INVESTMENT HIGHLIGHTS

• Visit to CMSB in Sarawak reassures our estimates for FYE17- FYE18

• Pan Borneo catalytic to construction materials’ segment

• Cement supply stable with a whiff of growth

• OM Materials recovery still too early to conclude

• Maintain BUY with TP of RM4.62 per share

Key takeaways from CMSB’s Sarawak visit;

Pan Borneo catalytic to construction materials’ segment. Pan Borneo project is expected to increase the demand for crushed stone aggregates such as microtonalites and limestones. For the past 8 years, construction materials’ segment has contributed 30% of CMSB’s revenue. We are expecting that the construction materials revenue will maintain its growth trajectory and meet our revenue estimates for FYE17/FYE18. (Figure 1: Revenue Mix) Our conviction is premised by Sibanyis quarry’s reserves of 63.0mt which accounts for 90.9% of CMSB’s quarry reserves coupled with the progress rate of Sarawak’s portion of Pan Borneo highway (881km) which we estimate to be within 3% to 4% range. CMSB is expected to start the second production line of Sibanyis quarry by the end of June 2018 to meet the demand especially for the central and northern region of Pan Borneo’s packages with production capacity of 1.3mt annually. Soft limestones and microtonalites found in Sarawak’s central and northern region are unsuitable for construction of roads furthermore the logistics such as jetty and barges are needed to transport the stone aggregates to the project sites. CMSB’s quarries are expected to meet the demand due to their stone aggregates supply and their logistics network. The jetty in Pending, Kuching provides extensive reach of products via barges to cities such as Mukah, Bintulu and Miri. (Figure 3: CMSB’s Quarry in Sibanyis)

Cement supply stable with a whiff of growth. We are positive on the development of CMSB’s cement division which contributes 39.3% of revenue for the past 8 years. (Figure 2 Total and Segmental Revenue Trends) For FY16, governments and private projects in Sarawak are picking up despite the lull of private projects in 2015.(Figure 4: Sarawak Projects Award) Additionally, CMS Cement is expected move from single product of Portland cement (OPC) to high performance concrete. The new product is expected to contribute up to 10% of revenue. CMS Cement could produce high performance cement from the supply of silica at lower cost through OM Materials as it is a by-product of smelting. (Figure 5: CMS Mambong Plant)

OM Materials recovery still too early. Although OM Materials have shown signs of improvement with the total of 16 furnaces to be fully commissioned by Q4FY17; it is still too early to spot an operational recovery and demand for manganese alloy is affected by cyclicality especially regional car and steel production rates. We note that the operational improvement could bear promising seeds of especially product mix of ferrosilicon and manganese alloy to manage demand-supply gap. But the impact to CMSB’s earnings is still minimal due to its 25% stake in the JV structure with OM Materials Ltd. Assuming, OM Materials (JV) registers a full year revenue of RM1.5bn supported by 15.5% net margin - the impact to CMSB’s earnings is just RM58.1m which is c.10.% of FY16’s construction materials segment’s revenue. We are comfortable to shift our pessimism should the trend of manganese alloy hits our technical estimate of USD2.50/kg and demand of ferrosilicon in Europe and Japan improves significantly.(Figure 6: OM Materials’ Plant and Furnaces)

Our View. That being said, the growth plot for CMSB’s cement division thickens as Baleh Dam in Kapit is expected to start its construction in June, 2018. The dam is a 188m high concrete rock fill dam which we estimate requires c.500m cubic metre of concrete or 1.2m tonnes of concrete minimally. We believe this would translate into total of RM400m of additional revenue to CMSB’s over 7 years or RM21.4m quarterly and RM57m annually. We are expecting that the two key divisions will support earnings from the periods of Q1FYE18 to Q3FYE20 due to billings recognition from Pan Borneo and Baleh Dam.

Valuation. We reaffirm our BUY recommendation with an SOP derived target price of RM4.62 per share. At writing, we have met our TP but we remain adamant as we surmised the construction sector will potentially take a breather as highlighted in our sector reports (21.03.2017 and 12.04.2017). Consequently, allowing KLCON Index constituents to normalize back to its valuation of 15x to 17.5x PER. Even though Baleh Dam is catalytic to CMSB’s earnings for FYE18-FYE20, we will not make adjustments to our valuation in order to comfort any ‘hard landings’ from earnings blips due to billings recognition of the Pan Borneo project. We opine that CMSB‘s entry should be guided by PER median of c.17.5x.

Source: MIDF Research - 5 May 2017