Highlights

• 1HFY17 results: To recap, Lafarge Malaysia’s 1HFY17 bottom-line swung YoY from profit to a loss of RM49.7m. This was mainly attributed to lower sales contribution from the cement segment caused by the soft market demand, increased industry capacity and continued pricing pressures.
• Pricing: We gather that cement price has stabilized and improved since 2H17 even without significant improvement in demand. We deem this as a signal that cement price has hit rock bottom and is poised for a recovery.
• Demand: Based on our tracking of domestic contract awards to listed contractors, last year saw a record RM56bn dished out, supported by mega job such as the MRT2 and several highway projects. We reckon that most of these jobs will hit a more significant rate of progress from 2H17 onwards, aiding the demand for cement.
• Cost: Going forward, we expect Lafarge to have a leaner operating cost structure due to cost optimization exercises which result in improved efficiency in Rawang and Kanthan plant. Hence, more cement will be supplied from the 2 plants instead of Langkawi plant which will reduce logistic cost.
• Outlook: We opine that the earnings of Lafarge have bottomed and are poised for a recovery given the improvement in cement price and leaner cost structure. Moreover, we believe the improvement in cement price is sustainable given no new supply capacity coupled with demand pick up in near term.

Risks

• Delays in the implementation of large-scale infrastructure projects, resulting in lower than expected demand for cement consumption.
• Increased price competition.
• Further increase in coal prices.

Forecasts

• Unchanged as we had assumed the recovery of industry from 2H17 onwards in our forecast previously.

Rating

HOLD ↑ , TP: RM6.15 ↑

• Lafarge is a proxy to ride on the construction upcycle. The improvement in cement price coupled with picking up of mega infrastructure projects signifies that earnings may have bottomed and is poised for a recovery. However, we reckon that the expected earnings recovery has been largely reflected after recent run-up of share price.

Valuation

• Although we opine that earnings have bottomed, the magnitude of its potential recovery remains vague in the near term. Hence, we think that a P/E based valuation underappreciates the intrinsic value of the company given its giant market share in local cement industry which is a beneficiary from the construction boom. As such, we change our valuation on Lafarge to a P/B methodology.
• Upgrade to HOLD with higher TP of RM6.15 after pegging the stock at P/B ratio of 1.7x which is 1SD below Lafarge’s 2-year historical mean.

Source: Hong Leong Investment Bank Research - 05 Oct 2017