Overall, we maintain our NEUTRAL view on the Building Materials sector despite being positive on the steel and aluminium sector as the market weightage of our negatively weighted cement sector is large. Due to the recently implemented safeguard measures (on rebars and wire rods) coupled with China’s initiative to cut down on overcapacity of steel, we believe local steel prices will be more stable and likely trend upwards in FY17 – providing local steel millers of long steel products an improved earnings outlook. Cement sub-sector is expected to remain weak due to high excess capacity from the additional 16% new capacities, causing intense price competition between cement manufacturers. Aluminum outlook is likely to improve on rising transport and construction demand and industry consolidation. We maintain our OP call on PMETAL and TP of RM5.00 on a strong growth outlook and undemanding valuations in view of its recent expansions. Maintain all calls and TPs within the Building Materials sector; (i) LAFMSIA (UP; TP: RM6.06), (ii) ANNJOO (OP; TP: RM2.24), and (iii) PMETAL (OP; TP: RM5.00).

2QCY16 results registered a mixed bag of results, with ANNJOO coming above, PMETAL within and LAFMSIA missing, expectations. This was slightly better than 1QCY16 where 2 were within and 1 below, expectations. LAFMSIA came in below due to higher-than-expected margins compressions from the existing price wars while ANNJOO was above due to higher-than-expected margins due to higher ASPs. As of our previous report cut-off date (30/6/16) against current cut-off (15/9/16), ANNJOO share price was up 71% likely due to the outperformance in its 2Q16 results. Despite coming way below earnings estimates, LAFMSIA’s share price was relatively unchanged. Meanwhile, PMETAL’s price was up 3% as investors continue pricing in the impact from full commissioning of its new Samalaju smelter. STEEL

Local demand for long steel products to remain. We are anticipating upcoming infrastructure projects ie Pan Borneo, MRT2, MRT3, SUKE, DASH, EKVE, BRTs and mega developments such as BBCC, KL118, TRX and Bandar Malaysia to spur demand within the construction steel sector. In 2Q16, the Department of Statistics in Malaysia reported that the value of construction work grew 11.7% YoY. Hence, we believe demand for steel products in the local market will remain robust.

Taming the Dragon. China’s overcapacity issue which led to dumping of steel has negatively impacted the global steel market in the previous years. Recently, the Chinese Government has taken various steps to solve this outstanding issue such as planned capacity cuts of 45m tonnes in 2016 through: (i) financial aids for lay-off supports worth RMB100b, and (ii) tighter bank lending to smaller mills. As of 7M16, we understand from news sources that China has effectively cut back on 47% (c.21m tonnes) of their planned capacity reduction of 45m tonnes. Besides that, larger steel mills in China are currently undergoing major consolidation to form two major steel groups in China ie: Southern Steel Group (Baosteel and Wuhan) and Northern Steel Group (Hebei and Shougang), which we believe would lead to further consolidation of smaller steel mills into these two larger groups in order to have better control over their domestic steel industry that could expedite steel capacity cuts more efficiently. On top of that, we understand that China has imposed stricter load regulations on commercial vehicles which we view it positively as domestic transportation for raw material/finished steel goods within China would be higher, translating into higher export prices. All in, we are positive on these measures in the long run as we can expect more stable steel prices from China due to reduction in steel supply and exports.

Safeguard measures to protect local millers. The recent safeguard measures implemented (26/9/16) on wire rods and rebars at a rate of 13.9% and 13.4% will benefit local millers as imports, especially from China will be pricier entering Malaysia. This would lead to thinner trading margins for local importers causing them to reduce the volume of imports – leading to reduced supply of Chinese steel in local market which is positive for local millers as Chinese steel prices are no longer competitive as before. To recap, we note that in anticipation of the safeguard measure by local importers, large quantities of steel were imported in the months of June and July 2016 (Chart 1) surging 11% and 44% YoY, respectively. However, post implementation of safeguard measures, we expect these imports for Chinese steel to taper down going forward. Hence, we believe local steel prices will see more stability and potentially higher prices in 4Q16, and local steel prices to see significant improvements in pricing from FY17 onwards when these large quantities of Chinese steel imports depletes.

Worst for Malaysian steel mills over? In FY15, local steel rebar prices saw lows of RM1,450/tonne due to China exporting steel rebars at extremely low prices causing steel players in Malaysia to register losses, and ANNJOO was particularly badly affected with a CNL of RM120m on the back of a 23.2% decrease in sales YoY. With the newly implemented safeguard measure, we believe it is highly unlikely for local steel rebar prices to see low of RM1,450/tonne again as: (i) China players will have to export steel at prices even lower than FY15, which had caused them c.USD10b of losses (overall steel industry at China), and (ii) the China steel rebar prices have recovered to c.CNY2500-2600 levels (vs. lows of c.CNY1800 in FY15) due to the capacity cuts in China. As of end September-16, local steel rebar prices trading at range of RM1,700-RM1,850/tonne.

Source: Kenanga Research - 7 Oct 2016