The start of the new “norm”: If 2012 has been a year of painful transition
for China basic materials, 2013E would be the start of a new “norm”. To an
extent, 2013E probably would end better than 2012E, as destocking
pressure eases on demand, producers are better prepared for slower growth,
and price movements of basic materials would also not be as dramatic as in
2012. Yet the excess supply will stay with us, and it would not be a market
where every producer makes money, in our view. This is the time when
quality outperforms beta, a theme that may actually work finally.
■ Risks on demand and supply: We believe risks to the “slow-but-stable”
demand outlook for 2013E will be: (1) upside risk in construction demand, (2)
downside risk in manufacturing sectors, and (3) transport and rail FAI may
have overshot in the near term. In the same context, we believe the excess
capacity for the sector has become more of a structural issue, than just a
cyclical set-back. In 2013E, we estimate the incremental S/D to (1) deteriorate
for cement, Al, Cu and rare earths, (2) remain mostly unchanged for steel and
coking coal, and (3) improve for domestic thermal coal, and tungsten.
■ Stock calls: In addition to our ratings and target price changes in the basic
materials sector (Figure 11), we also initiate coverage on West China
Cement (2233.HK, OUTPERFORM, TP HK$1.75). Our preferred names in
2013E are Shenhua, Chinacoal, Jiangxi Cu and Conch. Our least preferred
stocks are Yanzhou, Chalco, and CR Cement. In the small caps, we like
WCC due to the upside risk in both margin and multiples from a low base.
We believe Chinacoal has the best risk/reward profile in terms of exposure
to the upside risk in Chinese thermal coal prices.


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