The higher losses in 3Q18 were due mainly to (i) two major scheduled kiln maintenance, and (ii) lower domestic cement prices. The average domestic cement prices maintained at RM206/tonne throughout 1H18, and we estimate it to have fallen to RM186/tonne in 3Q18. Despite the initiatives carried out to improve operational efficiency, we believe Lafarge could only return to the black once cement prices show signs of recovery (which is unlikely in the near to-midterm, in our view). We reiterate our SELL recommendation on Lafarge with an unchanged TP of RM1.81 based on a P/B multiple of 0.9x

Disappointing quarter. Higher losses in 3Q18 were due mainly to (i) two major scheduled kiln maintenance (Kanthan and Langkawi), which has in turn resulted in higher operating costs and lower production volume, and (ii) lower domestic cement prices. Despite average domestic cement prices maintaining at RM206/tonne throughout 1H18, we estimate it to have fallen to RM186/tonne in 3Q18.

Moving into 4Q18. While Lafarge is able to raise cement production (as the maintenance in 3Q18 is able to bring utilisation rates at the two kilns to 90% from 70% and there will be only one scheduled maintenance in 4Q18), we believe sales volume will remain lacklustre in 4Q18 as raining season typically results in slower construction activities. For FY18, We gather that cement demand in Peninsular region will remain flattish at c.17.5m tonnes, well below the industry rated capacity of c.35m tonnes.

Moving into FY19. Management is expecting domestic cement demand to contract slightly (arising from slowdown in construction activities), pointing downside risk to cement prices.

Hit by rising coal prices too. YTD, coal price has risen by 10%. Although management expects coal prices to stabilise at current level, we believe a weaker MYR (against the USD) will result in higher coal cost (which 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 RM4.10, and (ii) Lafarge’s coal consumption of 100USD/tonnes p.a.

Focus moving forward. In view of the challenging operating environment, Lafarge continues to embark on various initiatives to manage its operating cost more efficiently, which include, amongst others, upgrading production plants (to reduce fuel consumption) and improving productivity of workforce (altering KPIs). With regards to the borrowings, Lafarge will be paring down its position once operating cash flow reaches a sustainable level. Recall that borrowings increased to RM841.5m in 3Q18, mainly due to an intercompany loan drawdown of RM256.4m.

Outlook. Despite the initiatives carried out to improve operational efficiency, we believe Lafarge could only return to the black once cement prices show signs of recovery (which is unlikely in the near-to-midterm, in our view). 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: RM1.81. We reiterate our SELL recommendation on Lafarge with an unchanged TP of RM1.81 based on a P/B multiple of 0.9x, as we believe the less promising prospects will likely remain for a while (given uncertain demand outlook and high coal price environment. Our 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 - 23 Nov 2018