• We have an OVERWEIGHT view on the Building Materials sector for the next 6-12 months. We are positive on all sub segments other than the cement industry in Peninsular Malaysia. The prospects of the sector are bright, underpinned by the stronger demand for building materials based on record order books of the construction players in the country. These include various mega projects such as the East Coast Rail Link (ECRL) (RM55bil), MRT2 (RM32bil), Pan Borneo Highway (RM16b), and mega-scale township development such as TRX, KL118 and others. Other potential projects in the pipeline include the Pan Borneo Sabah highway (RM12.8bil), LRT3 (RM9bil), Gemas–Johor Bahru electrified double-tracking rail (RM7.5bil), and Kuala Lumpur–Singapore high-speed rail (KL-Singapore HSR) (RM50- 60bil). These mega projects will further boost the demand for building materials such as steel, cement and aluminium.

• Our OVERWEIGHT stance on the Building Materials sector could be further strengthened by higher-than-expected ASP for selected building materials like steel and aluminium.

o Steel ASP has shown a recovery since 4Q2016 with the ongoing steel supply cuts in China (due to global steel glut caused by China in 2015) by 50mil MT by end-June 2017 and cost-push factors (increase in raw material prices). Local steel ASP is further boosted with the extension of safeguard measures for imported steel after a preliminary investigation by MITI to impose safeguard duties for steel reinforcing bar (REBAR) and steel wire rods (SWR) & deformed bar in coil (DBIC) till April 2020. YTD average steel ASP stands at RM2,050 MT. We project steel prices of RM1,890 MT and RM2,022 MT for 2017 and 2018 respectively.

o Meanwhile, aluminium demand is expected to grow modestly driven by the transportation and construction segment. ASP for aluminium is seen to remain stable due to the sturdy demand as well the ongoing reforms in China to cut excess supply coupled with the move to address pollution caused by the aluminium smelters in the country. YTD aluminium ASP stands at US$1,850 MT. We project aluminium prices of US$1,785 MT and US$1,910 MT in 2017 and 2018 respectively.

o Unlike steel and aluminium, the outlook for cement in the peninsula remains lacklustre. Cement ASP continues to depress in 1H2017 mainly due to the oversupply within Peninsular Malaysia. Earnings for peninsular cement players were further pushed down to a record low. For year 2017, cement ASP is forecast to be at RM245/tonne. Large-scale construction projects, which are expected to begin in 2H17, will spur greater demand resulting to an improved cement ASP. Contrary to peninsular cement players, the only cement player in Sarawak continues to deliver positive results due to strong demand of cement in the state coupled with better ASP. We project cement price of RM255/tonne in 2018.

• However, we may downgrade our OVERWEIGHT stance on the building material sector to NEUTRAL if: 1) demand volume for building materials is hampered by federal government plans to postpone, scale down or even cancel infrastructure projects due to unforeseen circumstances such as economy slowdown; and 2) ASP for building materials to drop significantly due to policies set by the regulator or startling external headwinds.

• Our top large-cap and small-cap picks are Cahya Mata Sarawak and Ann Joo Resources respectively.

• Cahya Mata Sarawak (BUY, FV: RM5.15). The sole cement manufacturer and one of the dominant local players supplying building materials (aggregates, premix and wire mesh) through its construction and materials trading arm. The ongoing development plan in the state, spearheaded by the federal and state governments, namely SCORE and SETP will spur the construction industry via infrastructure projects such as road connectivity improvement via the construction of Pan Borneo Highway and roads into the hinterland and building of additional power plants including hydroelectric power plant. Other potential projects in the state pipeline include improving public transport amenities via the introduction of LRT and BRT in Kuching.

• Ann Joo Resources (BUY, FV: RM3.86). Dubbed the dominant local steel players which controls 20% of the market share and able to produce high tonnage of steel. AJR is able to maintain better margin in comparison to its peers in the industry due to cost optimisation in production, adopting the hybrid BF-EAF technology.

Source: AmInvest Research - 13 Jun 2017