Investment Highlights

• We cut our FY18-20F earnings forecasts by 18%, 20% and 13% respectively, trim our FV by 20% to RM3.55 (from RM4.34), but maintain our BUY call.

• The earnings downgrade is largely to reflect a weaker sales volume growth of 2% in FY18F (from 5% previously) and higher input costs throughout FY18-20F. Our FV is based on 10x revised FY18F EPS, in line with the average of its three midcycles’ PE multiples during Jan’12–Sep’13, Jun’05–Jun’08 and Sep’10 till now.

• We came away from a recent visit to Ann Joo feeling cautious on the company’s prospects especially in FY18. The company has highlighted that its FY18 performance would not be as robust as expected largely due to the lower-than-expected sales volume for its long product (i.e. construction steel). This is mainly driven by a slower-than-expected rollout of large infrastructure projects in 1H18 resulting in lower construction steel demand. Not helping either is the sluggish property market segment which has further deteriorated the demand for Ann Joo’s wire rods in FY18.

• Adding to that is the escalating operating cost which has further dampened the overall company’s margin. The ASP of scrap metal has increased by 20% YoY due to sturdy demand brought about by: 1) the current activation of idle EAF mills (annual steel production of ~40mil MT which requires approximately ~45mil MT of scrap metal) in the US after Washington announced import tariff; and 2) rolling out of several EAF mills (~48mil MT capacity production) by stages from 2018 to 2023 in China, replacing closed mills with the endorsement by Ministry of Industry and Information Technology in 2017. Also, coke price has risen 11% YoY mainly due to the ongoing curb on coke production in China, further reducing the global supply in the market.

• On a brighter note, the company remains upbeat in 2H18 and beyond as it expects demand for steel construction to pick up strongly on the back of the “full rollout” of infrastructure projects and a modest growth in the property segment. Ann Joo also plans to upgrade its current steel mill facility in order to improve production efficiency and install new rolling capacity in 4Q18 with an estimated capex of ~RM50mil.

• We expect steel prices to improve further from FY18 onwards on the back of: 1) ongoing reforms in China to reduce another 30mil MT of its capacity (to date, the Chinese government has slashed production by 120mil MT with a target of 150mil MT by year 2020); and 2) the growing demand of construction steel from the rollout of infrastructure projects which are expected to pick up considerably from 2H18 onwards.

• We now assume steel volume growth in FY18 to be flat at 2% due to slower-than-expected infrastructure activities in the 1H18, but will pick up gradually from 2H18 onwards. Volume is expected to grow healthily by 5% annually in FY19- 20F on the back of stronger demand driven by the acceleration of mega infrastructure projects and improved export sales in the Asean region.

• We raise our steel ASP assumptions by 19-21% to RM2,500/MT, RM2,650/MT and RM2,850/MT for FY18-20F respectively. However, these are offset by our higher assumptions for raw material prices where: 1) scrap metal price is raised by 20% annually in FY18-20F to US$350/MT, US$370/MT and US$390/MT respectively; and 2) coke price up by 10% annually in FY18-20F to US$290/MT, US$310/MT and US$330/MT respectively.

• AJR’s earnings visibility remains good underpinned by: 1) steel production curbs in China due to the ongoing structural reforms (particularly, elimination of induction furnaces). This has opened the door for AJR to sell in the Asean market which currently relies largely on steel supply from China; and 2) stronger demand for construction steel thanks to the rollout of infrastructure projects.

• We continue to like AJR because: 1) it is one of the dominant local steel players, controlling 20% of the market share; 2) buoyant steel prices in the international market as a result of production curbs in China, while local steel prices will be further supported by safeguard duties on imported steel till April 2020; 3) rising local demand backed by the rollout of infrastructure projects; and 4) cost optimisation in production which enables AJR to realise better margins than its competitors.

Source: AmInvest Research - 30 Apr 2018