Highlights

Higher natural gas tariff effective May 2014. Gas Malaysia will raise natural gas tariff revision for non-power sector in Peninsular Malaysia by 18.2-26.2% to RM17.64- RM19.65/mmbtu (depending on usage).

Not unexpected. While the natural gas tariff hike announcement will have an impact on the local steel producers’ production cost (and hence earnings, as we believe the higher energy cost will unlikely be passed through entirely), we believe this is somewhat expected (as we have already highlighted of the possibility of natural gas tariff hike since end-2013).

Based on our estimates, the natural gas hike will reduce our FY15 net profit forecasts for the steel players (under HLIB’s coverage) by 3.6-10%, assuming: (1) The natural gas tariff will be raised by 19.5% across the board (i.e. users consume >750k mmbtu per year); and (2) The higher energy cost is to be absorbed by the players.

Maintain our Neutral stance on the sector.

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 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

For exposure, out top pick is Lafarge (BUY; TP: RM9.74). We like Lafarge its defensive earnings quality and strong balance sheet (net cash of 53/share as at 31 Dec 2013), which in turn indicates its ability to maintain its generous dividend payout.

Source: Hong Leong Investment Bank Research - 14 Apr 2014