Local steel players had a volatile year in FY12 as steel prices were pressured by: 1) overcapacity of the Chinese steelmakers, 2) weak demand in Europe and 3) a slower than expected growth in Asia, especially in China. We expect a gradual improvement in FY13 steel prices as the inventory gets pared down on the back of increasing demands. Meanwhile, cement players also faced some headwinds towards the end of FY12 due to the rising capacity in the industry caused by new entrant, Hume Cement. We expect the overcapacity issue to continue as two more cement players will be expanding their capacities in FY13 and FY14. While demand for building materials will be underpinned by the execution of ETP-related construction projects, we are maintaining our NEUTRAL recommendation on the building materials sector (steel & cement) due to the overcapacity issue, which could contribute to pricing pressure and thus dampening margins. As such, investors should take a cautious view on the steel players like ANNJOO (UP; TP: RM1.17) and MASTEEL (MP; TP: RM0.90) as well as on the cement players, LMCEMNT (NON RATED) and TASEK (NON RATED).

Steel:

Slow yet positive recovery seen. We believe that developing economies like China and India will still be the vital growth drivers for the steel industry. However, steel and raw material prices remained volatile. Steel prices, for example, saw improvements in 1H12 due to increasing raw material prices but declined in 2H12 due to the continued oversupply problem in the global steel market as a result of: 1) overcapacity of the Chinese steelmakers, 2) weak demand in Europe and 3) the slower than expected growth in Asia, especially China. Hence, we expect steel prices to continue to be subdued in the medium term and only stabilise when construction activities in developing nations in Asia, particularly China and India rebound.

Local demand remains strong. Despite the slower recovery in steel prices, we believe that the strong local demand underpinned by the execution of major construction projects under the Economic Transformation Project (“ETP”) i.e. MRT, LRT, Tun Razak Exchange, Iskandar region development, etc. will continue to support the demand for steel. We expect the busier construction activities in 1H13 will help pare down the steel millers’ high inventory level, although their bottom line growth will still be limited due to their current high holding costs. However, we believe that 2013 will turn out gradually better as compared to 2012, underpinned by a steady recovery in the global economy and lesser concerns about the debt issue in the Euro zone.

Cement:

Cement consumption underpinned by spillover from construction activities. The government has projected a 16% YoY growth in the construction GDP in its budget 2013. Recall that the construction GDP grew by 21% in 2012. Growth in the construction sector this year will be underpinned by property development projects as well as the various ETP-related projects such as the Klang Valley MRT, Tun Razak Exchange, RAPID refinery project, RRIM land development, Menara Warisan, etc. We expect cement consumption to grow by 5% annually until 2017, underpinned by the various infrastructure and property development projects above.

Potential oversupply situation. Going forward, we are wary of an oversupply situation in the industry due to capacity expansions in the market. Cement players are feeling pricing pressure across the board due to the arrival of new entrant, Hume Cement in late 3Q12, which added 1.5m tonnes or about 8% to the industry clinker capacity. Clinker capacity in 2012 was at 22m tonnes and is expected to increase 25% to 27.4m tonnes by 2015 through the addition of new capacities by the existing and new producers. CIMA and YTL Cement plan to expand their capacities by 1.5MT each, to be completed in 4Q13 and 3Q14 respectively, representing an addition to the total industry capacity by 8% each. While the increase in the industry capacity will be partially compensated by a 5% annual growth in cement consumption, we believe that cement players will still face substantial pricing pressures.

Valuation and recommendation. We are maintaining our Neutral recommendation on the building materials sector due to the unfavourable demand-supply dynamics. As such, investors should take a cautious view on the steel players like ANNJOO (UP; TP: RM1.17) and MASTEEL (MP; TP: RM0.90) as well as on the cement players like LMCEMNT (NON RATED) and TASEK (NON RATED).

Source: Kenanga