We reiterate our NEUTRAL rating on the BUILDING MATERIALS sector due to challenging outlook for the near-to-medium-term arising from the global steel oversupply issues as well as persistent and intense competition in the cement sub-sector. Maintain call and target price (TP) for LAFMSIA (UP; TP: RM8.68) and PMETAL (OP; TP: RM3.88). Meanwhile, we reiterate MARKET PERFORM call with lower TP for ANNJOO at RM1.01 from RM1.08. For this quarter, we feature PMETAL (OP; TP: RM3.88) as our PREFERRED PICK due to: (i) industry-leading margins at 17.7% vs. the global average of 12.6%, and (ii) bright earnings outlook driven by capacity expansion.

1QCY15 results broadly within expectation. Among the four stocks under our coverage, except for MASTEEL which remains suspended by Bursa due to a delay in submission of FY14 audited accounts, all were within expectations. We maintain all calls except for ANNJOO which we upgraded the stock to MARKET PERFORM from UNDERPERFORM after the stock dropped below our Target Price. Going forward, we expect steel-based companies such as ANNJOO and MASTEEL as well as aluminumbased company PMETAL to post weaker results in coming quarters. For the steel players, this is due to the downward trend in steel prices while PMETAL was affected by lower aluminum production due to a temporary suspension that lasted three weeks. Also, for the cement sector, we believe earnings risk persists for LAFMSIA due to their ASP remaining under pressure and aggravated by intense competition.

STEEL 11MP projects may not be sufficient to counter global steel oversupply issue. On 21-May-15, most of the mega projects (i.e. MRT2, LRT3, HSR, Pan Borneo Highway) were announced as expected in the 11MP. We opine that a huge portion of the RM260.b development expenditure will be allocated for infrastructure spending. According to our economist, the construction sector GDP growth will accelerate to 9.8% in 2015 from 9.6% in 1Q15. However, given that the China economy is slowing down to result in excess capacity, we view that steel import into local market will increase; hence, nullifying the strong demand from domestic infrastructure activity.

Steel sector likely to remain sluggish due to persistent global supply issue. We notice that as of YTD, the average prices for long steel products (billet, rebar, wire rods) have been reduced by 14.3%-21.1%, at a similar pace with reduction in raw material cost (coke and scrap) (refer Chart 1). Domestically, average production for iron, steel bars and rods have been reduced by 14.6% YTD. Meanwhile, exports (i.e., iron, steel bars and rods) volume was reduced by 21.4% YTD (refer Chart 2). We also noticed the imports (i.e. iron, steel bars and rods) volume surged by 20.6% YTD. Although the gap of exports and imports price have narrowed, steel import price appears to be competitive at below RM2,000/MT (refer Chart 4). Hence, we reiterate our view that the lower raw material costs may not provide sufficient positive impact to margin due to stiff competition from steel imports.

Iron ore price to fall amid lower steel demand? In terms of iron ore price, we note that it rose by 20.6% QoQ, which we believe was due to: (i) a delay in port works in Pilbara by BHP Billiton in Australia to restrain the expansion pace, which delayed c.70.0m MT of iron ore output, and (ii) a cut in iron ore production up to 30.0m MT by Brazillian miner, Vale. We note that collectively, the four major producers that dominate global iron ore production (i.e., BHP Billiton, Vale, Rio Tinto, and Fortescue Metals Group) controls over 70.0% of seaborne iron ore market. However, we view that iron ore price will fall in near-term as there is a slump in Chinese demand for steel due to slowdown in economy and construction activity. 

Source: Kenanga Research - 3 Jul 2015