We reiterate 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. We maintain our OP canll on PMETAL with a higher TP of RM2.95, as we roll forward our valuation base from FY16E to FY17E in order to appropriately capture earnings from its new Phase 3 smelter. Meanwhile, in view of lack of fresh catalyst, we maintain our call and target price for ANNJOO (UP; TP: RM0.61), and LAFMSIA (UP; TP: RM8.44).

4QCY15 results unveiled disappointments with all stocks below expectations. PMETAL and LAFMSIA missed expectations due to higher-thanexpected taxation expense and acquisition expense, respectively, while ANNJOO underperformed due to lower-than-expected average selling price (ASP) for steel and persistent strong competition from imports. This was worse off than 3Q15 where PMETAL beat expectations. Moving forward, we expect steel-based ANNJOO to continue posting weak results in the quarters ahead due to downward trending of steel prices and higher competition from imports. We believe the business may turn around to the black in 2H16, provided that steel prices pick up. For the cement sector, earnings risk persists for LAFMSIA due to intense competition pressuring ASP. As for the aluminum-based company, PMETAL, we expect upcoming quarters to show improvement as production from its Samalaju Phase 2 plant is fully operational since December 2015 while production from Samalaju Phase 3 is ramping up and expected to contribute to earnings from 1H16 onwards.

STEEL & CEMENT Infrastructure projects and cut in China steel production might not be sufficient to support local steel demand. Infrastructure projects, such as the upgrading of a stretch of Pan Borneo Highway, were awarded recently, while the MRT 2 and LRT 3 projects are expected to be rolled out this year. Although construction activity growth in 4Q15 was reduced to 7.4% YoY from 9.9% YoY in 3Q15, we expect these infrastructure projects to drive construction activities over FY16; thus, increasing local demand for building materials. However, we opine that the increase in demand may not be substantial due to stiff competition from cheaper imports. Although China announced on end-Jan 2016 that its steel production capacity will be cut by 100-150m metric ton (MT), China itself has surplus capacity of c.300m MT, which means that the cut in production capacity does not necessarily translate into cut in steel exports from China. This, therefore, neutralizes the positive impact to the local steel subsector. As for the cement subsector, despite potential growth in construction activities, we are still cautious on its earnings due to intense pricing competition among competitors and capacity expansion issue.

Lacklustre quarters ahead for steel sector as global steel oversupply issue persists. YTD, the average prices for long steel products (rebar, wire rods) declined by 4.2%-8.5% whereas billet increased by 2.3% YoY, at a slower pace as compared to reduction in raw material cost (iron ore, coke and scrap) (refer Chart 1). However, looking at the steel prices, the gap between imported and local steel prices widened with imported steel prices falling to RM1,840/MT in 4Q15 (-RM360/MT level as compared to preceding quarter) while local steel prices were priced unattractively at RM2,430/MT (refer Chart 4). Domestically, average production for iron, steel bars and rods fell by 19.7% in FY15 (refer Chart 2). Meanwhile, FY15 exports (i.e., iron, steel bars and rods) volume increased marginally by 0.8% (refer Chart 3) but imports (i.e. iron, steel bars and rods) volume surged by 17.7%. This shows that despite the reduction in raw material cost and increase in local construction activity, it does not necessarily led to higher demand for local steel, as demand for imported steel outweighed demand for local steel.

Source: Kenanga Research - 5 Apr 2016