Investment Highlights

• We maintain our UNDERWEIGHT call, forecasts and fair value (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 yesterday feeling mixed. Below are our key highlights:

1) The cement division (which typically contributes about 30% of the group’s earnings), will continue to face margin compression in the near to medium term. 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 FY19, they are still significantly higher vs. about US$38/tonne prior to FY19). We estimate that CMS currently sources about 60% of its clinker requirements internally. This should be reduced to 45–50% by FY22F.

To add salt to the wound, there will be a delay in the second phase of CMS’ cement plant upgrade due to the Covid-19 pandemic (CMS has planned to ramp 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). There was no guidance yet on how long the delay would be. In the meantime, we believe that CMS will continue to depend on imports from Southeast Asia and Peninsular Malaysia.

2) Meanwhile, the group has guided that its 25%-owned associate OM Materials (Sarawak) will highly likely be marginally in the red in 3Q20 due to prolonged weak selling prices of ferrosilicon and manganese alloy. It was also highlighted that only 12 out of a total of 16 furnaces are running as additional furnaces are placed on maintenance in 2Q20 due to limited manpower at the plant. We assume the unit to only break even in FY20F.

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. 

(3) There were no updates with regards to the award of additional work packages from key state projects (i.e. Coastal Road and Second Trunk Project. However, it was briefly mentioned that the timeline of all the tenders will be pushed back due to the Covid-19 pandemic.

• 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 - 3 Sept 2020