Local steel players had a bumpy start at the onset of 2013 due to the negative pressure on steel prices arising from mill overcapacity in China and a slower-than expected growth rate in Asia. Meanwhile, cement companies’ earnings hit by intense price competition. However, the scene has gradually improved with steel prices stabilising and China’s economy finally back on track coupled with the strong local demand from infrastructure and property projects. Hence, we are not too worried with the implementation of GST and subsidy rationalisation given that these additional costs could be passed through to the buoyant end-market. Hence, we expect the local steel players within our coverage to record better earnings as compared to FY12. However, we are keeping our NEUTRAL recommendation on the sector at this juncture given that the issues bogging the sector remains unresolved (i.e. Perwaja, Megasteel). As for cement sector, we are NEUTRAL, as we believe investors have largely priced in the robust construction sector given the valuation appears expensive already.

Satisfying 2QCY13 steel companies’ results. Both steel companies under our coverage, Ann Joo Resources Bhd (ANNJOO, MP, TP: RM1.31) and Malaysia Steel Works (KL) Bhd (MASTEEL, MP, TP: RM0.91) registered satisfying 2QCY13 results which was well within market expectations. The steel players did not disappoint the market this time around mainly due to their ability to consistently improve their cost structure in optimizing their feed cost coupled with the recovery in global steel prices.

Intense competition dragged 1H13 cement companies’ results. We observed the cement stocks i.e. Tasek and Lafarge delivered their 1H13 earnings below-than-consensus expectations. This was mainly due to the intense price competition amongst cement players following the new entrant of Hume Cement last year. We gather the cement price is currently selling at RM340/mt but the cement players have been offering rebates to attract their customers. Going forward in 2H13, we expect the cement price to start stabilizing as demand for the construction materials picking up due to the robust construction sector.

Stabilising steel prices. Global steel prices started off the year on a downtrend until the end of 1H13 where the prices for hot rolled coil fell to USD553/mt (-11%), cold rolled coil to USD662/mt (-6%), wire rods to USD566/mt (-6%), rebars to USD580/mt (-7%), and billets to USD509/mt (-5%). However, the prices for these commodities have seen a stable recovery since, with hot rolled coil trading at USD607/mt (+9%), cold rolled coil USD700/mt, wire rod USD587/mt (+4%), rebar USD601/mt (+4%) and billet at USD530/mt (+4%) with the prices holding up quite well. The steady recovery of steel prices in 2H13 had proved our earlier view wrong as we did not expect the prices to be sustainable. The stable recovery was mainly attributable to the pickup in China as the country quickened its railway investment and public housing construction, coupled with effort taken to reduce steel production capacity by shutting down blast furnaces that are smaller than 400 cubic metres or inefficient plants.

Busy contractors a boon for steel and cement players... The local construction market has been in a very busy mode with most of the construction players executing the KVMRT project namely MRT Line 1 in Klang Valley, while smaller players like Kimlun Corporation Bhd (KIMLUN) are busy constructing several major property development projects in the Iskandar region. The hectic scene in the construction sector is a boon for the local steel and cement players as demand for these materials have also picked up tremendously. We believe that the local demand would remain strong for the next few years as the Malaysian government is looking to finalise the MRT Line 2 and High Speed Rail project, while local property developers might even front load their property launches in 2014 right before the possible implementation of GST in 2015.

Maintain NEUTRAL on both Steel and Cement. We are keeping our NEUTRAL recommendation on the building materials sector at this juncture with slightly positive tone as we are hopeful to see the steel players under our coverage improving their profitability, while awaiting the issues on the steel sector (i.e. Perwaja, Megasteel) to be resolved before revising our call on the sector. We also noticed the investors have largely priced in the cement industry fundamentals i.e. robust construction by looking at the fwd-PER of both cement stocks’ TASEK (NOT RATED) and LAFARGE (NOT RATED) are currently trading at above its historical average and already at the regional peers’ fwd-PER of 19x – 21x.

Source: Kenanga