Tao Jin talks about the investment logic of building materials: the demand drive is obvious

　　Zhongxin Jingwei October 8 Title: "Tao Jin on the Investment Logic of Building Materials: Demand Driven Obviously"

　　Author Tao Jin (Deputy Director, Macroeconomic Research Center, Suning Institute of Finance)

　　In the middle of 2020, cyclical stocks have seen a sustained rise, and the building materials sector, as a typical cyclical stock, has also risen in fluctuations. However, the recent suspension of power rations has dealt a significant blow to the traditional high-energy-consuming building materials industry. How to view the investment prospects of the building materials industry? What are the main drivers of the building materials industry? These are very important questions for investors who focus on cyclical stocks.

　　Overall, China's economy will recover in 2020, real estate will continue to prosper, and the construction and building materials industries will rebound overall. Since 2021, real estate regulation has become stricter, housing enterprises have limited financing, the overall construction area growth rate will be under pressure in the future, and the growth rate of infrastructure construction is also declining, but the price increase has led to profit improvement expectations. The suspension of power rations that began in August and swept through many parts of the country in September made the logic of building materials change from price increases to production restrictions, so stock market prices fell significantly. From the current point of view, in view of the rigidity of the energy reduction policy, the continuous shortage of electricity and the unoptimistic growth expectations of real estate infrastructure in the fourth quarter, the future trend of building materials is still under pressure.

　　Building materials industry chain

　　The main segments of the building materials industry include: wood, bamboo, stone, cement, concrete, metal, bricks, ceramics, glass, engineering plastics, composite materials, etc.

　　Although there are many kinds of building materials products, from the logic of grasping the big and putting the small, the industrial chain of the building materials industry is relatively short, the structure is simple, and the main subdivisions can be divided into: metal building materials, non-metallic building materials and consumer building materials. In addition, green building materials have developed rapidly in recent years.

　　Performance drivers for investment in building materials

　　1. Technical characteristics and economies of scale

　　Many subdivisions of the building materials industry have strong technical intensity and obvious economies of scale, the most typical of which is the steel industry. In the era of industrialization, steel is known as the bone of the nation, the steel output of various countries is a symbol of their national strength, as a mature industry, the speed of its technological evolution is relatively slow, but the technical content of different types and uses of steel is still different, the technical ability requirements of enterprises are also different, to a certain extent, different competitive advantages have been formed. The economies of scale in the steel industry are obvious, and their economies of scale are simply derived from physical properties, that is, blast furnaces that cost twice as much to produce a volume that is several times larger than the original.

　　Major non-metallic building materials such as cement and glass have less economies of scale and product differentiation. Through the expansion and extension of the production line, the output increases while the average cost is not significantly diluted.

　　The field of consumer building materials is becoming the main force in the building materials sector to break the cycle and improve growth. Products in this field continue to innovate and differentiate products, giving enterprises more monopoly power and performance guarantees. Recently, the number of consumer building materials companies being surveyed by institutions is also increasing, indicating that the market is paying more and more attention to leading enterprises in this field.

　　2. Market structure

　　From the perspective of the three main areas of steel, cement and glass, the market structure is quite different. The market structure of China's steel industry is relatively concentrated, but its market concentration is still lower than that of European and American countries, which is to some extent related to the large space in China and the global market, and the minimum optimal output (the output when the long-term average cost reaches the lowest) is far less than the market space, that is, the market can accommodate many large steel manufacturers. This is one of the reasons why steel mills have weaker control over prices.

　　From the perspective of the cement and glass industry, product differentiation is relatively small, economies of scale are not obvious, so the market structure is generally scattered, the control of prices is very weak, even if some enterprises join forces to adjust production, a large number of new production capacity will quickly enter the market.

　　In recent years, supply-side reforms and capacity reduction have continued to increase the concentration of middle and upper reaches of the industry. For example, the production restriction of the steel industry has a significant effect on the suppression of upstream iron ore prices. However, in addition to steel, the upstream and downstream market forces of other building materials industries are still small. With the upgrading of consumption and technological progress, the downstream demand for building materials is changing, the requirements for product technology level are getting higher and higher, and enterprises that pay attention to production environmental protection and product innovation may be better developed, because they can form a monopoly in the field of segmentation with the help of the expansion of related high-end product demand.

　　Overall, the concentration of China's building materials industry under the perspective of horizontal comparison is low, the impact on prices is small, and it is easy to be affected by fluctuations in upstream raw material prices and fluctuations in downstream demand, but the ability of many enterprises to control costs is also generally strong, and innovative enterprises in the field of subdivision can form a certain monopoly.

　　3. Policies

　　As an important industry component of the national economy involving energy, the impact of industrial policies on the building materials industry cannot be ignored. Policies such as capacity reduction, elimination of excess capacity, and subsidies for technological upgrading have a fundamental impact on industry supply and competition. Taking the steel industry as an example (similar to the cement and glass industries), after the increase in production capacity at the end of 2015, the expansion of steel production capacity was limited, and the output growth was also greatly suppressed. A more typical example is that since 2020, the restrictions on steel production have increased, the policy rigidity has become stronger, and the speed of steel production has fallen faster than imagined.

　　The policy of "double carbon" and energy consumption reduction is more rigid, and the recent suspension of electricity production has had a greater impact on the normal production of the building materials industry, and the stock price has fallen significantly. The production of building materials such as steel, cement, and glass does produce greater pollution to the environment, and the pressure on carbon emissions is also very large, so the environmental protection policy for them must be high-intensity and continuous.

　　The most important factor is the fluctuation of demand

　　As a typical cyclical industry and the upstream of real estate infrastructure, macro demand fluctuations have a fundamental impact on the prosperity of the industry.

　　The two major industries of real estate and infrastructure constitute almost all the downstream demand of the building materials industry. The long-term trend of prices in the major building materials industry is basically the same, which also largely reflects the common determinants in the building materials field are the economic operation situation at the more macro level and the demand for real estate infrastructure.

　　Since 2020, the global epidemic has led to a rigid supply of global upstream resources, raw materials and products, and the recovery of supply has obviously not kept up with the recovery of demand, and the price rise has continued to drive up the profitability of building materials. The suspension of power rations will change the fundamental logic of the industry from price increases to production restrictions, and even in the future, it may evolve into the disappearance of corporate orders and the tightening of cash flow, and the blow to stock prices is likely to exceed expectations.

　　In addition to fundamentals, for the building materials industry, the significance of analyzing valuation is not very common. Individual companies may have new product advantages and technical advantages, especially in the field of consumer building materials. However, in general, the fundamental analysis of listed building materials companies constitutes its main investment logic, and the analysis of real estate infrastructure demand, as well as corresponding economic cycles and macro policies, is also very important. (Zhongxin Jingwei APP)

　　Zhongxin Jingwei copyright, without written authorization, any unit and individual shall not reprint, excerpt or otherwise use. This article does not represent the views of Sino-Singapore Jingwei.