Despite the unexpected earnings turnaround in 4QFY20 which propelled FY20 earnings above expectations, we maintain our Underperform call as we think: (i) the rally in Annjoo’s share price may have already over-priced prospects, and (ii) long steel prices may not be sustainable once currently idle plants ramp up productions. That said, we raise TP to RM1.57 (from RM0.77) as we switch our valuation methodology to PER (from PBV) to reflect its return to profitability as well as higher steel prices.

A positive surprise. 4QFY20 saw an unexpected turnaround by posting a CNP of RM17.3m which alleviated FY20 core net loss (CNL) to RM54m – above our/consensus loss estimates of RM98m/RM103m, respectively. The positive deviation stems from stronger margins attributable to higher steel prices. No dividends declared as expected.

Results’ highlights. QoQ, 4QFY20 CNP of RM17.3m marked a return to the black (from a loss of RM20.2m) as steel prices surged from RM1,997/tonne to RM2,164/tonne. Meanwhile, despite the Covid-19 pandemic, FY20 losses of RM54m narrowed 58% YoY also thanks to the higher steel prices (of RM2,130/tonne against RM2,090/tonne in FY19) which led to stronger margins.

Upcoming 1QFY21 earnings to be stronger QoQ on (i) higher steel prices of RM2,675/t (against RM2,164/t), and (ii) lagging COGS effect from higher raw material prices i.e. iron ore and scrap. Based on ASP of RM2,675/t, we anticipate 1QFY21 to record CNP of RM40m.

However, we have our reservations to turn bullish. We think that the rise in global long steel prices may have reached its peak as supply tightness would ease once plants (which were idle) ramp up production. Also, we think that long steel demand from China’s construction activities may gradually ease for the remainder of the year. Case in point, despite coming out from the winter months (Dec-Feb) which would see increased consumption of long steel, China long steel prices in March saw an initial spike but have since plateaued and are gradually trending down. Unlike flat steel prices which have been on a continuous uptrend globally (up till now), we deduce that China’s construction steel demand may not be sustainable.

Potential margin squeeze. The recent divergence of flat steel prices and long steel prices could also mean a margin squeeze for long steel producers. With steel manufacturers consuming the same pool of raw materials (i.e. iron ore, scrap, coke), the huge demand for flat steel could mean elevated (or higher) raw material costs in which long steel producer may not possess the capability to pass through.

Earnings outlook. Post results, we raise our FY21E earnings to CNP of RM89m (from loss of RM25m) and introduce FY22E CNP of RM67m. Our steel ASPs for FY21/FY22 are RM2,675/RM2,650/t, respectively.

Maintain Underperform on higher TP of RM1.57 (from RM0.77) after switching our valuation methodology from 0.38x PBV to 11x PER as Annjoo returns to profitability. We maintain our UP call as we feel the recent share price rally may have already over-priced the prospects. During the steel up-cycle back in 2016-2018, Annjoo fetched a peak Fwd. PER of 11x. Working backwards by dividing its current market cap of RM1.4b (diluted for RCPS) with a PER of 11x, this implies that Annjoo should be able to fetch earnings of RM127m per annum. However, with long steel prices expected to plateau coupled with the lagging higher material costs playing catch-up from 2QFY21 onwards, we think that RM127m is an aggressive target.

Source: Kenanga Research - 23 Mar 2021