Investment Highlights

• We maintain our UNDERWEIGHT call, forecasts and FV of RM1.42/share for Cahya Mata Sarawak (CMS) based on 10x FY21F EPS, in line with our benchmark forward target P/E of 10x for mid-cap construction/building material stocks.

• We came away from an analyst briefing last Friday feeling mixed. While its operations across the divisions are gradually normalising post-MCO (movement control order), its cement unit (which typically contributes about 30% of group earnings) will continue to be weighed down by margin compression. This is due to its heavy dependence on imported clinkers, of which prices have stayed elevated at about US$50/tonne at present (while they have eased from about US$58/tonne in 2019, they are still significantly higher vs. about US$38/tonne prior to 2019).

• It is ramping up its in-house clinker production from 625K tonnes in FY19, to 700K tonnes in FY20F, 750K tonnes in FY21F and 800K tonnes in FY22F, underpinned by the second and final upgrading phases in Sep 2020 and early 2021 respectively. In the meantime, we believe CMS will continue to depend on imports from Southeast Asia and Peninsular Malaysia. We estimate that CMS currently sources about 65% of its clinker requirements internally. This should go be reduced to 45–50% by FY22F.

• Our forecasts have assumed a gradual recovery in the unit’s margins, assuming the ramp-up in production is to proceed as planned.

• Meanwhile, 25%-owned associate OM Materials (Sarawak) has set aside A$20mil for its phase 2 expansion, comprising largely a sinter plant which can lower its manganese alloy production cost. The capex plan, slated for completion in FY22F, entails: (1) the modification of two existing ferrosilicon furnaces to produce metallic silicon and silicomanganese; and (2) the construction of up to 4 more manganese alloy furnaces.

• While CMS guided for better prices of ferrosilicon and manganese alloy in 2H20 as economies reopen, it fell short of providing guidance as to whether OM Materials (Sarawak) will be in the red or black in FY20F. We assume the unit to only break even in FY20F. Better prices and sales volumes in 2H should help the unit to recoup losses incurred in 1H due to low prices and sales volume amidst the Covid-19 pandemic.

• We remain cautious on the outlook for the construction sector. The government has very limited room for fiscal manoeuvre given the still elevated national debt and reduced petroleum revenues. In Sarawak, while the state could step in to fill the gap with the RM11bil state reserves-fuelled infrastructure projects comprising the Coastal Road, Second Trunk Road and 11 mega bridges (ahead of the state election which must be held by Sep 2021), the rollout of work packages from these highly publicised projects seems to have hit a snag after the initial hype.

• We are mindful of the potential threat to the market dominance of existing players in the construction and building material sector in Sarawak on an altered political landscape. Increased competition could put a dent on CMS’ prospects of winning new construction jobs and concessions, as well as sustaining high margins for its construction, road maintenance and cement businesses.

Source: AmInvest Research - 6 Jul 2020