This article first appeared in The Edge Financial Daily on May 12, 2017 - May 18, 2017

Lafarge Malaysia Bhd
(May 11, RM6.51)
Maintain sell call with an unchanged target price (TP) of RM5.50: Two of the three public listed pure cement players (Hume Industries Bhd and Tasek Corp Bhd) in Malaysia published their latest quarterly results ended March 31, 2017. The reported net profits were down 98% and 84% year-on-year (y-o-y) for Hume Industries and Tasek Corp respectively. The published results infer that domestic cement operating environment remains challenging and this does not bode well for Lafarge Malaysia Bhd’s upcoming quarterly results.

According to our channel check, y-o-y industry sales volume declined further in first quarter of calendar year 2017 (1QCY17). Although we had expected cement demand to remain weak in first half of 2017, the further decline in cement sales volume was surprising, considering this had already fallen 6% in 2016.

The challenging operating environment is due to subdued demand which is caused by weak property demand and the slow roll-out of infrastructure projects. The weak cement demand coupled with overcapacity has led to a significant downward pressure on cement pricing.

Since 4QCY15, the benchmark Newcastle coal prices have risen about 65% to an average price of US$94 per tonne in 4QCY16. Given that Lafarge usually locks in 50% of its coal requirement in the  previous year (usually in December), we opine that the negative impact of higher coal prices will show up in the financial year 2017 (FY17).

Not helping either, the decline in industry demand was exacerbated by the significant increase in the coal price which accounts for about 30% to 40% of cash production costs (based on our estimates). We maintain our earnings forecasts. However, we do not discount the possibility of further negative earnings’ surprise in the upcoming quarterly results.

Although Lafarge is a proxy to ride on the construction upcycle, its short-term prospects appear to be plagued by industry overcapacity resulting in downward price pressures as well as softening demand associated with the timing gap on project roll-outs. The current infrastructure boom may not be sufficient to make up for the demand gap caused by weak property market.

We maintain “sell” with unchanged TP of RM5.50 as we opine that the near-term prospects for the cement industry remains challenging. Our TP is pegged at price-earnings ratio multiples of 20 times of FY18 earning per share estimate.

Risks include: i) stronger demand for cement consumption due to stronger property market and pickup of mega infrastructure projects; ii) reduced price competition; and iii) further decline in coal prices. — Hong Leong Investment Bank Research, May 11