Cahya Mata Sarawak - Fundamental Analysis · OM Sarawak Phase 1 smelter project is expected to commenceinitial production by 2Q14. Earnings contribution stillwould be immaterial in

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(Member of Alliance Bank group) PP7766/03/2013 (032116)

2 December 2013

It’s time to SCORE Trading at 7.8x FY14 P/E (ex-net cash) and 1.0x FY14 P/B, CMS is significantly undervalued despite being the prime beneficiary of robust infrastructure development in Sarawak through its core business in cement, construction materials, road maintenance, and property development. We believe the natural monopoly of its cement division, which will not be affected by rising competition or hike in electricity tariff, remains under-appreciated while the value of its 20%-investment in OM Sarawak is yet to be priced in by the market. We see several key re-rating catalysts to share price in the making i.e. (1) investors increasingly reduce/switch their exposure in Peninsular-based cement stocks to alternatives; (2) commencement of OM Sarawak smelter in 2Q14; and (3) rising dividend payout in FY14-15. We initiate coverage on CMS with a STRONG BUY recommendation and SOP-based TP of RM7.57, implying an undemanding valuation of 10.8x FY14 P/E (ex-net cash) and 1.3x FY14 P/B. Prized cement division still under-appreciated CMS has a natural monopoly in Sarawak due to high barriers of entry given that: (1)

cement demand in Sarawak is not big enough for a two-player market; (2) limited location that have suitable limestone reserves; and (3) challenges in developing an efficient distribution network.

Despite not being fully integrated and incurring higher transportation cost in Sarawak, CMS still earns similar margins compare to Peninsular-based cement producers as the company managed to offset the additional costs through higher selling prices.

In fact, CMS is in a much better position as it will neither face rising competition nor hike in electricity tariff, unlike its Peninsular-based peers.

The best is yet to come – OM Sarawak OM Sarawak Phase 1 smelter project is expected to commence initial production by

2Q14. Earnings contribution would still be immaterial in FY14, but will turn substantial from FY15 onwards after the ramp-up in production.

We believe market is yet to price in potential contribution and value of CMS’ 20%-investment in OM Sarawak, which has several key competitive advantages such as: (1) long-term access to cheap power supply, (2) captive demand with ready off-take agreements; and (3) strategic location. We expect investors to gradually price these in once the smelter starts to deliver positive results after commencing production in 2Q14.

We estimate cashflow generation from Phase 1 of this smelter project would be sufficient to fund the progress into second phase, relieving the need for CMS to inject further investment into OM Sarawak.

Rising dividend payout In addition to its strong earnings CAGR of 16.1% p.a. in FY13-15, we also expect CMS to

raise its dividend policy from a minimum of 30% in FY13 to 40-50% by FY14-15 as management turns more comfortable with its financial position after OM Sarawak starts operation and is self-sustainable.

The higher payout translates to a higher DPS forecast of 14.0-32.0sen/share and decent dividend yield of 2.4-5.4% in FY13-15, comparable to peers.

Valuation and recommendation Based on our sum-of-parts (SOP) calculation, we derive a target price of RM7.57 for

CMS, implying a valuation of 10.8x FY14 P/E (ex- net cash) and 1.3x FY14 P/B. Given the attractive 31.0% total return to our TP, we initiate coverage on CMS with a STRONG BUY recommendation.

Key investment risks include: (1) perceived political risks; and (2) fluctuation in ferroalloy prices.

Cahya Mata Sarawak Strong Buy Building Materials Bloomberg Ticker: CMS MK | Bursa Code: 2852

Initiating Coverage

Analyst Toh Woo Kim [email protected] +603 2604 3917 12-month upside potential Target price 7.57 Current price (as at 29 Nov) 5.89 Capital upside (%) 28.6 Net dividends (%) 2.4 Total return (%) 31.0 Key stock information Syariah-compliant? Yes Market Cap (RM m) 1,993.6 Shares outstanding (m) 338.5 Free float (%) 30.9 52-week high / low (RM) 6.13 / 3.00 3-mth avg volume ('000) 1,175.4 3-mth avg turnover (RM m) 6.0 Share price performance 1M 3M 6M Absolute (%) 15.0 28.6 2.4 Relative (%) 15.3 22.3 -0.2 Share price chart

Major shareholders % Alwee Alsree Syed Ahmad 13.5 Majaharta Sdn Bhd 13.3 Taib Lejla 11.0 Abdul Rahman Taib Sulaiman 8.7 Bekir Taib Mahmud Abu 8.7 Sarawak Economic Development 8.0 EPF 6.0

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Initiating Coverage| Cahya Mata Sarawak| 2 December 2013

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SNAPSHOT OF FINANCIAL AND VALUATION METRICS

Figure 1 : Key financial data

FYE 31 Dec FY11 FY12 FY13F FY14F FY15F Revenue (RM m) 1,012.6 1,203.6 1,354.0 1,353.5 1,376.6 EBITDA (RM m) 218.2 287.2 309.9 326.5 348.7 EBIT (RM m) 253.0 340.5 363.5 386.5 418.3 Pretax profit (RM m) 178.7 226.9 260.6 278.9 315.0 Reported net profit (RM m) 120.0 135.7 155.5 182.8 212.6 Core net profit (RM m) 120.0 135.7 155.5 182.8 212.6 EPS (sen) 36.4 40.8 46.8 55.0 64.0 Core EPS (sen) 36.4 40.8 46.8 55.0 64.0 Alliance / Consensus (%) 95.6 93.7 89.5 Core EPS growth (%) 82.4 12.1 14.5 17.6 16.3 P/E (x) 16.2 14.4 12.6 10.7 9.2 EV/EBITDA (x) 6.9 5.3 4.6 4.3 4.0 ROE (%) 8.5 9.2 9.8 10.8 11.8 Net gearing (%) Net Cash Net Cash Net Cash Net Cash Net Cash Net DPS (sen) 11.3 12.8 14.0 22.0 32.0 Net dividend yield (%) 1.9 2.2 2.4 3.7 5.4 BV/share (RM) 4.86 5.07 5.52 5.93 6.36 P/B (x) 1.2 1.2 1.1 1.0 0.9 Source: Alliance Research, Bloomberg

Figure 2 : Forward P/E trend Figure 3 : Forward P/B trend

Source: Alliance Research, Bloomberg Source: Alliance Research, Bloomberg

Figure 4 : Peer comparison

Company Call

Target price (RM)

Share price (RM)

Mkt Cap (RM m)

EPS Growth (%) P/E (x) P/B (x) ROE (%) Net Dividend

Yield (%) CY13 CY14 CY13 CY14 CY13 CY14 CY13 CY14 CY13 CY14

Lafarge Malayan Cement Sell 8.43 9.83 8,352.5 3.5 -0.6 23.1 23.3 2.6 2.6 11.3 11.1 3.9 3.9 Cahya Mata Sarawak Strong buy 8.11 5.89 1,993.6 14.5 17.6 12.6 10.7 1.1 1.0 9.8 10.8 2.4 3.7 Tasek Corporation NR NR 15.24 1,846.2 4.6 2.5 19.3 18.8 N/A N/A 9.9 9.8 3.9 3.9 6.4 3.3 24.5 24.2 2.8 2.8 12.7 12.8 4.3 4.5 Source: Alliance Research, Bloomberg Share price date: 29 Nov 2013

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BACKGROUND Cahya Mata Sarawak Bhd (CMS) is among the largest public-listed company based in Sarawak. Started off just as a cement manufacturer in 1974, CMS has successfully diversified its business over the years into manufacturing and trading of construction materials, construction, road maintenance, as well as property development. See Figure 5 and 6 for an overview of CMS’ current business divisions and its corporate milestones.

Figure 5 : Overview of key business divisions

Source: Company

Figure 6 : Corporate milestones

Source: Company


4

CEMENT DIVISION A NATURAL MONOPOLY The only cement producer in Sarawak

Figure 7 : Geographical location of CMS cement and clinker plant

Source: Cement & Concrete Association Malaysia CMS is the sole cement producer in Sarawak and currently owns two cement manufacturing plants in Kuching and Bintulu (see Figure 8 and 9). Both plants have installed annual capacity of 1.0m MT and 0.75m MT respectively. Clinker is the main raw material in the production of cement In order to partly integrate its cement manufacturing business, CMS ventured upstream and acquired a clinker plant back in 2007 (see Figure 10). Annual production capacity of CMS Mambong clinker plant is able to reach approximately 900,000 MT now after an upgrading project was carried out in 2012, fulfilling about 50-60% of CMS’ clinker requirement internally.

Figure 8 : CMS Kuching Plant Figure 9 : CMS Bintulu Plant

Source: Company Source: Company

CMS is the sole cement producer in Sarawak with capacity of

1.75MT/year


5

Figure 10 : CMS clinker plant in Mambong, Kuching

Source: Company A natural monopoly due to high barrier of entry CMS has a natural monopoly of the cement market in Sarawak given that the barrier of entry for new entrants is high. As cement demand in Sarawak is relatively small at only 1.6m MT/year, it is not large enough to accommodate another cement producer. This is mainly because the minimum size for a cement grinding plant or fully integrated plant to be economically viable is 1.0-1.5m MT, which is sizeable relative to current cement demand in Sarawak. Furthermore, construction costs for those plants are also high i.e. at RM150m for a 1.0m MT cement grinding plant or RM700m for a 1.5m MT fully integrated plant. Besides that, raw material and geographical constraints also come into play due to limited locations that have suitable limestone reserve to build a clinker plant. This is further complicated by the additional cost and time required to develop an efficient distribution network given the geographic diversity of cement demand in Sarawak and the lack of railway infrastructure. Strong local demand outgrowing local cement production

Figure 11 : Sarawak cement demand and imports

Source: Company

CMS has a natural monopoly of the cement market in Sarawak given

the high barriers of entry

Among the entry barriers are limited location and challenges

faced in distribution network


6

Due to rapid development, demand for cement in Sarawak has been growing strongly at 8-9% p.a. over the past 4 years, reaching approximately 1.64m MT by 2012 (see Figure 11). This already constitutes more than 90% of CMS production capacity and hence, the shortfall in local supply is currently met by imports. With no capacity expansion coming onstream between 2013 to 2015, imports will continue to rise in tandem with the 3-4% p.a. estimated growth in cement demand. To reduce the imports of cement (where CMS earns negligible or very thin margins), CMS has already planned to build a new 1.0m MT cement grinding plant adjoining its existing clinker plant in Mambong. The new plant is expected to be completed by late 2015 and commence production starting 2016. Apart from replacing imports, the new plant will also provide CMS with reserve capacity in the events other plants are shut down for maintenance. There are also opportunities for exports to nearby areas such as Brunei and Kalimantan given that they have been facing on-going cement shortages. CMS is in a better position compare to Peninsular-based cement producers Cement is very much a “localised” business as transportation is a major cost consideration due to its relatively lower value on per tonne basis. Therefore, the pricing and dynamics of the cement market in Sarawak are actually not influenced by imports and is quite independent from the cement market in Peninsular Malaysia. Overall, the average selling price (ASP) for cement in Sarawak is around RM310-340/tonne (no rebates given), higher than cement ASP in Peninsular Malaysia of about RM280-290/tonne (net of rebates). This actually helps CMS to cover the higher transportation cost in Sarawak, enabling the company to earn decent margins similar to Peninsular-based cement producers. See Figure 12 and 13.

Figure 12 : PBT margins of cement producers in Malaysia, % Figure 13 : ASP for cement in various region of Sarawak

Source: Company, Alliance Research Source: Company

Compare to Peninsular-based cement producers, CMS is in a much better position as the company is shielded from competition risk and rising electricity tariff. With new capacity by YTL Cement and CIMA coming onstream soon, we believe the cement market in Peninsular Malaysia is bound to face a period of rising competition and pricing volatility ahead, as seen recently with the entrance of Hume Cement. CMS will not face such issues as the company has a natural monopoly on the cement market in Sarawak. Other than that, Peninsular-based cement producers will also suffer from rising cost of production due to potential hike in electricity tariff (made up about 20% of production cost) when the government rationalises subsidies on natural gas (expected to be in 1Q14). On the contrary, electricity tariff in Sarawak is not likely to increase given that the current power generation mix in Sarawak is mostly based on hydro.

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Cement demand in Sarawak already exceed CMS’ production capacity and is currently met by

imports

To reduce imports, CMS plans to build a new 1.0m MT cement plant

beside its existing clinker plant

Cement ASP is higher in Sarawak to cover higher transportation costs

CMS is in a better position as it will not be affected by rising

competition and hike in electricity tariff


7

CMS maintains 4,800km of state roads and 680km of federal roads

Concession period will expire by 2017-2018, but CMS is seeking for

renewal or extension

Rates are adjusted every 3-5 years

GOOD FIT AMONG ITS BUILDING MATERIALS BUSINESS CMS is also involved in the manufacturing of other building materials (i.e. concrete products, quarries, premix, and wire mesh) that complement its cement, construction, road maintenance as well as property development business. See Figure 14 for a summary of each business. Overall, CMS’ construction materials and trading division accounted for 23% of the group revenue and 18% of earnings in FY12.

Figure 14 : Brief summary of CMS building materials business beside cement

Business Brief description

Concrete Products

CMS Concrete Products S/B is a leading manufacturer of pre-formed concrete products in Sarawak Offerings include reinforced concrete square piles, bridge beams, culverts, kerbs, cement sand bricks, ready-mixed

concrete and industrialised building system (IBS) components. Annual production capacity of 70,000 MT for concrete products and 60,000 m2 for IBS components.

Quarries

Undertaken by CMS Quarries S/B and CMS Penkuari S/B which produce granite, microtonalite and limestone aggregates.

5 operating quarries in Stabar, Penkuari, Akud, Sebuyau and Sibanyis (located in Kuching) Quarrying licenses of up to 20 years Combined annual rated capacity of 3.15m MT, which is approximately 23% share of the stone aggregates market in

Sarawak. In the progress of applying for sand extraction license and new riverine jetty for upstate delivery. Future plans include opening new quarries in north Sarawak.

Premix

CMS has about 60% share of Sarawak’s high quality asphaltic concrete and bitumen emulsion market. These materials are used in the construction of roads, flyovers and airport runaways. Undertaken by its 6 plants in Kuching, Sarikei, Sibu, Miri, Bintulu, and Limbang. In the progress of acquiring mobile plants to service remote location contracts

Wire mesh

CMS Wires S/B owns a 5,500 MT/year plant to manufacture steel drawn wires and wire mesh Has a 15% market share, operating at above 80% utilisation rate. In the progress to acquire a more modern machine Future plan include building a new plant in Bintulu area

Source: Company, Alliance Research

STABLE EARNINGS FROM ROAD MAINTENANCE Strong recurring income from road maintenance concessions The construction and road maintenance division of CMS is mainly involved in road maintenance works across Sarawak, principally through CMS Roads S/B and 51%-owned PPES Works (Sarawak) S/B. The former maintains approximately 4,800km of state roads while the latter maintains approximately 680km of federal roads. CMS also has another subsidiary, namely CMS Pavement Tech S/B which is a specialist provider of construction, maintenance and rehabilitation technology for road pavements. The road maintenance concession period for CMS Roads S/B is 15 years and will expire by December 2017, while the concession for PPES Works (Sarawak) S/B will expire by August 2018. CMS is hopeful that these concessions will be renewed or extended upon expiry given the good track record and major investments made by the company into plant, machinery, and expertise over the years. To keep up with rising costs and inflation, rates for the concessions are negotiated and revised every 3-5 years. The last revision was in FY12 for the state road concession and FY10 for the federal road concession.


8

Not going all-outto secureconstruction jobs Construction now makes up less than 20-30% of the PBT for the road maintenance and construction division as CMS is not going all-out to secure new jobs due to thin margins. The company prefers to take a passive approach such as: (1) bidding in consortiums to manage risks; and (2) supporting internal projects by providing project management and contracting services. CMS’ construction orderbook currently stands at RM250m only.

LONG TERM GROWTH IN PROPERTY DEVELOPMENT Major owner of large landbanks in Kuching The property development division of CMS owns 4,510.9 acres landbank in Sarawak of which two are large landbanks comprising (1) a 4,211-acre landbank in Petra Jaya that is being developed into a riverine township called Bandar Samariang; and (2) a 199-acre landbank in Muara Tebas which is being developed into Kuching’s new central business district, The Isthmus. See Figure 15 for detailed summary and estimated GDV of CMS remaining landbanks in Sarawak.

Figure 15 : Estimated GDV of landbanks owned by CMS in Sarawak

Source: Company The integrated township of Bandar Samariang is located 7km from Kuching city centre (see Figure 16) and now home to some 25,000 residents. From 2013-2018, CMS plans to develop 155 acres of the land with an estimated GDV of RM474m on its own, focusing on further developing the public amenities and infrastructure in the early years. As part of its strategy to fast-track development in the township, CMS has recently disposed a 200-acre land to Sentoria Group Bhd. This land will be developed into ‘Borneo Samariang Resort City’, which will comprise of a water park, resorts, a centre for meetings, conferences and events, a river cruise recreational center, as well as a safari park. In the near future, CMS intends to conclude another 1-2 land sales of similar size.

CMS is not going all-out to bid for construction jobs. Construction now

accounts for less than 20-30% of PBT for this division

CMS owned 2 huge landbanks in Kuching

Bandar Samariang has an estimated GDV of RM474m

between 2013-2018

CMS recent disposed a 200-acre land to Sentoria


9

Figure 16 : Location of Bandar Baru Samariang in Kuching, Sarawak

Source: Company Meanwhile, the Isthmus development will be transformed into Kuching’s new central business district, which is now beginning to take shape in a more concrete manner with 47 out of 246 acres having been developed at a cost of approximately RM579m, comprising built works and infrastructure. To date, The Isthmus’ composition includes the 5,000-person capacity Borneo Convention Centre Kuching, a marina, Sarawak Energy Bhd’s headquarter, as well as a second bridge that speeds up access to the south of Kuching (see Figure 17 below).

Figure 17 : Master plan of The Isthmus, Kuching

Source: Company

The Isthmus will be Kuching’s new central business district and has

been developed at a cost of RM579m so far


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RIDING ON THE STRONG GROWTH IN SAMALAJU Exclusive facilities provider for Samalaju Industrial Park Samalaju is one of the five growth nodes under the SCORE initiative, with heavy industries earmarked for the area. Beside participating in the growth of SCORE through its 20%-stake in OM Materials (Sarawak) S/B, CMS also have a 51%-stake in Samalaju Property Development S/B (SPD) that are mainly involved in the (1) provision of temporary accommodation and meal facilities for construction workers at the Samalaju Industrial Park (SIP); and (2) development of a new township as well as a service centre for Samalaju. See Figure 18 for an overview of SIP.

Figure 18 : Overview of Samalaju Industrial Park and SPD’s workers lodge

Source: Company SPD is currently the only operator of government-approved accommodation and meal facilities in Samalaju, catering to about 5,600 people from various countries. Contracts for the provision of these facilities may continue for up to 10 years pending completion of the planned permanent township. Permanent township for Samalaju is in the works Master plan for the development of a new permanent township adjoining the SIP is in the works. Construction of Phase 1A of the project, which covers 600 acres of land for industrial lots and accommodation for 5,000 people, is scheduled to kick off by end of this year. Ultimately, given the number of major industries intending to relocate to the SIP, CMS expect the township will have a population of approximately 45,000 people by 2018, reflecting the captive market demand by workers in the SIP and convenience of the township in term of logistics.

CMS owns a 51% stake in SPD which involved in providing facilities

and township development in Samalaju

Master plan for the permanent township in Samalaju is in the

works and scheduled to kick off by end-2013


11

CMS owns a 20%-stake in OM Sarawak that will develop ferroalloy

smelter in 2 phases

Phase 1 has achieved financial close and the plant is currently in

construction

OM Sarawak is among the first ferroalloy smelter strategically

located outside of China

Smuggling of Chinese-produced FeSi via Vietnam has been ongoing

to avoid 25% export tax

SCORE-ING FURTHER WITHOM SARAWAK CMS owns a 20%-stake in OM Sarawak CMS has a 20%-equity stake in OM Materials (Sarawak) S/B which is currently constructing a greenfield ferrosilicon (FeSi) and manganese alloys smelter in SIP. The other 80% stake is owned by OM Holdings Ltd, an Australian-listed vertically integrated miner, smelter and trader of manganese and other ores/alloys. This smelter project will be developed in 2 phases at an approximate total cost of USD592m, funded through 70% project finance and 30% equity. To date, OM Sarawak has achieved RM1.1bn financial close for Phase 1 of the project. It has also appointed Sinohydro Corporation as its turnkey engineering, procurement and construction contractor, while Sinosteel Jilin Electro-Mechanical Equipment Co. Ltd is nominated as sub-contractor for the construction and commissioning of the smelting project. Phase 1 of the smelter project is expected to commence initial production by 2Q14, gradually reaching full-scale commercial production by 2Q15 (see Figure 19).

Figure 19 : Phase 1 timetable of OM Sarawak ferrosilicon smelter project

Source: Company, Alliance Research

A new supplier outside of China China currently controls about 70% of global FeSi production and 50% of global manganese alloy production. As OM Sarawak is probably among the first Asian ferroalloy smelter that is located outside of China, this put the company in a strategic position to capture demand from major alloy importer countries in Asia (i.e. Japan, South Korea and Taiwan) that are keen to diversify their supplies source away from China. This is because of the uncertainties with regards to future alloy exports from China due to rising production costs, regulatory policies (environmental controls), and export disincentives (export tax). In fact, to avoid the 25% export tax, there has been on-going smuggling of Chinese-produced FeSi via Vietnam of close to 300,000 MT/year since 2011 (see Figure 20). If the Chinese government eventually crackdown hard on these smuggling activities, major importer countries such as Japan and South Korea will face serious risk of supply disruption (see Figures 21 and 22).


12

OM Sarawak has secured off-take agreement for more than 60% of its

Phase 1 production capacity

Figure 20 : Estimated Fesi smuggled exports via Vietnam (‘000 MT, 75% basis)

Source: Alloy Consult

Figure 21 : Japan FeSi Imports (‘000 MT, 75% basis) Figure 22 : South Korea FeSi Imports (‘000 MT, 75% basis)

Source: AlloyConsult Source: AlloyConsult

Therefore, it should not come as a surprise that OM Sarawak has been able to secure off-take agreements easily from two Japanese partners and one European partner in 2012, which already account for more than 60% of its Phase 1 production capacity (see Figure 23).

Figure 23 : Amount of Phase 1 off-take agreements

Date Company FeSi off-take amount (MT/year)

Jun 2012 JFE Shoji Trade Corp 80,000 Jul 2012 Hanwa Co 50,000

Dec 2012 Fesil Sales AS 60,000 Total 190,000

Source: OM Holdings Ltd


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OM Sarawak has a key advantage given its long-term access to cheap

hydropower

Electricity accounts for 50% and 25% of the total production cost for

FeSi and manganese alloys

Other advantage include 5-year tax holiday, no import/export duties

and strategic location

Access to long-term supply of cheap hydropower A key competitive advantage of OM Sarawak smelter project is its long-term access to cheap hydropower with the signing of the 20-year 500MW power purchase agreement (PPA) with Sarawak Energy. According to management, hydro-based electricity tariff for the smelter project under the PPA should average around 5.5 US cents/KWh over the contract period, which is roughly 40% cheaper than coal-fuelled electricity tariff in China. This should position OM Sarawak among the lowest cost producer for FeSi and manganese alloys in the world given that the production of both alloys are highly dependent on power (about 50% and 25% of total cost respectively). Globally, any increase in electricity prices will lead to higher ferroalloy prices as they are mainly cost-driven, particularly for FeSi (see Figures 24 & 25). As such, having a fixed-priced electricity supply not just allow OM Sarawak to hedge against rising energy costs, but also enable the company to fully benefit from potential higher ferroalloy prices in the long term.

Figure 24 : Correlation between coal and FeSi prices Figure 25 : Coal price vs. FeSi price

Source: Bloomberg, Alliance Research Source: Bloomberg, Alliance Research

Other advantages include tax incentives and strategic location Apart from cheap power, OM Sarawak will also enjoy a 5-year tax holiday as well as no duties being imposed on its raw material imports (i.e. manganese ore, etc.) and exports of finished products. Logistics wise, the smelter plant is strategically located within close proximity to key raw materials supply and major alloy importer countries. See Figure 26.

Figure 26: OM Sarawak raw materials inflows and finished product outflows

Source: OM Holdings Ltd

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OTHER POTENTIAL COLLABORATIONS IN SCORE Interested in projects with IRR of at least 18% With huge cash reserve sitting on its balance sheet, CMS is keen to further invest into 2 more sizeable industrial projects in SCORE with potential IRRs of at least 18%. The only project being identified so far is the integrated phosphate plant in collaboration with Malaysian Phosphate Additives S/B (MPA). Meanwhile, we understand that CMS is also exploring partnership opportunities with parties who are involved in the downstream industry of the phosphate plant. Collaboration with Malaysian Phosphate Additives CMS has entered into a Memorandum of Understanding (MoU) with MPA to jointly develop an RM850m integrated phosphate plant with capacity of 500,000 MT/year in SIP. Currently, both parties are in the final stage of negotiating the PPA term sheet for the plant, which is likely to be finalised before year-end. Once this hurdle is cleared, the MoU will be formalised into a joint venture, with CMS holding a 40%-equity stake. Cash injection by CMS into the JV will be around RM100m assuming similar funding structure of 70% debt and 30% equity. The plant is expected to be operational by 2016. Opportunities in downstream industry While details are scarce, we understand that CMS has also been in talks with a few parties to pursue partnership opportunities in the downstream industry, utilising output from the phosphate plant. Based on the various types of phosphate and their uses, we list down the potential downstream industry that CMS will potentially venture into. See Figure 27.

Figure 27 : Various type of phosphate and their downstream industry

Type of Phosphate Potential Downstream Industry

Diammonium phosphate

Fertiliser Monoammonium phosphate Nitrate phosphate Nitrogen, Phosphorus, Potassium (NPK) Dicalciumphopshate Animal Feed Monocalcium phosphate

Purified phosphoric acid Food industries

Sodium tripolyphosphate Detergent Source: Alliance Research

CMS keen to invest into 2 more projects in SCORE

One of the projects is an RM850m integrated phosphate plant, which

could be finalized by year-end.

The other project could involve downstream industry such as

fertilizer, animal feed, food industries or detergent


15

FINANCIAL HIGHLIGHTS 3-year earnings CAGR of 16.1% in FY13-15

Figure 28 : FY13 PBT contribution by segments Figure 29 : Revenue and PBT for CMS (in RM m)

Source: Bloomberg, Alliance Research Source: Bloomberg, Alliance Research

We forecast CMS to achieve strong earnings CAGR of 16.1% p.a. in FY13-15 primarily due to the better performance of its cement division and maiden earnings contribution from 20%-owned OM Sarawak. Our key assumptions for the various divisions are as follow: 1. Cement division

In view of higher cement demand in Sarawak, we assume average utilisation rate for CMS cement plant to stay at 90% in FY13-15, while any shortfall in demand will be met through imports. We also assume flat average selling price of RM310/tonne as we do not expect any escalation in production cost in Sarawak. Earnings growth for CMS cement division is expected to be strong due to higher usage of internally-produced clinker after plant capacity was upgraded post the 8-month shutdown in FY12. Given some hiccups faced in early of the year, we only assume 75% utilisation rate for the clinker plant in FY13, which later rise up to 90% in FY14-15. Meanwhile, we expect clinker production cost to trend down as CMS can now utilise cheaper locally-mined coal with lower caloric value after modification was carried out during the plant upgrade. Beyond our forecast period, earnings growth for CMS cement division will still be healthy as it will replace cement imports with production from its new 1.0m MT cement plant starting 2016. In addition, the new cement plant will be located next to its clinker plant, hence generating some savings in term of logistics.

2. Construction materials and trading

In 9MFY13, construction materials and trading division has achieved a strong PBT growth of 64% on the back of higher revenue. We expect this division to achieve revenue of RM380m in FY13 (+35% y-o-y growth), but will normalise to RM342-359m in FY14-15. We assume a margin of 13.5% in FY13-15 as historical margins of this division are relatively stable over time.

3. Construction and road maintenance We expect relatively flat but stable revenue growth and earnings contribution from this division. Margins are also likely to remain stable given that key materials such as asphalt and bitumen are sourced internally from its construction material division. We assume negligible contribution from construction as we do not expect CMS to secure any major contracts, in line with management strategy.

Cement35%

Construction materials &

trading19%

Construction & road

maintenance28%

Property development

0%

Samalaju development

12%

Strategic investments

2%

Others1%

Elimination-1%

0

50

100

150

200

250

0

200

400

600

800

1,000

1,200

1,400

1,600

2009 2010 2011 2012 2013F 2014F 2015F

Revenue (LHS) PATAMI (RHS)

Strong earnings CAGR of 16.6% p.a. in FY13-15

90% utilisation rate, while ASP assumed to be stable at

RM310/tonne

Strong earnings growth due to higher usage of internally-produced

clinker and utilisation of cheaper coal available locally

The new 1.0m cement plant will come onstream in 2016

Strong revenue growth in FY13 with relatively stable margins

Flat but stable growth for its road maintenance concession. Negligible

contribution from construction


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4. Property development

We expect CMS to gradually ramp up its property sales in FY13-15, as major development of its landbank is likely to take place only in FY16-18. There will also be gain on potential land sales, but we do not factor this into our forecasts.

5. Samalaju development We assume revenue for SPD to rise to RM108-112m in FY13-14 (RM72.3m in FY12) along with more workers occupying its temporary lodge, especially after the construction for OM Sarawak smelter plant has started. With existing construction work at SIP most likely completed by FY14-15, we expect a decline in revenue to RM89m in FY15. Nevertheless, we have yet to incorporate potential earnings contribution from the development of the new permanent township, which would provide buffer for the declining revenue from the temporary lodge over the long-term.

6. OM Sarawak For Phase 1 of the smelter project, we assume a 20% utilisation rate upon commencement in FY14, which will later ramp-up to 70% in FY15. We expect the average selling price for FeSi to stay flat at current price of about USD1,400/tonne in the global export market. Production cost is estimated to be in the range of USD1,030-1,040/tonne after incorporating the lower electricity tariff. In addition, we also factor in interest cost of 5.5% p.a. on its RM1.1bn financing. All in, we are projecting a net profit of RM39.0m in FY14 and RM174.5m in FY15 for OM Sarawak. Note that OM Sarawak is exempted from income tax for its first 5 years of operation. Given its 20% stake in the project, CMS will equity account about RM7.8m and RM34.9m earnings in FY14 and FY15 respectively. In the longer term when production is at optimal level and Phase 2 of the smelter plant is operational, CMS expects OM Sarawak to ultimately contribute RM80-100mto its bottomline.

Additional RM150m capex for new cement plant Annual recurring capex for CMS is around RM80m. We expect additional capex spending of RM150m to be spread equally over two years in FY14-15 for the construction of the new cement plant in Mambong. We see no issue for CMS to finance the entire capex for its new cement plant via debt given its net cash position. Higher dividend payout possible Management guided that it could revise its dividend policy to a higher payout ratio in FY14-15 as management becomes more comfortable with its financial position after OM Sarawak starts operation and is self-sustainable. This is in addition to its strong earnings growth and healthy cashflow generation. As such, from a minimum of 30% in FY13, we expect CMS to increase its dividend policy gradually to 40% in FY14 and 50% in FY15. This translates to a DPS of 14.2-32.4sen and dividend yields of 2.5-5.7% in FY13-15.

Property sales to gradually ramp up in FY13-15

Revenue to peak in FY13-14 and decline in FY15 after completion of

most construction work in Samalaju

20% utilisation rate in FY14, ramping up to 70% in FY15. ASP for FeSi to stay flat at USD1,400/tonne

Production cost to be around USD1,030-1,040/tonne

OM Sarawak will eventually contribute RM80-100m to CMS

Higher dividend payout possible in FY14-15

We assume dividend policy to increase from 30% to 40-50% in

FY14-15


17

Figure 30 below summarises our key assumptions.

Figure 30 : Key assumptions

2011A 2012A 2013F 2014F 2015F

Clinker plant capacity ('000 MT) 800 800 900 900 900

Utilisation rate, % 90 30 80 90 90

Cement plant capacity ('000 MT) 1,750 1,750 1,750 1,750 1,750

Utilisation rate, % 81 88 90 90 90

Cement ASP (RM/tonne) 300 300 320 320 320

OM Sarawak Phase 1 '000 MT) - - - 308 308

Utilisation rate, % - - - 20 70

FeSi export price (USD/tonne) - - - 1,400 1,400

Production cost (USD/tonne) - - - 1,033 1,044 Source: Company, Alliance Research


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VALUATION AND RECOMMENDATION Significantly undervalued. Initiating coverage with Strong Buy Based on our sum-of-parts (SOP) calculation, we derive a target price of RM7.57 for CMS, implying a FY14 P/E valuation of only 10.8x (ex- net cash) and 1.3x FY14 P/B. We believe our TP is reasonable, having pegged the valuation of CMS’ various business divisions at FY14 P/E multiples that are rather conservative and in line with peers’ valuation. See Figure 31. Given the attractive 31.0% total return to our TP, we initiate coverage on CMS with a Strong Buy recommendation.

Figure 31 : Sum-of-parts valuation for CMS

Business division Valuation Multiple Valuation Per CMS Description

Method (x) (RM m) share

Cement P/E 15.0 1,237 3.72 Discount to our target FY14 P/E for Lafarge Construction material P/E 10.0 177 0.53 Pegged to 10x FY14 P/E Road maintenance P/E 9.0 525 1.58 Pegged to 9x FY14 P/E, in line with Protasco Property Book value

117 0.35 Estimated end-2012 book value, less MI

Samalaju development P/E 8.0 102 0.31 Conservative 8x FY14 P/E OM Sarawak P/E 8.0 62 0.19 Conservative 8x FY14 P/E Total value of business divisions 2,220.5 6.68 25% stake in K&N Kenanga

116.2 0.35 Market value

20% stake in KKB Engineering

139.7 0.42 Market value Net cash / (net debt)

563.7 1.70 End-FY14 forecast

Investment securities 107.4 0.32 End-FY14 forecast SOP 9.47 20% holding co discount (1.89) Target Price 7.57 Implied valuation of 10.8x FY14 P/E and 1.3x FY14 P/B

Source: Alliance Research, Bloomberg

Further upside to our valuation There are further upsides to our valuation for CMS as the value of its investment in OM Sarawak has yet to be fully reflected given that earnings contribution from Phase 1 of the smelter project is still very nascent in FY14. We believe Phase 2 of the project will also be earnings accretive to CMS due to cheap power secured under the 20-year PPA, but exact implementation timeline is yet to be disclosed by management. In addition, we had also valued CMS’ huge landbank in Kuching conservatively using historical book value, which actually is worth much more now if benchmarked against recent CMS’ recent disposal. Catalysts We expect several share price catalysts over the next 12 months: Investors increasingly reduce/switch their exposure in Peninsular-based cement stocks

- We expect cement market in Peninsular to face intense competition (new incoming supply) and rising production cost (electricity tariff hike) starting 1H14. The negative industry outlook, coupled with relatively premium valuation, should nudge investors to reduce/switch their exposure in Peninsular-based cement stocks to alternatives that are unaffected by those issues, such as CMS. In fact, we understand that institutional investors have generally been accumulating the stock, especially after the 13th GE was concluded in May.

Our SOP-based for CMS is RM7.57, implying 10.8x FY14 P/E and 1.3x

FY14 P/B

Value of OM Sarawak has yet to be fully reflected in our valuation

CMS’s huge landbank is worth much more

We expect investors to increasingly reduce/switch their exposure in

Peninsular-based cement stocks to alternatives such as CMS


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OM Sarawak Phase 1 smelter starts operation – We believe market is still taking a

cautious stance towards CMS’ investment in OM Sarawak given that it is different from its core business in building materials. Hence, the key competitive advantages of OM Sarawak (i.e. long-term access to cheap power, captive demand with ready off-take agreements, and strategic location) remain under-appreciated and overlooked by investors. We expect investors to gradually warm up and price in the value of OM Sarawak once the smelter starts to deliver positive results after starting production in 2Q14.

Higher dividend payout policy – From the current 30% payout, we expect CMS to raise

its minimum dividend payout policy to 40-50% in FY14-15. This would increase its dividend yield to 3.8-5.7%, making it comparable to peers’ dividend yield. With a decent yield now coupled with strong cashflow generation and strong balance sheet, we believe investors will re-rate the stock accordingly.

KEY INVESTMENT RISKS The key investment risks for CMS are: Perceived political risks - CMS is perceived as politically linked as it is majority owned by

family members related to the Chief Minister of Sarawak. However, given our conservative assumptions and valuations for its various business divisions, we believe we have adequately accounted for this risk. Furthermore, we believe situation is not likely to change materially even if there is a change in government, as CMS’ natural monopoly on cement market in Sarawak is primarily due to market forces rather than politically driven.

Fluctuation in ferroalloy prices – A decline in ferroalloy prices will result in lower profit contribution from OM Sarawak, but unlikely to turn into a loss given its much lower cost of production relative to global peers. We believe floor price for FeSi in the export market is capped at USD1,200/tonne, being the average production cost for FeSi exporters/producers in China if the 25% export tax is disregarded. This augurs well for OM Sarawak who has a cheaper production cost of about USD1,050/tonne due to its cheaper electricity tariff under the 20-year PPA.

We expect investors to gradually warm up to OM Sarawak once the smelter starts production in 2Q14

Higher dividend payout policy will make its yield comparable to peers

CMS is perceived as politically linked, but we have account for this

risk by using conservative assumptions

A decline in ferroalloy prices will result in lower profit contribution

from OM Sarawak


20

Cahya Mata Sarawak Financial Summary

Balance Sheet Income StatementFYE Dec FY11 FY12 FY13F FY14F FY15F FYE Dec FY11 FY12 FY13F FY14F FY15FPPE 458.7 488.6 515.7 611.4 697.5 Revenue 1,012.6 1,203.6 1,354.0 1,353.5 1,376.6 Land held for development 63.3 63.5 63.5 63.5 63.5 EBITDA 218.2 287.2 309.9 326.5 348.7 Intangibles 64.0 62.9 62.9 62.9 62.9 Depn & amort 34.8 53.4 53.6 60.0 69.6 Inventories 90.3 106.7 123.1 123.0 125.1 Net interest expense (18.3) (10.9) (1.7) (1.3) (4.9) Receivables 205.4 266.1 283.1 283.0 287.6 Associates & JV 13.6 4.1 6.0 13.8 40.9 Other assets 568.5 628.4 670.1 683.2 723.4 EI - - - - - Deposit, bank and cash 650.3 524.0 535.9 638.3 724.6 Pretax profit 178.7 226.9 260.6 278.9 315.0 Assets 2,100.6 2,140.2 2,254.4 2,465.3 2,684.6 Taxation (34.2) (60.3) (67.5) (66.3) (68.5)

MI (24.5) (30.9) (37.7) (29.9) (33.9) LT borrowings 67.3 49.1 - - - Net profit 120.0 135.7 155.5 182.8 212.6 ST borrowings 148.4 40.7 - 75.0 150.0 Core net profit 120.0 135.7 155.5 182.8 212.6 Payables 226.0 306.7 364.1 360.5 364.7 Other l iabil ities 56.8 56.8 56.8 56.8 56.8 Key Statistics & RatiosLiabilities 498.5 453.3 420.9 492.3 571.5 FYE Dec FY11 FY12 FY13F FY14F FY15F

Share capital 329.5 332.4 332.4 332.4 332.4 GrowthReserves 659.0 738.0 846.8 956.5 1,062.8 Revenue 7.3% 18.9% 12.5% 0.0% 1.7%Shareholder's equity 1,602.0 1,686.9 1,833.5 1,973.0 2,113.2 EBITDA 25.3% 31.6% 7.9% 5.3% 6.8%MI 186.0 206.0 243.7 273.6 307.5 Pretax profit 50.4% 27.0% 14.9% 7.0% 12.9%Equity 1,602.0 1,686.9 1,833.5 1,973.0 2,113.2 Net profit 82.5% 13.1% 14.5% 17.6% 16.3%

Core EPS 82.4% 12.1% 14.5% 17.6% 16.3%Equity and Liabilities 2,100.6 2,140.2 2,254.4 2,465.3 2,684.6

ProfitabilityCash Flow Statement EBITDA margin 21.5% 23.9% 22.9% 24.1% 25.3%FYE Dec FY11 FY12 FY13F FY14F FY15F Net profit margin 11.9% 11.3% 11.5% 13.5% 15.4%Profit before taxation 178.7 226.9 260.6 278.9 315.0 Effective tax rate 19.2% 26.6% 25.9% 23.8% 21.8%Depreciation & amortisatio 34.8 53.4 53.6 60.0 69.6 ROA 5.7% 6.4% 7.1% 7.7% 8.3%Changes in working capital 54.8 (5.1) 24.0 (3.5) (2.6) ROE 8.5% 9.2% 9.8% 10.8% 11.8%Net interest received/ (paid 6.9 0.3 1.7 1.3 4.9 Share of associates & JV pr (13.6) (4.1) (6.0) (13.8) (40.9) LeverageTax paid (24.0) (45.5) (67.5) (66.3) (68.5) Debt/ Assets (x) 0.10 0.04 - 0.03 0.06 Others 2.8 (6.8) (1.7) (1.3) (4.9) Debt/ Equity (x) 0.15 0.06 - 0.04 0.08 Operating Cash Flow 240.4 219.1 264.8 255.4 272.6 Net debt/ equity (x) Net Cash Net Cash Net Cash Net Cash Net Cash

Capex (153.1) (81.8) (80.0) (155.0) (155.0) Key DriversOthers 12.0 (61.6) (36.4) - - FYE Dec FY11 FY12 FY13F FY14F FY15FInvesting Cash Flow (141.0) (143.4) (116.4) (155.0) (155.0) Clinker plant capacity ('000 MT) 800 800 900 900 900

Util isation rate, % 90 30 75 90 90 Issuance of shares - - - - - Changes in borrowings (93.5) (40.4) (89.8) 75.0 75.0 Cement plant capacity ('000 MT) 1,750 1,750 1,750 1,750 1,750 Dividends paid 0.1 6.5 - - - Util isation rate, % 81 88 90 90 90 Others (129.0) (168.1) (46.6) (73.1) (106.3) Financing Cash Flow (222.5) (202.0) (136.5) 1.9 (31.3) Phase 1 smelter ('000 MT) - - - 308 308

Util isation rate, % - - - 20 70 Net cash flow (123.2) (126.3) 11.9 102.3 86.3 Ferrosil icon ASP (USD/tonne) - - - 1,400 1,400 Beginning cash 773.4 650.3 524.0 535.9 638.3 Ending cash 650.3 524.0 535.9 638.3 724.6 Valuation

FYE Dec FY11 FY12 FY13F FY14F FY15FEPS (sen) 36.4 40.8 46.8 55.0 64.0 Adj EPS (sen) 36.4 40.8 46.8 55.0 64.0 P/E (x) 16.2 14.4 12.6 10.7 9.2 EV/ EBITDA (x) 6.9 5.3 4.6 4.3 4.0

Net DPS (sen) 11.3 12.8 14.0 22.0 32.0 Yield 1.9% 2.2% 2.4% 3.7% 5.4%

BV per share (RM) 4.86 5.07 5.52 5.93 6.36 P/BV (x) 1.2 1.2 1.1 1.0 0.9

Price Date: 29 November 2013


21

DISCLOSURE Stock rating definitions Strong buy - High conviction buy with expected 12-month total return (including dividends) of 30% or more Buy - Expected 12-month total return of 15% or more Neutral - Expected 12-month total return between -15% and 15% Sell - Expected 12-month total return of -15% or less Trading buy - Expected 3-month total return of 15% or more arising from positive newsflow. However, upside may not be sustainable Sector rating definitions Overweight - Industry expected to outperform the market over the next 12 months Neutral - Industry expected to perform in-line with the market over the next 12 months Underweight - Industry expected to underperform the market over the next 12 months Commonly used abbreviations Adex = advertising expenditure EPS = earnings per share PBT = profit before tax bn = billion EV = enterprise value P/B = price / book ratio BV = book value FCF = free cash flow P/E = price / earnings ratio CF = cash flow FV = fair value PEG = P/E ratio to growth ratio CAGR = compounded annual growth rate FY = financial year q-o-q = quarter-on-quarter Capex = capital expenditure m = million RM = Ringgit CY = calendar year M-o-m = month-on-month ROA = return on assets Div yld = dividend yield NAV = net assets value ROE = return on equity DCF = discounted cash flow NM = not meaningful TP = target price DDM = dividend discount model NTA = net tangible assets trn = trillion DPS = dividend per share NR = not rated WACC = weighted average cost of capital EBIT = earnings before interest & tax p.a. = per annum y-o-y = year-on-year EBITDA = EBIT before depreciation and amortisation PAT = profit after tax YTD = year-to-date


22

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AIBB may have no input into company-specific coverage decisions (i.e. whether or not to initiate or terminate coverage of a particular company or securities in reports produced by Alliance Research) and Alliance Research does not take into account investment banking revenues or potential revenues when making company-specific coverage decisions. In reviewing this report, an investor should be aware that any or all of the foregoing, among other things, may give rise to real or potential conflicts of interest. Additional information is, subject to the overriding issue of confidentiality, available upon request to enable an investor to make their own independent evaluation of the information contained herein. Published & printed by: ALLIANCE RESEARCH SDN BHD (290395-D) Level 19, Menara Multi-Purpose Capital Square 8, Jalan Munshi Abdullah 50100 Kuala Lumpur, Malaysia Tel: +60 (3) 2604 3333 Fax: +60 (3) 2604 3921 Bernard Ching Email: [email protected] Executive Director / Head of Research

Documents

Cahya Mata Sarawak - Fundamental Analysis · OM Sarawak Phase 1 smelter project is expected to commenceinitial production by 2Q14. Earnings contribution stillwould be immaterial in