We remain OVERWEIGHT on the Building Material Sector given our optimistic outlook for PMETAL which makes up >95% of our sector weighting. The recent concern over China releasing aluminium stockpile is unlikely to have any material impact while aluminium price in fact is still solid at above USD2,400/MT level currently. As such, PMETAL will continue to benefit from high aluminium price, and coupled with its new 42% capacity, potential logistic cost savings and favourable raw material costs, this should propel its earnings to new heights. Reiterate OP with TP of RM6.50 for PMETAL. For flat steel player ULICORP, we believe earnings will remain consistent as most of their smaller competitors have been diminished during this pandemic - allowing ULICORP to regain market share and pricing power. Still an OP with TP of RM2.00 despite the 15% cut in FY21E earnings resulting from the FMCO. As for ANNJOO, we think that we have seen an earnings peak in 1QFY21A, to be followed by subsequently weaker quarters ahead, bogged down by FMCO and the absence of the bottom-line boosting “inventory lag effect” given declining steel prices. Maintain UP with unchanged TP of RM1.60.

LONG STEEL

We think that its 1QFY21A earnings of RM74m are Annjoo’s best quarterly earnings. Subsequent quarters’ earnings will no longer be as strong given (i) the FMCO, and (ii) declining steel prices in China. We believe the steel price rally ended when the Chinese government made the commitment to contain inflation and stem the rising steel prices. Case in point; Chinese rebar prices have retraced 19% (according to Bloomberg) since the peak in early-May.

While we do not expect a sharp drop in steel prices ahead given the pent-up demand post pandemic, Annjoo will no longer benefit from the inventory lag effect from rising steel prices which provided a boost to earnings in 1QFY21. In tandem with the weaker earnings, we believe valuations would revert back to normalised levels instead of the hyper momentum-driven levels seen in the past few quarters. Hence, maintain UP with unchanged TP of RM1.60 pegged to 11x FY22E PER. Note that we have used FY22E (instead of FY21E) valuations as we find it more reflective of a stable steel price environment where profits margins are not boosted by inventory lag effects.

*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 materials 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 re-pricing of products to remain competitive, the COGS would take a longer time to come off as raw materials were purchased from previous quarters at higher price. This would consequently lead to a margin squeeze.

FLAT STEEL

We think ULICORP will come out stronger post FMCO from capacity expansion and modernization plans. Ulicorp has implemented plans to increase its production capacity and improve margins through (i) new factory expansion on its 11 acres land at Nilai and (ii) further automating production to save on labour costs. Its upcoming Nilai factory expansion to be commissioned by 3QCY22 will add on two advance powder coating lines (from current two lines in Nilai) and ease the current production bottleneck. This would consequently add c.20% of capacity to its CSS tonnage production. Capex allocation is RM20m for this new factory which also has a hostel facility. Meanwhile, for their lighting division, Ulicorp is in the midst of automating its existing machines to ramp up production from current revenue base of RM30m/annum to RM50m/annum. Currently, automation progress is 20% with remaining 80% to be completed by next year. It expects a 30% reduction in workforce once this automation exercise is done.

Ulicorp’s products are less commoditised and more niche in nature. While we acknowledge that Ulicorp has benefitted from the inventory lag effect from rising steel prices in the previous quarters, we think they will still be able to sustain stronger profits once the FMCO ends. This is mainly due to Ulicorp’s ability to dictate product pricing given their less commoditised products coupled with the absence of competition which have diminished by the pandemic.

Comparing Ulicorp to the other listed steel names (Prestar, Leonfb, Astino), we note that Ulicorp has always registered stronger net margins mainly because (i) they have a higher degree of vertical integration within their production lines and the fact that (ii) Ulicorp has cemented its name in a niche and higher value added product offering space – giving them pricing power. This explains our targeted PE of 10x – at the higher-end spectrum for a manufacturer in the cyclical steel space.

Factoring a 1.5 month closure due to FMCO, we reduce our FY21E earnings by 15% from RM49m to RM41m. That said, Outperform is maintained with unchanged TP of RM2.00 as our TP is pegged to FY22E 10x PER.

ALUMINIUM

Aluminium prices are still solid. After a good recovery in the LME aluminum prices last year from the new low of USD1,425/MT in early April last year during the market meltdown, LME prices have continued to trend upward which jumped another 14% in the past three months or 22% YTD to USD2,451/MT currently. This is off the recent high of USD2,530/MT in early May, after recent concern following China’s National Foods and Strategic Reserves Administration said it plans to release copper, aluminium and zinc stockpiles from its national reserves to curb commodity prices from this year’s commodity rally that was driven by economies reopening-led demand. It was reported that the release volume is estimated to be c.2% of China’s annual demand which we believe it is unlikely to have substantial impact to the price given the tight supply at the moment. Nonetheless, the quarter-to-date (QTD) average of USD2,388/MT and YTD of RM2,236/MT are still well above our FY21-FY22 price assumptions of USD2,050/MT-USD2,100/MT.

Raw material cost trending lower. Despite rising aluminium prices (+14%), alumina prices fell 4% over the past three months to an average of USD296/MT in 2QCY21 from USD306/MT owing to supply outstripping demand. YTD, average alumina price is USD301/MT, 10% higher as opposed to average of USD275/MT in 2020. As such, the cost of alumina only made up 12.4% of aluminum prices in 2QCY21 as against 14.6% in 1QCY21, and YTD at an average of 13.5% as compared to 16.1% in 2020. This is well below the normalised level of 16-17% and implies that aluminium smelters are expected to see their profit margin expanding further given the favourable raw material cost.

Reiterate OP on PMETAL for its explosive earnings growth. We remain upbeat on PMETAL given the solid aluminium price coupled with favourable raw material cost structure while it will reap the fruits of the new 42% capacity expansion. Meanwhile, the upstream acquisition of two supply chain refineries will ensure raw material supply certainty while the acquisition of PT Bintan has enabled transportation cost savings for PMETAL. On the other hand, the recent price weakness presents a good opportunity to accumulate the stock as we believe the concern of China releasing aluminium stockpile is likely to be well absorbed. Thus, PMETAL remains as OP with unchanged TP of RM6.50 which is based on +0.5SD to its 5-year mean at FY22E PER of 32x.

SECTOR CALL

Overall, we maintain our OVERWEIGHT sector call given our optimistic outlook for PMETAL which makes up >95% of our BMAT Sector weighting and flat steel player ULICORP. However, we are still bearish on long steel player ANNJOO.

Source: Kenanga Research - 1 Jul 2021