In view of the challenging operating environment, Lafarge will continue to embark on various initiatives to manage its operating cost more efficiently, which include, amongst others, upgrading production plants and improving productivity of workforce. We believe Lafarge’s profitability in the near-term will continue to be hit by weak cement demand and ASP coupled with high coal prices. We reiterate our SELL recommendation on Lafarge with a lower TP of RM2.50 pegged to a lower P/B multiple of 0.9x (reflecting this previous sector downturn in 2008).

Recap on 2Q18 results. Lafarge recorded weak 2Q18 results largely due to: (i) slowdown in construction activities; (ii) continued oversupply of cement in the industry; and (iii) increase in coal prices. We recently met with the management to gather updates on the company.

Subdued cement prices to likely continue. Based on our estimates, local cement prices averaged at RM206/tonne in 1H18 as opposed to RM256/tonne in 1H17, reflecting the worsening market condition. We gather that cement demand in Peninsular region will remain flat for 2018 (growth in 1H to be offset by a weaker 2H) at c.17.5m tonnes, which is well below the industry rated capacity of c.35m tonnes. As such, we believe cement prices will likely remain depressed, at least in the near term.

Hit by rising coal prices too. We note that coal price has risen by 12% YTD which does not bode well for Lafarge (as coal accounts for c.30% of cement production cost). Based on our estimates, every USD10/tonne rise in coal price will increase Lafarge’s operating cost by 2.5%, assuming (i) MYR/USD of RM4.00, and (ii) Lafarge’s coal consumption of 100USD/tonnes p.a.

Focus on reducing operating costs. In view of the challenging operating environment, Lafarge will continue to embark on various initiatives to manage its operating cost more efficiently, which include, amongst others, upgrading production plants (to reduce fuel cost) and improving productivity of workforce (altering KPIs).

Improved contributions from exports. Although cement export prices have slightly picked up in 1HFY18 from an increase in demand and weakening MYR (vs USD), we believe this would not help to cushion Lafarge from the less-than-favourable local demand prospects and rising coal prices, as exports account for only 20% of volume produced and are priced lower in terms of MYR (c.RM140/T, FOB).

Outlook. We remain cautious on Lafarge’s earnings outlook as the review and cancellation of mega infrastructure projects poses uncertainties to cement demand recovery. We believe Lafarge’s profitability in the near-term will continue to be hit by weak cement demand and ASP coupled with high coal prices.

Forecast. Maintained as we believe our forecasts have adequately reflected the dismal prospects.

Maintain SELL, TP: RM2.50. We reiterate our SELL recommendation on Lafarge with a lower TP of RM2.50 (from RM2.78 previously) based on a lower P/B multiple of 0.9x (vs. 1x P/B previously), as we believe the less promising prospects will likely remain for a while (given uncertain demand outlook and rising coal price environment. Our new TP is based on 0.9x P/B which is in line with its valuation during the previous sector downturn (i.e. 2008).

Source: Hong Leong Investment Bank Research - 14 Sept 2018