We reiterateour NEUTRALrating on the BUILDING MATERIALS sector dueto its prevailing challenging outlookin thenear-to-medium-termarising from theglobal steel oversupply issuesas well as persistentand intense competition in thecement subsector. We expect neutral impact from the upcoming Budget 2016;hence,we maintain our call and target prices(TP) for ANNJOO (MP; TP: RM0.80), LAFMSIA (UP; TP: RM8.25) and PMETAL (OP; TP: RM2.59).For this quarter,we continue to feature PMETAL (OP; TP: RM2.59) as our PREFERREDPICKdue toits: (i) industry-leading marginat17.7% vs. the global average of11.7%, and (ii) brighterearnings outlook driven by capacity expansion.

2QCY15 results demonstrated mixed bag of results with 1 stock broadly within expectation and 2 stocks below expectation. ANNJOO missed expectations due to margin compression and slowdown in business post-GST implementation while LAFMSIA missed expectation due to lower sales. We maintained all calls with lower TP for ANNJOO (MP; TP: RM0.80), LAFMSIA (UP: RM8.25), and PMETAL (OP; TP: RM2.59). Moving forward, we expect steel-based company ANNJOO to post weaker results in quarters ahead due to downward trend of steel prices. Furthermore, for the cement subsector, we believe earnings risk persists for LAFMSIA due to their ASP remaining under pressure aggravated by intense competition. As for the aluminium-based company, PMETAL, we expect upcoming quarters to show improvement as production from Samalaju Phase 2 plant is ramping up and expected to be fully operational by Oct-15.

STEEL

Budget 2016 should give a boost to the Construction sector, but we expect neutral impact to the Building Materials sector. Budget 2016 will be announced on 23-Oct-15, in which we expect similar projects as per announced in 11MP on 21-May-15 (i.e. highway projects such as Pan Borneo Highway). Having said that, we would not be surprised should there be an extension in the time period of releasing the projects, in view of the current gloomy market outlook with falling Brent crude oil prices and weakening of MYR against USD (-27% and -18%, respectively, since 11MP was announced). Moreover, as of YTD, construction activity in 2Q15 has fallen to 5.6% YoY, in line with the flat property market. Although it may pick up marginally stimulated by the impending infrastructure projects, we opine that the building materials sector might not necessarily grow in tandem with the construction sector’s pace. Despite the contract announcements, local steel prices are still far unattractive comparatively (refer Chart 4), which led to higher demand for steel largely channeled to imports (refer Chart 3). As for the cement subsector, the industry has been facing intense pricing competition among competitors and capacity expansion issue; hence, we expect minimal impact from the upcoming Budget announcement.

Nonetheless, outlook for steel subsector remains dim in view of prolonged global steel oversupply issue. YTD, the average prices for long steel products (billet, rebar, wire rods) declined by 13.7%-21.2%, at a similar pace with reduction in raw material cost (iron ore, coke and scrap) (refer Chart 1). Domestically, average production for iron, steel bars and rods have been reduced by 13.8% YTD (refer Chart 2). Meanwhile, exports (i.e., iron, steel bars and rods) volume was reduced by 22.6% YTD (refer Chart 3) but imports (i.e. iron, steel bars and rods) volume surged by 27.2% YTD. Note that the gap between exports and imports prices has widened, with steel import prices appearing to be fairly competitive at below RM1,900/MT (-RM100/MT level as compared to preceding quarter) (refer Chart 4). Hence, we reiterate our view that the lower raw material costs may not provide sufficient positive impact to margin due to persistent stiff competition from steel imports.

Implementation of provisional safeguard duty on pre-painted, painted or colour-coated steel coils (PPCCSC) does not affect steel counter under coverage. On 25-Sep-15, MITI announced a provisional safeguard duty of 5.7-52.1% on PPCCSC imports. Steel company under our coverage, ANNJOO, is an upstream player and does not produce PPCCSC, thus this should not have any material impact on ANNJOO. Although ANNJOO has a trading division (c.40% of revenue and EBIT) that trades in downstream products, this should not impact them as the group buy these products from local suppliers and sell them locally. Based on our channel checks, the PPCCSC producers include CSC Steel Sdn Bhd and YKGI Holdings Bhd, in which these companies should benefit from the provisional safeguard duty.

Source: Kenanga Research - 7 Oct 2015