Highlights

Higher electricity tariff. The Government announced that electricity tariff for industry users will be raised by 16.8% (for industrial usage), respectively, effective 1 Jan 2014.

For the steel players. The hike in electricity tariff will further impair the domestic steel players’ earnings visibility, as electricity is one the major source of energy to the steel players, and we believe it is tough for steel players to pass on the higher cost of production to the end consumers given the tough competition environment.

For Lafarge. Despite the good demand prospects for cement, we believe Lafarge will still unlikely pass on the higher cost of production to customers, given the relatively intense price competition within the cement industry, resulting in cement players absorbing at least part of the higher energy cost in order to maintain their market position.

Based on our estimates, the hike in electricity tariff will reduce our FY14 net profit forecasts for the building material players (under HLIB’s coverage) by 9-52% (see Figure 1), assuming the electricity tariff to be raised by 16.8% across the board.

Catalysts

• Steel sub-segment
• China decides to further stimulate its economy; and
• More effective measures introduced by the Chinese authority to curb steel capacity.
• Cement sub-segment
• Timely implementation of ETP projects; and
• Sustainable demand from property development projects.

Risks

• Overcapacity in China remains over the longer term;
• Volatile input prices, making the sector a play on short-term potential price trend.

Forecasts

No change in our forecasts for now, pending more details on the electricity tariff revision and further update with respective company management.

Rating

Neutral

Steel sub-segment

Negatives – Overcapacity results in volatile earnings

Cement sub-segment

Positives – Positive demand outlook.

Negatives – Pricey valuation.

Sector View

We are keeping our Neutral stance on the sector for now, with a downward bias (due to the electricity tariff hike, and potentially, natural gas price hike which we believe will eventually be applicable to industrial users, in particularly the steel players).

Source: Hong Leong Investment Bank Research - 3 Dec 2013