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REMICON(MSE: RMC/530)- STRONG BUY ON VERTICAL INTEGRATION EXPANSION, EXCELLENT CORPORATE GOVERNANCE, PROFITABILITY,

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KEY HIGHLIGHTS

  • According to MSE in October 2011, GDP of Mongolia will reach 100B USD GDP by 2025 from forecasted 7.2B USD this year. Mongolia currently is fastest growing economy in the world with yoy growth of over 20% in Q3 of 2011, according to World Bank in November 2011. MSE has been best performing stock market in the world in 2010 with growth of over 130% and despite recent downturn still remains the best performing stock market in the world in 2011 with over 40% YTD. Part of MSE Top 20 Index, concrete producer RMC performed 126% YTD. Today, December 2,2011 RMC has hit new historic high of 193
  • RMC was the most liquid stock in October with 2.5M shares in October compared to  1.1M shares in September and compared to 2.67M shares in August and compared with 0.749 M shares in July. RMC is consistently one of top three liquid stocks on MSE.
  • RMC is  one of Frontier Securities top picks on MSE due to

-one of the rare quality companies on MSE with excellent standards of corporate governance  and transparency

-Profitability , accountability and sharing with minority shareholders

-high liquidity

-Rare capturing of tremendous economic growth in the country on MSE

-Sound vertical integration expansion plan

-while being not limited by limited domestic demand due to massing mining and infrastructure development

  • RMC has dedicated following by leading brokerages of Mongolia

  • Industry consensus is that RMC is emerging leader in concrete industry in Mongolia.

  • In 2010, the company produced 47K cm of concrete mortar (around 6% of the concrete mortar market in Mongolia) representing 31% of its overall capacity, which has increased significantly to 35K m in H1 2011 and forecast to increase to 80K c m for the full year 2011. Remicon’s production increased 5.2 times in 2010 and is expected to increase 2.3 times in 2011, according to the company management team. If Remicon operates at full capacity, it represents 20% of the overall market in Mongolia, ranking it number 1 in production. At current material cost and concrete mortar prices, Remicon generates gross margins of 45% by producing over 100K cubic m concrete mortar per year.

Graph by ResCap

  • common interest parties of Hera Holding are the majority stakeholder of Remicon JSC, holding around 51%. Also Frontier Securities and Gauli (a Korean invested brokerage firm), both licensed by the FRC of Mongolia, own 12% and 11% respectively. 16% is free float.

 

  • Hera Holding was established in 2003 under the name of Hera investment to work in domestic and foreign trade and investment areas. In 2004, the company became an official dealer of the Korean Hite Brewery Co. Ltd. Then the company diversified operation into equipment (becoming an official dealer of Korean “Hyundai Heavy Industries Ltd”), food and household products (Hera Foods LLC), finance (Hera Investment LLC), construction (Hera Construction LLC) and construction materials (Remicon), transportation (Ar Zam LLC) and mining services (Hera Mining Service LLC).

  • The majority of the members in Remicon’s senior management team have been with them since the incorporation of the system. They possess solid industry knowledge, extensive operational experience and have a proven track record of generating rapid growth for Remicon

  • Remicon has improved their corporate governance in accordance with the consulting report by Frontier Advisory. Frontier Securities believes that Remicon’s established corporate governance system and their management team’s familiarity and experience with international corporate governance standards will help contribute to Remicon’s success in the future

  • The economy grew at a furious pace in the third quarter with data showing GDP growth of 20.8 percent year-on-year . Construction sector rebounded at equally furious pace in the third quarter of roughly 80% yoy reaching 258  bln.tog

  • There are growing fears of another construction bubble fuelled by the inflow of money into the economy from currently high mineral prices, similar to the previous boom in 2004-08.  Prices of key construction materials have climbed sharply since last year while housing prices are soaring . On average, cement prices tripled in the last 5 years.

  • If there is a construction bubble and that bubble is to collapse, concrete producers with weaker financial capabilities and limited credit would be vulnerable with construction slowdown , thus creating conditions for industry consolidation

  • At the same time, on background of mining boom, the country plans massive infrastructure and housing spending, spurring demand for roads, buildings, and infrastructure , from which cement  and concrete industry is to benefit the most . Government of Mongolia has planned to invest MNT30.9 trillion (USD25.4bn) into infrastructure, mining, construction, energy and 4 other sectors from 2010 to 2015 which means that in the coming years, there is expected to be a sharp increase in demand for both concrete mortar and cement. Forecasts suggest domestic cement demand will double from 700,000 tons in 2008 to 1.7 million by 2012.
  • Concrete industry does have strong fundamentals with urbanization, increasing GDP and income, influx of foreigners, high rental yield, low housing stock, shortage of modern office and commercial space, Mongolian real estate and infrastructure sector is still severely underdeveloped compared to its correlated peers such Qatar and Kazakhstan

  • While concerns of an impending rupture of the real estate bubble grow, concrete producer companies face rising material prices, shortages of skilled labor and increasing infrastructure bottlenecks. Prices for main construction materials such as cement have grown by 40 percent in 2009 compared to 2006.

  • Limited number of domestic and foreign cement suppliers (who arbitrarily raise prices), lack of sufficient domestic cement production, transportation bottlenecks for cement and other material shipments from China, are the main factors for cost inflation.

  • Construction materials companies are affected to certain degree by chaotic unorganized developments in rapid urbanization in the Ulaanbaatar area  in real estate sector.

  • Skilled labor shortage exists in the construction materials sector.

  • Another is issue is quality of construction materials , and calls have been made to improve the regulation of construction material quality and strengthen the enforcement of building code compliance.

  • Current increased inflationary pressures /resulting monetary tightening as well greater concerns over the sustainability of the rising real estate prices definitely will force     commercial banks to slow down lending to developers, as in 2009, when credit crunch was a key reason for construction sector collapse

  • To ensure further growth and stability of construction sector, investments in construction material manufacturing capacities as well as skilled labor training is needed.

  • cement consumption in Mongolia increased more than tenfold in the past 10 years, with supply struggling to meet the increasing demand . On average, cement prices tripled in the last 5 years

  • total current cement consumption in Mongolia is approximately 1.5 mn tons a year. cement demand over the next 5 years for the 100 thousand apartment project only is around 1 million tonnes pa. Cement demand is projected to reach 2.0 mn tons pa in the near future, due to the massive infrastructure projects planned by the government. 

  • construction and capital repair increased nearly 4 times during 2004-2008, before declining sharply by more than 50% in 2009.

  • Among the government’s key modernisation plans is a strategy to build 100,000 new housing units in the capital to improve urban living conditions as well as water supply and sanitation nationwide. The administration has pledged to pay MNT1m ($772.20) to each eligible citizen towards the purchase of a new housing unit, with an apartment block with 15,000 units already under construction on Ulaanbaatar’s Yarmag Hill. Officials have said the project will cost MNT800bn ($617.8m), MNT467bn ($360.6m) of which would be allocated to the construction sector.Compelling macroeconomic and demographic trends and obvious improvements in structural conditions and investment in infrastructure are driving strong property price increase and subsequently increased demand for construction materials  over the past years in Mongolia. Over half of the residents (52%) of Ulaanbaatar are currently living in their traditional nomadic dwellings, known as gers while the remaining 48% live in apartments with complete civil supplies; this is 24% lower than international standards. Although Mongolia has one of the lowest population densities in the world, it also has one of the highest population densities per square meter of apartment space (as most of the population lives in the capital). The living area per person within the city is 31.2 percent lower than normal international levels

  • The cement and concrete industry in Mongolia is highly fragmented. Mongolia will very likely begin to experience corporate restructuring and consolidation at regional levels through gradual integration of operation and the optimization of resources allocation in order to concentrate the production effort and enhance competitiveness of cement and concrete producers.

  • Frontier Securities believes that a couple of the major concrete producers in Mongolia are considering to commence the consolidation process via mergers and acquisitions. The aim will be to increase a producer’s market share and competitiveness. At the same time, any consolidation effort will ultimately prove futile if the producers will not be addressing the problem of material acquisition for the production of concrete. By having their own cement plant, any producer would achieve a competitive advantage over all other suppliers when it comes to the pricing of the end product. 

  • Implementation of the “100 000 apartment” project requires approximately 2.3 million cubic m of concrete mortar or an increase of at least 400K cubic m of concrete mortar annually in the coming 5 years in Mongolia. Current market demand is around 800K cubic m annually.

  • The company is planning to build a cement factory with an annual capacity of 250-300K tonnes of Portland 42.5 cement product. The total required capital to build the cement factory is MNT13.5bn (US$10.8mn) which is relatively cheap as a result of Remicon planning to buy parts from small and mid-sized cement factories in China as Chinese small and mid-sized cement factories are closing in order to upgrade production level by combining factories.

  • The company is planning to finance the cement project by issuing shares through the MSE, with management/founders expected to subscribe for approximately 40% ($4 million) of the capital raising

  • Competitive advantages: leading concrete producer in Mongolia and are well positioned to capture the growth opportunities in its fast-growing construction industry.  convenient access to coal supply and limestone reserves , first cement producer in Mongolia to use desulfurization gypsum and construction waste as additives in cement products. In addition, Remicon will recycle industrial by-products

  • RMC’s strategies:  -Strengthen Remicon’s leading market position through capacity through vertical integration -Continue to lower Remicon’s costs through technological improvement  , among others

RATIONALE FOR REMICON’S BUSINESS VALUATION

  • During the shareholder meeting on July 20, 2011, RMC market price was 125 MNT. The Issuer and the Underwriter mutually agreed that, according to the company’s future cash flow projection, pricing of the Offer share will account for at least 50 percent premium of the market price as of July 20, 2011. Based on this consideration, therefore, 187.5 MNT or 190 MNT per share will be the minimum Offer price. 

  • Remicon’s net present value is approximately 34,712,000,000 MNT (thirty four billion seven hundred and twelve million MNT). The current outstanding shares and Offer shares are, in total, 118,138,464 shares. According to this cash flow valuation, the fair price is found to be 294 MNT per share.