Lafarge was satisfied with its FY12 net profit of RM349m, incurred from higher sales volumes,  better  local  sales  and  lower  maintenance  costs.  Its  management  expects various  construction  projects  under  the  ETP  and  10MP,  plus  on-going  property developments, to keep cement demand on an uptrend while it gradually absorbs the additional  capacity  of  new  players.  It  will  focus  on  product  differentiation  to  retain its  competitive  edge  and  margin,  which  justifies  our  conservative  price  escalation assumption.  That  said,  we  keep  our  NEUTRAL  call  and  FV  at  RM9.44  as  our valuation parameter at 20x FY13 EPS is a premium to its regional peers' 18.5x.  

A  commendable  year.  We attended Lafarge's analyst briefing yesterday. Mr. Bradley Mulroney, its President & CEO, was pleased with its commendable financial performance, whilst its plants managed to record zero fatalities in FY12. He stressed that the group will continue to focus on fulfilling customers'  requirements  and "reduce layers" in  order  to improve  the  flow  of  information  to  senior  management,  which  can  then  react  quickly  and accurately  to  market  changes.  ED  &  CFO  Mr.  Chen  Theng  Aik  attributed  the  7% improvement in FY12's revenue to a slight increase in sales volume and a better local vs export  ratio,  which  thereby  bumped  up  its  selling  price  thus,  its  margin.  Together  with reduce downtime and lower maintenance costs, its net profit rose by 9.8% to RM349m.

Steady  demand  in  2013? Mr. Mulroney expects domestic demand for cement in 2013 to be  driven  by  construction  projects  launched  under  the  Economic  Transformation Programme  (ETP)  and  10th  Malaysia  Plan  (10MP)  as  well  as  on-going  property developments.  He  confirmed  that  the  domestic  cement  market's volatility  in  4Q12,  as customers reacted to a new kid on the block, Hume Cement in October. Our suspicion that Lafarge offered better rebates after it raised its list price, especially to big clients, is likely to be true. That said, Mr. Mulroney thinks it is too early to confirm if market has since stabilize moving  into  1Q13,  but  expects  the  constant  growth  in  local  cement  usage  may  help  to gradually  absorb  any  additional  capacity.  Its  management  estimates  local  cement  usage may  have  increased  by  4%,  and  the  use  of  its  ready  mix  plus  other  concrete  products grown by 5% last year.

Product  differentiation  is  vital.  Undeniably, Lafarge's world-class  R&D  facilities  and technical support provides the ideal platform to deliver sustainable solutions in its cement and concrete products. Mr. Mulroney said the company will launch two more products this year, after the successful introduction of the Agilia and Hydromedia cements. With its edge in niche products, Lafarge secured exclusive concrete and cement supply agreements for the  new  low-cost  carrier  terminal  (KLIA2).  However,  its  contract  with  Malaysia  Airports Authority will end as the new airport is scheduled to be ready for commissioning in June. He  was,  however,  confident  in  securing  new  exclusive  supply  agreements  -  we  suspect Lafarge is now targeting niche cement products supply for the tunneling portion of the MRT project. It also secured similar supply arrangements with Tanjung Bin and Janamanjung for their respective power plant expansions. Product differentiation not only enables Lafarge to gain  an  edge  over  its  peers;  those  products  also  command  higher  selling  prices.  Staying focused on product differentiation  would boost Lafarge's profit margin, as the company is very sensitive to movements in the domestic selling price -  every 1% increase translates to a 4.4% enhancement in net profit.

OSK's  assumption  is  reasonable.  In  the  meantime,  we  hold  on  to  our  view  that  the cement price hike, which was supposed to take effect from Aug 2012, may only translate into  a  mild  increase  of  RM5  per  tonne  in  FY13  to  RM295.  However,  we  raise  our assumptions  for  FY1  by  RM10  per  tonne,  pushing  the  price  up  to  RM305  a  tonne.  We continue to think the intensifying competition from a new kid on the block, Hume Cement - representing an additional 9% of clinker capacity in Peninsular Malaysia  - is likely to cap the  price  hike,  at  least  until  the  conclusion  of  the  upcoming  General  Election.  After  that, construction  projects  may  gain  momentum  and  drive  the  demand  for  and  use  of  cement, as  well  as  progressively  absorb  any  additional  supply  (in  line  with  Lafarge  management view) by the new player from 2HFY13 onwards.  Management guided that its key material costs such as limestone royalties and gypsum have escalated over the years and its rates  have  risen  faster  than  the  reported  CPI  in  the  country.  That  said,  we  are  factoring  those factors in, for a higher coal price assumption of USD100/USD110 a tonne for FY13/FY14 (refer to Figure 1).

Maintain NEUTRAL. We reckon the company's valuation is a bit rich compared to its fast-developing South East Asia (SEA) region rivals. However, Lafarge remains the best proxy to  growing  construction  and  property  development  in  Peninsular  Malaysia,  as  it  is  the largest  cement  producer  in  Malaysia  and  the  only  liquid  cement  stock  on  Bursa  Malaysia following the recent privatisation of YTL Cement. Furthermore, the group is more generous in  terms  of dividend  payouts compared  to its  regional  peers  and  its  prospective  yield  also appears to be slightly ahead of its local rival, Tasek Corporation (Tasek). Accounting for the scarcity premium, we apply a 20x FY13 EPS valuation to the stock, which is at a premium to its regional peers' FY13 PE of 18.5x, and derive its FV at RM9.44. Given that its current share  price  implies  a limited  potential of  an  upside  to our  new  FV,  coupled  with  uncertain competition  from  the  new  player,  we  are  keeping  to  our  NEUTRAL  recommendation.  We advise  investors  to  accumulate  only  when  the  visibility  of  the  supply-demand  dynamic  for the local cement industry improves, or when it is trading at a lower price.

Source: OSK