CMS’ recent subscription to MYR110m convertible preference shares (CPS) in OMS suggests that the latter’s business environment may be more challenging than our initial projection. Therefore, we cut our FY16F-17F earnings by 14.8%/7.6% respectively and lower our SOP-based TP to MYR4.80 (from MYR5.86, 7% upside). We downgrade the stock to NEUTRAL (from Buy), but we believe its longer-term outlook remains intact.

Watchful on OMS. It has been a while since we first highlighted a potential risk of Cahya Mata Sarawak’s (CMS) investment in its 25%-owned OM Materials (Sarawak) SB (OMS). Ferrosilicon prices have plummeted in tandem with the broad weakness across the commodity complex, thus dampening its earnings outlook. CMS has recently subscribed MYR110m CPS issued by OMS. This unexpected cash call suggests that the outlook for OMS may be more challenging than we had expected. While a total of 16 furnaces at its ferrosilicon facilities have been completed, only six are currently in operations.

Other businesses remain vibrant. OMS aside, we remain upbeat on CMS’ overall outlook. Earnings from its road maintenance and materials and trading divisions have risen ahead of the impending Sarawak state election. We also believe that both divisions may eventually benefit from the MYR26bn Pan Borneo Highway project that would help to sustain the high earnings base recorded in FY15 moving forward. Meanwhile, we think that the commissioning of its new grinding plant in Mambong, Sarawak could help to improve profitability of its cement unit in FY16. Its Oct 2015 acquisition of a 50% stake in Sacofa SB, the sole telecommunication tower service provider in the state, would also see full-year earnings contribution from 2016 onwards.

Forecast and key risks. CMS’ response to Bursa Malaysia’s query on the reason for its subscription to OMS’ CPS was to help meet the latter’s cash flow demand. We suspect OMS may have suffered deeper losses than we had initially projected. We revise down our FY16F and FY17F earnings by 14.8% and 7.6% respectively but keep our FY18 estimates intact, after cutting our forecast on OMS. OMS remains the single largest risk within the group as the extent of its operating losses remains uncertain and we cannot discount the possibility of a wider loss than our newly-revised numbers.

Downgrade to NEUTRAL with a lower MYR4.80 TP. Nevertheless, we continue to like CMS as the best proxy to the rapid development activities in Sarawak. However, potential losses at OMS may dampen investor sentiment on the stock. That said, we believe its medium to longer-term outlook remains bright and CMS could make a comeback as soon as 2H16. Therefore, we downgrade to stock to only NEUTRAL (from Buy) with our SOP-based TP lowered to MYR4.80 (from MYR5.86). The downside risk to our call is higher-than-expected losses at OMS, while the upside risk is a sharp recovery in ferrosilicon prices, which could potentially cut losses at OMS.

Financial Exhibits

Financial & Recommendation

Cutting 2016-2017 earnings after factoring in higher loss estimates at OMS. We are not entirely surprised with the gloomy outlook for OMS as we had already factored in a net loss of MYR5.6m in 2016 and a small profit of MYR6.4m in 2017. However, CMS’ recent subscription to MYR110m CPS in OMS suggests that the latter’s current business environment may be more challenging than we had initially expected. Therefore, we widen our loss estimates for OMS to MYR48m/MYR19m for 2016/2017 respectively, and cut CMS’ earnings projections by 14.8%/7.6% respectively

Downgrade to NEUTRAL with a lower MYR4.80 TP. We believe higher-than-expected losses at OMS may dampen investor sentiment on the stock. Therefore, we re-evaluated our SOP-based valuation to make the following changes:

i. We previously valued OMS based on its long-term DCF. In order to be prudent given the current challenging business environment, we now ascribe zero value to this associate;

ii. As OMS’ likely worse-than-expected results may dampen investor sentiment towards the group’s overall valuation, we decided to remove the 10% premium ascribed earlier to its target P/E for the cement division, to be just in line with Lafarge Malaysia’s (LMC MK, SELL, TP: MYR7.60) multiple;

iii. We roll over our base year for DCF for its road maintenance and workers lodge segments to 2016 (from 2015), which accordingly trims the valuations for both divisions.

iv. We now value its investment in the 25%/20% stakes in K&N Kenanga (KNK MK, NR) and KKB Engineering (KKB MK, NR) respectively at 1x FY15 BV from 1.2x/1.5x FY15 BV previously. v. To be prudent, we deduct MYR110m used to subscribe to OMS’ CPS from CMS’ net cash position as at end-FY15.

All in, our SOP-based TP is lowered to MYR4.80 (from MYR5.86). We downgrade the stock to NEUTRAL (from Buy), although we believe the group’s longer-term outlook remains intact.

SWOT Analysis

Source: RHB Research - 14 Apr 2016