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 larger. Long steel prices trading were at year-high (as of report cut-off date of 22/12/16) of RM2,300-2,450/t which we believe is due to cost push factors coupled with the reduced imports from China. We believe decision of the extension of safeguard measure post investigation period remains crucial in order to sustain current steel price levels. In light of the higher-than-expected steel prices, we upgrade ANNJOO’s FY17E earnings by 7% after factoring higher steel price of RM2,200/t (from RM1,890/t). Cement subsector is expected to remain weak due to high excess capacity from the additional new capacities that is set to increase by 16%, causing intense price competition between cement manufacturers. Aluminum outlook is stable on supply-demand equilibrium although PMETAL will benefit from a stronger USD/MYR and increased operating efficiencies. Post adjustments to earnings, we maintain ANNJOO’s OP call with higher TP of RM2.39 (from RM2.24) based on unchanged FY17E PER of 7.0x. For LAFMSIA, we maintain our UP call with an unchanged TP of RM6.06. Meanwhile, we maintain PMETAL’s OP call with higher TP of RM2.15 (from RM1.79) on higher earnings as we update our USD/MYR assumptions.

3Q16 were mostly within except for LAFMSIA which missed expectations due to higher-than-expected rebates dished out by its cement division, causing severe margin compression. Last quarter’s results season was slightly better off with 1 exceeding expectations (ANNJOO) while the rest remained the same. As of our previous report cut-off date (15/9/16) against current cut-off date (22/12/16), ANNJOO’s share price was up 11% which we believe is due to the surge in long steel prices (+33% over 4QCY16). LAFMSIA was down 11% likely due to their poor 3Q16 results coupled with the absence of quarterly dividends for the first time since FY10. Meanwhile, PMETAL rose 12% in tandem with PER expansion from its new smelter and aluminum price appreciation (+11%) over the same period.

Long Steel Demand of long steel to be supported by infrastructure projects. For FY17, we expect the demand of construction steel to be supported by the pickup in infrastructure works which were awarded during FY16. Nonetheless, we expect the demand/consumption to remain flattish in view of the slowdown in the property market.

Long steel prices at all-year high. Local long steel prices were trading at year’s high of RM2,300-2,450/tonne (+57% YTD) mainly driven by cost push factors i.e. rising raw material prices and less Chinese imports (refer graph below). Hence, we believe there is higher demand for locally manufactured steel which allows the local manufacturers to have better flexibility in passing on the higher raw material costs to end users. ANNJOO, due to its position in the local scene as a hybrid producer (BFEAF) of steel, is poised to benefit from the high steel prices considering their flexibility from their production – making them less susceptible to the increasing scrap prices mainly denominated in USD vis-à-vis other local manufacturers.

Decision on safeguard measure crucial for the local manufacturers. Moving into FY17, we believe our local long steel prices are able to maintain above RM2,000/t levels should Chinese imports remain low. Currently, Chinese steel prices are trading at levels of c.USD450 level which makes it unattractive to be imported as local market prices are lower than China steel prices after factoring shipping costs and duty fees. Furthermore, the recently implemented safeguard measure (13.9% for wire rods and 13.4% for rebars) serves as an additional barrier for Chinese steel to enter local shores even if Chinese steel prices were to come off in 1Q17 as a result of slower construction activities due to winter season (Nov-March). Hence, we opine that the final determination of the safeguard measure post investigation period by April 2017 remains crucial for the sustainability of our local steel prices. Should MITI decide for the safeguard measures to be aborted, we could possibly see local steel prices trend down to lower levels of c.RM1,900-2,000/t. However, we believe there is a strong case for the safeguard to be approved considering Chinese capacity remains high – possibly threatening profitability of local players should there be another round of steel dumping as seen in FY15.

Upgrade ANNJOO earnings. In light of the higher-than-expected steel prices, we upgrade ANNJOO’s FY17E earnings by 7% to RM171.2m after adjusting for: (i) higher steel price assumptions of RM2,200/t (from RM1,90/t) , (ii) update our USD/MYR rate assumption to 4.25 (from 4.10), (iii) higher coke prices to USD300/MT (+50%) as China cuts capacity on coal production, and (iv) higher scrap price assumption of USD315/MT (+15%). We note that our sales volume assumptions for long steel (rebars and billets) remain unchanged based on a average utilization rate of 84%. No changes to FY16E earnings.

Maintain OP for ANNJOO. Post adjustment to earnings, we reiterate our OP call on ANNJOO with a higher TP of RM2.39 (previously RM2.24) based on unchanged 7.0x FY17E PER. We believe our valuation is fair as we have conservatively pegged it on MASTEEL’s FY10-FY12 lower range PER of 7-10x when earnings were relatively stable prior to the influx of cheap Chinese steel.

Maintain OVERWEIGHT on the construction steel sector. Despite the flattish demand anticipated in FY17, we remain positive on the long steel sector underpinned by the high steel prices buoyed by less Chinese imports. Risk to our call includes: (i) lower-than-expected steel demand, (ii) lower-than-expected steel prices, (iii) higher-than-expected imports, and (iv) disapproval of safeguard measure post investigation period.

CEMENT Malaysia 10M16 apparent cement consumption continued to weaken. 10M16 total apparent cement consumption was down 15.3% YoY to 16.8m tonnes (refer Table 1). We derive our apparent consumption of cement after deducting exports from the production and imports of cement. The lower apparent cement consumption is a good gauge for the weak demand currently being faced by cement players likely due to: (i) mega infra works in initial phases i.e. MRT2, and (ii) the delay in commencement of major construction works awarded in FY16 ie. KL118, and (iii) slowdown in property market.

Expecting better demand for FY17, but still unexciting. We expect cement demand to be better in FY17 against FY16 when mega infrastructure projects; i.e. MRT2, SUKE, DASH, WCE awarded in FY16, move into more advanced stages. However, we believe growth would be muted as the residential and commercial property sector is currently facing a slowdown which typically makes up two-thirds of cement demand.

Excess capacity issue to persist. In Peninsular Malaysia, the additional capacities from HUMEIND (+1.8m MT), YTL (+1.8m MT), LAFMSIA (+1.2m MT) in FY16 has added an additional capacity of 16% into the existing space (refer Table 1). On the back of the subdued cement demand coupled with the entry of these new capacities, we expect: (i) the supply-demand gap to widen further, and (ii) cement players to fight for market share in a shrinking pie scenario causing existing price wars between cement players to persist and keeping margins under pressure. To recap, LAFMSIA’s 9M16 EBITDA margin was down 7.7ppt YoY mainly due to the price wars in the cement space. We also note that LAFMSIA did not dish out any quarterly dividend in 3Q16 for the first time in 5 years. Recent industry channel checks also revealed that cement prices are currently going for rebates as high as RM140-150/MT (during Sept, it was c.RM180/MT). We keep our FY17E cement ASP assumption of RM280/t unchanged (average rebate assumption of RM110) for LAFMSIA on the back of a low utilization rate of 54%.

Maintain UNDERPERFORM for LAFMSIA. We remain Negative on the cement sector and reckon major re-rating catalyst lies with the recovery in the residential and commercial property market which typically makes up two-thirds of cement demand. Nonetheless, our in-house property view is such that the property market will only see recovery if positive monetary policies or property-related administrative measures are introduced. Hence, we maintain an unchanged UNDERPERFORM call and TP of RM6.06 on LAFMSIA (1.66x FY17 PBV @ -2.3SD 5 year Fwd PBV) due to the overcapacity issue coupled with the slowdown in the property market ahead.

ALUMINIUM Expecting stable prices, upside on USD appreciation. 2016 aluminum prices saw a solid recovery, rising by 16% in USD terms to USD1,733/MT and an even stronger 21% in MYR terms to RM7,775/MT, after imputing for USD appreciation against the RM. The full-year average of USD1,600/MT was spot-on with our forecast. Looking ahead, we expect 2017 USD aluminum prices to stabilize at the USD1,600-1,800 level with an average of USD1,700/MT. This is premised on stable demand growth from the increasing usage of aluminum in the transport sector, while we believe the closures of inefficient smelters have largely run its course, meaning supply is likely to stabilize over 2017. Furthermore, the demand outlook could further improve in the mid-term if US transportation companies do commit themselves to maintain manufacturing facilities in the USA – with continued labor cost pressures by manufacturing in the US, carmakers will increasingly need to find ways to improve production and vehicle efficiency by turning to cost-effective manufacturing materials such as aluminum. Meanwhile, PMETAL benefits from the recent appreciation of the USD due to its high export percentage while costs (c.70%) are largely MYR-denominated.

Steady supply-demand market. Global supply and demand trends continued to converge, with gradual demand coupled with a steadily declining supply due to closure of inefficient smelters. Based on available data, we observe that inventories have droped from c.4.85m MT over the course of 2016 to stabilize below 4.00m MT since Sep 2016, corresponding with the appreciation of aluminum prices over the same period. We think the steady inventory levels indicates that supply-demand is currently at equilibrium, hence US aluminum prices should be maintained at current levels at least in the near-to-mid term.

Asia ex-China outlook still positive. We are still positive on the aluminum demand outlook in Asia, as YTD Chinese production at 26.12m MT is only slightly higher than YTD Chinese demand of 25.89m MT, for a surplus of 287k MT or 1% of production. This is compared to Asia ex-China YTD production of 31.67m MT and YTD demand of 34.01m MT for a demand deficit of 2.34m MT, or 7% of Asia ex-China production. With Asian markets continuning to see strong regional demand (from countries like Japan and Korea with major automotive industries but minimal primary aluminum production capabilities), we believe Asia ex-China producers such as PMETAL will be beneficiaries of this trend.

Maintain OUTPERFORM on PMETAL with higher TP of RM2.15. We upgrade our TP on PMETAL to RM2.15 (from RM1.79) as we update our applied Fwd. PER to 16.0x based on higher FY17E EPS of 13.4 sen (from 11.9 sen). Our FY17E CNP is increased by 13% to RM519m as we update our USD/MYR assumption to 4.25 (from 4.10). We also update our applied PER to 16.0x (from 15.0x). We reiterate our positive view on PMETAL in light of stronger USD/MYR complementing aluminum price recovery, while margin expansion should continue with higher production volume and increased production of high-value alloys. (Please refer to our PMETAL Company Update report released concurrently for more details.)

Maintain NEUTRAL with selective buys on Building Materials. All in, we maintain our NEUTRAL view on BUILDING MATERIALS despite being positive on steel sector and aluminium sector as the market weightage of our negatively weighted cement sector is large. We maintain our UNDERPERFORM call on LAFMSIA (TP: RM6.06) due to the intense pricing competition from the overcapacity issue faced by cement players. Maintain OUTPERFORM on ANNJOO with a higher TP of RM2.39 (from RM2.24) post adjustment for the higher steel price assumptions. Meanwhile, we maintain PMETAL at OUTPERFORM with higher TP of RM2.15 (from RM1.79) as a beneficiary of rising aluminum prices and stronger USD, while margin should expand on improving effienciency and volumes with its new smelter.

Source: Kenanga Research - 6 Jan 2017