SHANGFENG CEMENT(000672)：LEADING OPERATIONAL EFFICIENCY AND QUALITY TO DRIVE ORGANIC GROWTH

　　Investment positives

    　　We initiate coverage on Shangfeng Cement Co., Ltd. (Shangfeng Cement) with an OUTPERFORM rating and a target price of Rmb14.00, implying 11.8x 2022e and 8.4x 2023e P/E with 28% upside.

    　　Why an OUTPERFORM rating?

    　　Supply and demand conditions to gradually rebalance following sector downtrend in 2022. We do not believe the significant downtrend in the cement industry will continue in 2023. Given recent policies launched to support the property market, we think cement demand may be gaining momentum for a rebound as the real estate industry bottoms out and the physical workload for infrastructure construction continues to expand. We expect sector demand to recover modestly in 2023. Meanwhile, we believe intensifying fluctuations in demand underscore the necessity for stronger supply control. We expect strengthened control over supply by the industry association and adjustment in corporate strategies to catalyze a rebalance in supply and demand conditions in the industry, driving a rebound in industry earnings amid milder competition.

    　　Main business enjoys location and cost advantages; competitive advantages to drive organic growth. Headquartered in booming eastern China, Shangfeng Cement has built production lines in northwestern and southwestern China, with additional capacity underway (including planned capacity and capacity under construction). As sector demand trends downward in the longer term, we expect the firm to penetrate further into regional markets to support steady expansion of its overall sales and market share. We believe the firm’s cement business (main business) has built a competitive advantage thanks to its operational flexibility and stringent cost controls, with its operations paralleling those of sector leaders in terms of quality and efficiency. As a medium-sized firm, we expect the firm to achieve organic growth through further penetration into regional markets by leveraging its advantages in size and management.

    　　Aggregate and collaborative waste disposal to act as new growth drivers. Shangfeng Cement has built a business structure of one main business (cement) and other supporting businesses (e.g. environmental protection, aggregate, and equity investment). Aggregate business: We expect the firm to expand steadily its aggregate capacity supported by proprietary mines and solid financials despite high mining right prices in the market. We believe profitability in the aggregate business will remain high. Waste disposal business: As its waste treatment capabilities ramp up, we believe the synergy of the firm’s environmental protection business and its main business will strengthen, boosting revenue and profitability. Equity investment in the new economy: The firm invests up to Rmb0.5bn every year in the semiconductor and new energy sectors. Despite low relevance to its main business, we believe this may help optimize the allocation of the firm’s capital.

    　　How do we differ from the market? We believe the market may be overly pessimistic about the firm’s earnings prospects amid falling sector demand. However, we are upbeat on the firm’s organic growth driven by expansion of capacity and market share of its cement business, and development of its aggregate and environmental protection businesses.

    　　Potential catalysts: Recovery in the real estate sector; falling coal prices.

    　　Financials and valuation

    　　We forecast EPS at Rmb1.19 in 2022 and Rmb1.67 in 2023. The stock is trading at 9.2x 2022e and 6.6x 2023e P/E. We initiate coverage with an OUTPERFORM rating and a target price of Rmb14, implying 11.8x 2022e and 8.4x 2023e P/E with 28% upside.

    　　Risks

    　　Sector demand continues to trend downward; coal prices remain high.