Overall, we maintain our UNDERWEIGHT call on the building material sector as we are negatively weighted on the long and flat steel as well as ceramic tiles sub-sectors. We expect higher raw material, lower average selling price, weaker demand and intense competition to pile on more pressure to manufacturing margins. However, for aluminium, we estimate the average 2019 aluminium price to be USD1,920/MT, a 9.0% drop from 2018 average of USD2,108/MT but still a recovery from current price of c.USD1,809 (as of 20 September 2019), supported by the current supply deficit globally. We believe the recent weakness in aluminium prices is temporary and it could see some recovery in the near term. We have UW calls on all counters in the sector except for PMETAL (OP, TP:RM5.50).

All below expectation. Overall, companies’ performance for the second quarter was much weaker than the previous quarter. 2QCY19’s result came in below our expectations - 4 stocks within our coverage delivered lower-than-expected sets of results. The negative deviations were mainly due to: (i) ANNJOO - higher than-expected raw material and production cost as well as lower-than-expected average selling price, (ii) PMETAL - lower-than-expected aluminium prices, (iii) ULICORP - lower-than-expected revenue and thinner-than-expected margins, and (iv) WTHORSE- weaker-than-expected revenue and margin.

Share price cut-off date performance. Over 3QCY19, as of our report cut-off date of 20/09/2019, the Industrial Product Index registered negative return of 3.8%, which slightly outperformed the KLCI index of negative 4.5%. Share price performance for counters under our coverage deteriorated to negative return of 7.0% from +11% over 2QCY19, largely due to: (i) disappointing earnings results for 2Q 2019, (ii) lack of project catalyst, (iii) intense competition in the domestic market, and iv) uncertainty from US-China trade friction.

Market remains challenging. Overall, the market remains challenging for building materials counters, largely due to: (i) higher raw material cost as a result of production and supply disruptions, and (ii) lower average selling prices led by oversupply situation and intense competition in the domestic market further depressing steel players’ margin. Despite the revival of a few mega-infrastructure projects as announced by the government, we believe that revenue will kick in into the industry only in subsequent quarters considering the slower work progress as some of the projects are still undergoing redesigning and tendering phases. Besides, resumption of the projects at reduced cost and intense competition in the tendering phase will further limit earnings potential. Hence,we opine that 2019 will continue to be a tough year for building materials sectors led by unfavourable market sentiment.

Long Steel

Chinese steel update. Based on the official data released by National Bureau of Statistic China, the Chinese steel output recorded c.87.3m tonnes in August, having registered 2.4% growth, MoM or 9.3% increase from a year earlier. Under the steel reform policy, the China government has shut down substandard steel mills which has helped to resolve overcapacity issue. On the other hand, the strong steel supply was also taken up by stable demand from property and infrastructure construction industry, hence balancing both supply and demand in the China market. As of cut-off date, the steel prices were traded at c.RMB3,690/MT, having retraced from its previous peak of c.RMB4,200/MT in April 2019.

Domestic steel. Back home, we see contraction in Malaysia’s 7M19 steel production by 24% compared to the same period a year earlier, largely caused by weaker domestic demand due to restricted development budget, lower property and construction activities, as well as uncertainty in international market due to the US-China trade friction. Besides, the domestic steel price have been relatively flattish over the past few months, and we noted that prices have started to drop following the plunge in iron ore price recently to USD93/DMTU, as Vale SA has partially resumed their operation. To recap, the iron ore price has increased significantly to USD120/DMTU (58%) from USD76/DMTU over the past few months due to a dam collapse in Brazil forcing the world’s biggest iron ore operation to temporary shut down operations.

Source: Kenanga Research - 4 Oct 2019