PETALING JAYA: UOB Kay Hian Research is expecting an exceptionally strong earnings season for steel companies in the third quarter (Q3) of this year.

This is due to the continued surge in steel prices in the month to date for August.

The research house has upgraded Ann Joo Resources Bhd to a “buy” with a target price of RM3.80 noting that the company had an extended earnings visibility and effective capital management that should lift its valuations.

After the 7.8% month-on-month (m-o-m) surge in July, steel bar prices in Malaysia jumped 12.1% m-o-m and 28.9% year-on-year (y-o-y) to RM2,440 per tonne in the first two weeks of August, according to the Ministry of International Trade and Industry.

“Assuming input costs are prudently managed, Q3 earnings of some steel companies could at least repeat the first quarter’s exceptionally strong earnings.

“Margins could expand in the third quarter as steel bar prices increased 12.1% m-o-m in August, offsetting the 9.8% m-o-m and 10% m-o-m increase in scrap and coal prices respectively,” the research house said.

“We believe margins will also improve on the back of strong sales volume in the third quarter,” it added.

Apart from China demand, UOB Kay Hian believed that local inventory was low currently and local stockists had curbed deliveries.

“Although we expect steel prices to ease in Q4 to reflect the seasonal slowdown in China’s construction activities, rising domestic demand (amid a pick-up in mega projects) should provide some support to domestic steel prices,” it said.

“Currently, domestic steel billets are fetching an 18% premium to China’s billet prices versus a 4% premium in August 2016,” it added.

UOB Kay Hian said given that steel companies were now enjoying strong cash flows and reasonably good demand visibility in the intermediate term, it expected some steel companies to adopt generous dividend policies or/and embark on a meaningful capacity growth.

UOB Kay Hian noted Ann Joo’s policy of up to a 60% dividend payout implied a dividend yield of 6.6%.

In 2016, Ann Joo distributed 45% of its earnings to shareholders, translating into a dividend yield of 4.8%, it said.

“Ann Joo is our top pick, while notable stocks include Choo Bee, Masteel, CSC Steel and Prestar.

“We expect investors to give due attention to the steel sector, given the sector’s cheap (single-digit) PE multiple in the third quarter, rising domestic demand (amid growing mega project construction activities) and the dearth of alternative compelling investments,” it said.

The research house also upgraded the sector to an “overweight.”

It also noted that while most steel companies traded at about six times price to earnings ratio, Choo Bee and Masteel traded at only half their respective book values.

“Masteel is also a laggard. Prestar comes across as interesting, riding on upcoming highway projects,” added UOB Kay Hian.