In view of the challenging industry prospects, the Government is encouraging local steel sector players to consolidate. Export market represents huge opportunity to tap especially from the Asian region. A key external risk arises from China not setting a blanket winter outputs cut for its steel producers (unlike previous years). Maintain UNDERWEIGHT rating on the sector. Maintain SELL rating on Ann Joo with TP of RM1.04 and HOLD rating on Lafarge with TP of RM3.28.

We recently attended the “2019 Trade Forum on the Malaysia Iron and Steel Industry” and walked away slightly disappointed as we felt the forum did not address the structural issues faced by domestic steel players.

More consolidation on the cards? In view of the challenging industry prospects (arising from lacklustre demand and intense competition from a relatively new entrant), the Government is encouraging steel sector players to consolidate. We understand from the forum that MITI will present its proposals to MoF on consolidation incentives (which may include, amongst others, tax incentives) in order to foster sector consolidation. Besides, MITI will also produce a White Paper on the local steel industry, to protect local steel players including imposing a moratorium on licences to foreign steel manufacturers who have intention to set up manufacturing facilities in Malaysia.

Opportunity in export market. The forum panel suggested local steel players to explore for opportunities outside of Malaysia, in particular, markets in Asia, given the region’s high steel consumption. We note that Asia consumed more than 15.9bn tonnes of steel in 2018, higher than other regions. Apart from conference highlights (which we deem neutral to the sector’s near-term prospects), we remain negative on the steel sector on the back of (i) renewed concerns on dumping from China, and (ii) weak near-term demand prospects locally.

Possible threat from China again. Also discussed in the forum was the subject of China not setting a blanket winter outputs cut for steel players unlike previous years. Rather, it has directed local governments to set limits based on the manufacturers’ emission level. With this, we feel there is a renewed concern that Chinese steel producers may dump its steel on the export market from its production, albeit a slight cut.

Steel demand still relatively weak. Domestic steel consumption remains weak given subdued construction activities. We believe the weak domestic demand will protract at least into end-1H20, no thanks to delays in project implementation arising from past reviews. Based on our channel checks, some industry players expect gradual recovery in steel demand to only materialise by mid-2020 largely on the back of the pickup in mega projects such as MRT2, LRT3, ECRL, RTS and Bandar Malaysia.

Maintain UNDERWEIGHT on Building Materials. We expect subdued earnings performance for cement and steel players to persist. Headwinds include (i) weak demand for cement (ii) weaker cement ASP (iii) overcapacity for cement and (iv) mismatch between production and consumption for steel. While share price of Ann Joo has come off (8.9% since 4 October) on the proposed JV news with Southern Steel, we maintain our SELL rating with an unchanged TP of RM1.04 based on FY19 BV of RM2.61. We maintain our HOLD rating on Lafarge with TP of RM3.28.

Source: Hong Leong Investment Bank Research - 11 Nov 2019