Overall, we maintain our NEUTRAL stance on the Building Materials sector. Over the last few months, ANNJOO’s share price was bogged down by a multitude of factors, i.e. (i) expectation of challenging 2H18 outlook, (ii) potential hike in labour costs, and (iii) subdued construction activities. While short-term pressures linger, we believe ANNJOO will be able to weather through this downturn, backed by increasing its proportion of exports sales to cushion the tepid domestic demand coupled with their position as the most efficient and cost effective domestic steel player. Steel cable support manufacturer, ULICORP, continued to disappoint as earnings were dampened by pricing and cost pressures. Meanwhile, we see potential pullbacks in aluminium prices to USD1,800-1,900/MT levels as the US relaxed an earlier sanction on Rusal, restoring aluminium supply globally. Notwithstanding, with YTD aluminium prices of USD2,161/MT comfortably remaining above our USD2,000/MT assumption, we expect PMETAL’s top-line to remain achievable for the year. The cement sub-sector is expected to remain lacklustre due to ongoing weak demand, causing intense price war amongst cement manufacturers. WTHORSE’s prospect as the largest ceramic tiles manufacturer in Malaysia also remains bleak from rising cost pressures and weak tiles demand due to soft property market. Maintain all calls within our universe with unchanged TP for PMETAL (MP; TP: RM5.00) and LAFMSIA (UP; TP: RM2.40), ANNJOO (OP; TP: RM2.35), ULICORP (UP; TP: RM0.675) and WTHORSE (MP; TP: RM1.75).

Share price performance. Over 3QCY18 (till report cut-off of 21/9/2018), ANNJOO’s share price fell 5% which we believe this was due to market expectation of challenging prospects in 2H18 as a weaker set of 2Q18 results and softer construction sector outlook. LAFMSIA was down 6% after registering sixth quarterly losses since listing. Similarly, WTHORSE’s share price dropped 7% likely due to their comparatively poorer YoY results announced. As for ULICORP, its share price plunged by 20%, which we believe was due to 2Q18 earnings disappointment owing to higher-than- expected operating costs that led to margins erosion. Meanwhile, PMETAL’s share price recovered 15% over 3QCY18 (till report cut-off of 21/9/2018) as aluminium prices stabilised around USD2,000-2,100/MT level. Aluminium prices were on a declining streak since it hit the peak of USD2,541/MT, triggered by the extension of Rusal sanction deadline, allowing more time for the 2nd largest aluminium producer in the world to flood the market with abundance of supply. Subsequently, the drop in aluminium prices was cushioned by the cost-push factor from mounting alumina prices.

Simliar to the last quarter. 2QCY18 results came in similar to 1Q18 with two stocks (WTHORSE, PMETAL) coming in within expectations, while three counters (LAFMSIA, ANNJOO and ULICORP) missed consensus and our forecasts. WTHORSE’s 2Q18 results were deemed in-line as we believe the group will be able to maintain its improved 2Q18 performance in anticipation of better sales from both Malaysia and Vietnam. Likewise, for PMETAL, we anticipate its 2H18 earnings to pick up on stronger USD/MYR, moderating carbon anode prices as well as better product mix. Meanwhile, reasons for the remaining counters to come below expectations was due to: (i) margins compressed by higher-than-expected cement rebates for LAFMSIA, (ii) lower steel ASPs and higher input cost for ANNJOO, and (iii) higher-than expected operating costs for ULICORP.

Long Steel

Less inspiring domestic space. Based on our channel checks, local long steel demand is expected to be flattish in near-tomid term as construction awards slow down. Domestic steel demand might pick up gradually in view of more positive news flow from the construction sector recently such as the soon to be awarded RM500m worth of contracts from Gemas-JB double-rail tracking projects. While we believe market is positive on the news flow as it added certainty on the progression of the mega projects, we believe the RM500m worth of contract may be less relevant to steel players as the jobs packages are for signalling and communication jobs. Given that the details of the upcoming awards are still cloudy coupled with uncertainties remaining within the construction sector, we believe demand for local steel in 2H18 may be stagnant.

Minimal import threats from China. Effective China steel import prices (after imputing shipping, import duties and safeguard) have been ranging between RM3,300- 3,500/t for the last two months against our local prices of RM2,400-RM2,550/t. Hence we believe there is a minimal steel import threat from China to Malaysian shores. In addition to the higher prices, the long waiting time of c.2 months for imported rebars to be shipped had led to minimal imports from China. We find the current price difference between Chinese and domestic steel prices of RM900-950/t to be more than sufficient buffer to fend off imports into our shores. Hence, we believe Malaysian long steel players would be minimally impacted in terms of additional import threats and earnings.

Maintain OUTPERFORM on ANNJOO with an unchanged TP of RM2.35. We reiterate our OP call on ANNJOO with an unchanged TP of RM2.35 based on unchanged 8.0x FY18E PER. Our 8.0x applied valuation is above 7.0x 1-year Fwd. PER implying 10% premium to its close peer MASTEEL. We believe our 8.0x PER valuation is justified given; (i) ANNJOO’s 2-year top-line performance for FY16-17 ranging between RM1.9-2.2b is higher than MASTEEL’s RM1.2-1.5b, (ii) ANNJOO’s 2-year earnings base for FY16-17 of RM166.8-205.4m was larger than MASTEEL’s RM21.4-RM75.5m, and (iii) 2-year historical dividend yield of 8.5%-10.7% is above MASTEEL’s 0.0%-1.2%. In view of unexciting demand outlook due to the still bleak construction outlook, 2H18 performance might be challenging in light of weaker local demand, potential increase in supply from Alliance Steel and higher operating cost. However, while we regard ANNJOO’s 2Q18 as the worst quarter, we note that the poor performance was also badly affected by major festive seasons and General Election that led to lower tonnage sold. Hence, we expect ANNJOO to deliver a stronger quarter ahead given its track record as the most cost efficient upstream steel player with highest capacity utilization amongst local upstream players. To recap, ANNJOO’s hybrid production approach allows them the flexibility to alter their cost structure based on cheapest available raw material (either iron ore or scrap) to produce steel unlike other players which are 100% scrap reliant. We also think ANNJOO’s outlook within the sector will still be satisfactory as it is confident of weathering the downturn by increasing its proportion of exports sales approximately 30% of its production in 2H18. Thus, we reiterate OUTPERFORM on ANNJOO with an unchanged TP of RM2.35 pegged at 8.0x FY18E PER.

Source: Kenanga Research - 5 Oct 2018