Investment Highlights

• We maintain our UNDERWEIGHT call, forecasts and FV of RM2.13 for Cahya Mata Sarawak (CMS) based on 10x FY20F EPS, in line with our benchmark forward target P/E of 10x for large-cap construction/building materials stocks.

• We came away from an analyst briefing yesterday feeling cautious on the company’s outlook largely due to the earnings risk arising from: (1) margin compression on its cement division; (2) competition in the state road maintenance space; and (2) weaker performance from 25%-owned OM Materials due to sustained soft selling price of its end-product.

• CMS guided for a softer year for its cement division on the back of the escalation in its input cost of clinker priced at average of US$50–54/tonne (vs. US$35–36/tonne normally). The company imports about 50–60% of its clinker requirement from Vietnam, with the balance 40– 50% being produced in-house. We believe that the price of imported clinkers could stay elevated for longer (which we are assuming) as the new and cleaner capacity may not come in soon enough to fill the vacuum left by the decommissioning of the obsolete and highly polluting capacity in China (due to stricter environmental policies).

• We reiterate that the company foresees competition in the state road maintenance business from FY20F, upon the expiry of its 6-month extension for the maintenance of the state roads (5,874km) ending 31 Dec 2019. The potential entrance of new players could reduce the size in terms of km-length 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 but slowing demand in China amidst the US-China trade war. We understand that FeSi prices eased by a further 23% to US$1,080/tonne in 1HFY19, as compared with US$1,320/tonne in 1QFY19, and its production cost of US$1,000/tonne. FeSi prices averaged at US$2,200-US$2,400/tonne in FY18. We have reflected these three 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 reserves-fuelled 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 sectors in Sarawak and the 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 - 29 Aug 2019