2Q17 results review recap.. 2Q17 results were rather inline with 2 counters coming in within (PMETAL, ANNJOO) while 2 came in broadly within (LAFMSIA, ULICORP). LAFMSIA was broadly within as we anticipate 2H17 to make up for the losses accumulated in 1H17, underpinned by healthier cement demand from the pick-up of infra construction activities while ULICORP is expected to catch up on delayed outsourced deliveries. The last quarter was slightly better off given that 1 (ANNJOO) actually came in above expectations.

Share price performance. Over 3QCY17 (till report cut-off of 21/9/2017), ANNJOO’s share price was up 17% which we believe is due to the: (i) rise in steel prices, and (ii) anticipation of strong results in 3Q17. LAFMSIA was up 27% as market anticipated recovery in cement rebates on the back of stronger demand from pick-up in construction activities moving ahead. Meanwhile, PMETAL’s share price soared 40% to RM3.71 and we upgraded our TP to RM4.05 on the back of stronger FY18 earnings outlook as aluminum prices appreciated 13% to hit USD2,080/MT as of end-Sep 2017. As for ULICORP, its share price fell by 9% since our coverage initiation on 25/5/2017 which we believe is due to their comparatively poorer YoY results announced owing to weaker sales from disrupted project deliveries and gestation expenses incurred during the year.

Long Steel

Favourable China steel prices. Currently, China steel rebar prices are trading at c.USD580 (RM2,400). After incorporating import duties (+5%), shipping fees (c.+5%) and safeguard measure (+13.2%), total effective cost for importing Chinese rebars is c.RM3,000 vs local rebars prices of RM2,560-RM2,710. Hence, we believe there are little to no imports from China into Malaysian shores now as it is too expensive at this moment. In addition, we believe the China winter construction period which is set to begin from Nov-Jan 2018 could possibly fuel another rise in steel price when supply tightens from the capacity reduction. Furthermore, the Chinese government has been strict on their carbon footprint and this could provide China steel prices another leg up when the government begin their regulatory checks during the winter season. We are generally positive on this given that the high China prices could serve as a benchmark to which our local steel prices can rally up to.

ANNJOO 3Q17 results preview. High local rebar prices which hit a 5-year high of RM2,800/t in 3Q17 was the precursor to strong earnings for ANNJOO in 3Q17. Based on a utilisation of 80%, targeting 3Q17 CNP of RM63m (+100% QoQ, +127% YoY) which would bring 9M17 CNP to RM160m (+64% YoY-YTD) accounting for 73% of FY17E estimates. However, should local steel prices sustain >RM2,600/t for the rest of FY17, which we believe is possible due to the pick-up in infrastructure construction, which would buoy demand and subsequently prices, be prepared for 4Q17 results to come in stronger than 3Q17, potentially surpassing our FY17E estimates. That said, we are maintaining our estimates for now based on an unchanged steel rebar assumption of RM2,225/t in FY17 pending further assessment on 4Q17 steel prices and 3Q17 results in end-Nov. We note that if we revise up our FY17 steel price to RM2,330/t (from existing RM2,225/t) to reflect 4Q17 steel price of RM2,600/t, our FY17E earnings estimates would increase to RM239m (+10% from current FY17E earnings of RM218m).

Rerating catalysts. Separately, we did a share price and valuation study on ANNJOO from 2016 till now (refer chart below) which reveals that ANNJOO would rerate whenever: (i) there is anticipation of a good set of results, which displays strong QoQ and YoY growth, (ii) when steel rebar prices hit an all-time high and (iii) approval/finalization of safeguard measures. Currently, ANNJOO trading at 8.7x FY18E PER. Given the high chance of ANNJOO to display strong set of results (strong QoQ and YoY growths) for the following 2 quarters, we believe ANNJOO would likely undergo further reratings.

A structural shift in fundamentals. We believe we are currently seeing a structural shift in fundamentals within the steel space as (i) China is actually walking their talk by undergoing supply reforms and implementing capacity reduction through the elimination of older and less efficient steel plants as evident this year with c.139m capacity elimination of ‘illegal’ induction furnaces (as of July 2017), and (ii) China is placing larger importance on environmental issues and undergoing more regulatory checks for their furnaces as they slowly transition into a service-based economy and away from manufacturing. With China taking lead with such reforms, we strongly feel this would spell for more sustainable global steel prices into the future. Given the positive shift in fundamentals and potential reratings, we reiterate our OP call for ANNJOO and upgrade our valuations to 11x FY18E PER (from 10x) translating to a higher TP of RM4.70 (from RM4.30).

To back up our newly applied valuations of 11.0x, we noted that MASTEEL (peer) was already trading at Fwd. valuations of 7- 10x in FY10-13 despite: (i) steel prices not as high coupled with the absence of safeguard measures back then and (ii) MASTEEL’s profitability of RM20-30m back then was much smaller compared to ANNJOO’s FY17E profit of RM218m. In addition, based on our new TP of RM4.70, ANNJOO’s dividend yield in FY17-18E remains relatively attractive at c.4.4%.

We highlight the potential risks associated to our earnings/call would be the fall in China prices due to overstocking of steel rebars by China players in anticipation of the winter construction. A decrease of China steel price below our local steel price level could invite imports again threatening local prices and profitability of local manufacturers. That said, we note that our current steel price levels are trading at a discount of c.12% compared to China prices - allowing for some room for China prices to come down before imports can flood into our shores. Other related risk is the slower-than-expected pick up in local construction activities.

Source: Kenanga Research - 6 Oct 2017