Malayan Cement (LMC MK) Buy

Malaysia Initiating Coverage

See important disclosures at the end of this report 1

Market Dateline / PP 19489/05/2019 (035080)

20 April 2020 Basic Materials | Building Materials

Malayan Cement (LMC MK)

On The Cusp Of Recovery; BUY

Buy Target Price (Return): MYR3.00 (+33%)

Price: MYR2.25

Market Cap: USD438m

Avg Daily Turnover (MYR/USD) 1.39m/0.32m

Analyst

Lester Siew

+603 9280 2181 lester.siew@rhbgroup.com

Share Performance (%)

YTD 1m 3m 6m 12m

Absolute (23.7) 10.3 (36.6) (23.7) (3.0)

Relative (12.3) (1.7) (24.8) (13.1) 10.2

52-wk Price low/high (MYR) 1.44 – 4.34

Source: Bloomberg

Initiate coverage with a BUY and TP of MYR3.00, 33% upside. Valuation

has turned compelling, reaching a trough at 0.8x P/BV (60% discount from its historical mean). Malayan Cement’s turnaround impetus remains intact. Recovering ASPs and decline in key input costs should drive a sharp earnings rebound in 2H20, outpacing the broader economy on back-loaded volume demand supporting utilisation rates. The company’s competitiveness is set to improve after integrating with its new major shareholder and industry leader, YTL Cement.

Earnings at an inflection point. Malayan Cement’s losses have narrowed

sharply on cost rationalisation and easing industry headwinds, namely bottoming out of cement production since 2Q19; subsiding key input costs, including coal and petcoke; and recovering ASPs since YTL Cement Berhad’s takeover in May 2019. These should continue to play out after the Movement Control Order-led production halt in 1H20, as forward volumes are expected to be supported by post Movement Control Order (MCO) pent-up demand from the steady pipeline of domestic construction projects in progress and decent exports traction spilling over into 2021. Hence, we expect its near-term prospects to be relatively sound, and forecast a return to profitability in FY21F (Note: FYE Dec changed to June starting FY20F).

Post-merger integration taking off. Looking ahead, efficiency gains would

serve as Malayan Cement’s key earnings driver, underpinned by significant synergistic benefits to be reaped from its ongoing business integration with YTL Cement. The latter has been in a class of its own, with a consummate historical track record of unbroken profitability owing to its superior execution and operational efficiency relative to domestic peers.

Cement demand to return to normal? We anticipate the upcoming 12th

Malaysia Plan to provide longer-term volume visibility – potentially skewed towards the upside owing to pent-up demand from previously delayed infrastructure project roll-outs. Malaysia’s 2019 cement consumption of 424kg/capita trails its long-term average of 632kg, suggesting a potential ‘rubber-band’ mean reversion down the line as macroeconomic conditions improve post-pandemic and spur a broad recovery in building materials demand. We note that public development expenditure increased during the 2008-2009 global financial crisis despite reporting a wider fiscal deficit.

Initiate coverage with a BUY and TP of MYR3.00. We ascribe a 1x FY21F

P/BV target – at a 30-50% discount to its 10-year average as well as domestic peers – factoring in the evolving operating landscape, in addition to its constrained liquidity position – albeit likely supported by YTL Cement’s financing flexibility. Key risks include a relapse in price war and prolonged COVID-19 situation undermining its cash flow.

Source: Company data, RHB

Lafarge Malayan Cement (LMC MK)Price Close

Relative to FTSE Bursa Malaysia KLCI Index (RHS)

Forecasts and Valuation Dec-18 Jun-20F Jun-21F Jun-22F

Total turnover (MYRm) 2,122 2,979 2,345 2,533

Recurring net profit (MYRm) (310) (150) 109 161

Recurring net profit growth (%) 34.7 (51.6) - 48.8

Recurring P/E (x) na na 17.62 11.84

P/B (x) 0.8 0.8 0.8 0.7

P/CF (x) na 40.10 6.99 6.34

Dividend Yield (%) na na na na

EV/EBITDA (x) na 19.56 6.69 5.25

Return on average equity (%) (11.8) (5.9) 4.4 6.2

Net debt to equity (%) 19.4 24.9 16.9 8.3 Interest cover (x) (10.31) (1.87) 2.89 4.10

Malayan Cement Malaysia Initiating Coverage

Financial Exhibits

Malaysia

Basic Materials

Malayan Cement

LMC MK

Valuation basis

P/BV methodology (1.0x FY21F)

Key drivers

i. Construction sector demand; ii. Industry consolidation; iii. Merger synergies.

Key risks

i. Broad economic slowdown ii. Property market overhang; iii. Pricing competition.

Company Profile

Malayan Cement is a producer of cement, concrete, and aggregates. The company's products are used in the residential and commercial building industry, and have various applications in infrastructure and oil and gas business segments. The cement business includes the production of Portland cement, specialty cement for building and infrastructure applications, mortars, low-carbon cements, and cement trading activities.

Source: Company data, RHB

Financial summary (MYR) Dec-18 Jun-20F Jun-21F Jun-22F

Recurring EPS (0.36) (0.18) 0.13 0.19

BVPS 3.00 2.82 2.95 3.14

Return on average equity (%) (11.8) (5.9) 4.4 6.2

Valuation metrics Dec-18 Jun-20F Jun-21F Jun-22F

Recurring P/E (x) na na 17.62 11.84

P/B (x) 0.8 0.8 0.8 0.7

FCF Yield (%) (19.1) (5.4) 9.1 10.5

EV/EBITDA (x) na 19.56 6.69 5.25

EV/EBIT (x) na na 13.49 9.07

Income statement (MYRm) Dec-18 Jun-20F Jun-21F Jun-22F

Total turnover 2,122 2,979 2,345 2,533

Gross profit 117 391 510 565

EBITDA (182) 127 343 395

Depreciation and amortisation (189) (265) (173) (167)

Operating profit (371) (139) 170 229

Net interest (32) (62) (44) (34)

Pre-tax profit (405) (182) 140 210

Taxation 87 36 (30) (47)

Reported net profit (319) (147) 109 161

Recurring net profit (310) (150) 109 161

Cash flow (MYRm) Dec-18 Jun-20F Jun-21F Jun-22F

Change in w orking capital (18) (33) 19 1

Cash flow from operations (217) 48 273 301

Capex (148) (150) (100) (100)

Cash flow from investing activities (147) (150) (100) (100)

Dividends paid (2) 0 0 0

Cash flow from financing activities 305 400 0 (100)

Cash at beginning of period 100 84 382 555

Net change in cash (59) 298 173 101

Ending balance cash 86 382 555 657

Balance sheet (MYRm) Dec-18 Jun-20F Jun-21F Jun-22F

Total cash and equivalents 84 382 555 657

Tangible f ixed assets 1,653 1,544 1,478 1,418

Total investments 21 41 55 70

Total assets 4,277 4,783 4,616 4,736

Short-term debt 301 101 101 101

Total long-term debt 280 880 880 780

Total liabilities 1,726 2,378 2,101 2,058

Total equity 2,551 2,405 2,515 2,678

Total liabilities & equity 4,277 4,783 4,616 4,736

Key metrics Dec-18 Jun-20F Jun-21F Jun-22F

Revenue grow th (%) (5.6) 40.4 (21.3) 8.0

Recurrent EPS grow th (%) 34.7 (51.6) 0.0 48.8

Gross margin (%) 5.5 13.1 21.8 22.3

Operating EBITDA margin (%) (8.6) 4.2 14.6 15.6

Net profit margin (%) (15.0) (4.9) 4.6 6.4

Capex/sales (%) 7.0 5.0 4.3 3.9

Interest cover (x) (10.3) (1.9) 2.9 4.1

Valuation & Recommendation Initiating coverage with a BUY and TP of MYR3.00 based on 1.0x FY21F P/BV. Our

target multiple is pegged to its 2008-2009 global financial crisis trough average. Share price has fallen 24% YTD, presenting a comfortable margin of safety amid battered-down valuations – at 60% discount from its long-term historical P/BV average of 1.9x (-2SD) – corroborated by a steep asset-based valuation discount of USD70 EV/tonne vs capacity replacement costs of USD110-130 EV/tonne. Against its listed peers – Hume Industries (HUME MK, NR) and Tasek (TC MK, NR) – the stock trades at a 30% discount on a trailing P/BV basis.

Malayan Cement’s share price has rebounded 26% MTD ahead of the broader indices, likely attributable to bargain-hunting. With the cement and construction sector given the go-ahead to resume operations, we believe interest in the stock could sustain, backed by a relatively resilient earnings profile under current market conditions, with:

i. Quick volume turnaround from pent-up construction works pipeline;

ii. Stable ASPs supported by low inventory levels and higher utilisation rates;

iii. Favourable cost environment due to lower commodity and energy prices;

iv. Further realisation of cost savings from ongoing integration with YTL Cement.

Other re-rating catalysts in the longer term include:

i. Signs of COVID-19 easing, beta-charged by an eventual broad market recovery;

ii. Revival of large-scale public projects such as HSR and MRT3;

iii. Renewed expectations leading up to the announcement of 12MP in 2H20;

iv. Evident return to profitability in successive quarters ahead;

v. ESG premium as an industrial stock constituent of FTSE4Good Bursa Malaysia.

Liquidity for the stock is expected to improve in the future. As Malayan Cement’s listing

status has been retained post-takeover, YTL Cement is expected to lower its 76.98% effective ownership in accordance with the minimum public shareholding spread of 25%. This is likely to occur when market conditions turn more favourable.

Key risks to our call include:

i. Reduced demand visibility from a sustained economic downturn;

ii. Spike in production costs due to supply chain disruptions from COVID-19;

iii. Contraction in ASPs led by a relapse in price war, and/or demand shock;

iv. Spike in private sector construction loan defaults;

v. Political instability which may negatively impact infrastructure project rollouts;

vi. Weak execution of post-merger integration with YTL Cement.

Figure 1: Malayan Cement’s historical P/BV Figure 2: Peninsular Malaysia’s cement sector P/BV

Source: Company data Source: Company data

Jul-10

Oct-11

Jul-15

Oct-16

P/BV Average +1SD -1SD +2SD -2SD

Jul-12

Oct-13

Jul-17

Oct-18

P/BV Average +1SD +2SD -1SD -2SD

Figure 3: Peer comparison – local & regional*

Market Cap P/E EV/EBITDA P/BV ROE Div. Yield

(USD) (x) (x) (x) (%) (%)

2019 2020F 2019 2020F 2019 2020F 2019 2020F 2019 2020F

Local Peers

Malayan Cement 423 - 25.4 72.9 10.4 0.8 0.8 - 3.0 0.0 0.0

Hume Industries 133 - 6.4 38.9 5.8 1.4 1.4 - 14.9 0.0 0.0

Tasek Corp 156 - - 103.8 - 1.3 - - - 0.0 -

Cahya Mata Sarawak 309 8.9 8.0 5.6 5.6 0.5 0.5 6.0 5.9 2.4 4.5

Mean 8.9 13.3 55.3 7.3 1.0 0.9 6.0 7.9 0.6 1.5

Median 8.9 8.0 55.9 5.8 1.0 0.8 6.0 5.9 0.0 0.0

Regional Cement Peers

Semen Indonesia 2906 18.0 18.7 8.4 7.9 1.5 1.4 7.5 7.8 2.4 2.0

Indocement 2741 20.9 22.0 11.1 10.4 1.9 1.8 6.6 7.6 3.2 3.9

Siam Cement 11848 11.5 12.2 10.1 10.1 1.4 1.3 11.4 10.5 5.1 4.1

Eagle Cement 740 6.5 6.7 4.2 3.7 1.1 1.0 17.5 17.5 4.0 5.0

Ultratech Cement 13097 24.6 26.6 12.6 11.7 2.7 2.4 10.6 7.7 0.4 0.5

Shree Cement 8173 35.5 27.4 15.8 14.2 4.8 4.2 12.9 14.6 0.5 0.5

Mean 19.5 18.9 10.4 9.7 2.2 2.0 11.1 10.9 2.6 2.7

Median 19.5 20.4 10.6 10.3 1.7 1.6 11.0 9.1 2.8 3.0

*Note: Calendarised figures; Negative P/E and ROE figures are excluded; Tasek Corp has no active analyst coverage

Source: Bloomberg, RHB estimates *Prices as of 15 April 2020

Investment Thesis

#1: Improved industry fundamentals

Cement volumes have bottomed. Both domestic cement production and consumption

volumes have seen meaningful pick-up since their multi-year lows in Jun 2019, in tandem with a pick-up in infrastructure-related construction as well as exports demand over 2H19.

The implementation of the MCO during March-April should ostensibly stifle output due to the suspension of construction-related works for four weeks. Nonetheless, the impact would be largely limited to 1H20, with cement manufacturing and construction works set to resume in mid-April after receiving the green light from the Government. The Government has previously also reiterated its commitment to proceed with mega infrastructure projects outlined under Budget 2020 such as the East Coast Rail Link (ECRL) and Mass Rapid Transit 2 (MRT2). Malayan Cement was previously awarded a MYR270m contract to supply cement for the ECRL project until Dec 2019, and is expected to renew its agreement for subsequent construction work phases.

Given a relatively healthy pipeline of construction works planned and in progress preceding the MCO, we expect cement production and utilisation rates to subsequently ramp up in order to fulfil the backlog of works, likely spilling over into 2021 as well.

Malayan Cement’s strategically situated Langkawi plant could also benefit from sustained exports demand from countries such as Singapore and Bangladesh, in addition to East Malaysia states, which rely on clinker imports to fulfil their cement production requirements.

Figure 4: Domestic cement volume, monthly (‘000 tonnes) Figure 5: Construction work done, YoY growth

Source: CEIC Source: CEIC

Figure 6: Residential construction projects Figure 7: Construction project awards (quantity and value)

Source: CEIC

*Note: 2019 value reflects down-revisions made on several large-scale projects

Source: CEIC

Jul-17

Jul-18

Consumption (LHS) Exports (RHS)

11.111.7

8.1 7.7

5.95.3 5.2

0.7 0.8

Construction Output YoY %

10,000

20,000

30,000

40,000

50,000

60,000

Jul-15

Jul-16

Jul-17

Jul-18

Residential Property: Construction Started (units)

Residential Property: New Planned Supply (units)

2017 2018 2019 YTD2020

Value of Projects, MYRbn (LHS) Number of Projects (RHS)

ASP recovery follows suit. Likewise, bulk and bag cement ASPs in Peninsular Malaysia

have rebounded off unsustainable decade-low levels since 1H19, in line with volume recovery. This was catalysed by industry consolidation following YTL Cement’s acquisition of Malayan Cement’s 51% controlling stake from LafargeHolcim in May 2019, providing a much-needed respite from years of intense price competition – amid falling cement demand and utilisation rates from 2015-2019 – which pushed all but one (YTL Cement) of the Peninsular Malaysia cement makers into the red.

We gather that bulk and bag cement prices in Peninsular Malaysia have since recovered to MYR240-250 per tonne and MYR15-16 per bag (50kg) in 1Q20, and are likely to stabilise at current levels unless the prospects of volume growth tick up. Conversely, we believe it is unlikely that price competition will return to the fold anytime soon, as the industry shies away from the detrimental volume game in favour of margin discipline under current market conditions.

Figure 8: Peninsular bulk cement average selling prices Figure 9: Peninsular bag cement average selling prices

Source: Company data, RHB Source: Company data, RHB

Easing cost intensity. Given their energy-intensive operations – c.50% of production costs

– cement producers are set to benefit from a benign cost environment, primarily supported by a fall-off in key input costs such as coal, petroleum coke, fuel and electricity prices. This is partially offset by the depreciation in the MYR but should nonetheless translate into better gross margins. Going forward, the cement producers’ reliance on primary energy sources is expected to drop due to the transition towards alternative fuel and energy-saving initiatives such as implementation of waste heat recovery systems.

Figure 10: Petcoke and coal prices Figure 11: Diesel price trend

Source: Bloomberg Source: Bloomberg

Aligned market dynamics supporting near-term earnings trajectory. Due to reasons

aforementioned, we expect Malayan Cement to post higher earnings resilience relative to the overall market, in light of COVID-19 taking its toll on corporate results in the near term. Amongst the three top-down factors, we highlight ASP recovery as the primary earnings driver owing to its quantum of improvement (+20% YoY based on our MYR240/tonne 2020F assumption for bulk cement prices) and the magnitude of its flow-through to the bottomline.

Jul-10

Oct-11

Jul-15

Oct-16

Bulk Cement (MYR/tonne)

Jul-10

Oct-11

Jul-15

Oct-16

Bag Cement (MYR/50kg)

Jul-15

Oct-15

Jul-16

Oct-16

Jul-17

Oct-17

Jul-18

Oct-18

Jul-19

Oct-19

Petroleum Coke (USD/tonne) Australia Thermal Coal (USD/tonne)

Diesel Price (MYR/litre)

#2: Internal transformation + favourable tailwinds = return to profitability

Leaner ship, smoother sails. Malayan Cement’s internal cost structure has trimmed down

significantly after continuous cost-cutting exercises amid challenging market conditions in recent years. Via its self-help measures, EBITDA margin has evidently recovered from the bottom of the pecking order to catch up to the listed peers in FY20F. Coupled with the present industry tailwinds, we therefore expect the company to subsequently register a strong return to profitability in FY21F.

Stronger competitive position. Going forward, the company is expected to generate

further opex savings through cost synergies with YTL Cement, the lowest-cost Peninsular Malaysia producer and notably, the only one to remain profitable since the commencement of its cement manufacturing operations in 1998. We estimate Malayan Cement to recognise the bulk of its upfront costs associated with rationalisation and business integration with YTL Cement by 6QFY20 (February), after receiving shareholders’ related party transactions (RPT) approval in January.

Post integration, we expect Malayan Cement to chalk up a clear competitive advantage through greater economies of scale and broad operational synergies under YTL Cement’s revenue and cost leadership, thereby unlocking the value of its No 1 market position by production capacity.

Figure 12: Quarterly EBITDA margin evolution Figure 13: YTL Cement’s vs Malayan Cement’s EBITDA margin

Banking on YTL Cement’s proven management track record. We are reassured by YTL

Cement’s historical track record of expanding its domestic operations through bargain brownfield acquisitions and subsequently delivering strong value creation for shareholders:

i. In 2003, it bought out the Pahang State Government’s 50% JV stake in Pahang Cement for a consideration of MYR138m (or FY02 P/BV of 1.32x), representing income and capital gains of MYR0.97 per MYR1 invested in 1995 to build the 1.2m-tonne integrated cement plant;

ii. In 2004, YTL Cement acquired a 65% stake in Perak-Hanjoong Simen (PHS) – then the second largest cement producer with 3.4m-tonne installed cement capacity – from two successive transactions for MYR0.70 per share and MYR1.00 per share (0.52x & 0.74x FY03 P/BV) respectively, during which PHS was struggling with hefty losses of MYR53m with revenue of MYR344m. By FY09, YTL Cement had successfully turned PHS around with PAT of MYR94m and revenue rising to MYR596m (10% CAGR). Its subsequent takeover of PHS’ remaining 35% interest in 2010 from Gopeng (GOP MK, NR) allowed the latter to exit its stake at a much higher price of MYR1.70 per share (FY09 P/BV of 0.93x) than what was fetched in 2004.

In contrast, LafargeHolcim’s 51% stake in Malayan Cement’s was bought over by YTL Cement for MYR3.75 per share, which amounted to a premium of 1.25x FY18 P/BV (subsequently extended to minority shareholders and YTL Cement ending up with 76.98% ownership) in spite of its loss-making position.

We believe that YTL Cement, whose convention of accumulating businesses at a book discount, is paying a premium for significant control value upon taking over the management of Malayan Cement’s businesses that have been losing ground to peers in recent years under LafargeHolcim. This is in addition to building up the former’s market share by controlling 60% of domestic production capacity – for a steeply discounted cement asset purchase consideration of USD75 EV/tonne relative to greenfield construction costs of USD130 EV/tonne – apart from broad synergistic benefits to be reaped through vertical, horizontal and functional integrations.

Malayan Cement Hume Tasek

This is indicated by Malayan Cement’s underperforming ROEs relative to YTL Cement, and also to other peers subsequently. While YTL Cement’s ROE edge was attributable to higher leverage employed in the early years, its latter years’ outperformance has been down to its margin leadership as well as resilient asset turnover. Conversely, Malayan Cement has struggled with bleeding market share and inflated cost base leading up to LafargeHolcim’s exit. In essence, we are upbeat on Malayan Cement’s turnaround prospects and discern considerable scope for value creation by aligning under the management of YTL Cement.

Figure 14: Sector historical ROE Figure 15: YTL Cement’s & Malayan Cement’s ROE decomposition

*Note: Hume’s cement operations materialised only in 2014-2015

Source: Company data

#3: Key beneficiary of revival in construction activities

Bombed-out proxy to cyclical rebound in the construction sector. Malayan Cement

stands out as an inexpensive pure-play for exposure to a comeback in construction project flow. After years of slowdown in construction work done for residential and commercial properties, coupled with a held back pipeline of large-scale infrastructure projects, we see limited negative surprises for the cement industry at this juncture. The stock should derive support from its bombed-out share price in addition to healthy demand visibility from the ramp-up in construction works for major projects such as ECRL, MRT2 and LRT3. On the other hand, there is sizeable earnings and re-rating potential coming off a low base, should a broad cyclical recovery play out subsequently.

Figure 16: Construction projects already/expected in the pipeline (non-exhaustive) Projects Estimated Cost

(RMbn) Latest Updates

Bandar Malaysia 56.0 In Budget 2020, the government announced that it is committed to this project

KVMRT2 30.5* Overall progress at 70%, with completion expected in 2022

KVLRT3 16.6* Progress resumed in 2H19. Sub-contractors expect awarded contract value to reduce, but the quantum remains up in the air.

Gemas-JB Double Tracking 8.9 Sub-contracting works awarded, with expected completion by Oct 2021

Johor–SG RTS Link 3.2 To be implemented, but no particular timeline was announced. 6-months extension was granted by Singapore, after restoration. Currently, supplementary agreement is being drafted as Malaysia look for options to reduce costs. Extension was granted until Apr 2020.

Pan Borneo Sarawak Highway 18.8 Progress of 11 packages (awarded previously) are ongoing.

Pan Borneo Sabah Highway 12.8 Under review. 12 out of 35 packages of Phase 1 were awarded to Sabah contractors. Three additional packages will be tendered out in the near future.

West Coast Expressway 6.5 Expected completion is 2022, with land acquisition at 95% completion. Four sections (5, 8, 9, 10) were opened from May to Dec 2019. Tolling began in Jan 2020 for section 8, 9, and 10. In percentage length, about 32% is opened to the public.

Central Spine Road 4.0 Implementation to be continued

Sarawak Coastal Road, Second Trunk Road and State Water Grid

9.1 Few packages for Coastal Road and Water Grid were already awarded in 2019.

Penang Transport Master Plan 27.0 Validity of PDP appointment has been extended to August 2020.

East Coast Rail Link 44.0 Restored. Target completion is Dec 2026. Permanent works for Section B is expected to commence in 2H20.

KVMRT3 30.0 Cancelled until construction of KVMRT2 is completed.

KL-SG High Speed Railway 40.0> Decision deferred to May 2020.

Note 1: * Project value reduced after revision Note 2: >Civil works Source: Various, Company data, RHB

Malayan Cement Hume* Tasek YTL Cement

Net Margin % (LMC) Net Margin % (YTL)

Asset Turnover (LMC) Asset Turnover (YTL)

Financial Leverage (LMC) Financial Leverage (YTL)

Long-term demand trajectory calls for an eventual rebound. Historically, Malaysia’s

cement consumption stood at 632kg per capita – against consumption of 424kg per capita in 2019. From a macroeconomic perspective, this suggests a reversion towards its long-term average down the road, prompted by the country’s developing-nation needs and rapid urbanisation drive. This is corroborated by global trends, whereby the world’s average cement consumption per capita is 521kg, while an aggregate comparison of peer countries signals for incremental cement consumption in line with higher per capita income for developing nations – as at 2018, Malaysia’s GDP per capita was USD11,400.

Figure 17: Domestic cement consumption Figure 18: Global cement consumption vs GDP per capita

Source: CEIC Source: International Cement Review (2018)

12th Malaysia Plan a potential turning point? We flag the possibility of the 12th Malaysia

Plan’s announcement in 2H20 to mark the next upcycle for the cement sector, after several consecutive years of declining demand, marred by property market downturn and delayed rollout of mega infrastructure projects. In our view, despite the Government’s limited fiscal headroom, some of the mega projects could return to the fore under 12MP, particularly those with a higher multiplier effect on the economy and/or socio-economic significance. These could include Bandar Malaysia (revived) and the high speed rail (HSR) (under review in May) with scope for accelerated implementation due to the provision of earlier studies and planning conducted in the past. The inherent spill-over effects of these mega projects also augur well for the property sector due to the opening-up of residential and commercial real estate clusters along the economic corridor. A synchronised pick-up in infrastructure and real estate construction activities is pivotal for restoring cement production’s long-run trajectory, given its balanced contribution to construction work done.

Figure 19: Government development expenditure and 9th-11th Malaysia Plan budget announcements

Source: CEIC, The Edge

#4: Scarcity of ESG-compliant manufacturers

Inclusion in FTSE4Good Bursa Malaysia. Coupled with the increasing traction of ESG-

driven investing, we believe this could enhance Malayan Cement’s investment profile down the road, given that it is amongst one of only 15 industrial stocks to be currently included in the FTSE4Good Bursa Malaysia Index.

565615 607

709742 722

753 762

554502

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Cement Consumption ('mil tonnes) Consumption per capita (kg)

9th MP Budget: MYR222bn

Financial Overview Results review. Earnings have rebounded YoY over the past five consecutive quarters,

largely reflecting its vigorous cost-cutting measures although there were also upfront costs incurred intermittently. Revenue has trailed meanwhile, as ASPs have only begun to recover in 2H19 while volumes were muted over the same period, partially attributable to major refurbishment works at its Rawang integrated cement plant.

Sequential earnings improvement. The group is expected to register meaningful

profitability recovery from 6QFY20 onwards. We project 5QFY20 to remain in the red due to the MCO-led volume disruptions in mid-March, in addition to upfront costs arising from Malayan Cement’s and YTL Cement’s business integration beginning in January.

Figure 20: Quarterly earnings Figure 21: Annualised earnings

Source: Company data Source: Company data, RHB

Conservative FY20-22 earnings forecasts. This is premised on a gradual increase in

cement and concrete volume demand in tandem with an eventual pick-up in construction activities. ASPs are forecasted to remain flattish based on current levels. Overall, we elect to keep our earnings estimates on the conservative end due to the COVID-19 overhang. We believe there is potential upside in terms of cement volume and ASP, in addition to margin expansion on the back of larger-than-expected merger cost savings. On the other hand, there could be some downside to clinker exports demand due to the COVID-19 impact on neighbouring importing countries such as Bangladesh and Sri Lanka. Nonetheless, clinker exports are not a major earnings contributor due to lower margins commanded.

Figure 22: Key assumptions

6QFY20F FY21F FY22F

Production

Cement (m mt) 6.5 4.6 4.9

Clinker (m mt) 7.3 5.3 5.7

Concrete (m m3) 4.3 3.5 3.8

Cement (MYR/tonnes) 215 240 240

Clinker (MYR/tonnes) 150 150 150

Concrete (MYR/m3) 180 190 190

Source: RHB

Liquidity position to solidify. Despite the group’s negative working capital position as at

4QFY20 – with short-term borrowings of MYR873m including short-maturity sukuk of MYR400m – we are not overly concerned, given its moderate net gearing of 0.27x in addition to projected cash flow improvements. This is corroborated by RAM Ratings’ upgrade of its credit outlook to positive (from stable) in January. Moreover, Malayan Cement stands to benefit from an ease of access to debt refinancing as a subsidiary of YTL Cement, owing to the latter’s established banking relationships.

547 532495

548 539

471 466 447

-69 -83-107

-56-26

-60-32 -34

1Q18 2Q18 3Q18 4Q18 1Q19 2Q19 3Q19 4Q19

Revenue Net profit

FY14 FY15 FY16 FY17 FY18 6QFY20F FY21F FY22F

Revenue Core net profit Earnings YoY% (RHS)

Stronger FCF generation with low capex spending. Malayan Cement’s free cash flow

generation should pick up strongly in tandem with its improving profitability. Capex commitments over the medium term are expected to fall short of its depreciation expenses. This is largely limited to routine maintenance and refurbishing parts of its plants for efficiency enhancement, as there is sizeable excess capacity to absorb incremental demand in the near future. Based on our estimates, this amounts to FY21F-22F FCF yields of 9-10%.

Future Plans Where will the cash end up? Due to its relatively healthy balance sheet and the low-

interest rate environment, we believe Malayan Cement could continue to gear up, in line with YTL Corp’s general practice of deploying leverage. However, prospects of resuming full dividend pay-out are less clear-cut. With Malayan Cement’s listing status retained post acquisition, it was previously reported that YTL Cement’s assets could be subsequently injected into Malayan Cement to facilitate a full merger. This would necessitate a sizeable equity capital buffer to absorb YTL Cement’s sizeable debt load taken on for Malayan Cement’s acquisition.

That said, these corporate exercise scenarios are not expected to play out anytime soon under current market conditions. For the time being, we do not factor in dividend pay-out to resume, but note that its historical payout ratio stood at 90-100%, which would translate into potential FY21F-22F yields of 5.1%-8.4%.

Key Risks & Earnings Sensitivity Downside risks for the company include:

i. Reduced demand visibility from a sustained economic downturn;

ii. Spike in production costs due to supply chain disruptions from COVID-19;

iii. Contraction in ASPs led by a relapse in price war, and/or demand shock;

iv. Spike in private sector construction loan defaults;

v. Political instability which may negatively impact infrastructure project rollouts;

vi. Weak execution of post-merger integration with YTL Cement.

Upside risks include:

i. Stronger-than-expected cement selling prices;

ii. Higher-than-expected domestic volume demand;

iii. Quicker-than-expected cost synergies derived from integration with YTL Cement;

iv. Sustained fall-off in energy and fuel costs;

v. Accelerated implementation of key infrastructure projects.

Earnings sensitivity

Key sensitivities. Under our current production assumptions, we estimate Malayan

Cement to hit EBIT-breakeven at MYR193 per tonne in FY21F.

i. Every 1% change in cement ASP would impact FY21F earnings by 8.8%;

ii. Every 1% change in USD/MYR would impact FY21F earnings by 2.1%;

iii. Every 1% change in cement volumes would impact FY21F earnings by 1.2%.

Industry Overview

Figure 23: Peninsular Malaysia market share by capacity Figure 24: Peer revenue in 2018

Supply outlook

Excess capacity to deter supply expansions in the near future. Over the longer term,

the threat of new competition is muted, in our view, given the sizeable excess capacity in the market and high barriers to entry. It is estimated that a greenfield cement grinding plant costs north of MYR1bn.

Demand outlook

Cement demand seen picking up in 2H20 due to work delay. Cement demand has

tapered down since 2015 owing to a weak residential property market and supressed infrastructure construction activities, which together historically accounted for two-thirds of industry volumes. While the property market continues to look unexciting, we believe cement demand should pick up after 1H20 due to pent-up demand post MCO. Going into 2021, demand visibility remains well supported by large-scale public project implementations including ECRL, MRT2, LRT3, Bandar Malaysia and the Johor-SG RTS shifting into higher gear.

Profitability

Rational price setting seen going forward. We expect ASPs to hold up at current levels

going forward, supported by supply cut flexibility post-industry consolidation, while mounting cash flow constraints for companies such as Hume and CIMA (CIM MK, NR) are also expected to render some pricing discipline.

Recommendation Chart

Source: RHB, Bloomberg

Malayan Cement12.95

YTL Cement7.2

CIMA7.2

Tasek2.3

Hume3.0

Peninsular Grinding Capacity ('mil tonnes)

YTL Cement MalayanCement

CIMA Hume Tasek

CY18 Revenue (MYR 'm)

Malaysia Foreign

Apr-15 Jul-16 Nov-17 Feb-19

Price Close

5 Recommendations & Target Price

Buy Neutral Sell Trading Buy Take Profit Not Rated

Date Recommendation Target Price Price

RHB Guide to Investment Ratings

Buy: Share price may exceed 10% over the next 12 months Trading Buy: Share price may exceed 15% over the next 3 months, however longer-

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Malayan Cement (LMC MK) Buy

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