We believe that ANNJOO is the most cost efficient upstream steel miller in Malaysia given its superior margins against peers. ANNJOO is also set to benefit the most from the reduced Chinese imports post safeguard. Maintaining our earnings forecasts pending 1Q17 results. Reiterate our OP call with a higher TP of RM3.75 (from RM3.03) after upgrading our valuations to 10.0x FY18E PER (from 8.0x FY17E PER).

Most cost efficient upstream steel player with a trader’s instincts. We believe ANNJOO is the most cost efficient upstream player among the steel millers (LIONIND, SSTEEL, MASTEEL) by having the strongest 4QCY16 EBIT margins of 14.4% versus peers range of 6.2%-8.0% - a relatively huge gap. Note that we decided to only compare 4QCY16 margins as it is the period in which safeguard measures were present with little to no imports from China. Unlike other upstream players, ANNJOO holds a higher amount of inventories given their background as a seasoned trader. Against peers, ANNJOO has an inventory level which could last them c.6 months (as of 4Q16) vs peers' inventory holding levels, which would last 3-4 months. We view this positively as ANNJOO’s higher inventory levels provides them the ability to hold back purchases when raw material prices are high and only buy when the prices are right while at the same time remain in full operation with no disruption to supply. While we note that ANNJOO would suffer from the heaviest write-down of inventories should steel prices plunge, we believe such risk is currently minimal as local steel prices would likely remain at relatively stable levels of >RM2000/t as we expect (i) local steel demand to pick up from 2H17 which would buoy prices and (ii) low threats of cheap China imports given the safeguard measures (+13.9%) and import duties (+5%) in place coupled with the higher China prices (currently c.RM2300/t) (refer back).

Results to outperform peers. Having higher level of inventories, we believe ANNJOO is also likely to outperform its peers in the upcoming quarterly earnings results (1Q17) in terms of margins. This is because during an increasing raw material costs environment (3Q16-1Q17), ANNJOO would likely be recognizing lower average cost of the raw material prices traded between 2H16 compared to other steel millers which would be recognizing relatively higher average raw material costs traded in 4QC16 ie. avg 4Q16 scrap price +10% against 2H16 avg. We note that scrap being the major raw material costs for local steel millers accounts for c.30-35% of ANNJOO’s operating costs. (Refer back for graph)

Expecting strong 1Q17 earnings. We estimate 1Q17 CNP earnings to likely come in above our expectation at a range of RM68m-80m (based on capacity utilization of 80%-90%) making up c.36%-43% of our FY17E CNP due to higher-than-expected rebar prices and lower costs. Our 1Q17 results review estimates for ANNJOO are based on (i) Actual 1Q17 average rebar selling prices of RM2247 vs our RM2200 estimate, (ii) average 2H16 scrap prices of c.USD239 (ours USD300) (iii) average 2H16 iron ore prices of c.USD65 (Ours USD90) and (iv) average 2H16 coke prices of c.USD217 (ours USD200). That said, we maintain our FY17-18E earnings forecast for now pending ANNJOO’s 1Q17 results by end of this month. Reiterate our OP call with higher TP of RM3.75. We are convinced that ANNJOO should justify a premium in valuation against its peers, i.e. MASTEEL, LIONIND, SSTEEL (trading at Fwd CY17 PER of 7.8x-12.3x;

refer back for more) given their dividend policy of at least 60% indicating an attractive FY17E dividend yield of 5.8%. Furthermore, with their optimum capacity size (650k MT of rebar capacity/annum vs annual local rebar demand of c.4.0m MT) in the existing market, ANNJOO has been constantly operating at an 80-90% utilization rate. Given all the favourable attributes, we upgrade our valuation of ANNJOO to 10.0x (from 8.0x) on FY18E PER (rolled forward from FY17E) valuing ANNJOO at a higher TP of RM3.75 (from RM3.03) while reiterating our OUTPERFORM call.

Source: Kenanga Research - 22 May 2017