This time around, the long steel sector is being clouded by rising uncertainties stemming from: (i) Trump tarriffs, (ii) entrance of Alliance steel into the local market, and (iii) weak steel demand in China leading to declining steel prices there. We are most concerned over the weak steel demand in China, which could potentially flood our shores with imports given that the cost to import Chinese steel is now cheaper than steel sold by listed local manufacturers. Steel cable support manufacturer, ULICORP, registered uninspiring earnings performance in 4Q17 which we suspect is from intense pricing and slower deliveries. While we tone down its valuation to be at par with industry players, long-term prospects are still intact, helmed by its market-leading position and strong capabilities. Aluminum price should stabilise as we do not expect further inventory buildup ahead. While we lower our PMETAL’s earnings assumption by 24-14% to RM720m-1.01b, we up our call to OP with a lower TP of RM5.00 as margins remain supportive at current metal prices. The cement sub-sector is expected to remain weak due to persistent weak demand; causing price competition amongst cement manufacturers. Therefore, we reiterate our UP call with unchanged TP for LAMFSIA (UP; TP: RM3.90). WTHORSE’s (MP; TP:RM1.80) prospect as the largest ceramic tiles manufacturer in Malaysia also remains bleak from rising cost pressures and weak tiles demand. All in, we maintain all calls within the Building Materials space except for PMETAL which we have upgraded. TPs are adjusted for steel players - ANNJOO (OP; TP RM3.45), ULICORP (OP; cum/ex TP: RM2.05/1.37) after reducing valuation levels on the back of the less aspiring outlook from rising uncertainties. Overall, we maintain our NEUTRAL stance on the Building Material Sector. Still positive on steel despite rising uncertainties as we believe earnings growth remains intact and should stay long-term positive on China’s supply side reforms. That said, cement and tiles player (LAFMSIA, WTHORSE) are still plagued by the weak property market causing subdued demands and subsequently weak profits.

4Q17 results review recap: 2 inline, 3 below. ANNJOO and PMETAL came in line while WTHORSE, ULICORP, and LAFMSIA fell short of estimates. Reasons for coming below were: (i) margins compressed by higher production costs and lower selling prices for ULICORP, (ii) wider-than-expected rebates from LAFMSIA, and (iii) weaker-than-expected WTHORSE’s tiles demand. This quarter’s performance was similar to the last quarter which saw 1 coming in line and 3 below.

Share price performance. Over 1QCY18, ANNJOO’s share price was down 16% on rising tension from the trade tariffs announced by Trump coupled with the plunge in China steel prices as construction demand in China was not as strong as expected. LAFMSIA was down as they underwent a de-rating after registering their 4th quarterly losses with 4Q17 recording their worst loss. WTHORSE’s share price was down 4% on weak 4Q17 results coupled with them breaking tradition by dishing out 7.0 sen full-year dividend for FY17 instead of 10.0 sen as for the past eight years.. ULICORP’s share price, however, slumped as much as 57% following the huge earnings let down, likely owing to lower volume deliveries and cut-throat price wars which in turn compressed margins, and also disappointing dividends.

Although PMETAL’s share price was marginally unchanged over the review period, the counter recorded a significant run-up followed by a sell-off, following its inauguration into the FBMKLCI towards end-2017 and subsequently experienced a correction in tandem with aluminum price declines. After its inclusion into the FBMKLCI, PMETAL ran up to a peak of RM5.79 on 1 Mar 2018 (YTD increase of 7%), as aluminum prices declined (as explained from page 4 onwards), dropped 15% to RM4.95 as of our cut-off date on 23 Mar 2018.

Long Steel

Rising uncertainties. Currently, the Malaysian steel industry is clouded by 3 factors; (i) Trump tariffs, (ii) weak steel demand in China, and (iii) entrance of Alliance Steel. We address these three factors separately as below:

1. 25% Trump tariffs on steel: We believe Malaysian long steel players would be minimally impacted in terms of additional import threats and earnings. Based on publicly available stats, US imported 30m MT of steel products in FY16 where 7m MT is long steel. Post implementation of the Trump tariffs, we believe a portion of this 7m MT of long steel supply would possibly needed to be channelled outside US possibly causing heavier pricing competition outside US. However, we note that this amount is small compared to China’s capacity (c.1.1b MT of steel). We believe China’s commitment to cut down steel products further would easily net off the tariff impact on global supply dynamics ex-US. We highlight that China had slashed c.120m MT of steel in FY17 and targets a further 25-35m MT tonnes steel capacity reduction in FY18. Furthermore, we note that the current largest long steel exporter to US is Canada, which has little tendency to export to Malaysian shores.

2. Entrance of Alliance Steel: Based on channel checks, Alliance Steel, which is based in Kuantan has started production with capacity of: (i) 1.0m tonnes for rebars and (ii) 600k tonnes for wire rod. Currently, we understand that Alliance Steel has built up inventories pending Sirim’s approvals before they can start selling to the local market. While we highlighted last quarter that the local market demand of c.6.0m tonnes/annum would be able to absorb this new supply without putting downward pressure on prices, we think that local steel prices moving forward might be capped from moving higher despite the gradual rise in construction activities stemming from mega infrastructures.

3. Weak steel demand at China: China steel prices have come down sharply recently due to the slower-than-anticipated construction activities post CNY season; indicating weaker-than-expected Chinese steel demand. We believe weak Chinese demand for steel products would be the most worrisome compared to the above two factors. Due to the weak Chinese real demand, current effective cost of importing Chinese rebars into Malaysia is c.RM2,400/t after accounting for the safeguards (+13%), import duties (+5%) and shipping fees (+5%). We are more cautious at this juncture as we note that current China prices are lower than local current rebar prices of RM2,600-RM2,750/t allowing for opportunities to import. The imports would typically take 2-3 months delivery time before they are reflected into our local prices here. Hence, we choose to monitor the situation closely and review when necessary. If China steel prices are subdued for a longer term, we might see higher volumes of imports which would depress our local prices for the coming quarters in FY18.

Maintain OP for ANNJOO but lowering TP on higher volatility. We are expecting ANNJOO’s 1Q18 results to potentially come in stronger-than-expected from the higher-than-estimated steel prices (RM2,700/t in 1Q18 vs our estimate of RM2,300/t). That said, no change to our FY18/19E earnings estimates for now. All in, we maintain our OP call for ANNJOO premised on China prices not falling further prompting a surge in imports and causing our local steel prices to fall below RM2,300/t level (our FY18 assumption). That said, we reduce our TP from RM4.70 to RM3.45 after lowering our valuation levels down to FY18 PER of 8x (+0.5SD) from FY18 PER of 11x (+2SD) as we turned more cautious given the short-mid term uncertainties despite still being long-term positive on China’s supply side reform.

Flat Steel

Turbulent FY17. Sales growth expectations from the rolling out of the Nilai plant was denied due to slowing project deliveries. We believe this was caused by volatile fluctuations in steel prices as customers became more cautious with their cashflows. This could also due to stiffer competition, which aggravated price competition. The double blows from the above ultimately led to the stock recording lower core net earnings by -35% YoY.

Are prospects still intact? Rampant growth of new competitors could be an indication of the tempting prospects within the cable support system space. ULICORP remains as the market leader for this segment with c.40% market share and is likely to hold out in a price war to weed out new entrants. While this would dampen earnings, the stronger production capabilities and economies of scale provided by the group’s plant should sustain operations until a more favorable time. Further, the group possesses valued-added propositions with its in-house galvanising and powder spray line.

Being on more grounded terms with ULICORP. While we maintain our OUTPERFORM call, we narrow our cum/ex-bonus issue target price to RM2.05/RM1.37 (from RM2.85/RM1.80, previously). This is premised on a revised 10.0x FY19E PER (from 14.0x FY19E PER, previously) which is in line with the average Fwd. PER ascribed to local steel players. The selling down of the stock is possibly aggravated by the negative surprise from its 4Q17 results which only contributed RM1.1m (-83% YoY) in core earnings, coupled with disappointing dividend returns (0.5 sen from 12.0 sen in FY16). Investors may understandably adopt a more cautious approach with the stock in anticipation of such results to repeat. Nonetheless, there may be some buying opportunities for the stock as we anticipate a recovery in its competitive landscape closer to FY19, which we expect to grow by 24% from FY18.

CEMENT and TILES

Malaysia FY17 apparent cement consumption at 5-year low. FY17 total apparent cement consumption of 17.7m MT was down 10.8% YoY (refer Table below) recording a 5 -ear low. The decrease in apparent cement consumption points to the weak demand faced by cement players, mainly due to: (i) slowdown in residential and commercial property markets, and (ii) mega infra-works still in initial phases. We derive our apparent consumption of cement after deducting exports from the production and imports of cement in Malaysia. While we think that FY17 is at the bottom and expect FY18 cement demand to pick up from the gradual progress of infrastructure projects we do not expect an exceptional rise in demand. We are expecting FY18 cement consumption to be in the range of 18.0m-19.0m tonnes at best.

FY18 cement outlook. We reiterate our view that (i) the underlying rerating catalyst for the cement sector is a recovery in the property market, and (ii) huge mega projects in place should not be the major catalytic drivers for cement counters given that the sheer percentage for cement tonnage/annum required for ‘mega projects’ on an individual basis only accounts for <1% of industry capacity of 35m tonnes. In addition, we note that there is also timeline issues for certain anticipated mega projects such as ECRL and HSR where cement demand would only kick-in between 1-2 years after the contracts are awarded. Given that ECRL and HSR awards may be awarded in FY18/FY19, the cement demand for these projects would only kick in from FY19-FY20 onwards. Furthermore, we think that the quantity of cement tonnage/annum needed for these projects would not be as large as expected.

LAFMSIA likely to continue suffering from de-rating catalyst. Based on channel checks, we note that 1Q18 cement bag rebates are still high, ranging from 30-55%. Hence, we expect upcoming 1Q18 results to remain in the red similar to previous quarters losses given that (i) construction activities have yet to see significant pick up and (ii) similarly high rebates. All in, we remain negative on the cement sub-sector and maintain our earnings estimates with unchanged UNDERPERFORM and TP of RM3.90 for LAFMSIA (1.20x FY18E Fwd. PBV; 7-year -2.0SD) as we believe LAFMSIA will continue to de-rate due to: (i) persistent losses and (ii) absence of dividend.

WTHORSE not looking good too. WTHORSE registered losses of RM0.8m in FY17 due to weak tiles demand from the slow property market leading them to write off inventories worth RM20m. While WTHORSE has the largest tiles manufacturing capacity locally with 30% market share in Malaysia, we are cautious over its prospects moving forward due to: (i) the weak property market which has been plaguing the cement space and potentially suppressing tiles demand along with (ii) rising cost pressures, i.e. energy and labor costs. No changes to earnings. Maintaining MARKET PERFORM call and TP of RM1.80 based on FY18E PBV of 0.56x (-1.0SD@5 years).

ALUMINIUM

Healthy price pullback. Aluminum prices softened in 1Q18 as China officially declared its winter season over, signaling that production re-starts would be permitted. In tandem with rising inventories, the London Metal Exchange (LME) prices weakened by 13% to USD1,969/MT, although we note that year-to-date (YTD) prices at USD2,142/MT remains comfortably above our USD2,000/MT average forecast. Note, however, that with strong ringgit performance against the USD, aluminum prices in ringgit has underperformed exchange prices with a 17% decline to RM7,608/MT YTD. We view this correction as expected, however, and do not expect further significant aluminum price decline for the year as we will explain below. Ringgit is also unlikely to see further strengthening at this point, as its current levels near USD/MYR at 3.90 is in line with our in-house economists’ forecast of USD/MYR of 3.90.

Inventory build-up causing knee-jerk price reaction… Global aluminum stockpiles rose in 1Q18, from a stable 3.5m MT through the whole of 2H18, to nearly 4.0m MT as of Mar 2018, which contributed to the recent price decline. While we observe that production and demand have been fairly close in 2H18, production appeared to outweigh usage in the winter months, possibly due to Chinese production cuts being lower than indicated by government directives. Nevertheless, we note that this remains lower than 2016 inventory levels that peaked at slightly under 4.1m MT, indicating that the build-up is not unusual and should head downwards once demand normalizes in the warmer months.

… but bulk of build-up is NOT in China! Despite the inventory buildup, Reuters reported that aluminum stockpiles registered with the Shanghai Futures Exchange (ShFE) in China actually saw a slight 154 MT decline to 970k MT indicating that the buildup in the past months was not in China, supporting the possibility that, as reported by Market Watch, “aluminum traders have stockpiled aluminum in U.S. warehouses in anticipation of the (US aluminum) tariff. Consulting firm Harbor Aluminum Intelligence estimated that record 2.3 million metric tons are in storage in the U.S.”. Indeed, based on data available up to Jan 2018, the demand deficit in Asia, inclusive of China production, remains in a solid deficit position (refer to charts below).

Upgrade PMETAL to OUTPERFORM with lower TP of RM5.00 as we update our USD/MYR assumptions to reflect our inhouse forecast, thus resulting in lower FY18-19E CNP to RM720-1.01b (-25-14%). Our Fwd. PER is maintained at 19.0x, applied to lower FY19E EPS of 26.3 sen (from 30.8 sen) as aluminum prices remain comfortably within our forecasts. We do not expect the US-China aluminum trade spat to affect PMETAL as the company exports minimal quantity to either country. The main impact would be on London Metals Exchange (LME) aluminum prices, on which PMETAL's selling prices are based. Nevertheless, with >50% of production hedged, we expect PMETAL’s earnings to see low volatility as any price risks would take c.6 months to be reflected, while its low unit production cost (c.USD1,550/MT) would support its profitability, especially compared to high-cost producers in both US and China. Even after our earnings adjustment, we believe the knee-jerk selling reaction by the market recently was unjustified given the solid outlook discussed above, and we upgrade our call to OUTPERFORM.

Source: Kenanga Research - 6 Apr 2018