We reiterate our OVERWEIGHT rating on the sector, anchored primarily by our OUTPERFORM call for PMETAL (OP; TP: RM5.74) and OMH (OP; TP: RM2.95). There was a significant sequential deterioration in earnings delivery by the sector in the recently concluded 1QCY23 reporting season due to weaker ASP and higher input cost as China’s reopening failed to lift its prospects. We expect a stable price trend for aluminium, ferrosilicon (FeSi) and silicomanganese (SiMn) given the supply constraints due to rising environmental concerns and Western sanctions against Russian aluminium. However, the same cannot be said for steel prices given the sluggish property market in China. Our top sector picks are PMETAL and OMH.

Uninspiring. There was a significant sequential deterioration in earnings delivery by the sector in the recently concluded 1QCY23 reporting season with disappointing results from all players under our coverage universe, vs. 40% and 60% above and below during the preceding quarter, respectively. Generally, the top line of all players contracted due to weaker-than-expected ASP and sales volumes with the exception of ENGTEX (OP; TP: RM0.58) which recorded improved demand for selective steel products. In terms of bottom line, all players were hit by margin erosion due to higher-than-expected raw material and operating cost (i.e., staff costs and electricity costs).

Diverging commodities prices outlook. Despite China’s reopening and introducing various measures to stabilise its property market, demand recovery has not significantly boosted aluminium demand. However, on a brighter note, supply constraints due to rising environmental concerns leading to the closure of fossil fuel-powered smelters (especially coal) and Western sanctions against Russian aluminium should keep aluminium prices firm. YTD, LME aluminium price average of USD2,371/MT is 1% higher than 2HCY22’s USD2,345/MT. Average YTD prices of FeSi and SiMn of USD1,595/MT and USD1,057/MT are -5%/+1% against 2HCY22 levels of USD1,682/MT and USD1,063/MT, respectively.

The same cannot be said for steel prices. The demand for both long and flat steel remains lacklustre due to excess production and sluggish property market in China while the roll-out of construction and infrastructure projects has not been as robust as anticipated. We believe realistically, a pick-up in property sector may only be seen in late 2023 on government support measures. If China decides to embark on pump priming resulting in a revival in construction activities, there is a chance of steel prices experiencing a gradual recovery. Hence, we anticipate ANNJOO (UP; TP: RM0.75) and ULICORP (OP; TP: RM1.15) to continue facing margin compression as steel ASP continues to fall. As for ENGTEX, it is poised to benefit from the revival of water projects nationwide as the new unity government settles in and start to embark on the roll-out of public infrastructure projects. While acknowledging its dominant market positions in both MS and DI pipes used in water projects, we are mindful that low-margin generic steel products still make up a lion’s share of its overall turnover.

Maintain OVERWEIGHT. We remain positive on the aluminium sector, anticipating supportive aluminium prices due to supply constraints which bode well for our sector pick PMETAL. Similarly, OMH is poised to reap the benefits of a structural cost advantage over global peers thanks to its access to cost-effective hydropower through a long-term contract until 2033. Conversely, the steel players face challenges with weak domestic demand in China, particularly due to the sluggish property market there. Consequently, steel producers such as ANNJOO, ULICORP and ENGTEX will continue to experience margin pressures. As for ENGTEX, pipe replacement contracts will gain momentum in the near term, thus stimulating demand and fostering growth in top line.

Source: Kenanga Research - 14 Jun 2023