We downgrade our stance on the building material sector to NEUTRAL from OVERWEIGHT as the demand outlook for both ferrous and non-ferrous metals is unlikely to improve over the immediate term in the absence of strong policy responses from Beijing to revive the Chinese economy. This will be partially cushioned by supply constraints due to the ongoing phasing out of polluting production capacity and easing input costs. Our sector top pick is OMH (OP; TP: RM2.07) as we believe the selloff on the stock has overshot its fundamentals, particularly, it being a low-carbon producer relying largely on hydropower. We also like steel product maker ULICORP (OP; TP: RM2.18) given the surge in demand for its cable support systems driven by the local construction boom.

Stable price outlook for non-ferrous metals. While prices have been weak in the past three months, we expect prices of aluminium, ferrosilicon (FeSi) and silicon manganese (SiMn) to stabilise at the current levels. The weak prices are largely attributed to economic challenges in China and the slowdown in advanced economies. However, on a brighter note, supply constraints will persist with the decommissioning of fossil fuel-powered smelters (especially coal) due to strict environmental requirements coupled with Western sanctions against Russian aluminium, providing support to ASP. YTD, LME aluminium prices averaged at USD2,275/MT, which is 4% lower than 2HCY22 of USD2,364/MT. Meanwhile, YTD, FeSi and SiMn prices averaged at USD1,489/MT and USD992/MT, which are 12% and 7% lower than USD1,682/MT and USD1,063/MT registered in 2HCY22, respectively. In view of softening ASP, aluminium smelter PMETAL and FeSi and SiMn producer OMH are expected to post weaker 2HFY23 results.

“Steel” in the doldrums. The outlook for the steel sector remains bleak primarily due to the lingering property debt crisis and the lack of substantial stimulus in China, as manifested in the lack of a significant pick-up in construction activities during the typical peak construction period in Sep-Oct. However, this is mitigated by supply constraints and the easing cost of inputs such as iron ore, scrap metal and coking coal. In Sep 2023, the local long steel price declined to c.RM2,581/tonne (-6% MoM) while local flat steel price declined to RM3,489/tonne (-3% MoM) amidst the slow demand recovery and excess production in China. As such, local steel players including ANNJOO (UP; TP: RM0.73), and ENGTEX (MP; TP: RM0.58) will still be not able to significantly raise selling prices to boost margins.

A bright spot in ULICORP. The steel product maker has seen a strong pick-up in orders for its key product, i.e. cable support systems, and is bracing for even busier times ahead driven by potential orders from MRT3, RTS, Singapore MRT expansion and new data centres. It is investing in two new plants that will boost its capacity by 40%.

We reduce our TP for PMETAL by 17% to RM5.00 (from RM6.00) as we moderate the terminal rate growth assumption in our DCF model to 2% (from 5%) to reflect the weakened prospects of the world’s largest aluminium consuming country, i.e. China. Consequently, we downgrade our call on PMETAL to MARKET PERFORM (from OUTPERFORM) and cut our recommendation for the building material sector to NEUTRAL (from OVERWEIGHT) given PMETAL’s significant weighting in the sector.

Our sector top pick is OMH given: (i) its structural cost advantage over international peers given its access to low-cost hydropower under a 20-year contract ending 2033, (ii) its strong growth prospects underpinned by plans to expand its capacity by 30%-36% to 610,000-640,000 metric tonnes per annum over the medium term, and (iii) its appeal to investor given its clean energy source. We also like steel product maker ULICORP given the surge in demand for its cable support systems driven by the local construction boom.

Source: Kenanga Research - 19 Oct 2023