ANNJOO has inked a MoU with Southern Steel Bhd to form a joint venture company comprising the long product steel manufacturing business of both parties in order to promote business efficacy and obtain synergies benefits. No changes in FY19E/FY20E CNL/CNP. Maintain UP with TP of RM1.10.

Forming a joint venture. Yesterday, ANNJOO inked a memorandum of understanding (MoU) to form a strategic alliance with Southern Steel Bhd (SSTEEL) by establishing a joint venture company (JV Co). Under the MoU, ANNJOO will sell its entire equity interest in Ann Joo Integrated Steel Sdn Bhd, Ann Joo Steel Berhad and Saga Makmur Industri Sdn Bhd to the JV Co for a total consideration of RM907.5m. Other the other hand, SSTEEL will dispose its interest in Southern Steel Rod Sdn Bhd, Southern Steel Mesh Sdn Bhd, Southern PC Steel Sdn Bhd and Danstil Sdn Bhd to the JV for RM742.5m. The sale consideration will be settled via shares issued from JV Co, therefore ANNJOO will be holding 55% shares of the JV Co while SSTEEL will hold the remaining 45% interest. In short, the transaction will not involve any cash consideration and hence reserve the financial strength of both parties. On top of that, the announcement also highlighted that the management intend to list the JV Co on Bursa Securities as soon as the company achieve the profit track record requirements.

Positive synergies. Through the formation of the JV, ANNJOO could integrate into the downstream industrial grade wire rod product which SSTEEL has been doing, while on the other hand, SSTEEL could utilise billet products from ANNJOO to replace imported billets. Besides, the management expect the combined capacity for both iron making and crude steel making to increase to 0.5m MT and 2.3m MT, respectively. On the longer term, management also seek to explore additional synergy by tying up other operations within both parties to further enhance the value of both companies.

Earnings contribution after 1HCY20. Management targets to complete the corporate exercise by 1HCY20, implying that earnings contribution would only start to kick in after that. Hence, we are not overly excited for the near term. However, we acknowledged that the forming of the joint venture between the two parties will bring in positive operational synergies such as cost saving, improved operational efficiency, economies of scale and expertise from both parties.

No change to FY19-20E CNL/CNP. We do not change our earnings estimate for now as the development is only at MoU stage. If it materialises, the JV earnings will impact only after 1H 2020. However, we note the significant impact to Ann Joo if the JV materialises given that Southern Steel had been a loss maker in the last 3 quarters ending its latest financial year ending June with a net loss of RM119m. The immediate impact on 2H20 could be negative if the environment does not pick up. We shall update our forecasts once we get clarity on management’s plans on turning around the business.

Maintain UNDERPERFORM for now with unchanged Target Price of RM1.10 based on Fwd. PBV of 0.5x pegged to FY20E BV/share of RM2.20, implying -0.5SD valuation basis. Overall, we are positive on the long-term prospect of the joint venture as it creates positive synergies between both companies in terms of efficiency, expanding product range and market share. However, we are concerned over the impact of macro factors toward the steel demand such as slower global growth which has restricted private spending, as well as uncertainty in government’s future policy. As such, we believe the valuation is justifiable due to such weaker macro factors.

Source: Kenanga Research - 8 Oct 2019