CMS’  share  price  declined  11.1%  on  rumours  of  the  Sarawak  CM stepping down.  While  this  could  happen  by  end-February,  he  could  be appointed  the  State’s new Governor.  Thus,  CMS’  selldown  may  have been  overdone  as  its  businesses  are  expected  to  go  on  as  usual.  The new CM is also likely to carry on with SCORE developments, which will benefit the group. Reiterate BUY and our SOP-based MYR9.15 FV.

Hit by resignation speculation. CMS’ share price declined 11.1% from its multiple-year high, after speculation that Sarawak Chief Minister (CM) Pehin Sri Abdul Taib Mahmud  will step down surfaced last Wednesday. The CM’s family owns a 42.72% stake in the conglomerate.

Business  as  usual.  Yesterday  (9  Feb),  Taib  Mahmud  stated  that  his retirement  will  likely  take  effect  by  end-February.  He  was  given  a mandate  by  his  political  party,  Parti  Pesaka  Bumiputera  Bersatu  (PBB), to nominate his successor while being recommended as the State’s new Governor. This demonstrates that he still has a firm grip on the Sarawak political  landscape.  That  said,  we  relooked  at  CMS’  businesses  and believe that its: i) cement division is likely to keep its strategic monopoly in the State, ii) materials unit is set to ride on its long expertise and win-win tie-up with a State agency, iii) property unit is backed by its vast low cost  landbank,  iv)  road  maintenance  remains  a  cash  cow  despite  non-renewal  risks  (its  concession  expires  in  2018),  and  v)  involvement  in Sarawak Corridor of Renewal Energy (SCORE) projects via 51%-owned Samalaju  Property  Development  SB  (SPD),  20%-owned  OM  Materials (Sarawak)  SB  (OMS)  and  40%-owned  Malaysian  Phosphate  Additives (Sarawak) SB (MPAS) – all CMS’ next growth engines.

Reiterate  BUY.  Based  on  the  aforementioned,  we  think  the  recent selldown of CMS’ stock may have been overdone. Its divisions will suffer little to no impact from the CM’s departure, even though Mahmud Taib’s family is a major shareholder. We also believe that the new CM will carry on  with  SCORE  developments,  which will continue to drive CMS’ units forward. We maintain BUY and our SOP-based MYR9.15 FV. That said, the  FV,  which  reflects  1.47x  FY14F  P/BV  and  12.2x  FY14F  P/E  after stripping  out  net  cash,  is  still  undemanding.  Note  too  that  our  SOP valuation does not yet include the value of OMS, MPAS and others.

Changes In Sarawak’s Political Landscape

The  political  connection.  CMS  has  long  been  marked  as  a  politically-linked company, as its major shareholders are directly linked to  current Sarawak CM, Taib Mahmud. Meanwhile, the last shareholding list in the company’s annual report shows that his family members own a 42.72% stake in the group.

Departure  of  Sarawak’s  long-serving  CM.  After  much  speculation  over  his retirement,  Taib  Mahmud  finally  revealed  at  the  Sarawak  Barisan  Nasional  (BN) leadership meeting  yesterday (9 Feb) that he was stepping down by the end of this month.  Meanwhile,  he  has  been  given  the  mandate  by  PBB  to  nominate  his successor,  of  which  an  announcement  is  expected  after  he  meets  with  the  current Governor. In appreciation of his contributions to the State, PBB representatives also confirmed that it would propose for Taib Mahmud  to take over as the new Governor of the State. The current Governor's term expires on 28 Feb.

CMS’  share  price  tumbles.  Since  we  initiated  coverage  on  the  stock  on  20  March 2013, CMS’ share price has gained 147.2% and hit a multiple-year high of MYR7.64 on  24  Jan  2014.  However,  the  share  price  dropped  11.1%  from  its  peak  after rumours  of  Taib  Mahmud  quitting  his  CM  position  surfaced  last  Wednesday.  We decided  to  take  a  look  at  the  group’s  fundamentals  in  the  following  section  to determine  if  the  recent  share  price  weakness  has  been  overdone  or  if  further downside is to be expected.

A  transformation  not  to  be  overlooked.  In  the  past,  the  market  tended  to  view CMS  negatively  as  a  politically-linked  company.  Admittedly,  we  shared  similar concerns  when  we  first  met  management  in  late  2012.  However,  as  we  researched and  analysed  this  mini-conglomerate’s businesses,  our  concerns  have  been  erased and we have come to understand the reforms implemented over the past eight years. Among  others,  the appointment of Dato’ Richard  Curtis  as group managing  director on 4 Sept 2006 has seen CMS transform into a truly professionally-managed group. Tuan Syed Hizam Alsagoff joined CMS in Jan 2005 and was subsequently promoted to group chief financial officer. Together with other dedicated long service managers, CMS  launched  a  rationalisation  exercise  to  focus  on  its  key  competencies  in Sarawak.  Among  its  major  milestones  were  the  disposal  of  its  stakes  in  RHB  Bank and  UBG  Group,  and  the  cessation  of  its  loss-making  IT  companies.  Meanwhile, Datuk  Syed  Ahmad  Alwee  Alsree,  the CM’s son-in-law,  is  the  only  family  member that has a position in the group’s executive board.

A “collective” SCORE. Business  and  politics  are  synonymous  in  Sarawak.  With political changes afoot, it is natural for investors to think the dynamics of business in the  state  could  well  change.  However,  with  PBB  mandating  Taib  Mahmud  to nominate his successor, on top of expectations that the party will recommend him as the next State Governor, in our opinion there may not be much change. The new CM is likely to carry on with the projects associated with SCORE in order to make full use of  Sarawak’s  abundant  energy  resources  in  the  central  region,  particularly hydropower – 20,000 megawatt( MW), coal (1.46bn tonnes), and natural gas (40.9trn cu  ft).  These  allow  Sarawak  to  price  its  energy  competitively  and  stimulate investments  in  the  power  generation  and  energy-intensive  industries,  consequently turning  them  into  vibrant  industries  within  the  corridor.  The  State’s accelerating 
economic growth and development are certainly vital to the new Sarawak CM, as well as CMS, whose business are centred within the Land of the Hornbill.

“Strategic” monopoly in the fast-growing cement industry. The cement business contributes  about  half  of  the  group’s  earnings.  CMS  Cement  SB,  a  wholly-owned subsidiary of CMS, has been Sarawak’s sole cement manufacturer since 1974. The group’s experience and local expertise enables it to distribute this relatively low-value but  bulky  material  at  competitive  prices  within  Sarawak  –  despite  the  State’s geographical  challenges  –  while  making  it  reliant  on  shallow  water  transportation. Management has not rested on its laurels, having invested in significantly upgrading its  state-wide  cement  distribution  capabilities  over  the  years.  In  addition,  CMS’ limestone  reserve  in  Mambong,  Sarawak,  is  said  to  be  the  only  reserve  within  the State that is strategically located near a port and catchment area for cement demand –  creating  another  barrier  to  entry  for  any  rival.  Therefore,  the  latest  change  in Sarawak’s political landscape should not pose a major risk to this key division.

Materials  division  has  win-win  tie-up  with  a  State  agency.  CMS  supplies  about half of Sarawak’s high-quality asphaltic concrete (premix) and bitumen emulsion. It is also  a  substantial  player  in  stone  aggregates,  commanding  about  a  23%  market share  in  Sarawak.  Some  may  argue  that  a  change  in  CM  may  see  its  business impacted,  as  the  Public  Works  Department  and  State  Government  agencies  have been one of its major customers in the past. However, we think otherwise, judging by the  group’s  extensive  quarries  together  with  its  facilities  strategically  located  across Sarawak.  The  Sarawak  Economic  Development  Corporation  (SEDC),  a  State agency,  also  co-owns  most  of  the  subsidiaries  within  the  materials  division  –  which gives  it  good  reason  to  channel  its  business  to  CMS,  as  part  of  the  profits  will eventually flow back to the State Government via SEDC.

Property  division  backed  by  vast  landbank.  CMS’ property development division owns significant landbank in and around Kuching, the capital of Sarawak. Of this, the two major assets are the remaining 3,711-acres – after stripping off recent land sold to Sentoria Group (SNT MK, NR) in Petra Jaya – which is currently being developed into  a  riverine  township  called  Bandar  Baru  Samariang  and  275-acres  in  Muara Tebas, currently  being  developed into Kuching’s new iconic central business district The  Isthmus.  Other than the two major projects, CMS’ property division also owns other land parcels that provide vast opportunities for future development. As most of the landbank was acquired way back at very low prices that are a far cry from present pricing,  we  are  confident  on  the  potential  value  accretion  that  this  division  will generate  over  the  medium  term  –  regardless  of  the  change  in  the  State’s  political landscape.

Road  maintenance  –  cash  cow  up  to  2018?  The  group  maintains  approximately 4,800km  of  State  and  680km  of  Federal  roads  via  two  separate  concession agreements  expiring  Dec  2017  and  Aug  2018  respectively.  This  unit  has  been generating  strong  cash  flow  over  the  years. We  believe  that  most  of  the  equipment used in road maintenance works was acquired many years ago and its value is in a nominal sum only in its books. Therefore, this allows CMS to offer competitive rates vs  any  newcomer  when  it  looks  to  negotiating  the  renewal  of  its  concession.  Apart from  that,  the  group  is  supported  by  its  extensive  experience  and  track  record. However,  note  that  –  since  our  initiation  in  March  2013  –  we  have  conservatively assumed that both concessions will not be renewed after they expire in our projection and DCF valuation for this segment.

SPD  –  track  record  speaks  for  itself.  SPD  is  a  joint  venture  (JV)  between  two  of Sarawak’s leading private companies, CMS (51%) and Naim Cendera  (NHB  MK, BUY,  FV:  MYR5.38)  (39%),  along  with  Sarawak  Government  agency  Bintulu Development Authority SB (10%). SPD’s first undertaking was the development of an international  class  temporary  workers  camp  at  the  Samalaju  Industry  Park  (SIP).  Occupancy at the camp rose to a peak of over 7,000 last year as construction works within  the  industrial  park  gained  momentum.  SPD  is  also  planning  to  fast-track  the development  of  a  new  Samalaju  Permanent  Township  on  2,000  acres,  whose  total GDV  may  be  substantial.  With  implementation  of  SCORE  likely  to  continue regardless  of  who  the  new  CM  of  Sarawak  will  be,  SPD  certainly  stands  to  benefit from this speedy development. 

Smelting  plant  on  track  to  be  next  growth  engine.  Apart  from  SPD,  CMS  has  a 20% stake in OMS, which is developing a 600,000 tonnes per year (tpy) manganese and  ferro  alloy  smelter  in  SIP.  Ferro  alloy  production  consumes  very  high  energy  – about 4,500 kilowatt hour (KWh) and 9,100KWh per tonne for manganese and ferro silicon  –  or  ~25%  and  ~48%  of  the  respective  total  direct  production  costs respectively.  The  competitive  power  tariff  secured  earlier  –  said  to  represent  a  40-50%  discount  to  the  power  costs  paid  by  heavy  industries  in  China  –  was  well protected  by  the  500MW  power  purchase  agreement  (PPA)  signed  with  Sarawak Energy. With the plant well on its way to being constructed and the first power intake expected  in  July  2014,  we  do  not  expect  any  change  in  the  project  despite  the changes  in  the  political  landscape  now  taking  place.  Our  back-of-envelope  DCF-derived  value  of  MYR2.1bn  is  enticing,  together  with  a  potential  IRR  of  16.7%  and payback period of five years. Although this reflects only about half of management’s base assumption (as stated in a memorandum to its bankers), our valuation puts the contribution from this project at MYR421m. Note that we have yet to incorporate this 
into our SOP valuation.

Another SCORE project in the pipeline. Last month, CMS formed a JV company to undertake a 40% stake in MPAS for the development of a 500,000 tonne per annum (tpa)  plant.  The  JV  is  expected  to  sign  a  150MW  PPA  in  1Q14.  As  the  plant  is expected  to be  operational  in phases starting from  1QCY16  –  it  is slated  to  be fully commissioned  by  2QCY18  –  we  have  not  incorporated  any  earnings  and  valuation for  the  project  at  this  juncture.  The  plant’s  estimated  capex  is  MYR1.04bn. Meanwhile, we do expect this project to carry on, as the State Government continues to  attract  power-hungry  industries  to  set  up  plants  in  Sarawak,  regardless  of  who  is appointed as the new CM.

Still Best Proxy To SCORE, Reiterate BUY

Maintain  BUY.  After  taking  a  closer  look  at  CMS’  businesses,  we  believe  you  will agree that hardly any of its operations are reliant on political connections – especially after  its  disposal  of  UBG  in  2010,  which  almost  entirely  removed  the  group  from  a construction  business  that  was  dependent  on  contract  awards.  Only  its  road maintenance  contracts  can  be  linked  to  its  political  ties,  but  this  operation  is  in  the form  of  two  separate  concession  agreements  signed  with  the  State  and  Federal Governments,  which  will  last  until  end-2017  and  August  2018  respectively.  Being conservative,  since  initiating  coverage  in  March  2013,  we  have  assumed  zero renewal of both concessions after their expiry in our projection and DCF valuation for this segment. Therefore, despite the change in Sarawak’s political landscape, CMS is still  an  excellent  proxy  to  the  robust  growth  riding  on  SCORE  developments.  We reiterate  our  BUY  recommendation  and  SOP-based  MYR9.15  FV.  The  latter,  which 
reflects 1.47x FY14F P/BV and 12.2x FY14F P/E  FY14F after stripping out net cash, is still undemanding. 

More upside from here? Although its share price has more than doubled since our initiation,  we  think  there  is still plenty of upside in CMS’  valuation.  Meanwhile,  we continue  to  value  its  core  business  division  (in  particular  its  cement  business)  at  a discount to its peers in West Malaysia – despite the fact that CMS monopolises the market in Sarawak vs to its peers in the peninsula that are competing in an oligopoly. The value we ascribed to its property division is also far cry from its actual RNAV and could  easily  double  our  valuation.  Apart  from  that,  we  prefer  not  to  include  the valuation  of  its  participation  in  OMS  and  MPAS,  which  could  add  a  value  of  MYR2 per share to CMS. The 2,000 acres of landbank earmarked for SPD to develop until 2030 could also fetch huge value, given the potential population  increase stemming from  the  progressive  development  in  the  industry  park.  All  said,  we  think  CMS remains  a  good  candidate  for  a  long-term  investment,  given  its  solid  business  plan ahead.

Financial Exhibits

The commissioning of its newly-upgraded clinker plant will drive earnings over the next two years. OMS, in which it owns a 20% stake, is set to be a key earnings contributor from as early as 2014

- Its strong cash-generating capacity provides room to reward shareholders via a 30% payout commitment

Financial Exhibits

The group’s solid balance sheet enables it to take on any attractive investment opportunities, particularly in SCORE

We project decent earnings growth over the short- to medium-term, which will continue to bolster its key financial ratios

SWOT Analysis

CMS’ rationalisation in the past few years has put it on the right footing to capitalise on the opportunities arising from SCORE

Company Profile

Cahya  Mata  Sarawak  (CMS),  a  conglomerate  with  most  of  its  operations  based  in  Sarawak,  has  its  main  business  in  cement manufacturing. The group is also involved in building materials, construction, road maintenance and property development. 

Recommendation Chart

Source: RHB