Highlights

Higher  natural  gas  tariff  effective  November  2014.  Gas Malaysia  will  raise  natural  gas  tariff  for  non-power  sector  in Peninsular  Malaysia  by  2.3%  to  RM19.65-RM20.11/mmbtu (depending  on usage).   

Minimal  impact.  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  the impact  is minimal.

Based  on  our  estimates,  the  natural  gas  hike  will  reduce  our FY15  net  profit forecasts for  the  steel  players  (under  HLIB’s coverage) by  less than 1% of their bottom lines,   assuming: (1) The natural gas tariff will be  raised by  2.34% 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  #p#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,  our  top  pick  is  Lafarge  (HOLD;  TP:  RM9.74). We  like  Lafarge  for  its  defensive  earnings  quality  and  strong balance  sheet  (net  cash  of  58/share  as  at  30  June  2014), which  in  turn  indicates  its  ability  to  maintain  its  generous dividend  payout.

Source: Hong Leong Investment Bank Research - 30 Oct 2014