We attended LAFMSIA’s 1H16 briefing and came away feeling unexcited as we opine that: (i) the positive capacity expansion contribution from its Rawang and Kanthan plants will be negated by intense price competition and capacity expansion of other cement players, and (ii) the cement oversupply situation is likely to persist due to a weak property market. Post-briefing, we slashed our FY16- FY17E earnings by 59-24% and reiterate our UNDERPERFORM call with lower TP of RM6.06 (previously RM8.00), based on unchanged FY17E PER of 21.8x.

1H16 results recap. Management recapped that 1H16 CNP was down 69.4% mainly due to: (i) lower cement revenue (-5.3%) underpinned by weaker demand for cement on the back of slowdown in property market and delay in commencement of mega projects i.e. KL118, TRX, (ii) Holcim synergization cost of c.RM10m, and (iii) higher effective tax rate (+13.8ppt) from less capital allowances. Management expects effective tax rates to be normalized in FY17 from capital allowances from its newly commenced Rawang and Kanthan plants expansions.

New capacity at Rawang and Kanthan. With the new capacity expansion in Rawang and Kanthan plant commencing in March and April 2016, respectively, management revealed that this would provide savings on overall transportation costs as clinkers are no longer required to be delivered from Langkawi (Kedah) to their grinding units in Pasir Gudang (Johor) which can now be delivered from Kanthan instead – which is approximately half the travel distance. Nonetheless, we believe these savings are minimal as it is just only a small portion of the total transportation cost, i.e. there are other transportation costs such as for: (i) delivery of raw materials to cement kiln for clinker production, (ii) delivery of clinker to grinding units, and (iii) delivery of cement to end consumers. Moreover, transportation-related costs are also only a small portion of total cost vis-à-vis other major costs element such as coal and power.

LAFMSIA’s strategy moving ahead. Besides looking out for further cost saving avenues, LAFMSIA is also looking for differentiation in this competitive market through strategies such as: (i) better products, i.e. higher investment in dry-mix cement, and (ii) strengthening of their brand name through more aggressive marketing. Meanwhile, management cited demand in FY16 to contract by 3-5% largely due to the slowdown in property market, delay in major jobs coupled with the large cement capacity from industry players (YTL, HUMEIND) with an additional capacity of 13% expected to come into the market in FY16.

Challenging outlook. We concur with management that FY16 is particularly weak and expect FY17 cement demand to pick up, underpinned by the huge magnitude of jobs dished out this year entering into more advanced stages. Nonetheless, we still remain unexcited on the cement sector due to excess capacity issues coupled with a slow property market, which typically makes up 2/3 of cement demand. Hence, we foresee pricing pressure to persist causing margin compression among players. In addition, we also note that the rising coal price would mean higher costs of production in FY17.

FY16-17 earnings cut by 59-24%. We downgrade FY16-17E earnings by 59-24% on the back of: (i) higher coal cost assumption (FY16: +6%; FY17: +19%) due to rising coal costs coupled with our conservative assumption previously, (ii) lower concrete and cement sales from lower plant utilisation (to 53% from 55%), (iii) higher Holcim integration costs for FY16, and (iv) higher interest expense and losses from associates in FY16 only.

Maintain UNDERPERFORM with a lower TP of RM6.06. Post-earnings adjustment; we tweaked our TP lower to RM6.06 (from RM8.00), based on an unchanged FY17E PER of 21.8x, which is the 5-year historical -0.5SD level. We believe key re-rating catalyst would be a significant recovery in the subdued property market.

Source: Kenanga Research - 5 Sep 2016