This article first appeared in The Edge Malaysia Weekly, on November 30 - December 6, 2015.

While construction companies are expected to be the winners in the upcoming mega infrastructure and property development projects, the same cannot be said for the building material industry.

This is because the players, comprising cement, concrete and steel construction product manufacturers, among others, are facing many problems in their respective segments, especially huge idle capacity and cut-throat competition from cheap imports.

Adding to this is a subdued property market, which spells poor demand for building materials. Industry players expect demand for cement, for example, to be flat or to track the country’s slow economic growth.

“We see relatively flat demand next year, reflecting slower private-sector economic activity that’s counter balanced by continued government spending on infrastructure,” says Datuk Richard Curtis, group managing director of Cahya Mata Sarawak Bhd (CMS), in a written reply to The Edge.

While the cement segment is gloomy at the moment, not all the producers face bleak prospects. Different factors — geographical footprint, capacity and pricing — play a role in the fortunes of the major cement producers.

For example, CMS (fundamental: 2.50; valuation: 0.50) will benefit from demand for cement in Sarawak as several big projects have been earmarked for the state, including the 1,090km Pan Borneo Highway, which is estimated to cost RM16 billion.

The Sarawak government, under the leadership of Tan Sri Adenan Satem, has made it clear that the construction of the portion that straddles the state will be awarded to local construction companies. Some of the notable companies are Hock Seng Lee Bhd (fundamental: 2.40; valuation: 1.20), Naim Holdings Bhd (fundamental: 1.20; valuation: 1.80), Zecon Bhd (fundamental: 0.35; valuation: 0.30) and, of course, CMS.

“A project of such magnitude will require the collaborative effort of the relevant quarters and where CMS is able to contribute to such projects, we will do our best as the state’s leading infrastructure facilitator,” says Curtis.

At the moment, CMS is in a sweet spot because it is the sole producer of cement in Sarawak, where demand almost matches supply. CMS’s total production capacity is 1.6 million tonnes per annum while demand for cement in Sarawak stands at 1.7 million tonnes.

Indeed, CMS is expanding its grinding capacity by a million MT a year with the commissioning of a new plant in the outskirts of Kuching next year. According to RHB Research analyst Ng Sem Guan, the new plant will improve the profitability of CMS’s cement division next year.

Given the numerous construction projects earmarked for Sarawak and its ongoing development, utilising its new capacity will not be a problem for CMS.

Its monopolistic position in Sarawak values CMS at a premium to its peers in the peninsula. RHB Research’s Ng ascribed a price-to-earnings valuation of 23.8 times to CMS’s cement division and a 10% premium to that of Lafarge Malaysia Bhd.

As a group, the company is valued at 21 times its financial year 2016 forecast earnings per share (EPS) of 26 sen by RHB Research. As at last Friday, CMS was trading at RM5.11 per share. With a target price of RM5.55 by RHB Research, CMS has an upside potential of 8.6% over the next 12 months.

The analyst consensus target price for CMS is RM5.20, which represents a potential gain of 1.76% from last Friday’s share price. Over the last year, the stock has risen 12.9%, giving the company a market capitalisation of RM5.5 billion.

The situation is more challenging in the peninsula where there are more cement players and installed capacity. Lafarge Malaysia (fundamental: 1.80; valuation: 1.10), YTL Corp Bhd and Tasek Corp Bhd are among the main players.

Lafarge Malaysia is the country’s largest cement producer with an installed capacity of 14.14 million tonnes per year. However, there are about 25 million tonnes of installed capacity in the peninsula and a highly competitive market.

Lafarge Malaysia president and CEO Thierry Legrand declines to reveal the group’s plant utilisation rate but opines that demand for cement will grow in tandem with the country’s economic growth of between 4% and 5% next year.

“We expect the construction sector’s growth to mirror that of GDP. We are happy that the government has continued to invest in infrastructure development, which will help stimulate the economy. We are confident Lafarge Malaysia is well positioned to serve some of these projects, especially the ones that are technically challenging,” he says in a written reply to The Edge.

Industry observers feel that the cement segment in the peninsula is doing fine despite the stiff competition among the players. They point out that the utilisation of cement plants in the peninsula is at a high 85%, although this is far from the rate enjoyed by CMS in Sarawak.

The competitive nature of the cement segment in Peninsular Malaysia has resulted in disappointing results for several producers so far this year. Lafarge Malaysia saw miniscule growth of 0.8% in its net profit to RM207.7 million in the nine-month period ended Sept 30.

“The results fell short of our and consensus estimates. Had it not been for an unrealised foreign exchange gain of RM21.6 million, the results would have been worse,” states Ng of RHB Research in a Nov 19 report.

Tasek’s (fundamental: 3; valuation: 1.10) net profit in 9MFY2015 slipped 6% year on year to RM72.8 million while the operating profit of YTL’s (fundamental: 1.50; valuation: 1.40) cement manufacturing and trading division fell 3% y-o-y to RM130.4 million in 1QFY2016 ended Sept 30.

In an Oct 7 report, Kenanga Research states that the cement segment is going to remain challenging in the fourth quarter of the year due to intense price competition and 11% capacity expansion in the peninsula until 2016.

Kenanga has an “underperform” call on Lafarge Malaysia, the only cement producer under its coverage, and a target price of RM8.01. Analysts have a consensus target price of RM8.32 on Lafarge Malaysia. As at last Friday, the group was trading at RM9.08.

Over the last year, Lafarge Malaysia has lost 5.68% of its value; its market capitalisation stands at RM7.72 billion. However, it is still trading at a price-earnings ratio of 28.55 times its estimated FY2015 EPS of 31.8 sen, which is higher than CMS’s 23.44 times and Tasek’s 17.9 times.

“Given the high competition in the market, we strongly believe that Lafarge Malaysia is overvalued at this juncture as there could be more downside to its earnings should the price war persist,” Kenanga says in a Nov 19 report.

In the steel segment of the construction industry, overcapacity will likely remain a major challenge next year, says Chow Chong Long, group managing director of Southern Steel Bhd.

Chow says despite the slowdown in the private sector, there will not be a big drop in demand for steel products because of the government’s push for infrastructure construction. However, most of the demand will be met by imported products, he adds.

“Next year will not be that good and if there is any recovery, it will come in the following year. This is supported by trade measures implemented by governments across the world against China’s dumping of steel products in their markets.

“Malaysia is not as aggressive as the other governments because we are looking more at free trade, so that opens up the industry for more dumping of China’s steel products,” says Chow, adding that as much as 70% of steel products in Malaysia comprises cheap imports, especially from China.

Dumping by China’s steel producers has weakened the outlook for Malaysian steel producers. The government should undertake more trade measures to correct the situation, says Chow.

According to him, Ann Joo Resources Bhd (fundamental: 0; valuation: 1.20) and Southern Steel (fundamental: 0; valuation: 0.90) could still get out of their current predicament because their steel products — steel bars, wire rods and hot rolled coil — are used in the ongoing MRT project and buildings.

Note: The Edge Research’s fundamental score reflects a company’s profitability and balance sheet strength, calculated based on historical numbers. The valuation score determines if a stock is attractively valued or not, also based on historical numbers. A score of 3 suggests strong fundamentals and attractive valuations. Visit www.theedgemarkets.com for more details on a company’s financial dashboard.

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