This article first appeared in The Edge Financial Daily on July 23, 2019

Cahya Mata Sarawak Bhd
(July 22, RM2.96)
Maintain underweight with a lower fair value (FV) of RM2.45: We cut our net profit forecast for financial year ending Dec 31, 2019 (FY19) by 18%, and FY20 and FY21 by 2% each; reduced our FV by 2% to RM2.45, from RM2.51 previously; and maintained our “underweight” call for Cahya Mata Sarawak Bhd (CMS). Our new FV is based on 10 times the revised FY20 earnings per share, in line with our benchmark forward target price-to-earnings of 10 times for large-cap construction and building materials stocks.

During a recent meeting, CMS highlighted to us two potential headwinds to FY19 earnings — competition in the state road maintenance space, and a weaker performance from 25%-owned OM Materials (Samalaju) Sdn Bhd due to sustained soft selling prices of its end-products. CMS foresees competition in the state road maintenance business from FY20 upon the expiry of its six-month extension for the maintenance of state roads (5,847km) on Dec 31, 2019.

New players’ potential entry could reduce the size in terms of the length, in kilometres, of state roads to be maintained by CMS, as well as the margins realised. In FY18, construction and road maintenance contributed about 20% to CMS’ total earnings. Meanwhile, the outlook for OM Materials is expected to remain weak in FY19, weighed down by weak selling prices of its key end-product ferrosilicon (FeSi), on rising supply and slowing demand in China amid the US-China trade conflict.

We understand that FeSi prices eased a further 8% to US$1,080 (RM4,449.60) per tonne in the second quarter ended June 30, 2019 (2QFY19), compared with US$1,170 per tonne in 1QFY19, and its production cost of US$1,000 per tonne. FeSi prices averaged at US$2,100 per tonne in FY18. We have reflected these two potential headwinds in our forecasts.

We maintained our view that a sustainable funding model for public infrastructure development in Sarawak is by tapping into federal funds versus draining Sarawak’s state reserves. In any case, we believe the market could have adequately priced in the potential of a state reserves-fuelled infrastructure boom in Sarawak, ahead of the Sarawak state election which must be held by September 2021, with CMS’ share price strongly recovered from its low of RM1.92.

We remained cautious on CMS due to a cutback in public infrastructure spending as the federal government tightens its belt. We are also mindful of the potential threat to market dominance by existing players in the construction and building materials sector in Sarawak, and an altered political landscape in Malaysia after the 14th general election.

An increased competition could dent CMS’ prospects of winning new construction jobs, securing extensions of its road maintenance concession, as well as sustaining a high margin for its construction, road maintenance and cement business. — AmInvestment Bank, July 22