We remain OVERWEIGHT on the Building Material Sector premised mainly on our optimistic outlook for PMETAL. Although its 3QFY21 results missed forecast on escalated logistic and raw material costs, it was still a record quarterly results. With aluminium prices remaining elevated and its new 42% capacity, FY22 is likely to be another earnings record year trailing after FY21. Retain OP with TP of RM6.96 for PMETAL. For flat steel player ULICORP, we believe its 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 to produce a strong pipeline of earnings in the upcoming quarters. Still an OP with TP of RM1.85 pegged to 10x FY22E PER. As for ANNJOO, we foresee earnings weakening on lower margins from lower steel ASPs while lagging raw material prices in previous quarters play catch-up. Thus, we maintain MP with unchanged TP of RM1.70 anchored to 0.75x FY22E PBV.

LONG STEEL

China long steel prices have declined almost 20% from its Oct 2021 peak. Steel demand in China is no longer as strong as before from: (i) an uneven recovery due to China’s zero Covid policy resulting in sporadic massive lockdowns, and (ii) recent housing debt crisis from major developers (i.e. Evergrande, Kaisa) which also reduces future demand prospects. All these headwinds have outweighed the effects of China’s long-term carbon neutral policy which had partially fuelled the steel price rally on expectations of a tightened supply at end of last year (in 2020). We believe the steel price rally seen over the past year has ended and steel prices would not be able to surpass peak prices seen in early May 2021 - also because it is in the Chinese government’s interest to keep a lid on commodity prices in order to keep inflation levels in check.

Local long steel prices remain stable. Meanwhile, steel prices at our local shores have remained stable at c.RM3,000/tonne levels throughout this period. That said, we believe there is now downside bias to local prices mainly because supply for local steel is anticipated to increase. The rationale is as such; due to China’s reduced demand and price, steel manufacturers based in Malaysia which have been supplying billets/rebars to China over the past year will likely divert some of these products back into local shores which would increase local steel products in circulation. On the back of unchanged demand, steel prices would consequently see some pressure moving forward. That said, we do not expect a steep drop in steel prices back to pre-Covid levels as raw material prices globally have also risen.

Annjoo’s peak profitability has passed. Annjoo which has benefitted from: (i) the strong demand and price from China (by selling billets), and (ii) superior margins from inventory lag effect amidst rising prices, will see weaker profits moving forward as the weakening steel price would compress margins as raw material costs play catch-up. In tandem with the weaker anticipated earnings in subsequent quarters, we maintain MP with unchanged TP of RM1.70 pegged to 0.75x FY22E PBV.

FLAT STEEL

We continue to believe Ulicorp has strong prospects in the coming quarters backed by:

i. Dwindling number of competitors facing cash flow issues under the pandemic. Currently there are <10 local manufacturers vs. a peak of 20+ three years ago. Current shortage in raw materials (HRC and CRC) coupled with high prices will further suppress the smaller competitors (in terms of cash flow) without a strong balance sheet.

ii. Pent-up demand. Current order-book stands at c.RM200m (Singapore: c.RM100m, Malaysia: RM80-90m while other markets such as Myanmar and Bangladesh make up c.RM20-30m) to be delivered in the next six months. Given that current demand far outstrips supply, Ulicorp gets to select good paymasters and avoid the bad ones.

Ulicorp’s products are less commoditised and more niche in nature. While we acknowledged 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 its strong profits once steel price stabilises. This is mainly due to Ulicorp’s ability to dictate product pricing to a stronger degree (vs. other steel manufacturers) given their less commoditised products coupled with the weakening competition which was diminished by the pandemic. This explains our targeted PER of 10x – at the higher-end spectrum for a manufacturer in the cyclical steel space. All in all, we maintain Outperform with unchanged TP of RM1.85 on 10x FY22E PER.

ALUMINIUM

Aluminium prices remain elevated. Although off its decade high of USD3,149/MT on 15 Oct 2021 after a military coup in early Sep in The Republic of Guinea which shook the aluminium market as the African mining nation accounts for 55% of China’s bauxite supply raising concern of a likely supply chain disruption, aluminium prices remain robust at USD2,600/MT USD2,700/MT recently driven by economies reopening-led demand. In addition, the major structural de-carbonisation trends for electric vehicles and renewable energy have boosted aluminium demand leading to aluminium prices remaining elevated. YTD, aluminium spot prices have risen strongly by 37% to USD2,710/MT as of 17 Dec 2021 while QTD average aluminium spot prices rose another 4% sequentially to USD2,749/MT in 4QCY21 after an 11% jump in 3QCY21 to USD2,646/MT from USD2,396/MT (+14% QoQ) in 2QCY21. On the other hand, the average YTD aluminium spot price of USD2,463/MT in 2021, against USD1,705/MT in 2020, still below our assumption of USD2,100/MT and USD2,400/MT for 2021 and 2022, respectively.

Raw material cost rising but still slightly below normalised range. Alumina prices have been lagging behind aluminium prices in 1HCY21 but had since picked up in 3QCY21 and escalated further in 4QCY21. The average alumina prices surged 33% QTD in 4QCY21 to USD434/MT after an 11% QoQ hike to USD326/MT in 3QCY21 from USD295/MT in 2QCY21 which fell 4% QoQ. This brought percentage of alumina cost to aluminium price to 15.7% in 4QCY21, closer to normalised level of 16%- 17%, from 12.3% in both 3QCY21 and 2QCY21. As such, this implies that aluminium smelters are expected to see their profit margin compressed in the upcoming 4QCY21. Nonetheless, the average cost per sales of 13.7% on average in YTD in 2021, is still well below normalised level, against 16.1% in 2020.

To benefit from high aluminium prices; OP on PMETAL. Despite record earnings yet again, 3QFY21 results came below our expectations on higher-than-expected operating costs as logistic and raw material costs spiked. But, we remain upbeat on its earnings prospects as aluminium prices are expected to stay high in the near term while its fully commissioned P3 Plant will lead volume growth, making FY22 another record year again. Thus, PMETAL is maintained as an OP with TP of RM6.96 which is based on +0.5SD to 5-year FY22E rolling mean of 33x.

SECTOR CALL

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

Source: Kenanga Research - 28 Dec 2021