Highlights

• Weak FY16 results: To recap, Lafarge Malaysia FY16 core net profit decreased 69.5% YoY. This is mainly due to weak demand for cement and pricing pressure.

• Demand: We understand that industry wide cement volume has dropped by about 6% in FY16 and this is due to timing gap in implementation of major infrastructure projects and weak property market. The growth rate of cement demand in FY17 is expected to be in the low single digits, mainly driven by the picking up of mega infrastructure projects in 2H.

• Supply: Domestic cement capacity has expanded by about 14% in FY16. Going forward, we understand that all major expansion in cement capacity has been completed and the industry capacity is expected to remain stable for the next few years. However, we do not expect cement price to rebound significantly in the short-term as the supply of cement still outpaces demand.

• Cost: We expect Lafarge to face a higher production cost in FY17 due to increase in coal and diesel prices. About 40% of the company total production cost is energy related costs (coal, diesel and electricity).

• Capital Expenditure: We understand that the company will incur capital expenditure (capex) in FY17 at a level that is higher than its usual maintenance capex (c.RM150m per annum) to improve internal cost efficiency. Besides, the company is also expected to enjoy tax reinvestment allowance arising from the capex.

• Outlook: Although cement demand is expected to recover marginally in FY17, we opine that the positive impact of improved demand will be offset by increase in production costs. Besides, any significant improvement in cement demand must be reinforced by a recovery of property market which we deem unlikely in the near term.

Risks

• Stronger demand for cement consumption due to stronger property market and pickup of mega infrastructure projects

• Reduced price competition

• Further decline in coal prices

Forecasts

• Unchanged.

Rating

SELL ↔ , TP: RM5.50 ↔

• Although Lafarge is a proxy to ride on the construction upcycle, its short term prospect appears to be plagued by industry overcapacity resulting in downward price pressures as well as softening demand associated with the timing gap on project rollouts. Current infrastructure boom may not be sufficient to make up for the demand gap caused by weak property market.

Valuation

• Maintain SELL with unchanged TP of RM5.50 as we opine that the near term prospect of the cement industry remains challenging. Our TP is pegged to P/E multiple of 20x of FY18 EPS.

Source: Hong Leong Investment Bank Research - 30 Mar 2017