All in, we maintain our UNDERWEIGHT call on the building material sector as we are negatively weighted on the cement, steel and tiles spaces. We expect the current dampened domestic demand to be exacerbated by potential additional steel supply coming from Alliance Steel to pile on more pressure on steel prices. Similarly, we foresee challenging operating environment for flat steel sub-segment, likely due to weaker domestic and export demand. Weak domestic demand woes, overcapacity in the market, and high cement rebates dished out will continue clouding the cement sub-sector. Tiles sub-sector outlook remains bleak due to the slowing down of property and construction jobs in the market which is affecting sales volume, whilst rising cost pressure lingers. For aluminium, we estimate average 2019 aluminium price to be at USD2,000/MT, a 5% drop from 2018 average of USD2,108/MT but still a recovery from current price of c.USD1,877 (as of 22 March 2019), supported by the current supply deficit globally. We believe the recent weakness in aluminium prices is temporary and hence, it could see some recovery in the near term. Furthermore, fortunately, PMETAL has managed to hedge c.40% of its FY19 aluminium sales volume at USD2,000-2,100/MT. All in, we upgrade calls to MARKET PERFORM with unchanged TPs for ULICORP (TP: RM0.450) and WTHORSE (TP: RM1.15). Meanwhile, we reiterate UNDERPERFORM calls and maintain TPs on LAFMSIA (TP: RM1.85) and ANNJOO (TP: RM1.25). For PMETAL, we reiterate our MARKET PERFORM call with a higher TP of RM4.50 (from RM4.00).

Mixed bags of results. In terms of earnings, 4QCY18 turned in fewer disappointments compared to the preceding quarter when 4 counters came below our expectations. Of the 5 stocks within our coverage, LAFMSIA and PMETAL came in line with estimates. However, one player, namely ANNJOO, delivered better than expected results, largely driven by positive tax of RM32.3m arising from tax incentives. Meanwhile, the other two players; ULICORP and WTHORSE fell short of estimates. The negative deviations for the two players are as follow: (i) ULICORP: thinner-than-expected margins arising from higher operating costs, and (ii) WTHORSE: lower-than-expected tiles demand in Malaysia and Vietnam, and weaker-than-expected ASPs as well as higher production cost leading to margins erosion.

Share price performance. Over 1QCY19 (till report cut-off date of 22/03/2019), LAFMSIA’s share price rebounded strongly, surging by 22% post sell-downs over 2018 following consecutive widening quarterly losses. Likewise, ANNJOO’s share price also rebounded, by 22%, over 1QCY19. We believe the strong share price rallies for the two counters were largely driven by markets being excited over the potential revival, albeit scaled-down East Coast Rail Link (ECRL) project cost to RM35b from a hefty RM55b; note that LAFMSIA had earlier won contract under ECRL projects. Meanwhile, WTHORSE and ULICOPR’s share prices were down by 24% and 34%, respectively, on weak 4Q18 results coupled with continuous quarterly earnings disappointments on lower volume deliveries and cut-throat price wars which in turn compressed margins. PMETAL’s share price was marginally lower over the review period, as aluminium prices remained below USD1,900/MT level vs. 2018 average of USD2,108/MT. Aluminium prices were on a declining streak since it hit the peak of USD2,541/MT, likely triggered by the extension and subsequent lift of Rusal sanction, allaying concerns that the 2nd largest aluminium producer in the world could flood the market with abundance of supply.

Infrastructure projects to spur existing demand? Not quite enough yet. We continue to believe 2019 remains a challenging year for most of the building material counters such as LAFMSIA, ANNJOO and WTHORSE as well as ULICORP, considering the lack of sector catalysts and unexciting newsflow while the weak property market and slow construction activities continue to be a drag for building material players. As such, even after project cost reviews for LRT3 and MRT2 have been concluded, work progress remains slow in the market. Hence, we opine that any infrastructure newsflows are unlikely to revive the sector in a significant way in the near-term. We noted that there more newsflows in the market on the infrastructure projects such as Pan Borneo Highway, ECRL and water treatment projects as of late. However, the sector requires the construction sector to see more momentus improvement before the building materials sector can catch a glimpse of light at the end of the tunnel. Construction activities may pick up on the back of more construction project roll-outs with local demand for building materials to improve, supporting steel and cement players under our coverage. That said, we view that the increase in demand might not be substantial due to stiff competition and looming margins compression as a result of higher-than-expected raw material costs. We opine the potential increase in local demand for steel and cement arising from the pick-up in infrastructure projects such as ECRL and LRT3 may not significantly benefit cement and steel sub-sectors as it will be largely be weighed down by the current overcapacity in the market.

Source: Kenanga Research - 5 Apr 2019