Overall, we remain UNDERWEIGHT on the building materials sector given our negative outlook on the long and flat steels as well as ceramic tiles sub-sectors. We expect weaker demand and intense competition to keep selling prices low and pile on more pressures onto their margins. However, we believe aluminium prices should have bottomed from the low base of c.USD1,794/MT average in 2019 given the current global supply deficit. We believe the recent weakness in aluminium prices is temporary and some recovery could emerge in the near term. In addition, the declining alumina prices, savings from transportation cost post a 25%-stake acquisition in PT Bintan Alumina and the 43% capacity expansion should propel PMETAL’s earnings to a new high. As such, despite having an UNDERWEIGHT rating for the sector, we remain OUTPERFORM on PMETAL for the said earnings potential calayst.

Mixed results. Overall, the companies’ financial performance in the third quarter was better than the previous quarter. Out of 4 coverage companies, 2 (PMETAL and ULICORP) matched our expectations while the rest (ANNJOO and WTHORSE) missed our estimates. The negative deviations were mainly due to: (i) ANNJOO - lower-than-expected average selling price and higher-than expected raw material and production costs, and (ii) WTHORSE - weaker-than expected revenue and higher-than-expected effective tax rate.

Quarter-to-date share price performance review. So far in 4QCY19, as of our report cut-off date of 20/12/2019, the Industrial Product Index registered a return of 1.0%, which slightly underperformed the FBMKLCI’s performance of 1.7%. The average share price performance for counters under our coverage rebounded to show negative returns of 3.8% from negative 7.0% over 3QCY19, as sentiment was lifted by: (i) catalyst from the revival of mega projects such as Bandar Malaysia and ECRL, and (ii) improvements in their 3QFY19 results.

Outlook remains challenging. Overall, the building materials market remains challenging largely due to: (i) weak selling prices amid an oversupply situation and intense competition in the domestic market, and (ii) slower construction and property development actitivies in the domestic market. Despite the revival of a few mega infrastructure projects as announced by the government, we believe demand will only pick up in the later quarters considering the slow work progress as some of the projects are still undergoing redesigning and tendering phases. Besides, the resumption of these projects at reduced costs coupled with the intense competition in the tendering phase could dampen profit margins . Hence, we opine that 2020 will continue to be a tough year for the building materials sector.

Long Steel Less impact from Chinese steel. As of the report cut-off date, China domestic steel rebar was traded at c.RM2,360/MT compared to the domestic steel price of c.RM1,920/MT, a gap of c. RM440 before including import duties, safeguard measure and transportation costs. If this scenario persists, then we believe there will be minimal impact from Chinese steel on our local steel products as: (i) the price differentials between the higher China steel prices versus our domestic steel ,and (ii) the relatively stronger steel demand in China on the back of more construction and property development activities will make Malaysia less attractive as an export market for their rebar products.

Supply outweighs demand. 9MCY19 steel production continued to drop, by 28%, YoY, compared to the same period a year ago, largely caused by weaker domestic demand arising from slower property and construction activities as well as uncertainty in the international market due to the US-China trade frictions. Besides, the oversupply situation remains a serious issue in the local market following the commencement of a foreign-owned steel mill from 2018. All in, this has caused the steel price to drop to c.RM1,920 (-18%) from RM2,350 a year ago. On the other hand, we see iron ore price normalizing to USD85/DMTU from the peak of USD120/DMTU following the partial resumption of operation by Vale SA. Moving forward, we expect lower selling prices will continue to drag ANNJOO’s performance, although it will be partly mitigated by lower raw material costs. We are also positive on the company’s strategy to expand their export markets taking advantage of the export tax incentives. Overall, we opine that sentiment will remain challenging for ANNJOO in the near to medium term.

Source: Kenanga Research - 6 Jan 2020