The 18.8% electricity tariff hike from Jan 2014 is an unpleasant surprise to power-hungry steel and cement producers in Peninsular Malaysia. As local steel players are struggling to survive, the tariff hike is painful despite only translating into 1.8% of production cost vs 2.9% for cement players. We downgrade most of our basic materials stocks, and DOWNGRADE the sector to NEUTRAL (from Overweight).
Domino Impact From Electricity Tariff Hike
Downward earnings revision
Local steel mills are more vulnerable to earnings cut. Local steel mills have been under tremendous financial pressure in the last couple of years, with no sign of significant improvement. The 18.8% hike in electricity tariff is no doubt a double whammy on top of its existing industry challenges. Our quick back-of-the-envelope assessment shows that all steel mills suffer earnings slash from FY14 onwards.Although AJR is less impacted as its mini blast furnace (BF) helps save ~300 kWhr per tonne of billet production, it will still be affected by the higher tariff as the company consumes ~300 kWhr of electricity to produce a tonne of billets at its newlyupgraded plant and 120-150 kWhr to manufacture a tonne of bars or wire rods from billets. This prompted us to cut its FY14 earnings estimates by 22%.
Lower earnings for LMC. While power is expected to make up some 17-20% of LMC’s production costs, the 18.8% increase in electricity tariff shaves only 9% of its FY14 earnings to MYR409m, thanks to its decent profit margin. While some may argue that the tariff hike may partially be passed on to cement users, we think it may not be easy especially that YTL Cement, Cement Industries of Malaysia (CIMA) and LMC plan to expand capacity on a staggered basis over the next two years, which should lead to more supply going forward.
Sarawak boys escape the hike. Power generation and distribution in the state of Sarawak is operated by Sarawak Energy Bhd (SEB), which is excluded from the latest revision. Therefore, while cement manufacturing is a key business of CMS, the group escapes the latest tariff hike. Meanwhile, Press Metal (PRESS MK, BUY, FV: MYR3.82) which consumes 680MW of power at its aluminium smelting operation in Sarawak is also not affected. PRESS’ power tariff is based on the pre-agreed escalation clause at 1.5% p.a. under its 25-year power purchase agreement signed with SEB.
Downgrade basic materials sector to NEUTRAL
Largely NEUTRAL on local steel mills. Although local steel mills are more vulnerable in terms of earnings, we already priced this in and value most of the steel companies at -1 to -1.5 SD of their respective P/BVs’ 5-year trading range. Therefore, we prefer to keep the stocks at NEUTRAL, with some of the counters’ FVs tweaked slightly lower following their respective marginal earnings downgrades. The exception is Malaysia Steel Works (MSW MK, NEUTRAL, FV: MYR1.07)), which we downgrade to NEUTRAL (from Trading Buy). We initially recommended investors to take position in MSW as we believe the company is in the steel industry’s sweet spot. However, we decided to downgrade the stock as we reckon the latest tariff revision may deter investors from the sector, which recently saw two steel counters being designated the PN17 status.
Downgrade LMC to NEUTRAL. While we continue to like LMC for its oligopolistic position in the cement market, we decided to downgrade the stock to NEUTRAL (from Buy), as the latest tariff hike may dampen sentiment as the counter’s valuation is already far more expensive than that of its regional peers. Our new MYR9.61 FV is derived from a 20x FY14 P/E, or +0.5SD (from +2 SD) of its 5-year historical trading range.
Downgrade basic materials sector to NEUTRAL. With most basic materials counters under our coverage having been downgraded to Neutral recently, along with likely negative investor sentiment on heavy industry players like steel and cement following the electricity tariff hike, we downgrade our sector rating to NEUTRAL (from Overweight). Meanwhile, we continue to like basic materials counters involve d in niche products or are operating in Sarawak. The latest development once again substantiate our earlier view that the Sarawak Corridor of Renewable Energy (SCORE) benefits from cheap energy, with the state’s vast hydro energy offering a competitive business environment to heavy industries like aluminium smelter, cement and others. Therefore, we are keeping our BUY recommendations on CMS (MYR7.55 FV) and PRESS (MYR3.82 FV).
Source: RHB
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Created by kiasutrader | Jun 14, 2016
Created by kiasutrader | May 05, 2016