Ann Joo is the largest steel counter listed on Bursa and is often regarded as one of the lowest cost producers of long products in the steel industry. While Ann Joo has a defensive cost structure and is a beneficiary of China’s local supply cuts coupled with narrowing domestic-import price gap, we feel this is offset by the weak domestic construction outlook post GE14 and the risk of China expanding its overseas production. We initiate coverage on Ann Joo with a HOLD recommendation and TP of RM1.82 based on 8x P/E multiple pegged to FY19 EPS.

Defensive cost structure. As a hybrid Blast Furnace-Electric Arc Furnace (BF-EAF) operator in Malaysia, Ann Joo is often regarded as one of the lowest cost producers of long products in the steel industry. The BF-EAF allows for flexibility in choosing between hot metal and scrap metal to produce liquid steel, allowing Ann Joo to take advantage of pricing differentials of input materials and save on electricity costs.

China’s production cuts and expansion of production overse as. As part of China’s Blue Sky Policy since 2016, steel production capacity shutdowns have been carried out alongside measures to ensure the capacity cuts are sustained moving forward. However, Chinese steel producers have been looking to expand their steel production capacity to overseas countries e.g. Indonesia, Malaysia and Zimbabwe. With the conflicting implications of China’s production cuts and expansion of production overseas, we believe there will be limited further upside to steel prices in the near-term, but should remain above the RM2,000 range (i.e. billets, wire rods and bars).

Less incentive to import from China. As the price of importing China billet and rebar have caught up to Malaysia’s, we believe there is now less incentive for Malaysian steel players to import from China. The current environment should also boost Malaysia’s competitive edge in the export market as its rebar are of cheaper price and higher quality.

Construction industry dependency. With Ann Joo’s finished products (i.e. long products such as steel bars and wire rods) mainly catering to the local construction industry, they are highly dependent on its outlook. While we acknowledge the large contract awards over the past two years are expected to flow through construction and spur demand, we acknowledge the risk of delays in project rollouts post GE14 (mega project reviews) which will hamper the potential upside.

Forecast. We project Ann Joo’s core net profit to be FY18: RM121.2m, FY19: RM122.2m, and FY20: RM129.8m. The 39.5% drop in FY18 core net profit forecast from FY17 largely reflects slower construction activities from the revision of mega infrastructure projects by the newly elected government. We expect earnings in FY19 to remain flat (+0.8% YoY) from a prolonged slowdown in construction activities but pick up in FY20 (+6.2% YoY), following a recovery from the weak construction scene.

Initiate with HOLD, TP: RM1.82. We initiate coverage on Ann Joo with a HOLD recommendation and TP of RM1.82 based on 8x P/E multiple (10 year average PE, ex outlier years) pegged to FY19 EPS. The outlier years include an exceptionally low earnings year (FY09) and the loss making years (FY12 and FY15). We initiate coverage on Ann Joo with a HOLD rating as we believe the positives of high steel prices is offset by the weak near term construction outlook.

Source: Hong Leong Investment Bank Research - 16 Oct 2018