We maintain OVERWEIGHT on the sector, mainly anchored by our OUTPERFORM call on PMETAL, while long steel producer ANNJOO and cable support system manufacturer ULICORP will continue to be weighed down by high-cost inventories. The sector’s 2QCY22 earnings performance (against expectations) did not show improvement against the previous quarter on falling ASP. While aluminium prices may continue to ease in 2HFY22, the downside will be capped given the supply constraints in the global market as European producers cut production amidst skyrocketing gas prices. The same cannot be said for steel prices due to the slowdown in China on intermittent lockdowns arising from Beijing’s strict zero-Covid policy and the property debt crisis. This means steel product producers like ANNJOO and ULICORP will continue to face margin pressures.

Subdued 2QCY22 performance. The 2QCY22 results of building material producers under our coverage universe were subdued with 33% and 67% coming in within and below our expectations, respectively, unchanged from the previous quarter (see Table below). PMETAL’s (OP; TP: RM5.62) 2QFY22 results fell short of our forecast as weaker-than-expected ASP negated higher plant utilisation of 97% (vs. 93% in the preceding quarter on plant maintenance). Meanwhile, ULICORP (MP; TP: RM1.08) missed expectations as it marked down product selling prices in tandem with the sharp decline in the market price of input cold-rolled coil (CRC) to stay competitive, while it had locked in CRC inventory at high prices. Similarly, ANNJOO’s (UP; TP: RM0.85) 2QFY22 core profit plunged 75% YoY (which was within our expectation) as the spread earned over COGS evaporated as steel prices fell.

Downside to aluminium prices should be capped. LME aluminium prices which peaked in early April at USD3,849/MT, had since started to trend lower, to c.USD2,300/MT-USD2,400/MT currently. YTD, average LME spot price of USD2,919/MT is still 18% higher than the USD2,476/MT recorded in 2021 and pre-pandemic level of USD1,728/MT in 2019. Having said that, ASP may continue to ease in 2H 2022 but the downside will be capped and unlikely to retrace back to pre-COVID-19 levels in the near term given the supply constraints in the global market amidst skyrocketing gas prices in Europe. Meanwhile, steel prices (both long and flat steel) have plunged since end June, mainly due to the weakening demand from China arising from its strict zero-Covid policy and the property debt crisis. Such steep fall in steel ASPs would mean contracting margins for steel manufacturers as they typically hold 3- 6 months’ worth of inventory (at higher historical costs). Hence, we anticipate ULICORP and ANNJOO to continue to face margin pressures in the subsequent quarters as inventory cost lags the sharp decline in ASPs.

Reiterate OVERWEIGHT on the sector as we remain positive on the aluminium sector given that aluminium prices will be well supported by supply constraints which augur well for our sector pick PMETAL. However, the same cannot be said for steel prices due to the slowdown in China on intermittent lockdowns arising from Beijing’s strict zero Covid policy and the property debt crisis. This means steel product producers like ANNJOO and ULICORP will continue to face margin pressures.

Source: Kenanga Research - 7 Sept 2022