Investment Highlights

• We reduce our FY19–21F net profit forecasts by 16%, 11%, and 9% respectively, cut our FV by 10% to RM0.87 (from RM0.97 previously) based on 8x revised FY20F FD EPS of 10.8 sen. We maintain our UNDERWEIGHT call for Ann Joo Resources (Ann Joo).

• The earnings cuts are largely to reflect the higher cost of input iron ore, squeezing margins further. Iron ore prices hit new highs in recent days, surpassing the US$110/tonne level, largely due to persistent supply disruption from Brazil in the aftermath of the Vale dam disaster coupled with the cyclone in Australia. For 2Q2019, iron ore averaged at US$106/tonne, rising almost 70% YoY vs. US$63/tonne in 2Q2018 (Exhibit 1). Typically, iron ore and scraps make up 60–70% of total steel production cost.

• While we maintain our steel average selling price (ASP) of RM2,100–2,300/tonne in FY19–21F, we raise our average iron ore price assumption to US$90/tonne (from US$85). We also maintain our flattish sales volume growth assumption of 0–1% against a backdrop of a muted outlook for the local construction sector.

• Our cautious assumption on steel ASP is in line with the unfavourable outlook for the steel industry in China (that constitutes more than half of the world’s demand and supply of steel). Industry experts forecast steel surplus in China to rise to 174mil tonnes in 2019F (+55% from 112mil tonnes in 2018) as production is projected to grow by 4–5% (on hope of increased spending on infrastructure projects in China) while consumption is projected to contract by 1.7% (as in reality, investments are slowing amidst the USChina trade war) (Exhibit 3).

• China’s steel surplus normally ends up as exports to the rest of the world. The oversupply situation could ease (but would not go away completely) in 2020F as China’s steel surplus is projected to reduce to only 96mil tonnes on the back of a 10% drop in production (as the authorities intensify their efforts to eliminate obsolete and highlypolluting capacity from the system on environmental concerns) and a further 2.3% decline in consumption.

• We remain cautious on Ann Joo as its fortunes as a long steel player are inevitably tied to construction sector, of which prospects have weakened. Given the still elevated national debt, the government has no choice but to remain steadfastly committed to fiscal prudence which means the revival of the East Coast Rail Link project could be a “zero-sum game” as it may impede the government’s ability to implement other public infrastructure projects.

Source: AmInvest Research - 5 Jul 2019