Investment Highlights

• We cut our net profit forecast for FY19F by 18%, and FY20– 21F by 2% each, reduce our FV by 2% to RM2.45 (from RM2.51 previously) and maintain our UNDERWEIGHT call for Cahya Mata Sarawak (CMS). Our new FV is based on 10x revised FY20F EPS, in line with our benchmark forward target P/E of 10x for large-cap construction/building materials stocks.

• During a recent meeting, CMS highlighted to us two potential headwinds to FY19F earnings: (1) competition in the state road maintenance space; and (2) weaker performance from 25%-owned OM Materials due to sustained soft selling prices of its end products.

• CMS foresees competition in the state road maintenance business from FY20F upon the expiry of its 6-month extension for the maintenance of state roads (5,847km) on 31 Dec 2019. The potential entry of new players could reduce the size in terms of the length (in km) of state roads to be maintained by CMS, as well as the margins realised. In FY18, construction and road maintenance contributed about 20% to CMS’ total earnings.

• Meanwhile, the outlook for OM Materials is expected to remain weak in FY19F, weighed down by the weak selling prices of its key end product ferrosilicon (FeSi), on the double-whammy of rising supply and slowing demand in China amidst the US-China trade war. We understand that FeSi prices eased by a further 8% to US$1,080/tonne in 2QFY19, as compared with US$1,170/tonne in 1QFY19, and its production cost of US$1,000/tonne. FeSi prices averaged at US$2,100/tonne in FY18. We have reflected these two potential headwinds in our forecasts.

• We maintain our view that a sustainable funding model for public infrastructure development in Sarawak is by tapping into federal funds vs. draining the state reserve of Sarawak. In any case, we believe that the market could have adequately priced in the potential of a state reservesfuelled infrastructure boom in Sarawak (ahead of the Sarawak state election which must be held by Sep 2021) with CMS share price having recovered strongly from its low of RM1.92.

• We remain cautious on CMS due to the cutback in public infrastructure spending as the federal government tightens its belts. We are also mindful of the potential threat to the market dominance of existing players in the construction and building materials sector in Sarawak and altered political landscape in Malaysia after the 14th general election. Increased competition could put a dent on CMS’ prospects of winning new construction jobs, securing extensions or its road maintenance concession, as well as sustaining high margin for its construction, road maintenance and cement business.

Source: AmInvest Research - 22 Jul 2019