Lafarge Malaysia Berhad - Largest Domestic Cement Player

We are initiating coverage on Lafarge Malaysia (Lafarge) with a MARKET PERFORM recommendation and Target Price of RM9.50 based on a targeted PER of 20x on FY14E EPS of 47.4 sen. Lafarge, the largest publicly-listed domestic cement manufacturer, currently trades at 20x Fwd PER, at a small premium to its closest peer, Tasek Corporation (18.9x) though we believe the mild premium is justified given its market leader status, better dividend yield, and decent growth potential. However, in the near-term, we expect lower margins due to recent cost hikes and possibly limited pricing flexibility. Overall, we estimate FY14E net profit to be unexceptional at RM403m (+4% YoY) with better prospects in FY15E at RM451m (+12% YoY) as additional capacity comes into play.
Leading market position. Lafarge is the largest domestic cement producer with a market share of approximately 41.6% in West Malaysia based on production capacity. Moving forward, we expect the Company to maintain its market lead by leveraging on its strong brand name and wide product mix including specialty cements, and undertaking gradual expansion to maintain its capacity advantage.
Strong balance sheet. With only RM0.8m debt and net cash position of RM451m as of FY13 (RM0.53 per share) we believe that Lafarge has sufficient excess cash available to support its dividend distribution and future expansions. We expect RM0.47 NDPS in FY14E which translates into a decent net dividend yield of 5.0%.
Linked to construction sector. In line with our bullish view on the construction sector, we expect demand for cement to improve due to significant pipeline flows from incoming ETP and 10MP projects. Mid-term prospects are also good as we think it is possible that the total amount of contract to be awarded may hit RM244b, while the confirmed property projects GDV are already reaching RM181b. As we expect at least 30% of the construction cost to comprise building materials, this should bode well for cement demand in the near term.
Growth from expansion and exports. Longer term, we believe Lafarge is likely to sustain decent sales growth as the Company has plans to increase production capacity by 1.20m mt in FY15, which amounts to an additional 9.3% on its existing 12.95m mt capacity. The Company also exports 20%-30% of its products. In the longer term, we believe that Lafarge should be able to gain new markets in Myanmar and other countries which are coming up in the Asian region.
However, pricing power may be limited. An attribute of the cement industry is the low level of brand differentiation for ordinary cement. With minimal switching costs for buyers between different brands of cement, cement producers have less discretion in terms of pricing. This is compounded by production capacity growth in the domestic cement industry in recent years which may lead to volatile prices in the near-term due to the increase in supply.
Short term margins may be squeezed due to increasing costs in FY14. We expect an increase in coal prices from USD92/mt in FY13 to USD95/mt in FY14E, putting pressure on margins while our forecasts also indicate a weakening ringgit ahead which further pressurise margin. Other cost pressures include increased electricity tariffs, diesel fuel price, transportation costs and staff costs. Combined, these factors contribute to our expected increase in overall operating costs ratio from +3.8% in FY13 to +8.2% in FY14E and +9.0% in FY15E, moderating to +6.7% in FY15E as cost structure stabilises.