SWOT analysis for YTL Cement BerhadStrengths1. Savvy owner-operator: the outperformance of this company to its savvy leadership, closely guidedby YTL Corp’s management.2. Strategic Plants: Based on the location of the plants, YTL Cement is in a good position to benefit from the construction mega-projects throughout the nation3. Consistent Delivery: With an average five-year (Return of Equity) ROE of 17%, YTLC consistently outperforms Lafarge Malaysian Cement (average five-year ROE of 3%) and Cement Industries of Malaysia Bhd. (average five-year ROE of 2.1%). Management was able to grow its business despite the construction industry doldrums shows.Weaknesses1. Over-dependence on expansionary fiscal policy: Bulk cement and ready-mixed concrete (RMC) demand is heavily dependent on a healthy economy with a spending drive. Making up over 70% of total sales, the demand for bulk cement and concrete typically comes from large-scale projects.2. Regulated ceiling price, with no cost pass-through: We reiterate our caution on the rising cost of materials and production, given that cement makers will have to absorb all cost hikes and are unable to pass-through the hikes to customers due to the price ceiling.3. A mature industry: The cement industry is relatively mature, with the top three cement makers controlling almost 90% of the market share. Growth by way of acquisition will be tough for YTLC, especially after a failed bid to acquire CIMA in 2002.Opportunities
1. Cement demand to rise: The bullishness of the pumppriming budget will trigger more construction activity and will inevitably result in higher consumption of building materials such as cement2. Recent price hike to boost growth: The recent 10%-blended price revision in December 2009 will benefit every cement manufacturer including YTLC. With the price hike in place, coupled with the heightened demand from the construction sector, we forecast a 13% and 40% earnings growth for FY10 and FY11 respectively.3. Geographic-hedge in Jurong Cement: We believe that management has taken a Geographic-hedge in buying Jurong Cement. The cement industry in Malaysia is relatively mature with minimal acquisition opportunities and we believe that YTLC will eventually penetrate into the Singapore and China market aggressively, especially once the construction sector in Malaysia cools down.4. A laissez-faire market: The cement makers are currently lobbying the C&CA to completely remove the price ceiling, and to allow market economics to determine the price of cement. Once deregulated, we believe the cement makers will cooperate and raise cement prices systematicallyThreats1. Price war, again: Though the price war ended with a mutual agreement among cement makers, this does not guarantee that another price war will not take place again. In desperate times, it believe that smaller cement makers will create a price war to defend their market shares and to stay afloat, inevitably forcing larger players to follow suit. Cement makers like YTLC are always prone to such price wars, unless the C&CA implements a “price floor”2. Excess capacity in the long run, if not managed correctly: Although the demand for cement and RMC is on the rise, they do not view the upcoming construction boom from the 9MP as a structural shift in demand to warrant a capacity expansion. To cope with the rise in local demand, management can adopt a policy to reduce exports, given that export
prices are typically lower and attract lower margins. Should YTLC expand its capacity sharply, we foresee a potential long-term capacity overhang and management will have to resort to exports to absorb the excess capacity.Risk ManagementThe YTL Cement Group’s strong financial profile is the result of a system of internal controland risk management designed to mitigate risks which arise in the course of business. This isexemplified by the YTL Cement Group’s strategy of financing acquisitions on a nonrecoursebasis, as well as in undertaking cement plant operations, in order to reduce risk levels. TheYTL Cement Group’s joint venture in 1993 with the Pahang State Government to build andoperate Pahang Cement Sdn Bhd’s (“Pahang Cement”) Bukit Sagu cement plant is anexample of this strategy. Pahang Cement is a whollyowned subsidiary of YTL Cementfollowing the acquisition of the remaining 50% stake in Pahang Cement by the Company in2004.Strategic optionYTL Cement will continue to focus on maximising production efficiencies in order to itigaterising costs, enhancing product quality and improving customer service levels. The Groupwill continue to build on its proven track record of organic and acquisitiondriven growth tofurther strengthen our integration into upstream and downstream business activities.Competitive Strategy1. Strategic, timely acquisitions complete platform for growthYTL Cement (YTLC) has transformed itself from mainly a ready-mixed concrete player intothe 2nd largest cement producer in Malaysia after Lafarge Malayan Cement (Lafarge). Bygaining control of both Pahang Cement and Perak Hanjoong, YTLC has built a solid platformfor growth. YTLC will consolidate a 100% contribution from Pahang Cement in FY05, whilePerak Hanjoong will contribute from FY06 onwards. These acquisitions combined will drivea conservative 3-year EPS CAGR of 11%2.ASP should recover ahead of demand bottoming out
YTLC’s new capacity was timely to catch the bottom of the domestic cement industry. In theimmediate term, supply side consolidation will almost automatically translate into betterpricing discipline among the remaining players. Although industry sales volume will take alonger time to recover, YTLC has an advantage over its peers as it can source internaldemand from YTL group’s construction and property divisions. In the medium term, we seelocal cement demand bottoming out which will result in better capacity utilisation and highercement prices, and hence widening of operating margins.3. Perak Hanjoong completes the jigsawYTLC has acquire a 65% stake in Perak Hanjoong. This will expand YTLC’s presencegeographically given that Perak Hanjoong is in the West Coast of Peninsular Malaysia. it fitsinto YTLC’s strategy to be a larger cement player to gain better economies of scale andIt will be carried out in two tranches; the first 32.1% stake to be acquired from DoosanHeavy Industries of Korea at RM75m, while the second 32.7% stake will be acquired fromDanaharta at RM110m.Perak Hanjoong operates two plants in Perak with a total clinker and cement capacity of 3.0mand 3.4m MT per annum respectively. Unlike Pahang Cement, Perak Hanjoong has beenoperating inefficiently and the weak operating performance is not enough to absorb its veryhigh financing costs. They estimate that Perak Hanjoong’s production cost is over 20%higher than Pahang Cement’s RM105/MT.YTLC will be able to turn around Perak Hanjoong within the next 2 years. Low-lying fruitsinclude Perak Hanjoong’s high interest costs (mainly due to near-junk bond rating debts) andhighly inefficient cost structure. Over the next 12 months, YTLC plans to embark on a majorcost-reduction program to bring Perak Hanjoong’s cost structure more inline with PahangCement’s.They have conservatively project some minor costs reduction for Perak Hanjoong, althoughmanagement is confident that they will be able to achieve more. This poses upside bias to ourforecasts.
The acquisitions will make YTLC the 2nd largest cement producer after Lafarge with acombined clinker and cement capacity of 4.2m and 4.7m MT respectively. Its clinkercapacity of 4.2m MT represents roughly a quarter of the industry’s installed capacity4.Valuation and recommendationWithin the industry, investors will likely still accord Lafarge a premium owing to its overallsize, and given its greater earnings sensitivity to a cement price and volume rebound in arecovery scenario. That said, YTLC’s current discount vis-à-vis Lafarge is too wide –YTLC’s 14x FY05f PE versus Lafarge’s 23x. In the past, Lafarge’s hefty premium valuationwas partly justified by Lafarge’s dominant market share and YTLC’s much smallerattributable capacity when it only has 50% stake in Pahang Cement.However, in view of YTLC’s emergence as a major cement player, the PE discount shouldmirror the fast narrowing gap in relative-market shares and pricing power of the twodominant players.Focus AreaYTL Cement will continue to focus on maximising production efficiencies in order toproductquality and improving customer service levels. The Group will continue to buiorganic andacquisition-driven growth to further strengthen our integration into upstr activities. mitigaterising costs, enhancingld on its proven track record of eam and downstream businessThe Group has continued to focus on reducing its total carbon dioxide emissions via theincreased usage of blended cement, whilst also improving the quality and performance of itsrange of products through its research and development (R&D) activities. The Group willcontinue to strengthen its market presence throughout Malaysia and in overseas markets, withan emphasis on regional expansion and leveraging on its established logistics network andoperational and technological know-how to develop new products and enhance its existingproducts to meet our customers’needs.