We maintain our OVERWEIGHT call on Building Materials based on the following factors: (i) robust domestic construction activity with possibly more contracts to be awarded during Budget 2015, (ii) near-term earnings boost from pre-GST stocking up activities, (iii) potential trade action on steel dumping activities by 1Q15, and (iv) margin expansion from stable selling prices and lower raw material cost. Since our upgrade on 2-Jul, the steel sector has performed well (ANNJOO +15% and MASTEEL +7%) but we believe that the uptrend has just started as steel players’ valuations are still undemanding at below historical P/B levels despite improving fundamentals. Our Top Pick for the sector is MASTEEL (OP; TP: RM1.22) due to its attractive valuation, high ROE, comfortable balance sheet and near-term growth supported by capacity expansion. Maintain OUTPERFORM on ANNJOO (TP: RM1.47) and MARKET PERFORM on LAFMSIA (TP: RM10.50).

2QCY14 results within expectations. Building Materials stocks performed largely within expectations in the quarter under review. ANNJOO’s results came in at 66% of consensus estimates which we deem as within expectations due to the one-off inventory reduction in 1Q14. MASTEEL’s earnings were also within expectations. Although LAFMSIA’s earnings made up 38% of our estimate and consensus forecasts, this was within expectations and in line with the historical trend of weaker 1H due to seasonality and scheduled plant maintenance.

Budget 2015 should boost Construction sector growth which is already doing well so far in 2014. The Construction sector could receive a fresh catalyst boost from the announcement of Budget 2015 thanks to the anticipated 10MP & ETP infrastructure projects (ie: MRT Line 2, East Coast Expressway), and major property development projects in Kuala Lumpur and Johor. These new projects should strengthen demand for building materials which is already supported by stable orderbook replenishment and major ongoing projects (ie: RAPID Pengerang, MRT, West Coast Expressway, PR1MA affordable housing). YTD, construction activity in 2Q14 remained robust at 10% YoY growth, mainly driven by the residential sector (16%) followed by non-residential (12%) and special trade (10%). While it has slowed down from 1Q14’s 19% growth YoY, we are not overly concerned as it is well on track to achieve our in-house economic forecast for construction sector growth of 11% for 2014.

Pre-GST stocking up should boost near-term earnings. We are of the view that the Goods and Services Tax (GST) effective 1 Apr 2015 could be positive for building materials players. We anticipate stocking up activities to take place in the months leading up to the GST implementation on 1 Apr 2014 as stockists and manufacturers may choose to load up on durable goods. Taking a 3-6 month view, we expect the GST implementation to contribute to a one-off boost in sales volume for steel players in 4Q14-1Q15. As for the cement sector, due to the short shelf life of cement (< 3 months) and concrete products (< 1 day), we expect minimal sales impact from GST implementation next year.

Potential catalyst on trade remedies for steel products. In the past 2 years, dumping of steel products (wire rod and rebar) into Malaysia from China has caused local prices to decline substantially. However, we think that things should improve by end-1Q15 due to recent investigations by Malaysian authorities. Recall that on 3 Sep 2014, the Ministry of Trade and Industry (MITI) announced an investigation into dumping of steel rebar imported from China and Korea. This is in addition to the ongoing administrative review on wire rods announced on 24 Jun 2014. As preliminary determination by MITI will usually be made within 120 days (about 4 months) from initiation, we believe that anti-dumping duties could be implemented in the near-term (before end of 1Q15). Previously imposed duties ranged from 5-35% based on the dumping margin of the manufacturer. We have yet to factor in the possible duties but we estimate that a 5% anti-dumping duty across the board could result in 2% higher ASP/MT which should lift earnings by 8% for steel players under our coverage. However, if we do not see any significant action from these investigations by end 1Q15, we are most likely to assign a lower P/B valuation below Mean valuation (from current Mean to +1SD valuation) to steel counters and downgrade the sector to NEUTRAL as the depressed prices will reduce competitiveness of local steel products.

Steel players’ margins should expand as raw material costs decline rate is more than final product prices. We observe that in 3Q14, key raw materials prices for steel production (iron ore, coke and scrap) fell by an average of 22% YoY and 2% QoQ quarter-todate (QTD) due to international oversupply. However, semi-finished and finished long product prices (billets, wire rod and rebar) were stable in 3Q14, at an average of -4% YoY and -1% QoQ (QTD). The slight price decline was mainly caused by slowing demand in China, offset by the improving US economy. As a result, we expect steel players’ margins to improve in the upcoming 3Q14 results due in Nov-2014. For the cement sector, coal prices have been on a similar declining trend in 3Q14 at -12% YoY and -6% QoQ (QTD). However, LAFMSIA may see a delayed or muted effect from the lower input cost due to its partial hedging policy.

Strong performance since upgrade but still ample upside seen. Since our sector upgrade to Overweight in the 3Q14 strategy update, steel counters have shown good performance with ANNJOO up 15% from RM1.16 and MASTEEL up 7% from RM0.99 during the quarter. Despite the rise in share prices, steel players’ valuations remain relatively undemanding with ANNJOO at -0.3 SD of its 3-yr historical P/B and MASTEEL at -0.2 SD. We reckon that further upside remains with the improving market fundamentals and potential trade action while downside risk is limited as both ANNJOO and MASTEEL are trading below mean valuation levels. With the robust construction demand and declining input costs, we maintain our OVERWEIGHT call on the Building Materials sector.

Potential catalyst will be higher selling prices for steel products should trade action be imposed.

MASTEEL is our Top Pick due to its: (i) attractive FY15 Fwd. PE valuation at 6.4x (lowest among all steel players), (ii) ROE of 5.5% (highest among all steel players), (iii) strongest balance sheet with only 0.5x net gearing (lowest among all steel players), and (iv) near-term growth seen from its aggressive capacity expansion by 44% or 200k MT to 650k MT by 2016 (currently 450k MT).

Source: Kenanga