We maintain OVERWEIGHT on the sector, mainly anchored by our OUTPERFORM call on our coverage universe heavyweight PMETAL (OP; TP: RM6.30). While there was improvement in the sector’s latest quarterly earnings sequentially, the 4QCY22 results remained lacklustre with 40%/60% of results coming in line/below expectations. Players generally felt the pinch from weaker ASP and sales volumes, and elevated input and operating costs. We see a diverging price outlook between: (i) aluminium, ferrosilicon (FeSi) and silicomanganese (SiMn) - positive due to lingering global supply constraints and increased demand stemming from China’s reopening, and (ii) steel - negative as domestic demand in China remains soft dragged by its languishing property market. The divergence augurs well for PMETAL and OMH (OP; TP: RM2.95) but otherwise for ANNJOO (UP; TP: RM0.80) and ULICORP (OP; TP: RM1.36). Meanwhile, water pipe maker ENGTEX (OP; TP: RM0.75) is poised to benefit from the revival of water projects locally.

Subdued results. The sector’s 4QCY22 results season remained lacklustre with 40% and 60% of the results coming in within and below our expectations as opposed to 25% and 75% above and below in the preceding quarter, respectively. The FY22 results of OMH fell short of expectations owing to weaker-than-expected ASP and sales volume in 2HFY22 while both ENGTEX and ANNJOO disappointed on unexpected losses due to higher-than-expected raw material and operating cost which eroded margins. Meanwhile, PMETAL and ULICORP came within our expectations.

Better commodity price outlook. Since China’s reopening in early January, commodity prices have rebounded strongly after a lacklustre 2HCY22, driven by expectations of a demand recovery in its property market. Together with supply constraints in Europe, ASP is set to rise if not supported at current levels. This is because ASPs are unlikely to retrace back to pre-COVID-19 levels in the near term as the demand recovery is largely due to normalisation of economic activities. YTD, LME aluminium price average at USD2,436/MT is 4% higher than 2HCY22’s USD2,345/MT. Average YTD prices of FeSi and SiMn of USD1,654/MT and USD1,092/MT are -2%/+3% against 2HCY22 levels of USD1,682/MT and USD1,063/MT, respectively.

Despite a reprieve for steel prices (both long and flat steel), having rebounded from the low in Nov 2022, we remain cautious on long steel prospects. This is due to the soft demand in China owing to the slow implementation of construction and infrastructure projects worsened by its property debt crisis. We anticipate ANNJOO and ULICORP to continue facing margin compression. As for ENGTEX, we expect more pipe replacement contracts to be dished out over the immediate term to reduce non-revenue water (NRW) by 2025. Potential pipe replacement programmes remained largely untapped including those from: (i) the Twelfth Malaysia Plan (12MP) (ii) pipe replacement in Selangor (i.e., Sungai Rasau Water Supply Scheme Phase 2), and (iii) the ongoing nationwide pipe replacement programme.

Reaffirm OVERWEIGHT on the sector. We remain positive on the aluminium sector with aluminium prices being well supported by demand recovery underpinned by the normalisation of economic activities. This augurs well for our sector pick PMETAL. Likewise, OMH will also enjoy a structural cost advantage over its international peers given its access to low-cost hydro-power under a 20-year contract ending 2033. The same cannot be said for steel prices due to weak domestic demand in China as its property market continues to languish. This means steel product producers like ANNJOO and ULICORP will continue to face margin pressures. As for ENGTEX, we expect more pipe replacement contracts to be dished out as more water projects are revived over the immediate term.

Source: Kenanga Research - 14 Mar 2023