T Cement Bhd Silent but steady Initiating coverage with Overweight; Dec-07 PT of M$5.90: With a 30% market share in the aggregate cement capacity in Malaysia, T Cement is poised to benefit from increased demand over the last three years of the Ninth Malaysia Plan. Building materials to gain: In line with the Ninth Malaysia Plan s (9MP) spending theme, we expect cement demand to rise systematically across the construction industry. As TC is operating at maximum utilization currently, we believe management will reduce the proportion of exports and increase their capacity within the next two years to cope with the local consumption. The recent 10%-blended price revision in December 2006 will also contribute to a margin expansion. Superior delivery due to savvy owner-operator management: The superiority of TC s management is reflected in the higher margins, more efficient asset turnovers as well as a more optimal gearing level compared to its peers, hence explaining the 12% ROE which is above its peers. The strategic plant locations also prompt us to favor them to benefit from the South Johor developments and the K-Singapore bullet train. Valuation, price target, key risks: We forecast earnings growth of 24%/12% for F07/F08. Our price target is derived from an EV/tonne multiple of US$150, in line with regional average. The key risk to our thesis is a potential price war that could arise from excess capacity after the 9MP. Bloomberg: TC MK, Reuters: TC.K M$ in millions, year-end June F06A F07E F08E F09E Sales 1061.9 1276.7 1351.9 1629.1 Core net profit 138.0 170.7 191.8 259.0 Core net EPS 28.5 35.2 39.6 53.5 Net DPS (sen) 10.0 10.0 12.0 12.0 Sales growth 56.8% 20.2% 5.9% 20.5% Net profit growth 168.9% 23.6% 12.4% 35.1% EPS growth 144.2% 23.6% 12.4% 35.1% ROE 10.9% 12.2% 12.4% 15.0% P/E 15.1 12.2 10.9 8.0 P/BV 1.6 1.5 1.3 1.2 EV/EBITDA 15.2 11.9 10.9 8.8 Net div yield 2.3% 2.3% 2.8% 2.8% 3Q06 4Q06 1Q07 2Q07 Sales (M$MM) 269.7 290.2 283.9 261.9 EPS (sen) 6.5 7.2 5.7 5.2 Source: Company reports, JPMorgan estimates. Initiation Overweight M$4.30 04 April 2007 Price Target: M$5.90 Malaysia Building Materials Jon Oh AC Five-year price performance 5.00 4.00 3.00 2.00 1.00 0.00 Mar-02 Mar-04 Mar-06 Source: Bloomberg. Performance 1M 3M 12M Absolute (%) 16.2 7.0 77.7 Relative (%) 1.8-6.7 41.2 Source: Bloomberg. Company data 52-week range (M$) 2.1-4.9 Market cap (M$MM) 2108 Market cap (US$MM) 609 Shares outstanding (MM) 490.18 Free float (%) 26 Avg daily vol (MM) 1.85 Avg daily value (M$MM) 5.37 Avg daily value (US$MM) 1.55 KCI 1271.31 Exchange rate M$3.46/US1 ear-end June Source: Bloomberg. www.morganmarkets.com JPMorgan Securities (Malaysia) Sdn. Bhd. (18146-X) See page 6 for analyst certification and important disclosures, including investment banking relationships. JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Company description The principal activities of T Cement include the manufacture and supply of cement and concrete products. TC is also the second largest cement producer in Malaysia, commanding a 30% market share of clinker capacity. The company originated from a series of acquisitions, dating back to December 2004 where they completed the acquisition of a 64.84% stake in Perak-Hanjoong Simen at that time the second largest integrated cement producer in the country with 3 million tonnes of clinker capacity. In 2005, the company acquired the remaining 50% stake in Pahang Cement, making it a fully-owned subsidiary with 1.1 million tonnes of clinker capacity. Most recently TC acquired a 20.94% stake in Singaporebased Jurong Cement (JC) for M$19.76 million. Corporate governance metrics Company dividend policy Not defined # Days to publish quarterly report Dividend track record 35% payout ratio # Days to consolidated annual report 60 days 180 % Independent directors Inter-company transactions 5 / 15 (33.3%) None History of share placement Insider ownership (%) None 52% Source: Company and JPMorgan estimates. Positive price drivers Rising demand, rising price: In line with the expansionary fiscal spending in the construction sector, we expect cement demand to rise systematically across the industry, ultimately benefiting many construction companies and building materials manufacturers in Malaysia. With a 30% market share in aggregate cement capacity, TC is poised to benefit from increased demand over the remaining three years of the Ninth Malaysia Plan (9MP) while the government observes a spending fiscal policy. Being a controlled commodity in Malaysia, the price of cement is regulated by the Cement and Concrete Association of Malaysia (C&CA). The recent 10%- blended price revision in December 2006 will benefit every cement manufacturer, including TC. Operating margins of cement manufacturers were eroding given escalating costs that were not matched by equivalent price hikes the previous cap of M$200 per tonne has not been revised for over 10 years. With the price hike in place coupled with heightened demand from the construction sector, we forecast a 24% and 12% earnings growth for TC in F07 and F08 respectively. Table 1: Industry-wide capacity and market share breakdown No. Cement company Estimated cement capacity (MM tonnes p.a.) Market share 1 afarge Malayan Cement 9.0 42.7% 2 T Cement 6.2 29.4% 3 CIMA 3.4 16.1% 4 Tasik 2.0 9.5% 5 Others 0.5 2.4% Total Capacity 21.1 100% Average Utilization 19.0 90% ocal Construction Demand 14.0 74% Exports and Excess 5.0 26% Source: JPMorgan estimates. Table 2: Assumptions and forecast of cement volume and ASP for TC F06A F07E F08E F09E Cement (local) Blended ASP (per tonne) 160 190 200 210 Cement capacity (MM tonnes) 6.0 6.0 6.0 7.0 ocal utilization 85% 95% 95% 95% Sales (M$MM) 816.0 1083.0 1140.0 1396.5 Source: JPMorgan estimates. Consistent outperformer, compared to afarge Malayan Cement and CIMA: With an average five-year ROE of 17%, compared to MC s 3% and CIMA s 2.1%, we acknowledge T Cement as the lowest-cost cement producer in the country. The outperformance of the ROE can be explained by the consistently higher margins, higher asset turnovers as well as a more optimal gearing level compared to its local peers. We credit such outperformance to the strong management skills, better plant efficiency, well-managed down-time and maintenance schedules. 2
Figure 1: DuPont analysis Rolling 5-year average ROE trends 20% 10% 0% 2000 2002 2004 2006 TC MC CIMA Source: Bloomberg, Company reports Figure 2: DuPont Analysis Rolling 5-year average net margin trends 15% 10% 5% 0% 2000 2002 2004 2006 TC MC CIMA Source: Bloomberg, Company reports. Figure 3: Plant ocations of TC, afarge and CIMA in Malaysia Savvy owner-operator: T Cement has shown strong growth over the last two fiscal years, at a time when most cement manufacturers and construction companies were feeling the pinch of a declining sector and plagued with excess capacity. The slowdown of the construction sector prompted management to grow by acquisition, buying out Pahang Cement (1.2 million tones of annual cement capacity) in 2003 and establishing a 65% subsidiary control in Perak-Hanjoong Cement (3.4 million tonnes of annual cement capacity) in 2004. In an effort to expand regionally, management continued its acquisition spree by buying a 21% stake in Singapore-based Jurong Cement. Although Jurong Cement has been making losses over the last five years, this would be considered a small entry fee for TC to potentially scale-up regionally and penetrate the Singapore and China market. Moving forward, we continue to expect a substantial portion (over 10%) of cement demand to arise internally, with a particular interest in the M$11 billion K-Singapore bullet train project that could be spearheaded by parent company, T Corp. Strategically located plants to benefit from construction pump-priming: The cement industry in Malaysia is mature, with the top four cement players controlling more than 97% market share. Given the relative homogeneity of cement products, we do not envision any immediate threat to TC s current market share of 30% given that cement prices are regulated with a blended average price ceiling of M$220 per tonne. Hence, the ultimate deciding factor boils down to the location of the grinding plants and its relative distance to the construction sites of the projects. Based on the plant locations, we conclude that T Cement is in a good position as to benefit from the construction mega-projects throughout the nation (refer to Figure 3). C Negative price drivers & risks to thesis C Rising production cost, with no pass-through: The cement industry has experienced several cost hikes of late, i.e., an electricity tariff hike of 12%, water tariff hike of 11%, KTM rail hikes of 10%, rising cost of paper-bags and sand. Although the recent cement price hike will lead to a margin expansion, we are mindful that the cost hikes cannot be passed through to their customers due to the regulated ceiling price. C T Cement afarge Malayan Cement CIMA Source: Company, JPMorgan. South Johor developments Second Penang Bridge Double-tracking project K-Sing Bullet train project West Coast Highway Figure 4: Revenue and net profit trends over the last 5 years Another price war: The cement price war in 2005 was a result of desperate measures among cement makers in defending their market shares due to a slowing construction environment. Cement prices went to as low as M$110 per tonne, trading at a 45% discount to the regulated ceiling price in 2005. Although no formal agreement has been made between the cement makers, we do not envision any immediate price wars since demand is expected to rise structurally. Nevertheless, a price war is inevitable in a contractionary market once the manufacturers are plagued with excess capacity. 2000 1500 1000 500 0 Net Profit Revenue 250 200 150 100 50 0 iquidity risk: Although trading volumes have improved recently in line with the general robustness of the KCI Index, the shareholding structure of TC suggests that it is thinly traded and tightly held by close associates of T Corporation and the eoh family. TC s public float is currently sitting at 26% with low foreign institutional holding. The T Group of companies and the eoh family currently own up to 52% of TC s shares. Source: Annual reports, TC. 3
Figure 5: Average cement price trend (M$ per tonne) 250 200 150 100 Cap 2004A 2005A 2006A 2007E Source: Management guidance. Spot Figure 6: TC One-yr historical daily trading volumes (MM shares) 1.5 1.0 0.5 0.0 Apr-06 Aug-06 Dec-06 Source: Bloomberg. Valuation and rating analysis We are initiating coverage on T Cement with an Overweight rating with a December 2007 PT of M$5.90, implying 37% upside. While the share price has consistently outperformed the market and the sector over the last 12 months, we think that valuations are still very attractive given the momentum that will arise from the construction and building materials sector. In deriving our PT, we ascribed an EV/tonne multiple of US$150, in line with the regional average. On a P/E multiple basis, this implies 15.7x on calendarised 2007 earnings. Table 3: Price target derivation Target EV/tonne multiple (USD) 150 Exchange rate (M$ per US$1) 3.46 Annual cement capacity (MM tonnes) 6.2 Net debt (M$ MM) on C07 376.4 Target EV (M$ MM) 2841.4 Target net equity value 2465.0 No. of shares outstanding (MM) 484.1 Implied price target (M$) 5.9 Implied C07 PER 15.7 x Implied C07 P/BV 1.9 x Implied upside from current price (M$4.30) 37% Source: JPMorgan estimates. Table 4: EV-per-tonne comparison across the region EV/tonne (US$) EV / EBITDA EBITDA margins F07 sales / tonne F 07 sales (US$) F 07 effective cement capacity Siam Cement PC 213.9 18.2 21% 57.1 1381.0 24.2 Siam City Cement Pcl 147.0 10.5 26% 53.7 727.2 13.5 Indocement Tunggal Prakarsa 142.9 8.8 37% 44.4 761.2 17.2 Semen Gresik Persero 136.7 8.9 28% 55.2 1007.7 18.3 Holcim Philippines Inc 187.3 17.2 26% 41.6 302.3 7.3 Republic Cement Corp 107.9 10.0 33% 32.7 276.9 8.5 T Cement 118.4 8.9 22% 61.5 369.0 6.0 afarge Malayan Cement 164.2 10.5 21% 73.0 657.1 9.0 Industry average 152.8 11.6 27% 52.4 Source: JPMorgan estimates, Bloomberg. Upon regional comparison, we also notice that TC trades at a significant discount in the key multiples: 1. P/E forward multiple of 12.2x versus industry average of 18.6x (Competitor afarge Malayan Cement trades at 24.7x). 2. P/BV forward multiple of 1.5x versus industry average of 3.1x (Competitor afarge Malayan Cement trades at 1.6x). We believe that our price target of M$5.90 highlights the undervaluation of TC compared to its regional peers. The track record suggests that TC is a more profitable organization than afarge Malayan Cement, and we believe that it deserves to trade at a higher multiple driven by its consistency in delivering earnings growth. 4
SWOT analysis Strengths Savvy owner-operator: We credit the outperformance of this company to its savvy leadership, closely guided by T Corp s management. Strategic plants: Based on the location of the plants, we conclude that T Cement is in a good position to benefit from the construction mega-projects throughout the nation. Consistent delivery: With an average five-year ROE of 17%, TC consistently outperforms MC (average five-year ROE of 3%) and CIMA s (average five-year ROE of 2.1%). Management was able to grow its business despite the construction industry doldrums shows. Opportunities Cement demand to rise: The bullishness of the pumppriming budget will trigger more construction activity and will inevitably result in higher consumption of building materials such as cement Recent price hike to boost growth: The recent 10%- blended price revision in December 2006 will benefit every cement manufacturer including TC. With the price hike in place, coupled with the heightened demand from the construction sector, we forecast a 13% and 40% earnings growth for F07 and F08 respectively. Geographic-hedge in Jurong Cement: We believe that management has taken a geographic-hedge in buying Jurong Cement. The cement industry in Malaysia is relatively mature with minimal acquisition opportunities and we believe that TC will eventually penetrate into the Singapore and China market aggressively, especially once the construction sector in Malaysia cools down. A laissez-faire market: The cement makers are currently lobbying the C&CA to completely remove the price ceiling, and to allow market economics to determine the price of cement. Once deregulated, we believe the cement makers will cooperate and raise cement prices systematically. Weaknesses Over-dependence on expansionary fiscal policy: Bulk cement and ready-mixed concrete (RMC) demand is heavily dependent on a healthy economy with a spending drive. Making up over 70% of total sales, the demand for bulk cement and concrete typically comes from large-scale projects. Regulated ceiling price, with no cost pass-through: We reiterate our caution on the rising cost of materials and production, given that cement makers will have to absorb all cost hikes and are unable to pass-through the hikes to customers due to the price ceiling. A mature industry: The cement industry is relatively mature, with the top three cement makers controlling almost 90% of the market share. Growth by way of acquisition will be tough for TC, especially after a failed bid to acquire CIMA in 2002. Threats Price war, again: Though the price war of 2005 ended with a mutual agreement among cement makers, this does not guarantee that another price war will not take place again. In desperate times, we believe that smaller cement makers will create a price war to defend their market shares and to stay afloat, inevitably forcing larger players to follow suit. Cement makers like TC are always prone to such price wars, unless the C&CA implements a price floor Excess capacity in the long run, if not managed correctly: Although the demand for cement and RMC is on the rise, we do not view the upcoming construction boom from the 9MP as a structural shift in demand to warrant a capacity expansion. To cope with the rise in local demand, management can adopt a policy to reduce exports, given that export prices are typically lower and attract lower margins. Should TC expand its capacity sharply, we foresee a potential long-term capacity overhang and management will have to resort to exports to absorb the excess capacity. 5
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T Cement Bhd: Summary of financials Profit and oss statement Cash flow statement M$ in millions, year-end June F06A F07E F08E F09E M$ in millions, year-end June F06A F07E F08E F09E Revenues 1,061.9 1,276.7 1,351.9 1,629.1 EBIT 216.1 277.4 300.1 377.0 % change / 56.8% 20.2% 5.9% 20.5% Depreciation & amortisation 0.0 0.0 0.0 0.0 Gross Margin (%) 26.4% 26.8% 27.1% 27.5% Change in working capital -126.5-139.8-89.8-159.9 EBITDA 216.1 277.4 300.1 377.0 Taxes 11.9 15.5 17.3 22.8 % change / 91.1% 28.4% 8.2% 25.6% Cash flow from operations 169.4 228.3 313.0 342.5 EBITDA Margin (%) 20.3% 21.7% 22.2% 23.1% EBIT 216.1 277.4 300.1 377.0 Capex -42.0-24.5-77.8-88.2 % change / 91.1% 28.4% 8.2% 25.6% Disposal/ (purchase) -9.8-9.8-9.8-9.8 EBIT Margin (%) 20.3% 21.7% 22.2% 23.1% Net Interest -58.4-56.2-54.0-51.8 Net Interest (58.4) (56.2) (54.0) (51.8) Free cash flow 127.4 203.9 235.2 254.3 Earnings before tax 158.1 221.7 246.6 325.7 % change / 109.8% 40.2% 11.2% 32.1% Equity raised/ (repaid) -0.4-0.4-0.4-0.4 Tax (2.3) (33.3) (37.0) (48.9) Debt raised/ (repaid) -31.0-31.0-31.0-31.0 as % of EBT 1.4% 15.0% 15.0% 15.0% Other 0.0 0.0 0.0 0.0 Net Income (Reported) 138.0 170.7 191.8 259.0 Dividends paid -35.0-35.3-43.0-43.0 % change / 168.9% 23.6% 12.4% 35.1% Net Change in Cash 51.2 127.2 150.9 170.0 Shares Outstanding 484.1 484.1 484.1 484.1 Beginning cash 291.2 342.2 469.4 620.3 EPS (reported) - M$ 28.5 35.2 39.6 53.5 Ending cash 342.2 469.4 620.3 790.3 % change / 144.2% 23.6% 12.4% 35.1% Gross DPS - M$ 10.0 10.0 12.0 12.0 Balance sheet Ratio Analysis M$ in millions, year-end June F06A F07E F08E F09E M$ in millions, year-end June F06A F07E F08E F09E Cash and cash equivalents 342.2 469.4 620.3 790.3 EBITDA margin 20.3% 21.7% 22.2% 23.1% Accounts receivable 160.1 192.5 203.8 245.6 Operating margin 20.3% 21.7% 22.2% 23.1% Inventories 112.8 135.6 143.6 173.0 Net profit margin 13.0% 13.4% 14.2% 15.9% Others 29.2 51.6 35.9 42.3 Pretax margin 14.9% 17.4% 18.2% 20.0% Current assets 644.2 849.1 1,003.6 1,251.2 Sales per share growth 42.4% 20.2% 5.9% 20.5% T investments 0.0 0.0 0.0 0.0 Sales growth 56.8% 20.2% 5.9% 20.5% Net fixed assets 1,825.9 1,759.9 1,735.2 1,698.5 Net profit growth 168.9% 23.6% 12.4% 35.1% Total assets 2,470.1 2,609.0 2,738.8 2,949.7 EPS growth 144.2% 23.6% 12.4% 35.1% iabilities Interest coverage (x) 369.8% 493.5% 555.7% 728.0% ST loans 335.2 335.2 335.2 335.2 Net debt to total capital (x) 19.3% 17.9% 10.4% 2.9% Payables 71.8 85.9 90.6 108.6 Net debt to equity (x) 37.5% 33.5% 18.5% 4.9% Others 1.4 1.4 1.4 1.4 Sales/assets (x) 43.0% 48.9% 49.4% 55.2% Total current liabilities 541.7 557.1 561.7 579.8 Assets/equity (x) 194.3% 187.0% 177.1% 170.3% ong term debt 483.9 601.6 570.6 539.5 ROE 10.9% 12.2% 12.4% 15.0% Other liabilities 24.2 54.8 54.8 54.8 ROCE 14.6% 17.2% 18.9% 23.7% Total liabilities 1,199.0 1,214.0 1,191.9 1,218.1 Shareholders' equity 1,271.1 1,395.0 1,546.9 1,731.6 BVPS - M$ 2.6 2.9 3.2 3.6 Source: Company, JPMorgan estimates