1QFY21 CNP of RM74m strongly surpassed expectations due to higher-than-expected trading margins, lower-than- expected effective tax rates and steel prices staying elevated longer-than-expected. With China’s effort to curb the high steel prices, we believe we have seen peak levels for China’s steel prices and consequently earnings for Annjoo. Thus, despite raising FY21E/FY22E earnings by 115%/36%, we keep our UP call on marginally higher TP of RM1.60 (from RM1.57) after rolling valuation year forward.

Strongly surpassed expectations. 1QFY21 CNP of RM74m accounted for 83%/70% of ours/consensus estimates – strongly above expectations due to: (i) higher-than-expected margins from its trading division thanks to the strong surge in steel selling prices while inventory cost lags, (ii) lower-than-expected effective tax rates (ETR) of 10% against our ETR assumption of 24%, and (iii) elevated steel prices lasting longer-than-expected. No dividends as expected.

Results’ highlights. QoQ, 1QFY21 CNP of RM74m increased 3.3x as steel prices surged from RM2,164/tonne to RM2,615/tonne (+21%). The strong surge saw its manufacturing and trading division recording sharp increase in EBIT (+406%) on higher margins (+12ppt). Likewise, 1QFY21 returned to the black against 1QFY20 CNL of RM18m on higher steel prices (of RM2,615/tonne vs RM2,122/tonne) and that 1QFY20 was also affected by reduced productivity from a 2-week total stoppages in operations as a result of MCO 1.0.

Peak steel prices may be over in our opinion. In recent months, speculation coupled with trend momentum has inflated China’s steel prices to unprecedented levels benefitting steel manufacturers in general. Annjoo also benefitted from this meteoric rise and has been exporting their products to China given the weak domestic demand here. However, we opine that China’s steel prices may have hit its peak in early-May as the Chinese government has resorted to various measures to curb the rising steel prices which could eventually lead to higher-than-desired inflation levels if left unchecked. Case in point, steel prices have since retraced 22% from its peak albeit still high compared against historic terms.

Annjoo’s earnings likely to follow suit. In tandem with the faltering steel prices, we think that 1QFY21 earnings of RM74m is likely already the peak and subsequent quarters would likely come in weaker as steel prices stabilise and inventory costs play catch up – providing less margins for the group. Note that EBIT margins for its trading division in 1QFY21 was a whopping 10%; higher than the average 3% seen over the past four years. In addition, the total lockdown announced over the weekend (for subsequent two weeks) will hamper 2QFY21 earnings as plant productivity and local steel demand will decline. However, export sales should provide support as ports are still allowed to operate (using MCO1.0 as a benchmark).

Earnings. Post results, we raise our FY21E earnings by 115% after factoring for higher ASPs of RM2,825/tonne (vs. RM2,675/tonne) and higher trading margins. Meanwhile we raise FY22E CNP by 36% on higher trading margins but keep ASPs at RM2,650/tonne.

Maintain UP on higher TP of RM1.60 (from RM1.57) after rolling valuation base year forward on unchanged 11x PER. We find FY22E valuations more reflective of a stable steel price environment where profits margins are not boosted by inventory lag effects. With our view that earnings will come off in the subsequent quarters, we think the current share price levels which have had a good run (+61% YTD) carries more risk than reward at this juncture. Thus, reiterate Underperform.

Source: Kenanga Research - 31 May 2021