Investment Highlights

• We maintain our forecasts, HOLD call and FV of RM4.05 for Lafarge Malaysia (Lafarge) following an analyst briefing yesterday. Our FV is based on 1.25x FY18F book value of equity per share (BVPS), consistent with its historical P/B ratio during the transitional period between the trough and mid-cycles.

• The company recorded the first full-year net loss in the past 12 years largely due to the double whammy of overcapacity and sluggish demand in the industry, resulting in severe price undercutting by players. Not helping either was the escalation in the production cost on rising commodity prices, especially coal (on the back of capacity cuts in China). Its earnings was hurt further by one-off expenses including: 1) Repair costs of RM10mil for its Rawang plant; 2) VSS cost of RM20mil; and 3) higher fuel cost.

• With little pricing power, Lafarge will pursue the following "strategic initiatives" to improve its performance: 1. Cost optimisation – Lafarge plans to source petroleum coke (20-30% of total production cost) directly from the Middle East, which will result in 5-10% savings in terms of cost, apart from buying it from local suppliers. 2. Asset optimisation – The Rawang plant is in the process of “modernisation” (to be completed in 2018) in order to achieve greater efficiency and reliability. Additionally, Lafarge plans to reduce its logistic cost by switching the transport mode from road to rail, minimising demurrage (charges for the delays in loading/unloading at the ports) and network optimisation. Also, Lafarge has invested in second ready mix plant (RMX) in Chan Sow Lin which is expected to be operational by 1Q2018. The location of RMX plant in KL provides better mobility to supply ready mix supply for mega infrastructure projects within its vicinity. 3. Fuel optimisation – The company plans to double the use of alternative fuel sources in all of its plants in order to dependency on fossil fuels and to maximise the recovery of energy from alternative fuel (i.e. solid waste).

• The company is also widening its reach to the high-margin retail segment (which we believe is just a fraction of total sales currently), comprising small contractors, renovators and homeowners, via: (1) flagship stores across the country (to date: 40 stores), (2) two Pro-Builder Centre (PBC) stores by end-2017, which carry a comprehensive range of building materials; and (3) e-commerce channels (such as Lazada) with attractive offers

• We like Lafarge because: 1) it is the dominant player in the cement sector in Peninsular Malaysia with a 40% market share, making it a good proxy for public infrastructure spending; and 2) it practises strong environmental, social and governance (ESG) standards.

• However, while the demand for cement will pick up over the near term thanks to the rollout of key mega infrastructure projects, it may not immediately absorb the expanded industry capacity stemming from aggressive capex by key players in recent years.

Source: AmInvest Research - 28 Feb 2018