Building Materials Heavy on Metal NEUTRAL By Lum Joe Shen / lumjs@kenanga.com.my ; Voon Yee Ping, CFA / voonyp@kenanga.com.my Overall, we maintain our NEUTRAL view on the Building Materials sector despite being positive on the steel and aluminium sub-sectors due to the larger market weightage of our negatively weighted cement sub-sector. We are positive on the long steel sector as we expect construction activities within the infrastructure space to pick up pace, which would drive demand for steel rebars and subsequently prices, targeted at RM2,225/t for FY17. Meanwhile, we have initiated coverage on a downstream flat steel player ULICORP and are positive on its prospects given their: (i) ability to protect margins and pass on cost to consumers, and (ii) planned expansion plans. Aluminum price outlook remains solid, thanks to announced Chinese production cuts and thinning inventories. PMETAL should see good earnings growth (FY17-18E: 51-21%) thanks to bullish aluminium prices and increased operating efficiencies. However, the cement sub-sector is expected to remain weak due to high excess capacity from the additional 16% capacity in FY16, causing intense price competition amongst cement manufacturers. Maintain call and TP for ANNJOO (OP; TP: RM4.30), ULICORP (OP; TP: RM5.60), PMETAL (OP; TP: RM3.15) and LAFMSIA (UP; TP: RM4.33). Mixed results in 1Q17 with 1 above (ANNJOO), 1 below (LAFMSIA) and 2 within/broadly within (PMETAL, ULICORP) expectations. ANNJOO came in stronger than expected due to higher-than-expected selling prices on the back of lower-thanexpected raw materials costs i.e. coke, iron ore, scrap. Meanwhile, LAFMSIA was underperformed due to lower-than-expected cement demand on the back of higher-thanexpected rebates dished out. That aside, we initiated coverage on ULICORP recently, which saw a decline in YoY earnings which we deem within expectations as we had anticipated higher OPEX to be incurred with the commissioning of its new plant. We believe that future performances will compensate with stronger volume output and wider margins. All-in, 1Q17 results performance is inferior over the last quarter when we saw all 3 counters within our coverage coming above expectations. Share price performance. Over 2QCY17 (till report cut-off of 23/6/2017), ANNJOO s share price was up 18% which we believe is due to their better-than-expected results. LAFMSIA was down 22% as they registered their first quarterly loss since 2005 and the worst loss since listing. In addition, they missed dividends for the third consecutive quarter which was previously consistently paid out every quarter since FY10. Meanwhile, PMETAL s share price was stable (+2%) at RM2.68 prior to its temporary suspension on 19-June as the company changed its corporate structure to an investment holding company format to better facilitate future expansions. As for ULICORP, its share price fell by 9% since our initiation of the stock on 25/5/2017 which we believe is due to their comparatively poorer YoY results announced. Long Steel Anticipating pick up in local construction activities. For 2H17, we are expecting a pick-up in construction activities from the infrastructure space driven by the increase activities from projects awarded in FY16 namely: MRT2, Pan Borneo, SUKE amongst others. We believe these projects will lead to higher demand for steel rebars and hence drive steel prices up by c.4-5% similar to levels back in January-17 which we have derived through industry players feedbacks. We are forecasting an average rebar price of RM2,225/t for FY17 while we note that the average rebar price for 1H17 was c.rm2,167/t. No immediate threats from China. Currently, China steel rebar prices are trading at c.usd450 (RM1,935). After incorporating import duties (+5%), shipping fees (c.+5%) and safeguard measure (+13.2%), total effective cost for importing Chinese rebars is c.rm2,400 vs local rebars which are trading at RM1,930-RM2,080 as of mid-june. In addition to the higher prices, the long waiting time of c.2 months for imported rebars to be shipped had led to minimal imports from China. Moving forward, we are expecting Chinese steel prices to remain stable supported by: (i) structural reforms from Chinese government to cut capacity by 150m tonnes (from 2016-2020) for FY17, they intend to cut c.50m MT of capacity through the shutdown of Induction Furnaces, and (ii) fiscal spending on China infra projects to drive China s domestic steel demand. Raw material prices normalising. We note that raw material prices (iron ore and scrap) have come down from a peak since 1H17 (iron ore price peaked in February-2017 at USD90 while scrap peaked in March-2017 at USD330). Iron ore and scrap are currently trading at USD62 and USD255, respectively. Moving forward, we believe prices for iron ore and scrap are capped due to: (i) increased supply of iron ore from larger players, i.e. Rio Tinto, Vale from the reopening of mines, and (ii) higher surplus of scrap due to the reduced usage in China from closures of induction furnaces (induction furnace are more reliant on scrap while PP7004/02/2013(031762) Page 1 of 8
blast oxygen furnace is more reliant on iron ore). Based on our estimates, we note that scrap, iron ore and coke make up approximately 30%, 20% and 15% for ANNJOO s operating cost, respectively. The lower raw material prices coupled with our higher anticipated steel prices in 2H17 would be a precursor for margin expansion for our local long steel players for 2H17. ANNJOO earnings intact. Our FY17-18E earnings for ANNJOO remain intact based on the following assumptions; (i) steel price of RM2,225/t, (ii) scrap prices of USD270/t, (iii) iron ore prices of USD73/t, and (iv) sales volume of >80% of capacity utilization. Maintain OP for ANNJOO. We reiterate our OP call on ANNJOO with an unchanged TP of RM4.30 based on unchanged 10.0x FY18E PER. Given ANNJOO s position as the most cost efficient upstream steel player with highest capacity utilization amongst local upstream players, we believe our 10.0x valuation is justifiable as it is at the higher end of MASTEEL s FY10-12 PER of 7-10x when steel prices were relatively stable. To recap, ANNJOO s hybrid production approach allows them to have the flexibility to alter their cost structure based on cheapest available raw material (either iron ore or scrap) to produce steel unlike other players which are 100% scrap reliant. Local Billet and Steel Rebar prices Source: MITI, Kenanga Research Flat Steel Downstream flat steel players to join the party. Meanwhile, we had initiated coverage on ULICORP (OP; TP: RM5.60), a downstream flat steel player who is a market leader in the manufacturing of steel cable support systems with clients portfolio principally involved in the infrastructure, construction, property as well as the oil and gas sector domestically and in Singapore. Full cost passing. ULICORP s raw materials are cold-rolled coils (CRC) and hot-rolled coils (HRC). Despite the higher average HRC and CRC prices registered for 1H17 (+37% YoY for HRC; +31% YoY for CRC) we note that being a market leader with c.40% market share within the relatively fragemented steel cable support system space, ULICORP has been able to fully pass on higher raw material costs to their end consumers while maintaining sales volume indirectly protecting margins. Expansion underway. ULICORP is undertaking an aggressive expansion plan to double its production capacity through the construction of a new plant in Nilai furnished with more capital intensive equipment, which could translate to expanded profit margins in the near term. While recent quarter s earnings may have been undermined as a result of the heavier expenses incurred during the gestation period of the Nilai plant, we are hopeful for stronger performance in the coming quarters on the back of a higher volume output alongside wider margins. ULICORP could potentially reward shareholders with decent dividend yields at 3.9%/5.1% in FY17E/FY18E assuming a c.60% payout ratio, which outperforms the average yield of the BMAT counters under our coverage (PMETAL, LAFMSIA, ANNJOO) of 3.4%/4.3%. We value the stock at an ascribed targeted 16.0x FY18 PER, closely in line with +1SD and above the stock s 5-year average Fwd. PER which we believe is justified considering the positives above. Maintain OVERWEIGHT on the steel sector. We remain positive on the long steel sector underpinned by the high rebar prices buoyed by the increased infrastructure activities in 2H17. Meanwhile within the flat metal space, we are positive on ULICORP s outlook given their: (i) ability to protect margins and pass on cost, and (ii) planned expansion plans. Risks to our call include: (i) lower-than-expected steel demand, (ii) lower-than-expected steel prices, (iii) higher-than-expected imports, and (iv) discontinuation of safeguard measure post investigation period. PP7004/02/2013(031762) Page 2 of 8
HRC and CRC Prices Source: CEIC,Kenanga Research CEMENT Malaysia 4M17 apparent cement consumption weak. 4M17 total apparent cement consumption of 6.3m MT was down 12.5% YoY (refer Table below). The decrease in apparent cement consumption indicates the weak demand faced by cement players mainly due to: (i) mega infra-works in initial phases, and (ii) slowdown in residential and commercial property markets. We derive our apparent consumption of cement after deducting exports from the production and imports of cement in Malaysia. Nothing extraordinary for 2H17. We expect cement demand to be better in 2H17 against 1H17 when mega infrastructure projects; i.e. MRT2, SUKE, DASH, WCE, TRX, progress into more advanced stages. However, we believe growth could be muted as the residential and commercial property sector which typically makes up two-thirds of cement demand is currently facing a slowdown. Hence, we are anticipating a mild apparent cement consumption growth range of 3-6% for 2H17 against 1H17 within the industry. Higher raw material costs do not bode well with the sector. Moving forward, cement players are expected to face higher cost due to: (i) higher coal prices due to capacity cuts from China, (ii) higher electricity rates of c.2%/annum from the unwinding of industrial tariff rebates, and (iii) higher diesel prices, which have gone up 16% YTD. Power costs typically make up bulk of the cost at c.40-45%. Demand yet to keep up with increased supply. In Peninsular Malaysia, the additional capacities from HUMEIND (+1.8m MT), YTL (+1.8m MT), LAFMSIA (+1.2m MT) in FY16 have increased capacity by an additional 16% into the existing space (refer to Table 1). Despite anticipating an increased in cement demand of 3-6% YoY from infrastructure projects, we believe it is still not sufficient to absorb the sudden 16% supply expansion resulting in continued price wars between players which would keep margins under pressure. We also note that rated capacity for cement players in Malaysia stands at 34.8m MT vs our FY17E apparent cement consumption of c.20.5m MT still indicating a large excess capacity. Still Negative on the cement sub-sector. We remain Negative on the cement sub-sector and maintain an unchanged UNDERPERFORM call and TP of RM4.33 on LAFMSIA (1.20x FY18 Fwd PBV) due to the overcapacity issue coupled with the slowdown in the property market. Apparent Cement Consumption in Malaysia Apparent cement consumption 4M13 8.349 4M14 8.581 2.8% 4M15 8.535-0.5% 4M16 7.489-12.3% 4M17 6.556-12.5% Source: CEIC,Kenanga Research Total Cement and clinker capacity in Malaysia Companies Total Clinker Capacity Total Cement Capacity Cement Market Cap (m MT) (m MT) Lafarge Malaysia 9.20 15.35 40.0% CIMA Group 4.63 5.44 14.2% Tasek Corp Bhd 2.30 2.30 6.0% YTL Group 5.70 7.80 20.3% Hume Cement 3.65 3.65 9.5% Aalborg 0.19 0.21 0.5% Cement Industries (Sabah) Sdn Bhd 0.00 0.90 2.3% CMS Group (Sarawak) 0.90 2.75 7.2% Total 26.57 38.40 100.0% Source: Various sources, Kenanga Research YoY PP7004/02/2013(031762) Page 3 of 8
ALUMINIUM Prices stable at 3-year highs. Since Dec-2016, aluminum prices have been trading at USD1,800-2,000/MT, or close to 2015 high levels. Indeed, prices hit a 3 year high of USD1,962/MT in Mar-2017. In terms of Ringgit, its recent appreciation moderated local price performance, narrowing YTD RM price gains to 4% vs. USD appreciation of 9%. Nevertheless, YTD prices averaged USD1,880/MT or RM8,250/MT, coming in above our aluminum price assumption of USD1,750/MT or RM7,600/MT, which bodes well for earnings performance in 2Q17. Aluminum Price USD vs. RM/MT Aluminum Price Performance USD vs. RM/MT Softening capacity growth. While global capacity growth in last the 10 years were driven by China, Middle East and India, the overall capacity growth trend has been gradually declining. This is due to the long period of low prices between 2015-2016 leading to the closure of inefficient smelters globally, as well as a gradual destocking process after reforms at the key London Metals Exchange reduced incentives to maintain inventories. While prices have since recovered, we do not expect capacity to pick up any time soon due to the time lag for restarting a smelter, and commitments from China to cut its environmentally inefficient smelters. Aluminum Production Capacity ( 000 MT) Asia China & ex-china Capacity Inventory drawdowns to support near-term prices. In the nearer term, we expect prices to remain supported at current levels in light of continued inventory drawdowns. Global demand at Apr-2017 came in at 5.06m MT, exceeding production of 4.94m MT. We believe that demand will continue to top supply, as updated inventory numbers show a consistent decline to 3.52m MT in Jun-2017, from 4.08m MT in Jan-2017. We take this as a signal that Chinese producers have indeed begun curbing excess production, which bodes well for prices in the near-to-mid term. Aluminum Global Supply & Demand PP7004/02/2013(031762) Page 4 of 8
Gradually narrowing Chinese surplus; Asia ex-china s demand still healthy. We see further evidence of gradual production cuts in China, with a narrowing production surplus to 30-35k MT per month as of Apr-2017, from 35-45k MT per month in the same period last year. Meanwhile, Asia demand at c.3.5m MT/month remains consistently healthy above production levels of c.3.3m MT/month, for consistent deficits of 200k MT/month, or a 6% shortfall. Excluding China, the discrepancy is sharper, with demand of c.800k MT/month against production of c.600k MT/month a 25% shortfall. China Production vs. Demand Asia Production vs. Demand Asia ex-china Production vs. Demand Reiterate OUTPERFORM on PMETAL with unchanged TP of RM3.15 based on Fwd. PER of 17.0x applied to average FY17-18E FD EPS of 18.5 sen. We maintain our bullish view on the stock with aluminum prices at 3-year highs, as management continues its plant expansions and upgrades, including a new billet line and conveyor belt connecting the Samalaju plant to the Samalaju Port, which is slated to commence in 2H17. SUMMARY Maintain NEUTRAL with selective buys on Building Materials. All in, we maintain our NEUTRAL view on the building material sector despite being positive on steel sector and aluminium sector as the market weightage of our negatively weighted cement sector is larger. We maintain our UNDERPERFORM call on LAFMSIA (TP: RM4.33) due to the intense pricing competition from the overcapacity issue faced by cement players. Maintain OUTPERFORM on ANNJOO with unchanged TP of RM4.30 on the back of anticipated pick-up in construction activities, which would drive steel demand. We also maintain ULICORP at OUTPERFORM with an unchanged TP of RM5.60 as we believe its future growth prospects driven by improving production capabilities are still intact. Meanwhile, we maintain PMETAL at OUTPERFORM with unchanged TP of RM3.15 due to continued cost efficiency improvements and rising proportion of higher margin products. PP7004/02/2013(031762) Page 5 of 8
APPENDIX ANNJOO Fwd PBV Band ANNJOO -Fwd PBV Band Source: Company, Kenanga Research ULICORP Fwd Core PER Band ULICORP-Fwd PBV Band Source: Company, Kenanga Research LAFMSIA Fwd Core PER Band LAFMSIA -Fwd PBV Band Source: Company, Kenanga Research PMETAL Fwd Core PER Band PMETAL -Fwd PBV Band Source: Company, Kenanga Research PP7004/02/2013(031762) Page 6 of 8
Valuation & Justification For Calls Company Last Price (RM) @ 23- June-17 New TP (RM) New Call Valuation Basis Old TP (RM) Old Call Quantum of TP Revision Call Action ANNJOO 3.12 4.30 OP 10.0x PE on FY18E earning 4.30 OP 0% Maintain LAFMSIA 5.22 4.33 UP 1.20x FY18E PBV 4.33 UP 0% Maintain PMETAL 2.68 3.15 OP 17.0x average FY17-18E PER 3.15 OP 0% Maintain ULICORP 4.12 5.60 OP 16.0x FY18 PER 5.60 OP 0% Maintain Source: Kenanga Research Peer Comparison Company Name Price (23- June-17) Mkt Cap Core PER (x) Est. Div. Yld. Historical ROE P/BV Core Net Profit (RMm) This Year Growth Next Year Growth Target Price Rating (RM) (RMm) FY16A FY17E FY18E (%) (%) (x) FY16A FY17E FY18E (%) (%) (RM) CORE COVERAGE ANN JOO RESOURCES BHD 3.12 1,609 10.1 7.4 7.3 6.8% 15.6% 1.5 154.1 219.0 228.0 42% 4% 4.30 OUTPERFORM LAFARGE MALAYSIA BHD 5.22 4,435 52.5 (474.5) 41.8 0.0% 2.8% 1.4 84.5 (10.0) 107.0-112% -1170% 4.33 UNDERPERFORM PRESS METAL BERHAD 2.68 10,350 22.7 16.3 14.8 3.4% 12.0% 4.6 430.0 648.0 783.0 51% 21% 3.15 OUTPERFORM ULICORP 4.12 598.2 19.2 15.3 11.7 3.9% 11.8% 2.2 31.1 39.0 51.0 15.0% 18.5% 5.60 OUTPERFORM PP7004/02/2013(031762) Page 7 of 8
Stock Ratings are defined as follows: Stock Recommendations OUTPERFORM : A particular stock s Expected Total Return is MORE than 10% MARKET PERFORM : A particular stock s Expected Total Return is WITHIN the range of -5% to 10% UNDERPERFORM : A particular stock s Expected Total Return is LESS than -5% Sector Recommendations*** OVERWEIGHT : A particular sector s Expected Total Return is MORE than 10% NEUTRAL : A particular sector s Expected Total Return is WITHIN the range of -5% to 10% UNDERWEIGHT : A particular sector s Expected Total Return is LESS than -5% ***Sector recommendations are defined based on market capitalisation weighted average expected total return for stocks under our coverage. This document has been prepared for general circulation based on information obtained from sources believed to be reliable but we do not make any representations as to its accuracy or completeness. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may read this document. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees. Kenanga Investment Bank Berhad accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or any solicitations of an offer to buy or sell any securities. Kenanga Investment Bank Berhad and its associates, their directors, and/or employees may have positions in, and may effect transactions in securities mentioned herein from time to time in the open market or otherwise, and may receive brokerage fees or act as principal or agent in dealings with respect to these companies. Published and printed by: KENANGA INVESTMENT BANK BERHAD (15678-H) Level 12, Kenanga Tower, 237, Jalan Tun Razak, 50400 Kuala Lumpur, Malaysia Telephone: (603) 2172 0880 Website: www.kenanga.com.my Email: research@kenanga.com.my Chan Ken Yew Head of Research PP7004/02/2013(031762) Page 8 of 8