9MFY18 core earnings of RM101.9m (-33.4% YoY) accounted for 64-84% of consensus and our full-year forecasts. Core earnings dropped YoY and YTD largely due to lower sales tonnage, weaker ASP and higher raw material costs. Management expects the weak local steel demand to linger into 1HFY19, with hopes of rebound in 2HFY19. We expect earnings to remain tepid as the slowdown in construction activities will likely remain weak in the near-term. Maintain HOLD, with a lower TP: RM1.44 to reflect the revision in our earnings forecast.

Below expectations. 9MFY18 core earnings of RM101.9m (-33.4% YoY) accounted for 64-84% of consensus and our full-year forecasts. We deem the results below expectations as we now expect 4Q18 to come in even weaker (on QoQ basis) on the back of rainy season (which in turn restricts construction activities, and hence domestic demand for steel products) and lower ASP (arising from intense competition).

QoQ. Despite the slight increase in revenue, core earnings fell 58.4% to RM12.4m, due to weaker ASP and higher raw material costs, which have in turn resulted in margin compressions at both manufacturing and trading segments.

YoY/YTD. Core earnings dropped 75.4% and 33.4% to RM12.4m and RM101.9m respectively, attributed to lower sales tonnage, weaker ASP and higher raw material costs, which have in turn, resulted in margin compressions at both manufacturing and trading segments.

Challenging market environment. The domestic steel industry remains challenging with competition from new player (namely Alliance Steel), slowdown in construction activities post-GE14, and high coke prices from supply restrictions in Australia. Management expects the weak local steel demand to linger into 1HFY19, with hopes of rebound in 2HFY19.

Looking to export. Given the soft local market demand, Ann Joo continues to place efforts to increase its export exposure. However, we believe this will not help boost its earnings significantly as (i) majority of products exported as of now are pig iron, which constitutes only a small portion of revenue (c.3% based on our estimates) as only 20% of pig iron produced are exported, and (ii) it may not be easy to export billets in the countries where Ann Joo is eyeing at, as most of these countries are taking a protective stance towards imports (amidst the global trade tension) and recent fall in prices of China billets has weakened Ann Joo’s price competitiveness. Note that prices of China billets have fallen c.20% in Nov-18, likely from laxer winter production curb measures accompanied by weak demand.

Outlook. Ann Joo’s profitability remains largely dependent on the local steel demand despite attempts to increase export market exposure. We expect earnings to remain tepid as the slowdown in construction activities will likely remain weak in the near term.

Forecast. We lower earnings forecast by 5%/21%/10% to account for lower ASP and higher coke price assumptions. FY19 now shows a slight drop in earnings from FY18 as the latter saw strong earnings in 1QFY18 from construction activities pre-GE14.

Maintain HOLD, with a lower TP: RM1.44 (from RM1.82). Our TP of RM1.44 is based on 8x FY19 EPS. We maintain our HOLD recommendation as we believe the market has priced in the gloomy market outlook of the steel industry from the slowdown in construction activities.

Source: Hong Leong Investment Bank Research - 3 Dec 2018