We upgrade our sector call to OVERWEIGHT (from NEUTRAL), anchored by our recent upgrade of sector heavyweight PMETAL (OP; TP: RM6.35) to OUTPERFORM from MARKET PERFORM. There was a significant improvement in earnings delivery (against our expectations) by the sector in the recently concluded 1QCY24 reporting season with stocks under our coverage either beating or meeting our forecasts. We expect aluminium prices to stay firm on supply constraints while stable steel prices translate to stable steel product prices, reducing earnings volatility of steep product producers. Water pipe makers are poised for an exciting time ahead on the revival of water projects. Our sector top picks are PMETAL and ENGTEX (OP; TP: RM1.41).

There was a significant improvement in earnings delivery (against our expectations) by the sector in the recently concluded 1QCY24 reporting season with 33% and 67% of companies under our coverage exceeding and meeting our forecasts, vs. 25% and 75% meeting and missing our forecasts three months ago, respectively. PMETAL beat our forecast driven by higher-thanexpected ASP and stronger-than-expected performance from associate PT Bintan, while ENGTEX and ULICORP (OP; TP: RM2.38) met our expectations as they shook off margin suppression from high-cost inventories.

Aluminium prices have been on an uptrend since the beginning of the year on surprisingly strong consumption in China during the early part of the year, while outside of China, the demand has been spurred by RE projects and the EV production. We are mindful that sustainable demand in China depends on a revival of infrastructure and property projects of which outlook is still uncertain currently. Meanwhile, the closure of fossil fuel-powered smelters (especially coal) on rising environmental awareness coupled with Western sanctions against Russian aluminium producers will continue to cap the supply. YTD, LME aluminium prices have averaged at USD2,337/MT, 4% higher than an average of USD2,255/MT during the whole of 2023.

Meanwhile, at a YTD average of USD1,253/MT, prices of FeSi have come off 13% as compared the average of USD1,437/MT for the whole of 2023 (buoyed by broad-based speculation on commodities during 1HCY23). We expect FeSi to remain soft for the rest of the year on a high stock level amid weak demand. Conversely, YTD, prices of SiMn averaged at USD994/MT, 3% higher than the average of USD962/MT for the whole of 2023, due to higher cost of ore. We expect SiMn prices to remain firm for the rest of the year on elevated ore prices.

On the other hand, steel prices have remained stable despite the recent hike in tariffs imposed by US authorities on Chinese steel imports to 25% (from 7.5%) as China’s steel exports to the US are insignificant and they are largely less price sensitive high-grade steel products. The global demand for both long and flat steel, driven largely by China, will remain muted weighed down by the property debt crisis in China. Locally, the demand for steel should improve along with the roll-out of mega public infrastructure projects such as the Mutiara Line of Penang LRT, Kuching ART and MRT3. The good news is that stable steel prices translate to stable steel product prices, reducing earnings volatility of steep product producers including ENGTEX and ULICORP.

Water pipe makers are poised for exciting times ahead as water operators kick start their long-overdue water projects backed by stronger finances following the recent water tariff hikes including: (i) non-revenue water (NRW) reduction initiatives or pipe replacement, and (ii) the construction or upgrading of water treatment plants (including the consolidation of old and small plants to optimize cost). We understand that water operators are currently identifying old pipes to be replaced and working out the cost to be submitted to the Ministry of Finance (MOF) for approval. According to Malaysian Water Association, water operators have thus far submitted proposals to the MOF for water projects worth ~RM4b. In addition, there are plans to raise water tariffs again within the next two years.

We upgrade our sector recommendation to OVERWEIGHT (from NEUTRAL) following our recent upgrade of PMETAL, which holds significant weighting of the sector, to OUTPERFORM from MARKET PERFORM. Our sector top picks are: (i) PMETAL given its structural cost advantage over its global peers thanks to its access to low-cost hydropower locked in until 2040, and (ii) ENGTEX as a proxy to the revival of water projects locally.

Source: Kenanga Research - 18 Jun 2024