We are cautious on news of Lafarge Malayan Cement (Lafarge)’s potential capacity expansion as the total new capacity including Hume’s latest addition represents some 24% of Peninsular Malaysia’s clinker capability. We think that diverting its export volume back to the local market may be a better option. In view of its rich valuation and the possibility of the potential new capex limiting its capability to introduce any capital management, we maintain our NEUTRAL rating on Lafarge with fair value tagged at MYR9.44.

Expansion on the cards? Business Times quoted Lafarge President and CEO, Bradley Mulroney as saying that the company may probably expand, but he will not discuss this further pending finalisation by the board. He added that the company, as a market leader, has to ensure that it has sufficient capacity to maintain its position. Lafarge Malaysia currently has a 40% domestic market share.

Are we ready for additional new capacity? The cement industry remains our favourite – it is a monopoly market in East Malaysia and an oligopoly market in Peninsular Malaysia. However, Lafarge still faces irregular price and volume competition in the Peninsular Malaysian cement market. In October 2012, newcomer Hume Cement (Hume) commissioned 1.5m-tonne-per-year (tpy) capacity, triggering a price competition especially in the state of Perak. The other major rivals in the sector namely YTL Cement and Cement Industries of Malaysia (CIMA) are in the midst of capacity expansion of around 1.5m tpy each. The total new capacity, which includes Hume’s latest addition, represents some 24% of Peninsular Malaysia’s clinker capability.

Export diversion may be a better option. While we acknowledge that new investments are usually planned two to three years ahead, we are unsure if all the “mega projects” introduced by the government under the Economy Transformation Programme (ETP) may lift the country’s cement requirement by some 4.5m tpy per annum. Lafarge is exporting some 20% to 30% of its cement production overseas in order to ensure optimum utilisation at its clinker plants, but the export is barely breaking even at best. Therefore, diverting some export volume back to the local market may actually help cement its dominant market position and boost its bottomline, in our opinion.

Limited room for capital management. Any integrated cement plant requires at least 1.5m tpy in capacity to achieve its optimum efficiency. Thus, a new plant may easily cost Lafarge MYR700m in capex based on the replacement cost of USD150 a tonne. The company is now trading at a rich valuation of 21.1x FY13 EPS, which we think is supported by the scarcity premium and a decent dividend yield of 4.3%/4.7% for FY13/FY14. We also suspect investors are eyeing for its strong cash-generating capability coupled with its net cash position at MYR352m as at 31 December 2012. That said, additional investment will certainly limit its capability to introduce any capital management in the form of special dividends or capital repayment. Therefore, we are keeping our NEUTRAL recommendation on Lafarge, with a MYR9.44 fair value derived from a 20x FY13 PE.

Source: RHB