We came away from our recent meeting with CHINWEL management feeling less upbeat about the outlook of the company. Key takeaways include: 1) sales volume for fastener remains subdued in the near term, 2) bleak earnings outlook for wire division as it awaits contract from ECRL, and 3) higher compliance cost to fulfil carbon tariffs and ESG requirements. We maintain our Sell call on CHINWEL with an unchanged target price of RM1.11 premised on PER 9x CY25 EPS.

Sales Volume for Fastener Remains Subdued in Near Term

Sales volume is expected to remain subdued in the near future, primarily due to softer demand for fastener and wire products. We attribute this to the sluggish recovery of the Chinese property sector. Despite the introduction of a CNY 1 trillion stimulus package aimed at alleviating deflationary pressures, the sector continues to face challenges in the absence of further clarity of the stimulus. Furthermore, in European regions, escalating shipping costs and extended shipping times from Malaysia to Europe – up to 30 days – due to logistical disruptions stemming from the Red Sea crisis have further dampened demand. Nonetheless, the company is anticipating that the headwinds will gradually ease off from 2HCY25 onward, backed by the rollout of more new infrastructure projects and the recovery of the global economy.

Bleak Earnings Outlook for Wire Division as It Awaits Contracts from ECRL

On top of the slowdown in export demand, CHINWEL's wire division is facing intense competition from Chinese players, resulting in a lower ASP for galvanised wire products due to price wars. Hence, the group is diversifying its wire division downstream to offer value-added services. This includes the production of galvanised steel wire mesh and high-security fences with special features, which command higher profitability margins.

While the division's primary clients are predominantly local and from Saudi Arabia, the group could be benefited from potentially securing contracts for the ECRL project to supply galvanised fencing. This is supported by its competitive pricing, stemming from effective cost optimisation measures. However, it is expected that the division's contribution to PBT will remain small in FY24 and FY25 as it awaits the award of contracts from the ECRL. Note that wire division only contributed 4% of the group’s total core PBT in 1HFY24.

Higher Compliance Cost to Fulfill Carbon Tariffs and ESG Requirements

To recap, the Carbon Border Adjustment Mechanism (CBAM) transitional period commenced on 1 Oct 2023. Under CBAM, a carbon tariff or carbon tax will be imposed on carbon-intensive products exported to the European Union (EU), effective from 1 Jan 2026. It is expected that Malaysia will adopt a similar policy to align with global initiatives aimed at reducing carbon footprints.

Despite the framework and details of Malaysia's carbon policy being currently unknown, CHINWEL plans to allocate approximately RM10mn over the next 3 years to upgrade its facilities to comply with ESG requirements. This initiative is awaiting the release of its carbon emissions report by the end of this month.

Impact

Maintain Our FY24 to FY26 Earnings Forecasts.

Valuation

No change to our target price of RM1.11, based on PER 9x CY25 EPS. Maintained Sell on the stock.

Source: TA Research - 19 Mar 2024