Investment Highlights

• We maintain our UNDERWEIGHT call and forecasts, but reduce our fair value by 20% to RM1.14/share (from RM1.42/share previously) for Cahya Mata Sarawak (CMS) based on 8x FY21F EPS (from 10x previously). We peg CMS to a lower PE following a steep 45% loss in its market value since the beginning of the year, rendering it less investable to large institutional investors.

• Key highlights from our recent meeting with the company are as follows:
  
  1. CMS guided for its Phase 2 cement plant upgrading to begin in 1Q2021 (vs. Sept 2020 in its initial plan), while assessing the new expansion timeline for Phase 3 (vs. the initial target of early 2021). We understand that the delays were due to the introduction of additional safety precautionary measures following a Covid-19 infection.
  
  Recall, CMS is ramping up its in-house clinker production capacity from 625K tonnes at present to 700K tonnes under the Phase 2 upgrading, and further to 750K tonnes under Phase 3. The rationale is to reduce its reliance on clinker imports of which prices could spike occasionally, hurting its cement margins.
  
  Upon completion of the upgrading, we estimate that CMS’ dependence on clinker imports (largely from Southeast Asia and Peninsular Malaysia) will decline from 60% to 45–50%. Based on our channel checks, the market demand of cement in Sarawak is about 1.7mil tonnes annually.
  
  2. We believe that OM Materials (Sarawak), at best, could only break even in FY20F. Indications are pointing towards the 25%-owned associate slipping into the red in 2H20 (erasing RM9mil PBT it reported in 1HFY20) as selling prices of ferrosilicon have dropped to at about US$850/tonne at present (vs. our estimated breakeven price of US$950/tonne and an average spot price of about US$1,050/tonne in 1HFY20).
  
  Also, there has been a slight hiccup in operation with four ferrosilicon furnaces (out of a total of 10) currently offline due to maintenance and travelling restrictions on expatriate engineers (from China). The good news is that all its six manganese alloy furnaces are currently operating.
  
  Meanwhile, the expansion plan of OM Materials (Sarawak) is intact. Recall, OM Materials (Sarawak) has set aside A$20mil (RM60mil) for its Phase 2 expansion, comprising largely a sinter plant which will lower its manganese alloy production costs. Slated for completion in FY22F, the expansion plan entails the construction of up to four more manganese alloy furnaces.
  
  3. CMS remains hopeful that the state government will roll out more public infrastructure projects ahead of the 12th Sarawak state election (that will have to be held by Sept 2021). However, it acknowledged that the execution (i.e. tendering, evaluation and contract award) has been disrupted by the pandemic.
  
  Meanwhile, StarBiz reported on 5 Oct 2020 that the Sarawak state government reiterated its commitment to build the Northern Coastal Highway (previously known as Phase 2 of Pan Borneo Highway, Sarawak) at a cost that is yet to be determined. This is basically an 86km spur road of Pan Borneo Highway, Sarawak. It branches out at Miri and links up Limbang and Lawas in Sarawak’s northern tip. While this could be green shoots of recovery of the construction sector in Sarawak, we are not holding our breath.
   
• 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.

• Also, 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 a dynamic political landscape in Malaysia at present. 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 - 8 Oct 2020