Investment Highlights

• We maintain our UNDERWEIGHT call, forecasts and fair value 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.

• CMS’s 1HFY20 core net profit of RM34.0mil came in at only 34% and 33% of our and consensus full-year forecasts respectively. However, we deem this within expectations as we expect a stronger 2H20 with its various divisions gradually optimising their operations under the new norms.

• CMS’s 1HFY20 core net profit dropped 58% YoY mainly due weaker performance across the board. Cement recordeda sharp 40% fall in operating profit as clinker production was partially disrupted the pandemic. We believe that demand for cement also dropped significantly on the back of almost a complete halt in construction activities at the height of the pandemic. Construction and road maintenance also suffered as road length under maintenance has been almost halved effective 1 Jan 2020) while its property division underperformed due to the soft market.

• On a brighter note, contributions from its associates spiked 24% YoY on a better performance from 20%-owned fabricator KKB Engineering (due to a strong showing from its steel pipe manufacturing business) and Kenanga Investment Bank (due to a surge in trading volumes and retail participation in the local stock market).

• Meanwhile, we estimate that 25%-owned OM Materials, at best, only broke even. Sales volume of ferrosilicon (FeSi) fell 26% YoY due to: (1) a shutdown of two FeSi furnaces in early February 2020; and (2) an additional FeSi furnace being placed on maintenance in 2QFY20. On the other hand, sales volume of manganese alloy, an input in the steel production, dropped 14% due to a weaker global market demand for steel.

• We maintain our view that given the still elevated national debt, the government has very limited room for fiscal manoeuvre. Already, S&P Global Ratings downgraded Malaysia’s outlook to negative from stable on 26 June 2020 to reflect a heightened risk of fiscal deterioration, weighed down by the economic impact of the Covid-19 pandemic, depressed oil prices and fiscal stimulus

• 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 the back of an altered political landscape in Malaysia after the 14th general election. 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 - 27 Aug 2020