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Cement counters unexciting as analysts favour steel [01-04-2011]  
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For exposure to construction materials, analysts are more bullish on steel counters than cement as the latter faces near term demand uncertainties and pressure from rising input prices.

Analysts also note that the larger cement stocks have “been priced to perfection” and are no longer cheap.

Construction material counters have come into the spotlight on optimism that the Malaysian construction sector is heading for sunny days ahead driven by a long list of property and infrastructure projects lined up.

Among the steel stocks, analysts’ top pick is Ann Joo Resources Bhd given its projected strong earnings momentum and increasing domestic demand for steel.

Analysts expect its earnings to grow by some 37%, which will drive its forward price-to-earnings (PER) ratio to 8.8 times from 12.1 times, according to Bloomberg forecasts. Ann Joo last traded at RM2.88.  

As for cement players, analysts said domestic demand would likely only grow in the second half of this year but any growth in demand would unlikely be significant given that it was currently at a low base.

“To be fair, there has been some demand improvement with the low-cost carrier terminal or KLIA2 jobs and the light rail transit (LRT) jobs.  

“There appears to be enough catalyst to drive demand in the second half but the question is, has it been priced to perfection?” an analyst at AmResearch told The Edge Financial Daily.

Another analyst notes, “If there is enough demand to go around, then cement companies won’t have to give that much rebates.”

In a recent note, Maybank IB Research said it understood that discounting activities had intensified in January and February this year with rebates trending up to about RM35 per tonne versus about RM28 per tonne in 4Q10.

Maybank IB Research also said domestic cement average selling prices (ASP) had been raised efficiently, since the liberalisation of the cement sector in 2008, to correspond with cost inflation and protected cement markers’ margins.

Adding to the cloud over cement counters is speculation as to whether cement prices could see an imminent hike after a period of flat pricing.

“The price of coal is the wild card here. It is a concern for companies,” said an analyst at a local research house, given that coal contributes to 30% to 40% of cement companies’ cost.

The benchmark Newcastle coal prices surged to a three-year high of US$134.80 (RM408.44) per tonne on Feb 10 after floods in the Australian state of Queensland in January disrupted supply.

Prices, however, have eased off with coal trading at US$123.20 per tonne last Friday for April delivery.

Analysts said that although cement companies could pass on a portion of rising costs to customers, it was not as simple as it seemed.  

Meanwhile, a strong rally in cement stocks is also making them less appealing relative to earnings growth, although analysts note they generally yield good dividends.

Cement stocks like Lafarge Malayan Cement Bhd and Tasek Corp Bhd saw a good run last year as Lafarge rallied to historic levels of around RM8 per share late last year.

Lafarge shares have since been hovering lower to close at RM7.40 last Friday.

Tasek Corp shares surged 16% to RM8.48 on Feb 21 after the company declared a 30% final dividend less 25% tax. Its shares hit a historic high of RM8.85 on Friday.  

YTL Cement Bhd shares held steady above the RM4.50 level in the last six months to close Friday at RM4.80.

However, an analyst pointed out that valuations for cement counters were no longer cheap, especially for industry bellwether and fund favourite Lafarge although smaller stocks in the sector like Tasek and YTL Cement are still attractively priced at about 10 times forward earnings, but with modest earnings growth prospects.

According to Bloomberg data, Lafarge is trading at a forward price-to-earnings ratio of 16.1 times while YTL Cement and Tasek are trading at 9.7 and 10.3 times respectively, based on their closing prices on Tuesday.

While earnings growth prospects are seen as unexciting due to cost pressures, they do offer decent dividend yields for investors. According to Bloomberg forecasts, gross yields are 4.4% for Lafarge, 2.7% for YTL Cement and 3.4% for Tasek.  

In a recent note on Lafarge, Maybank IB Research said short term sentiment on Lafarge had been coloured by concerns over high coal costs which had risen some 15% since the last cement ASP hike of 10% to RM300 per tonne in May last year.

“We believe an ASP hike is imminent given the positive domestic pricing power and healthy balance sheets among the sector’s oligopolistic players,” said Maybank IB Research in a note dated Feb 24.

In February, Maybank IB Research maintained its “buy” call on Lafarge with a target price of RM8.50.

AmResearch, meanwhile, stuck to its “hold” call with a fair value of RM7.27 taking into account a 9% to 12% cut in its forecast earnings for Lafarge in FY11 and FY12 given the spectre of rising input costs.

In early March, Hong Leong Investment Bank (HLIB) Research said Lafarge was bracing for higher cost of production as prices of coal, gypsum and paper bags have increased since last year. “Management is working hard to improve its cost efficiency to contain the rise in production cost,” it said.

HLIB Research said export prices for cement are unlikely to recover anytime soon, due to the strong ringgit and weak construction activities in its targeted overseas markets.

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