Cahya Mata clouded by political risks

This article first appeared in The Edge Malaysia Weekly, on May 28, 2018 - June 03, 2018.
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THE historic change in federal government saw Cahya Mata Sarawak Bhd (CMS) plunge when markets reopened after the May 9 polls. The share price weakness stabilised somewhat towards the end of last week, after

RM2.37 billion in market capitalisation had been wiped out in six trading days.

However, risks still hang over the well-connected company for investors looking for a bargain entry.

From a valuation perspective, CMS looks attractive after the heavy selldown. It closed at RM2.04 last Thursday, settling above the RM2 threshold at 9.5 times price-earnings ratio.

That is a 53.5% fall from its pre-election close of RM4.13 on May 8. The counter was last seen below RM2 in December 2013. In a May 21 note, RHB Research opines that the selldown was “overdone”.

Interestingly, all seven analysts tracking the stock retained their “buy” rating with a consensus target price of RM4.19. The ratings were last updated between May 16 and 22.

But assessing the stock may require a broader perspective than just numbers, as CMS’ fortunes could be affected by political developments, particularly moves by the federal government that could dampen its prospects.

“It is hard to quantify the political risks,” says TA Securities analyst Chan Mun Chan via email. “The company’s biggest exposure to the federal government is the Pan Borneo Highway and about 200km of federal road maintenance jobs.”

To recap, in its statement to investors, CMS attributed the selldown to various factors.

One was negative market sentiment towards stocks seen as politically linked to the previous federal government. Another factor was the statement by the state opposition — which is part of the ruling coalition at the federal level — suggesting that state road concessions in Sarawak be awarded via open tender.

CMS also acknowledged that the selldown could have been sparked by the offer from the Switzerland-based Bruno Manser Fund (BMF) to share information with the new federal government on the alleged corrupt practices of Sarawak governor Tun Taib Mahmud when he was chief minister from 1981 to 2014.

A fund manager tells The Edge that the market remains jittery and any news from the federal government that it is investigating the allegations against Taib could renew selling pressure on CMS.

 

‘Independent of Taib’

CMS, which has been listed since 1989, is perceived to be controlled by Taib’s family, whose members have been a presence on the board for decades. These include Taib’s brother, Tan Sri Onn Mahmud, who was chairman from 1995 to 2004.

The current interim chairman is Taib’s son, Datuk Seri Mahmud Abu Bekir Taib. The sole executive director is Datuk Syed Ahmad Alwee Alsree, his son-in-law. Taib’s family members collectively have a 33.35% stake in CMS.

In a May 20 note to investors, CMS stressed that it had evolved away from the Taib family’s control. It cited the collective shareholding of institutional investors, including foreign funds and local names such as the Employees Provident Fund (EPF) and Lembaga Tabung Haji (LTH), which amounts to 35% — larger than the Taib family’s collective stake.

Up to last Thursday, Bloomberg data showed that EPF and LTH were net buyers of CMS shares during the selldown. However, foreign shareholding decreased slightly.

“CMS has been fully transparent and has made full disclosure of all material affairs in its operations and remains confident that any investigation would be inconsequential,” the company said.

Management added that the allegations against Taib were not new and expressed doubt that there was political will to prosecute Taib’s family.

“Even if it [an investigation] did take place, it is unlikely to impinge on CMS, which has since 2006 been professionally and independently managed,” says CMS, “and is visibly known in the state for working professionally, fairly and independently of Taib’s family.”

 

Diversified earnings

Several analysts The Edge spoke to feel that while CMS’ earnings could be hurt by any unfavourable moves at the federal level, it is worth noting that its earnings have diversified in recent years.

“CMS’ future will be less dependent on the federal and state’s economic activities going forward,” says Chan of TA Securities.

The diversification includes the company’s investments in OM Materials (Sarawak) Sdn Bhd, which operates a US$500 million manganese and ferrosilicon smelting plant in Samalaju Industrial Park, Bintulu. CMS is a 25% shareholder.

OM Materials was loss-making for years and dragged down CMS’ earnings. However, it booked a profit in the fourth quarter of 2017.

Datuk Isaac Lugun, group CEO for corporate, previously told The Edge that he expects OM Materials to be profitable in 2018, subject to commodity prices.

The diversification may cushion any near-term negative impact from its exposure to the federal government — primarily through the Pan Borneo Highway and maintenance concession.

CMS is the primary cement supplier of aggregates and building materials for the project. Its joint venture with Bina Puri Holdings Bhd is also undertaking a RM1.36 billion work package.

“In the worst-case scenario, the Pan Borneo Highway project may be delayed, scaled down or even cancelled,” says AllianceDBS analyst Abdul ‘Azim Muhthar via email.

On May 14, state opposition leader Chong Chieng Jen of DAP said the Pan Borneo Highway would continue but would also be subject to an audit process to review the construction costs.

Note that CMS maintains only about 240km of federal roads in Sarawak. Any renewal of its concession to maintain 5,847km of state roads, which expires in June, will be decided by the state government.

“As for the state road maintenance concession, we expect it to be renewed by the Sarawak government, which has remained unchanged,” says Abdul ‘Azim.

 

More competition seen

In the longer term, CMS is likely heading into heightened competition due to political developments, analysts say, which could lead to squeezed margins and fewer state-related jobs.

Part of that would come from eroding support — evident in the latest general election — for the state Barisan Nasional, which Taib used to lead. The next state election must be held by 2021 at the latest.

If Pakatan Harapan gains control of the state government then, it could open up the Sarawak market further, to encourage competition in accordance with its manifesto, and reduce direct awards.

“Nevertheless, even through open tender, I believe CMS will still be the front runner to secure some state government jobs due to its capabilities, experience, networking and limited large-scale competitors in Sarawak,” says Chan.

“However, the margin may get affected as the state government may try to break down the jobs into smaller packages in order to award them to smaller players. In such a scenario, CMS will have to sacrifice some margin to compete with others to get the jobs,” he adds.

In the near term, however, potential upside catalysts for the share price include confirmation from the Sarawak government that CMS’ state roads maintenance concession will be renewed.

Another possible upward catalyst would be “affirmation by the new federal government that the Pan Borneo Highway project will continue without any delay or scale-down”, says Abdul ‘Azim. “At the moment, we ascribe a 10% discount to our valuation due to the political risks.”

 

 

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