We foresee the challenging outlook for the building material sector to persist throughout 2019 despite the improving news flow for the construction sector. Construction activities should remain tepid for 2H19 before picking up gradually in 1H20 while property sentiment remains weak; this forms the basis of our less sanguine view on both subsectors. Maintain UNDERWEIGHT rating on the sector. Maintain SELL rating on Ann Joo with TP of RM1.12 and HOLD rating on Lafarge with TP of RM3.28.

Still challenging. Despite the improving news flow for construction driven mainly from the revival of various construction activities, near-term outlook for building material sector remains challenging.

Cement sub-sector – weak pricing power to persist into 2H19. We believe cement consumption will remain lacklustre in 2H19, on the back of still-weak construction (work on mega project revivals have yet to significantly begin) and property development activities, which will in turn translate to weak near-term cement prices. On a slightly more positive note, we note that price of coal (the key source of energy in producing cement) has fallen by more than 20% since Dec 2018 and this should help lower production cost. Beyond 2019, we expect cement prices to recover gradually, as construction activities pick up (expected by 1H20). However, we reckon that the expected pick up next year will happen on a gradual basis as work contribution from mega project revivals may be partially offset by (i) lower construction contract awards seen post GE14 and (ii) weak property sentiment (which in turn translates to low property development activities).

Steel sub-sector – weak near-term prospects. We maintain our less sanguine view on the steel sub-sector’s near-term prospects, mainly on the back tepid construction activities (which we expect it to pick up gradually only by 1H20), and ongoing competition from a rather new entrant (Alliance Steel). Demand aside, we believe rising iron ore price (one of the key inputs in making steel) will push steel production cost higher, and this will squeeze profitability of steel producers further. While we expect iron ore price to ease from its recent high (on the back of high iron ore inventory level and lower steel production in China), it would take a while for iron ore price to normalise back to its previous price level (i.e. below US$80/tonne prior to Vale’s dam accident), hence resulting in high production cost in the near term.

On dumping risk. We believe the risk of dumping of steel products into Malaysia remains remote for now, until the safeguard measures expire (by mid-Apr 2020). Besides, we note that steel prices in China are higher than in Malaysia (even before taking into account of the safeguard duties).

Forecast. Maintain.

Maintain UNDERWEIGHT. We expect subdued earnings performance for cement and steel players to persist into 2H19. Headwinds include (i) weak demand for cement (ii) weaker cement ASP (iii) overcapacity for cement (iv) escalating iron ore price (v) mismatch between production and consumption for steel. We maintain our UNDERWEIGHT rating on the sector. We maintain our SELL rating on Ann Joo, with an unchanged TP of RM1.12 based on 8x FY19 fully-diluted EPS of 14 sen. We maintain our HOLD rating on Lafarge with a lower TP of RM3.28 (from RM3.75 earlier), as we switch our valuation methodology to replacement cost, as our previous TP of RM3.75 no longer holds water following the lapse of the General Offer in earlier Jun. Our new TP of RM3.28 is based on replacement cost of US$100/tonne for Lafarge’s clinker capacity.

Source: Hong Leong Investment Bank Research - 15 Aug 2019