Monday, May 19, 2008

Results Brief: Shui On Construction (983) - part ii

Part ii is about the relatively small but interesting cement business (45% owned JV with French Lafarge).

The JV is the largest cement producer in the central/southwest whose development has been the government's priority, irrespective of the earthquake. Cement is a very localized business and transportation costs make trans-province sales next to impossible. A favorable development is that the industry is undergoing consolidation because of excess competition (and expansion) in the past. Reinvestment has been kept low and old facilities which are environmentally unfriendly are plenty. It's good that government is enforcing stricter standard and so unfitted facilities are closing down quickly. This is reflected in the rise of the cement price across the nation.

It's worthy to note the JV's average selling price of cement last year was higher than Anhui Conch, the industry leader. So it seems the JV doesn't compete on price and there should be little doubt about quality of cement and the technological level of the plants. Capacity was 24m tons p.a. and the JV plans to double it to 50m tons by 2012. For comparison sales volume of Anhui Conch was 87m tons last year.

Profits are starting to climb. Before tax and impairment charges (on old facilities), SOC's share of earnings was $90 million last year and just $30 million the year before. Last year's share of turnover was $2b, the low profitability and high selling price seem to suggest there's much scope for improvement.

Like last time, it's very hard to put a value on a turnaround business. If I use the takeover of Chia Hsin Cement by TCC last year as a benchmark, then the value is 3x turnover (i.e. $6b in SOC's case). If I take the internal transfer price of SOC's guizhou cement plants to the Lagarge JV (which happened this year), then it's 1.5x book value (i.e. $4b for the all SOC's cement assets).

Both method give a very modest valuation if compared with Anhui Conch, which has 8x the capacity and generated 10x the turnover last year, had a market capitalization of $116 billion (@$74), more than 19x of even the higher value of $6b I just arrived. The Taiwanese Asia Cement which had similar turnover and size to SOC's stake in the Lafarge JV is currently listed at a capitalization of $7.2b. So it appears my ballpark figures should be close enough.

The combined valuation of SOC then becomes $10b (from part i) and $6b of cement assets minus $4.5b debt, which equals $11.5b. The current market capitalization (on enlarged basis after CB conversion) is only $7.6b, so it appears the current price is very safe and backed by ample value.

I must warn this share is not actively traded and there's great fluctuation in daily volume. And you may want to refer back to my analysis of SOC last year to complete the picture, for there were things that I won't repeat here.

DISCLOSURE: I hold 983 at time of writing.

Saturday, May 17, 2008

Results Brief: Shui On Construction (983) - part i

There's been a change in the business mix of SOC, as it has been selling down its Shui On Land (272) holdings. The SOL shares were part of the original attraction of buying SOC because SOL was itself undervalued in my view, and indirectly buying it via SOC gives an additional holding company discount.

But now SOL holdings is down from 17.5% to 9.5%, and further sales are likely for SOC to finance its other projects. So far SOC's has realised $2.8b proceeds and applied $1.8b in property projects, jointly invested with SOL and CCP (its 40% owned distressed property fund listed last year on AIM in London).

I found this perplexing. SOC sold downs SOL shares to co-invest with SOL? It's a similar case with CCP where the AIM listing proceeds were plough back into joint projects with CCP.

One guess is financing in China has gone really tight and therefore SOC had to put money back in. Or maybe those projects were so lucrative that SOC must lay its hands upon. I think the former is more likely though I don't doubt the viability of the projects. Business risk has risen as a property portfolio (via SOL/CCP) is replaced by individual investments.

With the above in mind. SOC now is a combination of China properties, cement, construction, and venture capital.

The property assets include 9.5% in SOL, 40% plus CB interest in CCP, and individual projects. As the SOL holdings are expendable, it's fair to use market price to value those shares. For interest in CCP and individual projects totalling $4b, 1.5x book value is about right given past completed projects of CCP were quite profitable, which should balance out the relatively unknown quality of SOC's new projects. If the property market does get from bad to worse, then CCP should get more buying opportunities (as it's a distressed property fund), which means it isn't totally bad for SOC.

There's a fund management component in the CCP business where SOC earns both management and performance fee out of the minority shareholders (~$3b invested). However I don't see much contribution yet as it only started out in the 2nd half of last year. As SOC are committed to these projects anyway, via CCP or co-investment, this is a nice side business with no incremental cost but upside. Last time I attached as much as over $1b for this part, maybe too aggressive as I overestimated the fund size, but $500m of capitalization should be attainable.

Construction business provided too little contribution although it's improving, and venture capital investments are just too remote for me (even profits are mostly accounting profit). So I won't spend more time here.

Up to now the combined value is about $10b.

DISCLOSURE: I hold 983 at time of writing.

Wednesday, May 07, 2008

Results Brief: Chalco (2600)

Here's the long overdue review of the final results of Chalco, so late that it's even after the company's 08Q1 results. My apologies, as I had a conclusion quite some time ago but couldn't find the time to put it down. And my neck pain led to further delay.

So let me start with my conclusion 1st to save you reading time, Chalco is still a good investment but unlike when I recommended it in Jan last year, I don't think it can outperform the index (2828) this year. So if you have a fair share of money in the index already you need not bother adding Chalco.

Final results were far below expectation, or more precisely 2nd half results were quite bad considering Chalco had taken on a few aluminium smelters. I was looking for earnings of about $13b (a guess based on 1st half earnings of $6.6b) but in the end there's only $10.2b. If you work out the math you'd see 2nd half results were only half of the 1st half.

Segmental margins for alumina and aluminium were 27% and 19% in the 1st half but full year margins decreased to 23% and 14%, so 2nd half went pretty bad as Chalco was squeezed pretty hard at both end of the value chain. This wasn't something I had expected as a lower alumina price didn't seem to help the downstream aluminum business.

Management reported that alumina was still in shortage (though China will probably gain self-sufficiency in a year or two) and aluminum market was basically in balance. And looking at the use of metals, i.e. construction, transportation, electricity, and packaging, it's safe to say demand will hardly go away. Yet prices were falling for both alumina and aluminium. Management cited the fear of the US economy softening in the 2nd half drove London future prices down which in turn affected the domestic prices in China. This is probably true as Chalco has to compete with import as well and alumina/aluminum is a light metal to be transported around.

Another contributory factor, though smaller, was the newly acquired smelters which were likely to be run less efficiently (henceforth the reason for integration with Chalco), and it will take time for Chalco to turn them around and synergy to kick in.

Chalco is extremely financially sound, so much so that I think it should not issue any more new shares in future acquisitions. Gearing was only 30% (it's always been kept at such low level) and interest coverage was over 16x.

One can't go wrong putting money in the biggest alumina/aluminum producer in China which occupies over half of the market, for demand will continue to grow as long as China is in the building mode.

DISCLOSURE: I hold 2600 at time of writing.

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