West China Cement - is this one to add into the mix?

Not everybody believes Anthony Bolton's optimism on China is justified. But to judge by the recent share price spike, shareholders in West China Cement Ltd (LON:WCC) certainly do.
WCC is an infrastructure play which has benefited handsomely from the Chinese government's stimulus package. Growth has been rapid - earnings growth over the last four years has been at a minimum 18%, and as high as 92% - and the company looks set for future growth.

Two of the company's original three plants are now producing at full capacity, while the newer Ankang plant produced 1.34m tonnes out of its 1.8m tonnes total capacity last year and should be running at its maximum this year. A new plant in Yangxian starts production this month, while the Mianxian plant will come on stream in Q3, increasing capacity by 2.2m tonnes between them.

Though the company is based in Shaanxi province, its newer plants are well located to supply across the border to the Sichuan earthquake zone where reconstruction efforts will require materials. The company will get to 7m tonnes a year full production once the new plants are working, against 5.08 m tonnes produced last year, and is looking to increase capacity to 11.9m tonnes a year by the end of this year - two acquisitions plus new production lines [ref] Preliminary results: http://www.westchinacement.com [/ref] . This will give it about one fifth of the market in its home province - the leader in the south of the province - though the company remains a strong regional company, not a national player [ref] Investors Chronicle, 9 March 2010: http://www.investorschronicle.co.uk/Tips/Sell/MiniTips/article/20100309/97d39192-2b73-11df-baff-00144f2af8e8/West-China-leaves-UK-on-a-high.jsp [/ref] .

The recently announced results show revenue up 75%, and operating profit more than doubled, with operating margins up from 33% to 41%. Earnings per share increased from RMB 3.84 to RMB 5.12 [ref] Preliminary results: http://www.westchinacement.com [/ref] . That all looks sterling stuff.  Margins expanded as the price  of coal fell, while the company sustained the prices which it had increased by 36% in 2008 [ref] Investors Chronicle, 2 September 2009: http://www.investorschronicle.co.uk/Companies/ByEvent/Results/Analysis/article/20090902/8af5b53e-97a5-11de-b57d-0015171400aa/West-China-Cement-building-up.jsp [/ref]

However, China's economy is a bit of a worry. It's still growing, but it's difficult to work out how much of that is due to the stimulus package - and there is substantial overcapacity in the cement industry. For instance, an article last year in China Daily suggested that there was a 300m tonne oversupply [ref] China Daily. 11 June 2009: http://www.chinadaily.com.cn/bizchina/2009-06/11/content_8273087.htm [/ref] .
While last year saw volumes rising, I don't like the fact that prices were flat [ref] Preliminary report, p 8 [/ref] . That, I suspect, reflects the fact that supply isn't exactly tight - this is not a seller's market. And it might suggest there's no room to push prices up any further. Any worsening of the supply/demand balance could see prices falling - and my feeling is that negative price elasticity isn't built into the price.
Besides, the Chinese government is now taking measures to rein in overcapacity [ref] China Cement: http://www.cementchina.net/news/shownews.asp?id=6855 [/ref] . Now that might actually help WCC, as it will mean closing the least efficient plants - and WCC is a modern, relatively large scale, and environmentally friendly producer. It might also lead to consolidation plays in the industry - in which WCC could take part with further acquisitions. (Who knows, a larger producer might even gobble up WCC.)

Another concern is that when I look at WCC's balance sheet, I see very high debt - 1284m net debt,  against only 1295m equity. That's uncomfortable, I think. (The company confuses matters by referring to this as 50% gearing. I generally don't include the debt on both sides of a gearing formula - I look at debt to equity, not debt to total liabilities.) Then when I look at the cash flow account, I see that the company is spending more on capex than it generates in cash flow - so it's burning cash each year. If this is the top of the cycle, and it might be, that would leave WCC exposed.

Currently, the stock appears to be trading around 12 times earnings, and that looks fairly cheap. Of course, there's always something of a discount for Chinese stocks. I don't think, though, it's quite enough of a discount for me to overlook the risks.

And the other thing I don't like is that WCC is leaving AIM to relist in HK - and in the process is shedding its UK based directors. I can understand why a Chinese based board is more appropriate, but as a UK based investor I really want someone looking out for my interests. On the whole, I'm not convinced. More due diligence might be rewarded - but then again, it's my time, and time is money.