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? Comparing the two biggest players in Malaysia’s cement industry. In this report, we make a comparison between the two largest cement players in Malaysia, i.e. Lafarge and YTL Cement. Year-to-date (YTD), Lafarge’s share price has outperformed the FBM KLCI, while YTL Cement’s share price has underperformed. Based on our estimate, Lafarge is currently trading at 17.1x of our revised FY12/11 EPS forecast of 46.4sen, while YTL Cement is trading at just 11x of our CY11 fully-diluted EPS forecast of 43.0sen. We think a 6x multiple discount is excessive and we outline two reasons on why the discount should narrow over time.
? In short. We do not doubt that Lafarge is poised to benefit more than YTL Cement from the anticipated pick-up in domestic cement consumption, given its leadership position in the domestic cement market and strategic location of its plants. But YTL Cement is actually not that far behind Lafarge in terms of domestic market share, or far off than Lafarge in terms of location of its plants. As such, we see no reason why YTL Cement should trade at such a wide discount to Lafarge.
? Earnings forecast adjusted for Lafarge. We have cut Lafarge’s FY12/10-11 earnings forecasts by 5.8-16.2% and raised Lafarge’s FY12/12 earnings forecasts by 5.4% after adjusting for ratio of domestic vs. export sales, domestic net selling price and effective tax rates.
? Earnings forecast tweaked for YTL Cement. We increased YTL Cement FY06/11-13 earnings by 1.9-7.4% after adjusting for higher domestic net selling price. Our FY12/11-13 domestic sales volume growth assumption for YTLCement remains unchanged at about 1.0% p.a..
? The risks include: (1) Delays in the roll-out of projects, resulting in lower cement consumption; (2) Steep rise in energy prices; and (3) Potential price war in the industry when new capacity (i.e CIMA expansion and Hume Cement’s new plant in Perak) come onstream near the end of 2012.
? Investment case. Given better investors’ risk appetite for cement stocks in the near term, we thus raised our 1-year target forward PER for the cement stocks under our coverage from 11-14x to 13-16x. Following the raise in 1-year target forward PER, our indicative fair values for the cement stocks are raised by 7.8-19.2%. Nevertheless, our recommendations for the respective companies are maintained. Hence, our Neutral call on the cement sub-sector is maintained as well.
? Comparing the two biggest players in Malaysia’s cement industry. In this report, we make a comparison between the two largest cement players in Malaysia, i.e. Lafarge and YTL Cement. Other major players in the Malaysia’s cement market include Tasek Corporation and delisted Cement Industries of Malaysia (CIMA). The cement industry in Malaysia is essentially an oligopoly with four players as imports of cement are relatively minimal due to high prices after factoring in freight costs.
Comparative Analysis
? Lafarge clearly outperformed YTL Cement in share price performance. Year-to-date (YTD) share price performances for both companies are a stark contrast (see Chart 1). On one side, Lafarge’s share price has generally outperformed the FBM KLCI index, recording an absolute return of 26.6% YTD as compared to FBM KLCI YTD return of 17.8%. On the other side, YTL Cement’s YTD absolute return is just 9.8%, clearly underperforming the FBM KLCI despite the surge in its share price in recent months.
The expected pick-up in domestic cement consumption from 2011 onwards (due to the implementation of large-scale infrastructure projects as well as more robust property development activities) will definitely benefit the cement industry as a whole. While the strong share price performance of Lafarge clearly reflects this, we think the underperformance of YTL Cement’s share price is unjustified.
? YTL Cement trading at a wide discount to Lafarge. Based on our estimate, Lafarge is currently trading at 17.1x of our revised FY12/11 EPS forecast of 46.4sen, while YTL Cement is trading at just 11x of our CY11 fully-diluted EPS forecast of 43.0sen. While we do agree that Lafarge should trade at a premium to YTL Cement, we think a 6x multiple discount is excessive. We outline two reasons on why the discount should narrow over time.
? First Reason: Lafarge is the market leader, but not by a wide margin as generally perceived. Based on clinker production capacity (see Chart 2), Lafarge clearly leads with a total of 7.9m tonne per year, almost double that of the second largest player, YTL Cement of 4.2m tonne per year. Clinker is a major raw material in cement production, thus making it a rough gauge of industry market share. However, as some of the cement produced by the industry is exported and not solely for domestic consumption, the actual market share of the respective players in the domestic cement market are slightly different. Based on what we gathered from both companies, we estimate that Lafarge’s actual share of domestic cement market is 40%, while YTL Cement’s market share is close to 30%. The reason for this is because Lafarge exports roughly 30% of its cement production, while YTL Cement exports less than 5% of its cement production. Clearly, although Lafarge is still the leader in terms of domestic cement market share, the gap with YTL Cement as the second biggest player is definitely not as huge as generally perceived.
? Second Reason: Lafarge has geographical advantage, but YTL Cement is not very far off either. Geographical location is an important factor for cement players as transportation cost accounts for roughly 10% of total operating costs. Ideally, a clinker production plant should be in close proximity to its source of raw material i.e limestone, while a cement grinding plant should be in close proximity to major construction sites. We notice that Lafarge’s integrated plant in Rawang has the most strategic location as the location has abundant raw material and is also nearest to the Klang Valley region (see Chart 4). This is an advantage over the other cement players because 50-55% of Malaysia cement consumption is concentrated in the Klang Valley region. As for Lafarge’s plant in Kanthan, Perak, the advantage is mainly due to the accessibility to raw material, while its integrated plant in Langkawi is strategic for export purposes.
While YTL Cement might not have a strategically located plant closer to the Klang Valley region (see Chart 5), its Pahang integrated plant is the only plant in the East Coast of Peninsular Malaysia, and thus enjoys a monopoly in the Eastern region. For its plant in Perak, the advantage is the same with Lafarge’s Kanthan plant i.e. accessibility to raw material. YTL Cement also has two slag and cement grinding plants, one situated in Westport, Klang and the other in Pasir Gudang, Johor.
We believe YTL Cement position will not be very far off despite not having a plant closer to the Klang Valley region, unlike Lafarge. While Lafarge’s plant in Rawang is set to benefit from the rollout of large-scale infrastructure projects and robust property development activities in the Klang Valley region (see Table 2), we highlight that the plant’s annual clinker and cement grinding capacity of just 1.7m tonne and 2.6m tonne respectively is not sufficient to meet the annual cement requirement in the Klang Valley. Thus, the annual cement requirement in Klang Valley are likely to be met with production coming from cement plants in other states, such as CIMA’s plant in Negeri Sembilan as well as both Lafarge and YTL Cement plants in Perak.
In addition, we believe that YTL Cement’s integrated plants in Pahang and Perak are also set to benefit from the projects and developments under the Eastern Coast Economic Region and Northern Corridor Economic Region respectively (see Table 2).
Conclusion
? No doubt Lafarge poised to benefit more than YTL Cement. We do not doubt that Lafarge is poised to benefit more than YTL Cement from the anticipated pick-up in domestic cement consumption, given its leadership position in the domestic cement market and strategic location of its plants. Other than that, we also think Lafarge will most likely sell more of its cement production locally, thus reducing its exports (which are of thinner margin), hence resulting in an overall improvement in its operating margins. In fact we are forecasting a higher-than-industry growth rate for Lafarge in terms of domestic cement sales, mainly because of our belief that rival YTL Cement has no much room to increase its domestic cement sales by reducing its exports.
? …but valuation is stretched. With the recent run-up in its share prices, Lafarge’s valuation has become very rich at a PER of 17.1x to our revised FY12/11 earnings. Although its domestic sales and operating margins, and hence bottomline are expected to improve, we highlight that this is likely to be dragged down by higher effective tax rates going forward (which we think has been largely ignored by the street). In the past, Lafarge’s effective tax rates were lower mainly due to the utilisation of reinvestment allowance. We note that Lafarge will most likely finish utilising all of its reinvestment allowance (RM148.4m as at FY2009) in FY2010.
? Hence, we prefer the cheaper YTL Cement. As what we have argued above, YTL Cement is actually not that far behind Lafarge in terms of domestic market share, or far off than Lafarge in terms of location of its plants. As such, we see no reason why YTL Cement should trade at such a wide discount to Lafarge. Although domestic sales volume growth for YTL Cement is expected to be lower than the industry, we highlight that it will still benefit from higher domestic net selling price. At current PER valuation of just 11x our estimated CY11 fully diluted EPS of 43.0 sen, we believe that YTL Cement is a cheaper entry and proxy to the cement sub-sector.
? An imminent re-rating for YTL Cement. We believe a re-rating for YTL Cement is imminent given the increased investors’ appetite for cement stocks currently. We think that the street currently either views Lafarge as expensive or fully-valued, judging by its share price that has surpassed even the most aggressive analyst target price. Hence, we think investors’ interest would gradually shift to YTL Cement as the second biggest cement producer in Malaysia. This could also happen when more analysts cover the stock. Based on Bloomberg data, there are 11 analysts who actively cover Lafarge, vs. only two analysts for YTL Cement.
Risks
? The risks include: (1) Delays in the roll-out of projects, resulting in lower domestic cement consumption; (2) Steep rise in energy prices; and (3) Potential price war in the industry when new capacity (i.e CIMA expansion and Hume Cement’s new plant in Perak) comes onstream near the end of 2012.
Forecast
? Earnings forecast adjusted for Lafarge. We have cut Lafarge’s FY12/10-11 earnings forecasts by 5.8-16.2% and raised Lafarge’s FY12/12 earnings forecasts by 5.4% after adjusting for: 1) Higher ratio of domestic vs export sales; 2) Higher domestic net selling price (due to less rebates given); and 3) Higher effective tax rate (from 10-12% previously to 18-25%). We highlight that the cuts in our earnings forecasts, despite our expectation of strong growth in domestic cement consumption, are mainly due to higher effective tax rates.
? Earnings forecast tweaked for YTL Cement. We increased YTL Cement FY06/11-13 earnings by 1.9-7.4% after adjusting for higher domestic net selling price. Our FY12/11-13 domestic sales volume growth assumption for YTL Cement remains unchanged at about 1.0% p.a.
Valuations and Recommendations
? 1-year target forward PER raised. Given better investors’ risk appetite for cement stocks in the near term on the back of the implementation of several large-scale infrastructure projects as well as pick-up in property development activities, we have thus raised our 1-year target forward PER for the cement stocks under over coverage from 11-14x to 13-16x, which is roughly in line with our 1-year target forward PER for the construction sector.
? Indicative fair values raised. Following the upgrade in the 1-year target forward PER, our indicative fair values for the cement stocks are raised by 7.8-19.2% (see Table 2). Nevertheless, our recommendations for the respective companies are maintained.
? Neutral call on the cement sub-sector remains unchanged. No change to our recommendation on the cement sub-sector. Maintain Neutral.
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