We attended Lafarge Malaysia Berhad (LAFMSIA)’s 2Q14 briefing at their newly opened Construction Development Lab (CDL) in Petaling Jaya which included a tour of the CDL facilities and a demonstration of their value-added concrete products. We came away reassured by the company’s efforts to maintain its market leadership position by offering unique value-added products and services. We also gathered that its 1.2m metric ton (MT)/year production capacity expansion is on track, although management shared that discussions are yet to take place for the Malaysian side of the LafargeHolcim mother companies’ merger. However, the significant capacity growth in the domestic cement industry could limit price expansion in the near term. Maintain MARKET PERFORM with TP of RM10.50 based on 20x FY15E EPS of 52.4 sen.

Transforming into a construction solutions provider. With the set up of the Construction Development Lab (CDL) in June 2014, LAFMSIA aims to position itself as a value-add construction solutions provider. Facilities at the CDL include a cement lab, concrete & aggregates lab, product showroom and open testing area. Among the projects in current development include affordable housing construction solutions for use in PRIMA housing development, and testing for Hydromedia concrete as a self-draining alternative for rural roads. Currently, roughly 40% of LAFMSIA’s ready-mixed concrete sales are value-added products, with the company targeting for sales to eventually become fully solutions-based. We are positive on this move as value-added products could offer up to 40% margin improvement over current levels. The Concrete & Aggregates segment makes up 20% of total revenue and <1% of total EBIT.

Organic growth on track, however, no news on LafargeHolcim merger locally. We gather that LAFMSIA’s 1.2m MT/year capacity expansion at its Kanthan and Rawang plants are progressing as planned, with the new capacity to come on stream by early 2015. Note that the new capacity will increase existing grinding capacity of 12.95m MT/year by 9.3% to 14.15m MT/year. Also, recall that in mid-April, LAFMSIA’s parent company, Lafarge S.A. announced a merger deal with Holcim Ltd. Lafarge S.A. owns 51% of LAFMSIA. Note that Malaysia’s Holcim Cement operates one plant in Pasir Gudang, Johor with 0.77m MT grinding capacity. Management has shared that todate, the two companies continue to operate as separate entities, with no discussions yet on the outcome of the merger of their mother companies. Nevertheless, the merger is expected to be finalized in 1H15. Should the merger materialize, the possible Holcim plant injection would increase the combined entity’s production capacity by another 8.5% to a total of 14.92m MT annually.

However, industry-wide capacity growth to limit price expansion. Major cement producers are embarking on capacity expansion which could expand total local production capacity by up to 14.1% by FY15. As the new expansions are expected to begin production at staggered timelines, the resulting supply growth could result in some degree of price volatility as the market adjusts. We gather that LAFMSIA intends to maintain its market leadership position, and is willing to adjust their prices accordingly. Hence, despite the recent list price increase to RM370/MT in 2Q14, we believe that the effective price would be slow to adjust accordingly as producers usually offer attractive rebates to maintain competitiveness. We believe the excess supply situation could lead to potential price volatility and dampen sales growth in the near-term.

Maintain MARKET PERFORM and TP of RM10.50. We maintain our MP rating due to the near-term supply uncertainty which could limit the potential upside arising from LAFMSIA’s organic expansion. However downside is supported by decent dividend yield of 4.5%. Our TP is based on 20x FY15E EPS of 52.4 sen which implies a +0.5SD on 3-year historical P/E. We believe our premium is justified due to LAFMSIA’s leading market share, decent 4.5% dividend yield, and strong balance sheet position with net cash position of RM494m or RM0.58 per share.

Source: Kenanga