Buy | Target price: MYR10.10

Upgrade to BUY. LMC has turned debt free in 3Q12 and its already very high cash position (28sen/shr) will keep piling up with its cash generating power. We see the prospect of a capital repayment or significantly higher dividend yields than the current 4.0%/4.7% net. Additionally, earnings are also protected from the falling coal cost. We maintain our earnings forecasts but raise LMC to a BUY (from HOLD) with a higher MYR10.10 TP (+19%) on 21x 2013 PER (17x previously).

Turned debt free. LMC has paid its last bullet of MYR105m floating rate note in Sep 2012, making it zero-gearing and sitting on a historical high cash pile of MYR240m (or 28sen/shr). This is despite the fact that it re-geared to the 16% net gearing level (or raised MYR566m borrowing) in 2007 for a capital distribution of 20 sen/shr.

Optimistic on capital repayment. In our view, a capital repayment is highly likely given that: (i) LMC has the track record of undertaking capital repayment when it turned zero-net gearing (in 2007); (ii) French parent prefers its subsidiaries to upstream cash; (iii) LMC has low capex obligation (due to overcapacity and expansion by its peers) and strong cashflow generation ability (FCF yield of 5%); and (iv) debtfunded capital repayment will enhance ROE (10% currently).

>10% total yield? Assuming LMC gears up to 16% net gearing level again (or raise MYR500m borrowing), this indicates 58sen/shr capital distribution potential (or 6.2% yield). Including our expectation of 38 sen/shr dividend for 2012 (16sen has been paid as interim in 1H12), total net yield would be 10.2%. Nevertheless, we expect a decision on this would only be made at its upcoming board meeting in Nov 2012.

Premium valuation warranted. We maintain our below-consensus forecasts, which already incorporate for a stronger 2H12 amid the falling coal cost and higher ASP. Though valuation of LMC is rich at 2013 PER of 19.6x, we believe market will pay a higher premium for LMC given the prospects of a higher dividend payout and capital repayment. We now peg LMC at 21x 2013 PER (similar to its peak in 2010) and derive our new TP of MYR10.10 (+19%).

Other updates

Visible demand growth. LMC’s 1H12 cement sales volume grew by 9% YoY and we think the demand will sustain on progressions of the big-scale infrastructure projects (LRT extension, Sg Buloh-Kajang MRT, Tanjung Bin and Janamanjung power plants). We note that LMC’s cement plant utilization has increased to >80% presently, from around 70% in 2011. LMC is conservatively looking at a modest 5% p.a. domestic demand growth in 2012-13, compared to our 7% for 2012-13.

Minimal cost inflation. While the quantum of the net ASP hike may not be as much as its raised list price (+6% in Aug 2012), we think LMC’s earnings is at least protected by the falling coal cost (3Q12: -9% QoQ, -28% YoY), which should more than offset the potential hikes in electricity tariff in 2013. Note that coal cost accounts for c.40% of total production cost while electricity accounts for c.25%.

Diverting sales to the domestic market. Given that the margin of domestic sales is higher than the export market, LMC is also diverting more of its sales to the domestic market. This should enhance its margins in 2H12. Note that the domestic:export sales volume ratio was around 70:30 in 2011.

Manageable industry expansion. Key risk to our earnings would be the irrational price cutting by the cement-makers when the new capacity in the industry hits the market in early-2013. However, we believe cement-makers will exhibit pricing discipline as the new supply (+5% p.a. over 2013-2015, from Hume, CIMA and YTL Cement) will be absorbed by the new demand (+5% p.a.).

Source: Maybank Research - 5 Oct 2012