricity costs increases should be offset by the fact that the company generates some power of its own through so called residual-heat power generation, whereby it uses the heat generated by its own production process to produce electricity. According to syndicate analsyts, Asia Cement (China) is a leader within this technology in China and already uses it at its plants in Sichuan and Jiangxi. RHPG equipment will also be installed at all its new plants.
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