We maintain our NEUTRAL view on the BUILDING MATERIALS sector due to a challenging outlook in the near-to-medium-term, attributable to the prevailing global steel oversupply issues and intense competition in the cement subsector. As we are of the view that downsides are largely priced-in with no fresh catalyst, we maintain our call and target prices for ANNJOO (UP; TP: RM0.61), LAFMSIA (UP; TP: RM8.01) and PMETAL (OP; TP: RM2.59). Nevertheless, we like PMETAL (OP; TP: RM2.59) as our PREFERRED PICK due to its: (i) globally competitive EBIT margin of 14.1% vs. the global peers of 7.3%, and (ii) positive earnings outlook driven by capacity expansion.

3QCY15 results demonstrated another set of mixed results with 1 stock above expectation and 2 stocks below expectation. PMETAL beat expectations due to betterthan- expected margin. In terms of disappointments, ANNJOO missed expectation due to margin compression and slowdown in business post-GST implementation while LAFMSIA missed expectation due to erosion in earnings. This was a further disappointment from the previous quarter given that these 2 stocks were also below expectations previously. Moving forward, we expect the steel-based company, ANNJOO, to continue posting weaker results in quarters ahead due to downward trending of steel prices and tighter competition from imports. Furthermore, for the cement sector, we believe earnings risk persists for LAFMSIA due to their ASP remaining under pressure aggravated by intense competition. As for the aluminum-based company, PMETAL, we expect upcoming quarters to show improvement as production from Samalaju Phase 2 plant is fully operational while production from Samalaju Phase 3 is ramping up and expected to contribute to earnings from 1H16 onwards.

STEEL Infrastructure projects to spur existing demand? Maybe not. Post announcement of Budget 2016, infrastructure projects such as Pan Borneo Highway, MRT2 and LRT3 were announced as expected. Hence, we expect construction activities to pick up in FY16 and local demand for building materials to increase going forward, supporting steel and cement players under our coverage. That said, we view that the increase in demand might not be substantial due to stiff competition from cheaper imports, therefore neutralising the positive impact to the steel subsector. To note, as of YTD, construction activity growth in 3Q15 improved to 9.9% YoY from 5.6% in 2Q15, with the expectation that it may slow down in the upcoming quarter as the economy faces delayed recovery. As for the cement subsector, we are still cautious as it is still affected by intense pricing competition among competitors and capacity expansion issue.

Steel sector is expected to remain uninspiring as global steel oversupply issue persists. YTD, the average prices for long steel products (billet, rebar, wire rods) declined by 12.8%-20.9%, at a similar pace with reduction in raw material cost (iron ore, coke and scrap) (refer Chart 1). Looking at the steel prices, despite imported steel prices picking up to RM2,200/MT in 3Q15 (+RM300/MT level as compared to preceding quarter), local steel prices are still priced unattractively at RM2,730/MT (refer Chart 4). Domestically, average production for iron, steel bars and rods have been reduced by 17.3% YTD, lower than 2Q15 (refer Chart 2). Meanwhile, exports (i.e., iron, steel bars and rods) volume was reduced by 2.5% YTD (refer Chart 3) but imports (i.e. iron, steel bars and rods) volume surged by 23.3% YTD. Interestingly, while demand for imported steel remained higher than local steel, imported steel volume had reduced significantly compared to 2Q15 (refer Chart 3), suggesting that local demand for steel is still at the low side, despite numerous contract announcements. Hence, we maintain our view that the lower raw material costs may not provide sufficient positive impact to steel demand and margins due to stiff competition from steel imports. 

Source: Kenanga Research - 7 Jan 2016