A tough year Weak domestic demand and oversupply of cement has put pressure on average selling prices (ASPs). Coupled with disappointing 2H16 results, the year looks gloomy for Lafarge. Profit margin is squeezed by higher depreciation expenses and integration costs that will likely persist for the next two years with continuing losses from associates. Downgrade to SELL from Hold with a lower DDM-based TP of RM7. given the earnings risks. Cash balance of RM166m should support a DPS of 21 sen for 217E, giving a net yield of 2.6%. Prolonged weak domestic demand Year-to-date (YTD) domestic production of cement has shrunk by 8.6% yoy to 1.3m MT in 2Q16 and this would likely persist throughout 216. The demand will be underpinned by ongoing infrastructure projects (contributing about 1/3 of revenue). However, construction work done has declined by 11.7% yoy to RM3.4bn in 1H16 and housing starts have declined by 1.3% YoY to 9,696 units in 1H16. This does not bode well for Lafarge s revenue (2/3 property: 1/3 infrastructure). We forecast construction sector growth to soften to 4.4% yoy in 2H16E from 8.4% yoy in 1H16 but rebound to 8.% yoy in 217E. This report marks a transfer of analyst coverage. Double-edged sword Oversupply of cement due to the additional 5.2m MT capacity in 1H16 has put pressure on ASPs. This resulted in stiff price competition among the players to gain market share. Coal price has surged by 122% year-to-date to US$112/T because China is cutting the over-capacity in local production. The negative impact will be felt more in 217 as Lafarge hedges up to 8-9% of its annual coal requirement at a fixed price a year in advance. Only the remaining 1-2% will be exposed to current high prices. Earnings cut We have cut our earnings by 66% to RM17.8m in 216E after imputing (1) weaker domestic demand; (2) lower ASP; (3) higher integration costs; (4) higher depreciation expenses; (5) higher interest expenses; and (6) associate losses will likely continue. Downgrade to SELL with a lower TP of RM7. (DDM-based) Our DDM-derived 12-month TP of RM7. is based on assumed average dividend payout ratio of 14%. Our TP implies a 217E PER of 34x, which we believe is reasonable as it is above the 12-month forward mean PER of 21x but less than 1 standard deviation above mean PER of 39x. Earnings & Valuation Summary FYE 31 Dec (RMm) 214 215 216E 217E 218E Revenue 2,743.1 2,75.8 2,84. 2,979.2 3,19.1 EBITDA 494. 59.4 353.7 433.6 583.6 Pretax profit 345.2 345.2 148. 228.1 38.7 Net profit 256. 251. 17.8 175.4 3.5 EPS (sen) 3.1 29.5 12.7 2.6 35.4 PER 26.9 27.4 63.8 39.24 22.9 Core net profit 254.4 267.6 17.8 175.4 3.5 Core EPS (sen) 29.9 31.5 12.7 2.6 35.4 Core EPS growth (%) (31.9) 5.2 (59.7) 62.7 71.3 Core PER 27.1 25.7 63.8 39.2 22.9 Net DPS (sen) 43. 32. 13.2 21.1 36.9 Dividend Yield (%) 5.3 3.9 1.6 2.6 4.6 EV/EBITDA 13. 13.6 19.8 15.9 11.8 Chg in EPS (%) (66.3) (46.) (1.2) Affin/Consensus (x).6.7 1.1 Source: Company, Bloomberg, Affin Hwang forecasts Company Update Lafarge Malaysia LMC MK Sector: Building Materials RM 7.8 @ 9 November 216 SELL (downgrade) Downside 1% Price Target: RM 7. Previous Target: RM 8.6 (RM) 1.5 1. 9.5 9. 8.5 8. 7.5 7. 6.5 6. Nov-13 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Price Performance 1M 3M 12M Absolute -3.% -3.6% -14.2% Rel to KLCI -2.1% -2.3% -12.3% Stock Data Issued shares (m) 849.7 Mkt cap (RMm)/(US$m) 6627.6/1569 Avg daily vol - 6mth (m).3 52-wk range (RM) 7.35-9.51 Est free float 22.2% BV per share (RM) 3.58 P/BV (x) 2.18 Net cash/(debt) (RMm) (2Q16) (188.2) ROE (216F) 3.5% Derivatives Nil Shariah Compliant Yes Key Shareholders Lafarge Cement UK 51.% EPF 1.% SASB 8.2% Source: Affin, Bloomberg Loong Chee Wei, CFA (63) 2146 7548 cheewei.loong@affinhwang.com Cassandra Ooi (63) 2146 7481 cassandra.ooi@affinhwang.com Page 1 of 11
2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 1 November 216 A tough year Prolonged weak domestic demand YTD domestic production of cement has shrunk by an average of 8.6% yoy to 1.3m MT in 2Q16 and this would likely persist throughout 216. The domestic demand will still be underpinned by on-going infrastructure projects (contributing about 1/3 of revenue) but construction work done in 2Q16 has declined by 11.7% YoY to RM3.4bn because major infrastructure projects are at the tail end. We forecast the construction sector growth to soften to 4.4% yoy in 2H16E from 8.4% yoy in 1H16 but rebound to 8.% yoy in 217E. Fig 2: Domestic cement production (m MT) Cement (LHS) YoY (RHS) (YoY) 2. 1.8 1.6 1.4 1.2 1..8.6.4.2-2 15 1 5-5 -1-15 -2-25 -3 Source: CEIC, Malaysian Department of Statistics, Affin Hwang estimates Fig 3: Construction work done and GDP growth (%YoY) Construction GDP 4 Construction Work Done: Total value 3 2 1-1 -2 Source: CIDB, Ministry of Finance, Affin Hwang estimates Page 2 of 11
Fig 4: GDP forecast 1H16 2H16E 216F 217F GDP by Expenditure Components Total Consumption 5.7 4.1 5.5 4.8 Private consumption expenditure 5.8 5.2 3. 5.4 Public consumption expenditure 5.2.4 3.4 2.5 Total Investment 3.2 1.4 4.5 4. Private investment expenditure 4. 1.8 1.5 5. Public investment expenditure 1.1.9 4.5 2. Domestic Demand 5. 3.4 -.8 4.6 Net exports -9.8 17.9 1.1 2.8 Exports.2 3.6 1.3 2. Imports 1.6 1.8-53.4 1.9 Changes in inventories -314.1 19.3 4.2. GDP (21 real prices) 4.1 4.3 4.4 GDP By Kind of Economic Activity -2.8 Agriculture, Forestry and Fishing -6. 4.6 1.6 2. Mining and Quarrying 1.4 2.6 4.3 1.5 Manufacturing 4.3 4.7 8.3 4.5 Construction 8.4 4.4 5.2 8. Services 5.4 4.6 13.8 5.1 Import duties 14.6-1. 4.2-1. GDP (21 real prices) 4.1 4.3 4.2 4.4 Source: Bank Negara Malaysia, Affin Hwang estimates Housing starts have declined by 1.3% YoY to 9,696 units in 1H16. This does not bode well for Lafarge s revenue as 2/3 is made up of property. Fig 5: New housing starts and yoy growth Unit (LHS) YoY growth (RHS) (%) 12, 1, 8, 6, 4, 2, - 5 4 3 2 1 - (1) (2) Source: NAPIC, CEIC Page 3 of 11
Double-edged sword Stiff price competition due to oversupply Oversupply of cement due to the additional 5.2m MT capacity in 1H16 has put pressure on ASPs. This resulted in stiff price competition among the players to gain market share. The additional clinker/cement production has flooded the cement market by increasing the total cement production capacity by 15% to 32m MT per annum. Lafarge added new capacity of 1.3m MT in Kanthan and.2m MT in Rawang this year. Hume and YTL cement have also increased their capacities by 1.9m MT and 1.8m MT respectively. We understand that higher selling price rebates have been given to compete for market share. Declining profit margins suggest that cement manufacturers have sacrificed margins for the sake of volume. Fig 6: Total capacity of Lafarge Before Clinker capacity m MT Grinding capacity mmt Clinker capacity m MT Grinding capacity mmt Lafarge Plant Location Langkawi 3.3 5.4 3.3 4.3 Kanthan 3.2 4.2 4.5 5.9 Rawang 1.7 2.6 1.9 2.5 Pasir Gudang NA.8 NA 2. Total 8.2 13. 9.7 14.6 Source: Company, Affin Hwang Estimates After Fig 7: Total grinding capacity of cement players Company Estimated annual production capacity (m MT) Lafarge Holcim 14.6 YTL Cement 5. Tasek Corp 2.3 Hume Industries 2. Cahya Mata Sarawak 2.8 Cement Industries Sabah.9 Cement Industries M'sia 3. Aalborg Portland 1.9 Total 32.4 Source: The Edge, Affin Hwang Estimates Page 4 of 11
Surging coal prices Coal price has surged by 122% YTD to US$112/MT because China is cutting over-capacity in local production to improve air quality. However, the negative impact will be felt more in 217 as Lafarge normally hedges up to 8-9% of its annual coal requirement at a fixed price a year in advance. Only the remaining 1-2% will be exposed to current high prices. We gather that Lafarge usually locks in 5% of its annual coal requirement at a pre-agreed price through its parent Lafarge SA s global coal sourcing network in December. There is also the option to source another 3-4% of its annual coal requirement at the same pre-agreed price once the initial locked-in quantum is exhausted. In the event that coal spot prices are high, the company will likely exercise the option. The remaining 1-2% of annual coal requirement will still be exposed to price volatility in the spot market. Our assumption on the average coal price is US$62/MT for 216E (after taking into account its hedged position) and US$78/MT for 217-18E based on Bloomberg estimates. Fig 8: Coal price (US$/MT) 16 Coal price 14 12 1 8 6 4 Source: Bloomberg, Affin Hwang Estimates Page 5 of 11
Earnings cut We have cut our earnings by 66% to RM18m after imputing: (1) weaker domestic demand; (2) lower average selling price of cement; (3) higher integration costs; (4) higher depreciation expenses; (5) higher interest expenses; (5) losses from associates will likely continue. Fig 9: EBITDA and margin (RM m) EBITDA (LHS) EBITDA Margin (RHS) (%) Fig 1: Net profit and margin (RM m) Net profit (LHS) NPM (RHS) (%) 7 25 4 14 6 5 4 3 2 1 2 15 1 5 35 3 25 2 15 1 5 12 1 8 6 4 2 21 212 213 214 215 216E 217E 218E 21 212 213 214 215 216E 217E 218E Source: Company, Affin Hwang estimates Source: Company, Affin Hwang estimates We expect revenue to grow modestly given the weak domestic demand and current cement glut, translating to stiff competitive pricing among the cement manufacturers. We believe that EBITDA margin will likely remain relatively low at an average of 14% for 216E and 217E and return to the norm of 2% in 218E. This is due to higher integration costs that will likely continue for the next two years. Higher maintenance costs will be charged this year due to the recent accidental release of dust from its Langkawi cement plant to villages compromising 1, houses on 12 September 216. Higher depreciation expenses will be recognized in 2H16 as one of its newly installed cement manufacturing plants will be fully operational in 3Q16. We forecast depreciation expenses to increase by 12% yoy to RM18m in 216E. Net profit margin is further squeezed by higher interest expenses. We estimate that interest expenses would increase nearly sixfold yoy to RM15.3m in 216E due to the RM34m in new borrowings to finance the purchase of Holcim s local operations. Losses from associates will likely further exacerbate the decline in earnings this year. For 216E, we revised our net profit forecast to RM18m, a 57% yoy decline. Page 6 of 11
Silver lining in 217 We expect 217 earnings to rebound by 64% to RM176.6m underpinned by existing supply contracts for projects like MRT2, LRT3, Bandar Malaysia, Tun Razak Exchange (TRX) and Merdeka PNB118. In addition, maintenance cost should be lower in subsequent years and 1% cost savings would be realised next year. Lafarge bagged a RM254m contract by becoming the co-exclusive concrete supplier for the proposed RAPID project and other Petronasrelated projects in Pengerang, Johor, for five years. We also believe cement demand will improve next year, driven by higher infrastructure spending. The recent Budget 217 announcement sees a 2% yoy increase in development expenditure to RM46bn. New projects like the 688-km East Coast Rail Line (ECRL) and RM25bn allocation to build government hospitals will spur demand for cement in the long run. Low gearing Despite raising about RM34m in new borrowings for the acquisition of Holcim, the group s net gearing remains low at 4%. The strong positive free cash flow, following the completion of the capacity expansion in 216, should return the group to a net cash position of RM2.77m in 218E. Page 7 of 11
Post-merger stabilization Strategic merger The purchase of Holcim in November 215 for RM33m will enhance its production capacity to 14.6m MT from 13.m MT previously. Lafarge and Holcim have grinding plants of.7m MT and 1.2m MT, respectively, in Pasir Gudang, Johor. Thus, the strategic merger will cater to growing demand in the southern region. Cost savings 25-5% of the cost savings should be realised in the first year of the merger and 1% in the subsequent year. Lafarge has completed its staff rationalization. The merger creates synergies through higher economies of scale and reducing cost of shared resources. Lafarge should enjoy greater capital and operational cost efficiencies post-integration with Holcim. Bigger market share The merger will reaffirm Lafarge as the market leader in the domestic cement industry. We estimate that the Holcim acquisition will increase Lafarge s market share by 5 ppt to 45%. Fig 11: Estimated market share Cement Industries M'sia 9% Cement Industries Sabah 3% Cahya Mata Sarawak 9% Aalborg Portland 6% Lafarge Holcim 45% Hume Industries 6% Tasek Corp 7% Source: The Edge YTL Cement 15% Page 8 of 11
Valuation: Downgrade to SELL with a lower TP of RM7. We downgrade Lafarge to a SELL from Hold with a lower DDM-based 12- month TP of RM7., from RM8.6. Volatility in ASP and oversupply concerns have heightened earnings forecasts risks. We believe this will likely disappoint the market as our 216E net profit forecast of RM18m is 38% below consensus estimate of RM173m. Our DDM-based TP of RM7. is based on assumed average dividend payout ratio of 14%. Cash balance of RM166m should support DPS of 21 sen in 217E, giving net dividend yield of 2.6%. Our TP of RM7. implies a 217E PER of 34x. This is above historical 12-month forward mean PER of 21x but less than 1 standard deviation above mean PER of 39x. Fig 12: Lafarge s DPS and payout ratio (sen) DPS (LHS) Payout Ratio (RHS) (%) 5 45 4 35 3 25 2 15 1 5 211 212 213 214 215 216E 217E 218E Source: Company, Affin Hwang Estimates 16 14 12 1 8 6 4 2 Fig 13: Lafarge s 12-month forward PER (X) 8 7 6 5 4 +1SD: 39x 3 2 1 Avg: 21x -1SD: 3.6x 29 21 211 212 213 214 215 216 Source: Bloomberg, Affin Hwang Estimates Risk to call Upside risks to our SELL call include; (i) a decline/reversal in coal prices, (ii) decreased price competition; (ii) stronger-than-expected demand and (iv) higher-than-expected dividend payout ratio. Page 9 of 11
Lafarge Malaysia - FINANCIAL SUMMARY Profit & Loss Statement Key Financial Ratios and Margins FYE 31 Dec (RMm) 214 215 216E 217E 218E FYE 31 Dec (RMm) 214 215 216E 217E 218E Revenue 2,743.1 2,75.8 2,84. 2,979.2 3,19.1 Growth Operating expenses (2,249.1) (2,241.4) (2,45.3) (2,545.6) (2,66.5) Revenue (%) (3.8).3 1.9 6.2 7.1 EBITDA 494. 59.4 353.7 433.6 583.6 EBITDA (%) (24.6) 3.1 (3.6) 22.6 34.6 Depreciation (158.7) (16.9) (18.3) (185.7) (188.2) Core net profit (%) (31.9) 5.2 (59.7) 62.7 71.3 EBIT 335.3 348.5 173.3 247.9 395.3 Net interest income/(expense) 8.7 2.7 (1.3) (9.8) (8.5) Profitability Associates' contribution 1.2 (6.1) (15.) (1.) (6.1) EBITDA margin (%) 18. 18.5 12.6 14.6 18.3 EI 1.6 (16.6) - - - PBT margin (%) 12.6 12.5 5.3 7.7 11.9 Pretax profit 345.2 345.2 148. 228.1 38.7 Net profit margin (%) 9.3 9.1 3.8 5.9 9.4 Tax (89.2) (93.9) (4.) (52.5) (79.9) Effective tax rate (%) 25.8 27.2 27. 23. 21. Minority interest (.) (.2) (.2) (.2) (.2) ROA (%) 6.4 5.8 2.5 4. 7. Net profit 256. 251. 17.8 175.4 3.5 Core ROE (%) 8.1 8.6 3.5 5.7 9.8 ROCE (%) 7.6 6.8 3. 4.9 8.5 Balance Sheet Statement Dividend payout ratio (%) 142.7 18.2 13.8 12.3 14.3 FYE 31 Dec (RMm) 214 215 216E 217E 218E PPE 1,466.9 1,659.9 1,9.2 1,774. 1,649.6 Liquidity Other non-current assets 1,334.8 1,589.6 1,53.2 1,53.2 1,53.2 Current ratio (x) 1.9 1.1.9 1. 1.2 Total non-current assets 2,81.7 3,249.5 3,43.4 3,34.2 3,179.8 Op. cash flow (RMm) 46.9 383.4 373. 35.1 46.5 Cash and equivalents 46.9 311.4 166. 239.5 231.3 Free cashflow (RMm) 364.7 (161.1) (47.6) 29.6 342.7 Inventory 275.4 29.4 38.7 329.6 352.4 FCF/share (sen) 42.92 (18.96) (5.61) 34.2 4.33 Trade receivables 372. 432.8 387.6 411.9 48.7 Other current assets 8.7 74.9 74.9 74.9 74.9 Asset management Total current assets 1,188.9 1,19.5 937.2 1,55.8 1,139.3 Inventory turnover (days) 51.2 53.4 52.3 52.3 55. Trade payables 426.3 443.8 51.6 535.5 544.6 Receivables turnover (day 49.5 57.4 5.5 5.5 55. Short term borrowings. 334.1 296.6 259.1 221.6 Payables turnover (days) 79.2 81.6 85. 85. 85. Other current liabilities 186. 222. 222. 222. 222. Total current liabilities 612.3 1,. 1,2.2 1,16.6 988.2 Capital structure Long term borrowings - 7. 7. 7. 7. Net Gearing (x) net cash.1.4. net cash Other long term liabilities 253.4 258.2 25.4 25.4 25.4 Interest Cover (x) net cash net cash 11.3 19.3 35.5 Total long term liabilities 253.4 265.2 257.4 257.4 257.4 Minority Interest 4.22 5.23 5.45 5.68 5.91 Shareholders' Funds 3,12.7 3,88.5 3,84.5 3,8.4 3,67.6 Cash Flow Statement FYE 31 Dec (RMm) 214 215 216E 217E 218E PAT 256. 251.2 18. 175.6 3.7 Depreciation & amortisation 158.7 16.9 18.3 185.7 188.2 Working capital changes 221.1 279.4 84.6 (11.2) (82.5) Others (174.9) (38.) - - - Cashflow from operations 46.9 383.4 373. 35.1 46.5 Capex (12.8) (549.6) (42.6) (59.6) (63.8) Others 18.8 8.3 - - - Cash flow from investing (83.9) (541.3) (42.6) (59.6) (63.8) Debt raised/(repaid) (.5) (3.5) (22.2) (22.2) (22.2) Equity raised/(repaid) - - - - - Dividends paid (365.4) (271.6) (111.9) (179.5) (313.3) Others (.8) 279.6 36.3 (15.3) (15.3) Cash flow from financing (366.7) 4.5 (97.8) (217.) (35.8) Source: Company, Affin Hwang forecasts Page 1 of 11
Equity Rating Structure and Definitions BUY Total return is expected to exceed +1% over a 12-month period HOLD Total return is expected to be between -5% and +1% over a 12-month period SELL Total return is expected to be below -5% over a 12-month period NOT RATED Affin Hwang Investment Bank Berhad does not provide research coverage or rating for this company. Report is intended as information only and not as a recommendation The total expected return is defined as the percentage upside/downside to our target price plus the net dividend yield over the next 12 months. OVERWEIGHT Industry, as defined by the analyst s coverage universe, is expected to outperform the KLCI benchmark over the next 12 months NEUTRAL Industry, as defined by the analyst s coverage universe, is expected to perform inline with the KLCI benchmark over the next 12 months UNDERWEIGHT Industry, as defined by the analyst s coverage universe is expected to under-perform the KLCI benchmark over the next 12 months This report is intended for information purposes only and has been prepared by Affin Hwang Investment Bank Berhad (14389-U) (formerly known as HwangDBS Investment Bank Berhad) ( the Company ) based on sources believed to be reliable. However, such sources have not been independently verified by the Company, and as such the Company does not give any guarantee, representation or warranty (express or implied) as to the adequacy, accuracy, reliability or completeness of the information and/or opinion provided or rendered in this report. Facts, information, views and/or opinion presented in this report have not been reviewed by, may not reflect information known to, and may present a differing view expressed by other business units within the Company, including investment banking personnel. Reports issued by the Company, are prepared in accordance with the Company s policies for managing conflicts of interest arising as a result of publication and distribution of investment research reports. Under no circumstances shall the Company, its associates and/or any person related to it be liable in any manner whatsoever for any consequences (including but are not limited to any direct, indirect or consequential losses, loss of profit and damages) arising from the use of or reliance on the information and/or opinion provided or rendered in this report. Any opinions or estimates in this report are that of the Company, as of this date and subject to change without prior notice. Under no circumstances shall this report be construed as an offer to sell or a solicitation of an offer to buy any securities. The Company and/or any of its directors and/or employees may have an interest in the securities mentioned therein. The Company may also make investment decisions or take proprietary positions that are inconsistent with the recommendations or views in this report. Comments and recommendations stated here rely on the individual opinions of the ones providing these comments and recommendations. These opinions may not fit to your financial status, risk and return preferences and hence an independent evaluation is essential. Investors are advised to independently evaluate particular investments and strategies and to seek independent financial, legal and other advice on the information and/or opinion contained in this report before investing or participating in any of the securities or investment strategies or transactions discussed in this report. Third-party data providers make no warranties or representations of any kind relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages of any kind relating to such data. The Company s research, or any portion thereof may not be reprinted, sold or redistributed without the consent of the Company. The Company, is a participant of the Capital Market Development Fund-Bursa Research Scheme, and will receive compensation for the participation. This report is printed and published by: Affin Hwang Investment Bank Berhad (14389-U) A Participating Organisation of Bursa Malaysia Securities Bhd Chulan Tower Branch, 3rd Floor, Chulan Tower, No 3, Jalan Conlay, 545 Kuala Lumpur. www.affinhwang.com Email : affin.research@affinhwang.com Tel : + 63 2143 8668 Fax : + 63 2145 35 Page 11 of 11