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 at healthy levels (as of report cutoff date of 10/3/16) of RM2,140-2,290/t which is mainly is due to cost push factors coupled with the reduced imports from China. We believe a decision of the extension of safeguard measure post investigation period remains crucial in order to sustain current steel price levels. Cement sub-sector is expected to remain weak due to high excess capacity from the additional new capacities of +16% in FY16, causing intense price competition between cement manufacturers. Aluminum price outlook is solid thanks to announced Chinese production cuts and potential anti-dumping duties on Chinese exports. PMETAL should see good earnings growth (FY17-18E: 51-21%) thanks to bullish aluminium prices and increased operating efficiencies. Maintain ANNJOO’s (OP; TP: RM2.65), PMETAL’s (OP; TP: RM3.15) and LAFMSIA’s (UP; TP: RM6.06) calls and TPs.

Excellent results in 4Q16 which saw all 3 counters under our coverage (ANNJOO, LAFMSIA, PMETAL) coming above expectations. LAFMSIA was above due to higher tax credits from reinvestment allowances for their new plants while ANNJOO and PMETAL outperformed due to higher-than-expected steel and aluminum ASPs, respectively. This quarter improved significantly against 3Q16, which saw two results coming in within and one below. Over 1QCY17 (till report cut-off of 10/3/2017), ANNJOO’s share price was up 22% which we believe is due to their better-than-expected results coupled with the announcement of a 9.0 sen dividend and the surge in long steel prices (+15% YoY). LAFMSIA was down 5% likely due to the absence of quarterly dividends for the second consecutive quarter which was previously consistently paid out every quarter since FY10. Meanwhile, PMETAL’s share price soared 60% in 1QCY17 on the back of aluminum price appreciation (+10% to USD1,868/metric ton (MT)) combined with a bullish commodities outlook and higher-than-expected earnings performance.

Long Steel Steel demand to be supported by infrastructure projects. In FY17, we expect the demand of construction steel to be supported by the advancement in infrastructure works which were awarded during FY16. That said, we believe growth in demand/consumption would be mild given that the property market has slown down.

Healthy steel prices. Local long steel prices currently trading at healthy levels of RM2,140-2,290/t (+32% YoY) being driven by: (i) cost push factors i.e. higher raw material prices (coal, iron ore, scrap), and (ii) the lower volume of China imports (-32% YoY) as seen from chart below. Despite the higher raw material costs, local manufacturers are able to pass on the higher raw material costs to end users due to the lower Chinese imports – allowing them to protect margins. We believe ANNJOO’s position in the local scene as a hybrid producer (Blast Furnace-Electric Arc Furnace) of steel, is poised to benefit from the high steel prices given their flexibility in production – making them less susceptible to the increasing scrap prices mainly denominated in USD vis- à-vis other local manufacturers. To recap, ANNJOO’s hybrid production method allows them to produce Hot Metal from Iron ore which is then fed along side with scrap metal (c.40:60 ratio) as a raw ingredient into their EAF for steel production vs other local manufacturers which are 100% scrap reliant for steel production as no BF facilities are available to them.

Finalized decision on safeguard to be announced in April. We believe 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 the c.USD400-500 level rendering them 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 as a result of slower construction activities due to winter season. 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. If approval of safeguard is finalized, we might consider rerating our valuations as it would bode well for sentiment.

Earnings intact. Our FY17-18E earnings for ANNJOO remains intact based on the following assumptions; (i) steel price assumption of RM2200/t, (ii) scrap prices of USD300/t, (iii) coke prices of USD200/t, (iv) iron ore prices of USD90/t, and (iv) sales volume assumption of >80%.

Maintain OP for ANNJOO. We reiterate our OP call on ANNJOO with an unchanged TP of RM2.65 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. We remain positive on the long steel sector underpinned by the high steel prices buoyed by less Chinese imports. Risks to our call include: (i) lower-than-expected steel demand, (ii) lower-than-expected steel prices, (iii) higher-than-expected imports, and (iv) discontinuation of safeguard measure post investigation period.

Maintain OUTPERFORM on PMETAL unchanged TP of RM3.15. We reiterate our OUTPERFORM call on PMETAL with an unchanged TP of RM3.15 premised on Fwd. PER of 17.0x and average FY17-18E FD EPS of 18.5 sen. Our Fwd. PER of 17.0x is based on our expansion-based PER 16.0x with an additional 1.0x to account for the early-2017 aluminum price run-up. We would consider reverting to 16.0x should aluminum prices correct closer to our estimate. We are positive on PMETAL due to the bullish price environment, continued cost efficiency improvements and rising proportion of higher margin products.

SUMMARY

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 larger. 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 unchanged TP of RM2.65 on the back of the healthy and stable steel price levels. Meanwhile, we maintain PMETAL at OUTPERFORM with unchanged TP of RM3.15 due to continued cost efficiency improvements and rising proportion of higher margin products.

Source: Kenanga Research - 30 Mar 2017