While the 18.8% rise in the power tariff from 1 Jan onwards dealt a blow to power-hungry manufacturers like LMC, the 19.4% drop in its share price in just over a month looks overdone. The market may have overlooked the recent cut in cement rebates, which could be sufficient to cover the higher costs, while a revision in its list price may also be just around the corner. We upgrade LMC to BUY, with a MYR9.61 FV.
Look Beyond Higher Electricity Tariffs
Power rates increase gives electric shock. From 1 Jan 2014, higher electricity tariffs took effect in Peninsula Malaysia. After the tariff increase, cement producers in Peninsula Malaysia, including LMC, still enjoy a discounted special industrial tariff (SIT) of 10% as electricity cost exceeds 5% of their total operating expenses. As the provision of SIT is contradictory to the Government’s energy-efficiency policy, it was decided that the discount would be phased out gradually and the SIT will be raised by 18.8%, which is 2% higher than the usual increase in industrial tariffs.
Jolt to LMC’s share price overblown? This piece of news is no doubt an unpleasant surprise to big power consumers like LMC. While cement production is less power-hungry, with about 100-130 kWhr of electricity used per tonne of cement, power makes up 17-20% of production cost given cement’s relatively lower value compared with steel. The new tariffs raised production cost by some MYR6.00/tonne. However, LMC share price has since plunged 19.4% - or 29.2% from its 12-month peak on 7 July 2013. The question facing investors now is whether the sell down in the past one month has been overdone.
Lower bulk rebate goes unnoticed. We had earlier argued that it may be difficult to further pass on the power rates hike to cement users, since we originally assumed that local cement prices will increase by MYR15/tonne this year. Upon making some quick checks with hardware shops in the Klang Valley, we sense that cement manufacturers may have acted faster than we had anticipated to slash the rebates offered to suppliers (ranging from MYR0.50 to MYR1.00 per 50kg bag) in order to mitigate the higher electricity and other costs. We also understand the price of mass quality ready-mix (grade M20 and M25) cement has been raised by MYR5 per cubic meter (cu m) recently. While we are unable to verify the ex-gate price of cement in Peninsula Malaysia, we believe it will at least lie within the MYR15/tonne increase we projected earlier. This also suggests that the recent realised cement price increase will be more than adequate to cover the higher electricity cost.
Cement list price may go up soon? Meanwhile, the cement list price remains unchanged at MYR17.75 a bag in the Klang Valley despite the cut in bulk rebate. The hardware shops we visited are already feeling the pinch, as lower rebates only mean added pressure on their razor-thin margins. We understand doorstep-delivered cement now costs up to MYR19 a bag, after incorporating transportation and handling fees. Although some cement distributors still enjoy old rebates from orders that were locked in earlier, most new orders from January would only qualify for the new, lower rebate. Meanwhile, most distributors have also heard rumours of the cement list price being increased soon, although the quantum and timing of this is not yet known. With CMS Cement SB announcing last Friday that it will increase its selling price in Sarawak by 5-9% from 17 Feb 2014 onwards, we think this may provide Peninsula Malaysia players with a valid reason to follow suit.
More cause for cheer as coal price declines. We find comfort in the persistent weakness in coal price, which remained below USD100 a tonne in 2013 and was last at USD82.80. Coal is a major component in cement production as a tonne of cement uses up to 150 to 170 kg of coal. Meanwhile, we are assuming a coal cost of USD85/95/95 per tonne for FY13/14/15 respectively. Our assumption for FY13 is slightly higher than the 2013 average of USD84 per tonne, while our FY14 and FY15 coal cost assumptions are higher than our in-house projection of USD85.60 and USD87.60 respectively. For illustration purposes, every 1% drop in coal price may lift LMC’s earnings by about 0.9%, but we prefer to keep our original estimates for now as we are unable to ascertain the actual increase in current cement prices.
Government infrastructure, affordable housing to the rescue. We are relieved that Budget 2014 did not propose the cancellation of any mega projects. Instead, the Government pledged to build more affordable homes. We are also heartened by the number of projects currently in progress vs those nearing completion, or were recently handed over. Barisan Nasional (BN)’s pledge to continue with the Economic Transformation Programme (ETP) as well as to upgrade the country’s’ infrastructure should boost market confidence. We hold the view that the construction of the Mass Rapid Transit (MRT) Line 2 is proceeding as planned, and developments such as these will spur demand for basic materials like cement and steel.
Cement demand to grow 5%. Cement sales in Malaysia grew by an average 5.9% annually in the last three years. RHB estimates that cement usage in Peninsula Malaysia grew 2/9.2/5.8% during FY10/11/12 respectively, while cement sales in Sabah were more volatile, dropping 6% in 2011 despite rising 9.4% in 2010 and 7.8% in 2012. By state, Sarawak recorded the strongest annual growth of over 9% from 2010 to 2012, thanks to the SCORE initiative and robust oil & gas activities. With the Government being committed to infrastructure spending and affordable housing projects, we expect local demand for cement to go up by 5% annually in the short to medium term, including in the peninsula.
Overall Market Dynamics Conducive
Cement industry stands out in the basic materials segment. Within the basic materials sector, we continue to prefer the cement industry as there is only one producer each in Sabah and Sarawak while the market in Peninsula Malaysia is dominated by an oligopoly. We would describe Malaysia’s cement market as “three markets in one country’’ as plants are operated by a mixture of local producers and multinational corporations. LMC leads the oligopoly in the Peninsula with an estimated one third market share.
Peninsula Malaysia cement capacity on the rise. All said, seven out of nine cement manufacturers operate in the peninsula, where cement import is limited as domestic capacity can mostly meet local needs. The excess capacity in Peninsula Malaysia has led to LMC exporting some clinker from its Langkawi plant to improve its overall efficiency. When Hume Cement, the youngest player, started trial operations in October 2012, cement prices came under pressure until 1H13. Meanwhile, with YTL Cement, Cement Industries of Malaysia (CIMA) and LMC separately planning to expand their capacity on a staggered basis over the next two years, the supply of the commodity will escalate moving forward.
New capacity nothing to worry for now? Applying 2012 production numbers as the base case, kiln utilisation in West Malaysia is estimated to drop from 87% to 80% following the entry of Hume Cement, and will fall further to 69% upon the commissioning of YTL Cement and CIMA’s new brownfield. However, the emergence of a price war is dependent on the growth of domestic demand and manufacturers adjusting their production according to demand. Meanwhile, the additional volume from Hume Cement’s late-2012 debut was swiftly absorbed by escalating local demand, judging from LMC’s sequential profit surge in 3Q13. We also find comfort
after confirming with our source that YTL Cement’s extra capacity would only be ready towards end-2014 – just in time to absorb rising cement demand. We also believe the existing capacity growth may be less disruptive to the market as the cement players will only be tapping on their own established distribution channels, unlike new player that may need to offer attractive prices to attract new distributors.
Share Price May Bounce Back
Room for upward earnings revision? All said, in view of current developments within Malaysia’s cement industry, we certainly see room to raise our earnings estimates. Lafarge only exports its excess tonnage to keep its plant at optimum utilisation as well as lower its average overhead cost. As such, it is the least sensitive to changes in export prices but this also makes it very sensitive to any movements in the domestic selling price. As local cement price has risen beyond our original estimates of MYR15 a tonne for 2014, every 1% increase in cement price may translate to 4.6% potential improvement in bottomline. Energy is the undoubtedly the single largest cost element capable of swinging LMC’s profitability, but we do not expect any further electricity tariff increase in the near future. That said, our coal price assumption is already way higher than our in-house projection.
4Q the seasonally strongest quarter. We also decided to take a look at LMC’s quarterly earnings trend and found, to our surprise, that 4Q is typically its strongest quarter. We suspect that this may due to: i) more renovation works being done prior to Christmas and Lunar New Year celebrations, and ii) contractors trying to finish up their existing jobs in hand prior to festive celebrations or the end of the year. Therefore, we suspect the company is likely to meet our full-year estimates despite our projections being slightly more bullish than our peers. This may also help to boost sentiment toward the counter.
Valuations more tantalising now. The sharp price correction following the announcement of an electricity tariff revision and its eventual implementation have pushed LMC’s valuation to more appealing level. In a comparison of the valuations of cement companies in the fast-developing South-East Asia (SEA) region, we find Lafarge a tad rich in P/E terms, especially compared with Indonesian players. We suspect the lower valuations of Indonesia’s cement counters is due to the slower growth in that country’s cement consumption, which only grew 5.5% in 2013 versus a few years of double-digit escalation. Apart from that, the heavy investments to expand their capacity have also limited their ability to pay dividends, as opposed to LMC. The company’s forward valuation is also more expensive than Siam Cement (SCC TB, Buy, FV: THB 550)’s, possibly due in part to political instability in Thailand. This said, Holcim Philippine (HLCM PM, NR) is trading at a premium to LMC.
Source: RHB
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Created by kiasutrader | Jun 14, 2016
Created by kiasutrader | May 05, 2016