Upgrade the BMAT Sector to OVERWEIGHT from NEUTRAL given our optimism over PMETAL’s prospects which make up >95% of our sector weighting. With our view that aluminium prices upcycle would persist coupled with its new +42% new capacity, potential logistic cost savings and favourable raw material costs should propel its earnings to new heights. Reiterate OP with TP of RM13.00 for PMETAL. As for flat steel player ULICORP, we believe earnings will remain consistent as most of their smaller competitors diminish during this pandemic - allowing them to regain market share and pricing power. Still an OP with TP of RM1.45. That said, we think the rally for long steel manufacturer under our coverage, i.e., ANNJOO might have overpriced in the prospects of the commodity rally. Being a commodity manufacturer, we find current fwd valuations of 15x is a stretch. Hence, keep ANNJOO at UP with TP of RM1.57.

LONG STEEL

Our long steel coverage ANNJOO performed well in the last quarter (+36%) as long steel prices in China saw a steep rise driven by a surge in demand while supply only came on stream gradually.

1QFY21’s profits will be strong. We are anticipating 1QFY21 to come in strongly at c.RM40m CNP mainly due to 2 key factors: (i) the sharp rise in long steel prices seen in 1QFY21 (from RM2100/t to RM2700/t) and (ii) an inventory lag effect*. However, we think the subsequent quarters’ profits (after 1QFY21) should come off as raw material prices play catch up and supply tightness for long products would ease once plants (which were idle) ramp up production. Also, we opined that long steel demand from China’s construction activities may gradually ease for the remainder of the year.

*inventory lag effect works as a double edged sword. In a commodity uptrend, the quantum of increase in revenue would be greater than the quantum of increase in COGS (cost of goods sold) as raw mat purchased at lower prices from previous quarters would be accounted for in the existing quarter’s COGS – leading to higher margins. Vice versa, in a downtrend, as revenue comes off due to lower repricing of products to remain competitive, the COGS would take a longer time to come off as raw mats purchased from previous quarters were higher. This would consequently lead to a margin squeeze.

Compared to the 2016-2018 steel rally experienced, the current context is less favourable to margins. Firstly, raw materials (iron ore, coke, scrap) this time around are higher. Secondly, there is a higher proportion of sales being derived from China exports (instead of domestic sales) given the strong demand there. Sales to China are in the form of semi-finished products i.e billets which commands thinner margins as compared to rebars (finished product) considering that Annjoo does not have the required license to export rebars to China. Taking these two aspects into considerations, margins this time around would be lower compared to the 2016-2018 period.

We think that current valuations may have over-priced its prospects. Using the 2016-2018 upcycle valuations as a yardstick, peak valuations were only c.11x then compared to current levels of c.15x now despite the less favourable context. Also, being a commodity player whose profits strongly hinges upon the global prices (with no form of differentiation when it comes to product specs), we think that Annjoo’s current valuations maybe a stretch. All in all, we maintain UP for ANNJOO with unchanged TP of RM1.57 based on FY21E PER of 11x.

Source: Kenanga Research - 6 Apr 2021