Cement demand is likely to be dampened by potential delays in the Ninth Malaysia Plan (9MP) project implementation following the change in the political landscape, and notable projects deemed promising may be reviewed, said Aseambankers Research.
It said exports might offset the slack in domestic demand, as industry players fill up excess capacity, but the depreciating US dollar would mitigate value gains, pressuring operating margins as coal prices continue to rise.
“While we still hope for a ceiling price hike in 2H08, we are now Neutral on the cement sector. We have also downgraded Lafarge Malayan Cement Bhd to a Hold (previously Buy) with a revised target price of RM4.80 based on 13 times FY09 EPS,” it said.
Aseambankers Research said the results of the general election had thrown some degree of uncertainty in terms of implementation of the 9MP projects, and that some of the mega projects particularly in opposition-controlled states could be delayed or reviewed.
“This has led to our reassessment of domestic cement demand. Cement growth stemming from 9MP projects would likely be stymied, but demand will still be seen from the private sector for local property developments. In particular, significant developments are taking shape in the Iskandar Development Region, Johor, including Lido Boulevard, Horizon Hills and East Ledang.
“We had earlier projected domestic cement growth of 5% this year, but have now lowered our expectations to a modest 3% growth. We maintain our 2009 local cement demand growth forecast of 6%,” it said.
The research house also said said that with the opportunity to expand capacity utilisation via the growing export markets, particularly to the Middle East, India, Pakistan, Africa and China, industry players to some extent were able to reap economies of scale in operations.
“Although the depreciating US dollar may shield industry players from the full extent of increasing coal prices which have risen by over 100% since 12 months ago, this may also lead to margin contraction, as value gains would be insufficient to cover the higher material costs,” it said.
The research house said that with the continuing increases in freight, coal and other raw material costs, there would be pressure from the Cement and Concrete Association (CNCA) for an upward price revision.
“While the outcome would be based on the extent of negotiations with the government, we are still hopeful for a 10% price hike in 2H08.”
“Without this, we foresee earnings contraction in the industry with little support over the near term to significantly boost local demand apart from the property sector. We also believe the implementation of the automatic pricing mechanism (APM) would very likely be deferred,” it said.
Meanwhile, the research house, in downgrading Lafarge Malayan Cement Bhd to hold with a target price of RM4.90, said the investment dynamics had changed since it initiated coverage on the stock, adding that with the uncertainties over 9MP implementation, its 2008 local cement demand growth forecast for the industry and Lafarge is trimmed to 3% from 5%.
“We expect 2% net profit growth in FY08 and a higher 8% growth in FY09. We do not anticipate the APM to take shape soon, but have assumed a 10% ceiling price hike in 2H08.”
“Without the price hike, operating margins could drop by an estimated 2 percentage points, and earnings per share (EPS) could contract by 15% in FY08 and 11% in FY09, assuming a potential further 15% rise in coal costs over FY08-09 and a weakening of the US dollar to a low of RM3 per dollar,” it said.
Aseambankers Research said its revised target multiple for Lafarge was also consistent with its valuation downgrades for the construction sector to 10 times to 12 time price earnings ratio, from 13 times to 16.5 times.
It added that Lafarge’s strength lies in its strong parentage and that export sales could still help improve Lafarge’s capacity utilisation despite uninspiring local demand growth.
“Exports account for about 30% of Lafarge’s current output, where we believe capacity utilisation is hovering at over 90%. Given parent Lafarge SA’s initiatives to penetrate emerging markets in China, the Middle East and South Asia to offset the cement demand slowdown from the US, we believe Lafarge (the Malaysian subsidiary) may also have its share of increased exports,” it said.