We are NEUTRAL on both the steel and cement sectors as the positive impact of better demand is generally neutralized by higher costs. However, we believe ANNJOO is well positioned to absorb the impact of higher costs. From the valuation standpoint, the steel sector seems to have bottomed out. We prefer ANNJOO due to its limited downside and better earnings growth potential in 2014. Taking a contrarian view, we are upgrading ANNJOO to OUTPERFORM (from MARKET PERFORM) with unchanged Target Price of RM1.31 due to attractive valuations. We also upgrade MASTEEL to MARKET PERFORM (from UNDERPERFORM) with unchanged Target Price of RM1.14 as its valuation has becomes more attractive. Meanwhile, valuations for cement players are currently fair and we expect limited rerating catalyst in the near-term.

4Q13 results review. The performance of steel players under our coverage in FY13 was decent with ANNJOO (MP; TP: RM1.31) exceeding consensus estimates by 38% with core earnings of RM36.5m, while MASTEEL’s (UP; TP: RM1.14) results were broadly within expectations with RM28.8m core earnings or 91% of consensus estimate of RM31.6m. The better-than-expected performance from ANNJOO was mainly due to improved sales performance in both domestic and international markets despite weak prices, and improvements in operational efficiency. As for cement players, we have added LAFMSIA (MP; TP: RM9.50) to our coverage in 1Q14. LAFMSIA’s FY13 core net profit was RM387.5m or 106% of consensus forecast of RM364.3m.

Expecting sustained demand. We expect domestic demand in the near-term to remain strong on incoming 10MP and ETP projects (including the RM25.0b MRT2, RM6.0b West Coast Expressway (WCE) and RM60.0b RAPID projects) and various property construction projects (with at least RM181.2b of confirmed GDV). This is likely to sustain decent near-term volume sales growth as we estimate that 30% of construction costs are for building materials.

However, cost hikes are likely to hit margins. The recent electricity tariff hike effective 1 January 2014 and the reduction in fuel subsidies in late 2013 are likely to impact production costs. Electricity comprises 25-35% of production cost in the steel sector. Within the sector, ANNJOO is better positioned to absorb the impact of rising electricity costs as it has begun reaping the benefits of its hybrid Electric Arc Furnace (EAF) with hot metal charging technology, which allows for higher production per unit of electricity consumed and improved grade of the steel output. For the cement sector, electricity makes up 10-15% of production cost while fuel and transportation costs make up 25-30% of costs combined. We believe that decreased fuel subsidies and higher KTM tariffs will drive up operating costs in the cement sector.

NEUTRAL maintained. We are NEUTRAL on both sectors’ outlook for the year 2014 as the positive impact of better construction demand is generally offset by higher costs. While we believe that the electricity hike will impact the steel industry more compared to the cement industry due to higher usage of electricity in steel sector, ANNJOO is well positioned to absorb the impact. From a valuation standpoint, the steel sector valuation seems to have bottomed at roughly 0.5x Price/Book (P/B) (ANNJOO at 0.51x and MASTEEL at 0.39x). Among these two, we prefer ANNJOO due to its limited downside and better earnings growth potential in 2014. Note that for ANNJOO, its current valuation is close to negative 1.5 Standard Deviation (SD) below its mean P/B. For MASTEEL, its current valuation is close to its mean P/B of 0.41x.

However, compelling valuation prompts us to upgrade ANNJOO to OUTPERFORM (from MARKET PERFORM) with an unchanged Target Price of RM1.31. We believe the sell down on ANNJOO has been excessive as its share price has slumped 67% from its peak of RM3.35 in Jan-2010. Our Target Price of RM1.31 is conservative as it is based on 0.6x P/B to FY14 Book Value of RM2.18 or pegging it at negative 1 SD below its 5-year historical Fwd. P/B Band.

Also upgrading MASTEEL to MARKET PERFORM (from UNDERPERFORM) with unchanged Target Price of RM1.14 as the recent share price decline has made its valuation more attractive at 0.39x P/B. The Company is also expected to expand its capacity progressively in the next two years, although we believe that near-term earnings impact is limited.

Maintain MARKET PERFORM on LAFMSIA. Valuations for cement players are currently fair with LAFMSIA trading at 19.3x Fwd. P/E (above its mean P/E of 18.2x) and we expect limited rerating catalyst in the near-term due to the rising cost environment. Note that we have used P/E methods for cement industry due to its more stable earnings historically.

Source: Kenanga