Investment Highlights

• We maintain our UNDERWEIGHT call, forecasts and FV of RM0.73 based on 8x FY20 FD EPS of 9.1sen.

• Ann Joo has entered into a memorandum of understanding (MoU) with Southern Steel Bhd (Southern Steel) for a RM1.65bil merger deal, effectively. Both companies will inject their core operating units (assets and liabilities) into a JV company, in exchange for a stake in the JV (and hence, no cash is involved in the deal). The core operating units of Ann Joo and Southern Steel are being valued at RM907.5mil and RM742.5mil respectively, and therefore Ann Joo and Southern Steel will be granted a stake of 55% and 45% in the JV accordingly.

• The rationale of this deal struck by the two major long steel players in Malaysia is to create a vertically integrated entity with upstream iron making capability such as hot metals and pig irons through Ann Joo’s blast furnace (BF) technology), and downstream products such as bar and wire rods through Ann Joo and Southern steel electric arc furnace (EAF) and rolling mills. In addition, the merger will also bring about greater operational efficiency, synergy and cost savings.

• We believe over the immediate to short term, the deal is, at best, only neutral to Ann Joo. On one hand, the deal will bring about scale. On the other hand, by virtue of a 55% stake in the combined entity, Ann Joo will have to bear the losses from Southern Steel’s operations. For FY19 (June), Southern Steel reported a net loss of RM119mil vs. Ann Joo’s narrower net loss of RM44.4mil for 1HFY19 (Dec).

• Assuming Southern Steel’s losses are to sustain, Ann Joo is to make RM54.3mil net profit in FY20F based on our existing forecasts and the merged entity will derive synergies and cost savings amounting to RM104mil (2% of combined turnover, we assume). Based on our estimates, Ann Joo’s FY20F will be eroded by about 60% from RM54.3mil to RM21.6mil. Over the longer term, assuming Ann Joo is able to help turn around Southern Steel, there could be a higher chance that the merged entity could do better.

Source: AmInvest Research - 8 Oct 2019