YTL Corp (YTL) is proposing to acquire a 51% equity stake in Lafarge Malaysia (LMC) for RM1.6bn or RM3.75 per share by cash. Post the completion, YTL will also launch a mandatory general offer to acquire the remaining 49%. The deal is expected to be completed by 3Q19. We view the deal negatively, as we believe the outlook for the cement industry remains challenging in the short term, and this would negatively impact YTL’s ability to pay dividends due to the drag on its earnings. Reiterate SELL and unchanged TP of RM0.70.

Creating a Dominant #1 in the Player

The combination of YTL Cement and Lafarge Malaysia (LMC MK, RM3.72, Hold) would no doubt create a dominant player with a combined market share of around 58%, which dwarfs the existing #2 player with 9% market share. Although there is no mention about the deal requiring approval of any government authorities, we believe there is a possibility that the deal might require clearance from the MyCC (Malaysia Competition Commission) due to the creation of an entity with dominant market share.

Leveraging on Market Share Is the Key

As the sector has been faced with overcapacity over the past few years, we believe that the consolidation among players will no doubt help to alleviate the problem. YTL could in theory leverage on its market-share position to start increasing selling prices, but we think it would be challenging due to the current weak demand. As LMC has been lossmaking since 2017, it would be critical for YTL to turn the operations around or the deal would be a drag on its earnings.

Will be a Drag on Cash Flow and Earnings in the Short Term

As the deal is likely to be fully funded by debt, assuming the RM3.1bn debt carries a 5%/pa interest cost, YTL would have to bear around RM150m of interest cost a year or 38% of our FY20E full-year profit forecast. This does not include any new fresh borrowings for LMC to maintain its current operations given that it currently generates negative cash flow.

Maintain SELL With An Unchanged TP of RM0.70

We are maintaining our SELL call and an RNAV-based TP at RM0.70, due to the weak prospects and lack of near-term growth catalysts for YTL. No change to our EPS yet, pending the completion of the deal. Upside risk: i) Higher construction contracts win and ii) Improving outlook for the utilities and cement operations.

Source: Affin Hwang Research - 3 May 2019