Building materials sector’s rise depends on strength of economic recovery

Monday April 13, 2009

THE newly formed Cabinet is expected to expedite the roll-out of construction projects under the stimulus packages and the Ninth Malaysia Plan.

IJM Corp Bhd CEO Datuk Krishnan Tan told a news wire service on Friday he was positive the new government would push forward the implementation of the fiscal stimulus packages. There are grounds for optimism in the rising supply of deals coming on stream. In view of the improved construction sector outlook, IJM intended to focus on its home turf, instead of in the Middle East and India, he added.

Fund managers share his optimism. Their buying support enabled IJM’s share price to gain 54% this year to RM4.64 on Friday, one of the best performing big cap stocks.
That is a partial but significant recovery from IJM’s high of RM8.25 last year.

As fund managers glimpse a light at the end of the smart tunnel, they have been buying up construction stocks, principally the Big Three – Gamuda Bhd, IJM and WCT Bhd.

This interest has also extended to the stocks of companies that manufacture building materials. In particular, fund managers poured into Lafarge Malayan Cement Bhd, the biggest player in the industry, leading it to rise to RM4.40, close to its 52-week high of RM4.76. The company is highly profitable, earning a net profit of RM119mil in just one quarter (Oct-Dec 2008). That helped Lafarge to rise to a total market value of RM3.7bil. Interestingly, as the biggest cement company, its market value is more than five times that of the biggest steel company, Southern Steel Bhd (RM680mil).

Lafarge commands a valuation premium in the industry, which is common for the biggest player in a sector. Hence, its share price exceeds that of YTL Cement Bhd (RM2.66) which is a sizeable number two in the industry.

The premium of Lafarge is all the more larger as YTL Cement’s earnings estimate is 55 sen a share for its financial year ending June 30 as against Lafarge’s 37 sen for the year ending Dec 31, according to consensus compiled by Bloomberg. This is not a spot that YTL is used to. Group holding company YTL Corp Bhd is itself near its 52-week high of RM7.60 as the stock closed at RM7.15 on Friday. In contrast, YTL Cement is far from its 52-week high of RM4.80.

While the profitability of cement producers is buoyant, that of steel producers sank into heavy losses, mainly inventory losses, in the Oct-Dec quarter.
It helps the cement producers that their main raw material – limestone – is mined locally at a time of volatile prices for natural resources in the global market.

Eventually, the steel producers will make profits again, but in the meantime, their market values have been bashed down with, sometimes plunging further than, their losses.

In the case of Lion Industries Corp Bhd, the market accords no value to its four steel mills at Bukit Raja, Banting (both in Klang), Pasir Gudang and Labuan.
Lion Industries has a market value of RM540mil and borrowings of about RM1.5bil which are less than the combination of its shares and convertible loan stocks in Parkson Holdings Bhd that are worth over RM1.3bil, its cash of RM600mil and steel inventories of RM440mil. On paper, investors in Lion Industries are getting its steel mills free. Alternatively viewed, it could repay all its borrowings if it sells its Parkson shares. That can be done with the Lion group’s chief Tan Sri William Cheng maintaining his reins over Parkson in which he holds a major direct stake.

CSC Steel Holdings Bhd is a smaller steel milling company but its parent is the very large China Steel Corp of Taiwan. Although CSC also incurred inventory losses the Oct-Dec quarter, it held net cash of over RM160mil. This too will be a company that will survive to benefit in the recovery cycle that will come sometime in the future.

Malaysia Steel Works Bhd, a unit of the Soon Seng group, is another depressed steel stock which traded at 71 sen or about a third of its net assets. While investors fretted over potential losses, the company has been consistently profitable over the last five years, including the Oct-Dec quarter last year when the rest of the industry was in the red. In that quarter, it earned a net profit of RM5.5mil.
Stainless steel FACB Industries Bhd is the smallest in the industry after its share price fell to 29.5 sen, giving it a market value of just RM25mil, an unlikely figure for a steel company. It suffered a large loss of RM41mil in the Oct-Dec quarter but that was almost entirely due to inventory losses.

Building materials are in a cyclical sector but as the Government’s stimulus spending accelerates, the worst should be over in this industry.The industry’s step-up to the next stage of its cycle will, of course, depend on the strength of the economic recovery.