Ann Joo Resources: Under Pressure From All Sides

Ann Joo posted a net loss of RM1m for 1QFY12  as margins  narrowed due to relatively high material costs  vs  softer steel prices,  and  due to  expenses  arising from  the  newly commissioned blast furnace (BF). We  see  gradual improvement on its BF with  the  arrival of cheaper iron ore and coke, plus partial replacement of expensive coke with cheaper PCI coal. However, we are keeping our estimates since: i) management lacks a track record in handling BFs, ii) the grim outlook for the steel industry as there are fresh concerns of a deepening economic crisis in Europe, and iii) slow pick-up in local steel demand. We are still NEUTRAL on Ann Joo, with our FV cut to RM1.60, based on 0.75x on FY12 BV, or -1 standard deviation of the stock’s historical trading range.

Minor loss in 1Q. Ann Joo’s marginal net loss of RM1m for 1QFY12 was below our and way below  consensus’ estimates  when  annualised. The poor results can be attributed to weak steel demand during  the  Chinese New Year celebration, during which steel prices were soft, which led to thinner margins. Nonetheless, the company managed to increase its market share, and as such  recorded higher local and export  sales, which pushed up revenue by 22.4% q-o-q, but we believe this was to a certain extent achieved at expense of margins. Furthermore, the commissioning of the blast furnace (BF) also resulted in Ann Joo incurring interest expenses and depreciation costs in respect of its new plant, as well as other start-up costs. These further added pressure on its bottomline.

Potential near-term spike, but... We are optimistic that Ann Joo will return to the black in the  coming quarter,  buoyed by higher  steel prices higher q-o-q  and  a marginal dip in average material cost as cheaper scrap metal arrives. We also expect its BF operation to improve gradually, but we  also  think it is fair to assume  that  the company may need  to undergo a  gestation period  in  handling this first-of-its-kind furnace in the country. Meanwhile, the immediate cost reduction should  come from the arrival of lower cost iron ore and coke.  Elsewhere,  the  smooth commissioning of  the company’s  Pulverized Coal Injection (PCI) equipment would also allow Ann Joo to substitute part of its expensive coke with cheaper PCI coal. But in the absence of a  proven track record, we prefer to see the actual cost savings materialize  before fully incorporating these positive numbers into our earnings model. Also,  as the  implementation of “mega” projects under the Economic Transformation Programme (ETP) may take time - at least until the conclusion of the next General Election - and in turn spur  physical steel demand, we are  keeping our original estimates unchanged. We also cautious on the  overall steel industry outlook, given renewed concerns over the deepening economic conditions in some of the countries in the European Union. Therefore, we are keeping our NEUTRAL recommendation on Ann Joo, with  our  Fair Value  cut to RM1.60 after lowering  our valuation by  a  notch to  -1 standard deviation of the stock’s historical trading range.

Source: OSK