Overall, we maintain our NEUTRAL view on the Building Materials sector despite being positive on the steel sub-sector due to the negatively weighted cement sub-sector. We are positive on the long steel sector as we expect construction activities within the infrastructure space to pick up pace, supporting demand and consequently, steel prices. In the meantime, the recent selldown of ULICORP’s shares following the disappointing 3Q17 results may present a buying opportinunity. We believe that it is overdone as its enhanced production capabilities and medium-tremainlook remains intact against tight competition and high steel prices at present. Aluminum price outlook is solid thanks to Chinese production cuts and rising costs raising the price floor. PMETAL should see good earnings growth (FY17-18E: 44-56%) thanks to bullish aluminium prices and continued efficiency upgrades. However, the cement sub-sector is expected to remain weak due to high excess capacity from the additional 16% capacity in FY16, causing intense price competition amongst cement manufacturers. Note that we recently initiated coverage on WTHORSE (MP; TP:RM1.90), the largest ceramic tiles manufacturer in Malaysia. Maintain all calls and TPs within the Building Materials space except for ULICORP which we trimmed its TP to RM4.10 (from RM4.45) following lower margins assumptions impacting short-term earnings while upgrading the stock to OUTPERFORM as we believe the stock’s selldown presents a buying opportunity.

3Q17 results review recap. For 3Q17 results season, one came in broadly inline (ANNJOO) while the other three fell short of estimates (LAFMSIA, ULICORP, PMETAL). We deem ANNJOO to be broadly in line as we expect stronger average steel prices coupled with lower costs to lift 4Q17 earnings.Meanwhile,e the rest were below due to: (i) lower demand for cement for LAFMSIA, (ii) higher carbon anode costs for PMETAL, and (iii) slower sales for ULICORP. Last quarter was better off given that there were no disappointments.

Share price performance. Over 4QCY17 (till report cut-off of 15/12/2017), ANNJOO’s share price was up marginally by 2% which we believe is due to the slight improvement in steel prices while LAFMSIA was down 3% stemming from their poor 3Q17 results. With its long-awaited inclusion into the FBMKLCI, PMETAL’s share price jumped 33% to RM4.98, as we upgraded our TP to RM5.00 reflecting the re-rating factor on joining the key market index, while also reflecting the continued strength in aluminum prices. As for ULICORP, the 16% slide in share price is likely attributed by the disappointing YoY results coupled with the lack of dividends. We believe this is due to intense price competition with new entrants in the market and surgeprices,eel prices which affected the group’s ability to pass down costs and protect margins.

Long Steel

China steel prices still higher than local prices. Currently, China steel rebar prices are trading at c.USD665 (RM2,700). After incorporating import duties (+5%), shipping fees (c.+5%) and safeguard measure (+13.2%), total effective cost for importing Chinese rebars is c.RM3,300 vs. current local rebars prices of RM2,700-RM2,850 (as of 29 Dec 17 based on MITI weekly bulletin). Hence, we believe there are currently little to no rebar imports from China into Malaysian shores as it is too expensive at this moment. We also believe that China’s supply side reforms with the implementation of capacity reduction through the elimination of older and less efficient steel plants and China’s game plan in tackling environmental issues, i.e. winter smog would spell more sustainable global steel prices into the future. Hence, we are positive on this given that the high China steel prices could serve as a benchmark to which our local steel prices can rally up to.

ANNJOO 4Q17 results preview. In 4Q17, local steel prices hit another record high this year at RM2,700-RM2,850/t levels which are higher than September’s high of RM2,650-2,800/t (refer graph next page). We note that this level is at a 5-year high. We believe the higher local steel prices were driven by the slight improvement in demand as major infrastructure construction works progress, tighter rebar supply due to insufficient raw materials (billets) for certain millers and rising raw material prices (scrap). We believe the high prices are beneficial to ANNJOO and we are estimating its 4Q17E earnings to come in at RM67m (+42% QoQ) which would bring FY17 CNP to RM217m (+41% YoY-YTD) accounting for 99% of our FY17E estimates. Our 4Q17E CNP preview are based on average plant utilization of 90%, average rebar prices of RM2,500/t, scrap prices of USD335/t, Coke prices USD290/t and iron ore prices of USD70/t.

Outlook for FY18. In FY18, we believe construction steel demand will remain strong stemming from the major projects underworks i.e. MRT2, LRT3, TRX, which support steel rebar prices. However, we note thhat Alliance Steel’s new plant capacity (1.5m tonnes long products) is expected to be operational from Feb 2018. That said, we only expect its full capacity of 1.5m tonnes of long products to come online in 2H18 due to teething/gestation period during the early months of operations. While we understand that this new capacity is meant for the export market, we note that no restrictions were put in place for Alliance Steel to sell domestically. Nonetheless, we take comfort that: (i) the domestic steel market has a large enough demand to absorb this new capacity in which domestic steel demand is c.10mt/annum while ecapacitiescapacity of all rebar manufacturers locally are at 8.3mt (with some mills running at low utilFurthermore,on rates). Also, with the additional demand from the mega infrastructure developments in place, we believe this new capacity from Alliance Steel would have minimal pressure towards selling prices for FY18. That said, we note that our FY18E rebar price assumptions are also relatively conservative at RM2,300/t vs. current prices of RM2,700-2,850/t.

Maintaining our Top Pick. We maintain ANNJOO’s FY17-18 earnings of RM218-228m based on average steel rebar prices of RM2,225-2,300/t. We note that this is the second consecutive quarter ANNJOO is picked as our top pick and reiterate our OUTPERFORM call with an unchanged TP of RM4.70 based on 11x FY18E PER. We believe our applied valuation of 11.0x is fair as we note that MASTEEL (a peer) was already trading at Fwd. valuations of 7-10x in FY10-13 despite: (i) past 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 TP of RM4.70, ANNJOO’s dividend yields for FY17-18 remains relatively attractive at c.5.4%.

Other risks associated to our earnings/call would be a plunge in prices due to overstocking of steel rebars by China players from the forced capacity reduction by their government over the winter period leading to a surplus in stock. A decrease of China steel price below our local steel price level could spur 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.15% 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 slower-than-expected pick-up in local construction activities.

Source: Kenanga Research - 5 Jan 2018