There was deterioration in earnings delivery (against our expectations) by the sector in the recently concluded 4QCY23 reporting season. Players continued to struggle with high-cost inventories and weak ASPs as the global steel sector languished. Nonetheless, prices of both ferrous and non-ferrous metals may have bottomed out as the weak economic outlook of the largest consuming country, i.e. China is partially mitigated by supply constraints. Our sector top picks are low-carbon ferrosilicon (FeSi) and silicomanganese (SiMn) producer OMH (OP; TP: RM1.80) and water pipe maker ENGTEX (OP; TP: RM1.41) on the back of the revival of domestic water projects.

There was deterioration in earnings delivery (against our expectations) by the sector in the recently concluded 4QCY23 reporting season with 25% and 75% of companies under our coverage meeting and missing our forecasts, vs. 67% and 33% meeting and missing our forecasts three months ago. PMETAL (OP; TP: RM4.90) came in within our expectation, thanks to higher ASP, whereas ENGTEX, OMH and ULICORP (OP; TP: RM1.91) were weighed down by high-cost inventories.

Downside risk for commodity prices limited. There has not been any significant pick-up in demand for aluminium despite China’s reopening and its government’s efforts to stabilise the property market. On the flip side, the rising environmental concerns prompting the closure of fossil fuel-powered smelters (especially coal) combined with Western sanctions against Russian aluminium are expected to keep aluminium prices firm. YTD, LME aluminium prices have averaged at USD2,195/MT, which is 1% higher than 2HCY23’s USD2,178/MT. Meanwhile, YTD prices of FeSi averaged at USD1,285/MT, which is 2% lower than 2HCY23 level of USD1,314/MT while the average price of SiMn of USD910/MT is 2% higher than USD890/MT in 2HCY23.

Similarly, the global demand for both long and flat steel stays muted primarily due to the ongoing property debt crisis in China. The much-anticipated surge in construction and infrastructure projects following China's reopening has failed to materialise. Adding salt to the wound is the excess steel production, surpassing 1b MT in 2023 in the absence of government-mandated production cuts. However, we believe steel prices have bottomed out.

On a brighter note, ENGTEX will be buoyed by a higher demand for water pipes following water tariff hikes translating to strengthened cash flows of water operators, allowing them to kick start their capex programmes including non-revenue water (NRW) reduction initiatives. This will be in addition to a significant allocation for pipe replacement programmes under the Twelfth Malaysia Plan (12MP). The demand for water pipes will also be driven by the development of Sungai Rasau Water Supply Scheme Phase 2 in Selangor.

Our sector top picks are: (i) OMH given its structural cost advantage over its global peers thanks to its access to low-cost hydropower locked in until 2033, and (ii) ENGTEX as a proxy to the revival of water projects locally.

Source: Kenanga Research - 11 Mar 2024