We are keeping our NEUTRAL
recommendation on the sector (steel & cement) at this juncture given the
vulnerability in, and volatility of, the raw material prices, which could
further compress margins for the building material players, especially steel
millers. Generally, steel millers are still hit by the slower-than-expected recovery
in steel prices and high inventory costs due to 1) the recent economic uncertainties
arising from the debt crisis in the Euro zone, 2) the economic slowdown in
China and 3) the extensive dumping of construction steels by Chinese mills
globally. However, we could still see a better prospect for the overall
industry in 1Q13 underpinned by the execution of major construction projects
under the Economic Transformation Project (“ETP”) i.e. MRT, LRT, Tun Razak
Exchange, Iskandar region development and etc. As such, we prefer cement
players than the steel millers, with LMCEMNT (Not Rated) being the likely
immediate beneficiary. We are not positive on the steel millers like ANNJOO
(UP; TP: RM1.17) and MASTEEL (MP; TP: RM0.90) as their performances are likely
to be subdued in the near term. We are looking to initiate coverage on LMCEMNT
(Not Rated) in the near term.
Steel:
Slower sales volume
to continue. Thus far, the steel players’ earnings have been bogged down by
a lower sales volume and expensive inventory prices due to the impact of slower
demand for steel globally coupled with the slowdown in China’s economy. Due to
the high inventory level and weak demand, China steel mills are holding back
their productions, which could be prolonged in the next 6 to 12 months before a
gradual growth in demand take place. Steel prices are expected to be subdued
due to the current on going rampant
dumping activities. To recap, China's supply represents c.47% of the world’s
crude steel supply in 2012. Steel
trading opportunities. Despite the slower recovery in steel prices, local
demand has continued to support the demand for steel players like ANNJOO (UP; TP: RM1.17) and MASTEEL (MP; TP:
RM0.90). The local demand will somewhat partially cushion the impact of the
slower exports, underpinned by the execution of major construction projects domestically
under the Economic Transformation Project (“ETP”) i.e. MRT, LRT, Tun Razak Exchange,
Iskandar region development, etc. With the busier construction activities in
1H13, we expect this will help pare down steel millers’ high inventory level,
but their bottom line growth will still be limited due to their current high
holding costs.
Cement:
Valuations already
rich. Cement stocks namely LMCEMNT (Not Rated) and TASEK (Not Rated) on
average are already trading at their up-cycle valuation at a 1-year forward PER
of 19x (+0.5SD above the mean of their 5-year forward PER of 15x). TASEK is
currently trading at 16x 1-year forward PER, which is more than a +2SD above
its 3-year historical forward PER mean of 10x. Due to the rich valuations but
stable earnings growth, we have assigned
a Neutral rating on the sector. We expect cement demand to grow by 5% annually
through 2017.
Flattish margin ahead
as capacity increases. Going forward, we are turning cautious on the cement
companies’ ability to sustain their high/lucrative margins as more and more
supply are gradually coming into the market. New entrant, Hume Cement has already started production in
4QFY13. Upon completion of its plant in 1QFY13, it will add about 1.5m MT p.a. in
clinker capacity, making up about 8% of the current industry capacity. CIMA and
YTL Cement are also expanding with c.1.5m MT p.a. of additional clinker
capacity each. However, we believe that the price competition will be a tricky
one due to increase in demand of about 5% annually up till 2017 underpinned by
the various mega projects, e.g. KVMRT, Tun Razak Exchange, RRIM land, Menara
Warisan, etc. Note that Budget 2013 expects the construction sector to grow by
11.2% in 2013. While the volume growth will be sustained, the net selling price
may face some pressure arising from the higher rebates offered due to the
increased competition.
OTHER POINTS
Higher ASP but offset
by higher rebates. Despite LMCEMNT
increasing its ASP by 6% from RM320/mt to RM340/mt in August, the accretion to
its earnings was offset by the higher rebates given due to the increased
competition. Based on our channel checks, rebates have increased to more than
RM70/mt from RM40-50 in October. This was attributed to the entry of Hume
Cement and the rainy weather in 4QFY12, which slowed down cement consumption.
If rebates stay at current high levels, smaller players like Hume Cement will
be the main losers. Based on our sensitivity analysis, the rebate level of
RM120/mt will be close to the break-even point for cement producers.
Low coal prices provide the cushion. On a positive note, we would like to point
out that there has been a dip in the coal price, which makes up about 30% of
the production cost. The benchmark Newcastle coal price has fallen by c.20% YTD
from USD111/MT to USD90/MT. We expect coal prices to gradually recover as key
economic indicators are showing an improving Chinese economy and from efforts
by coal producers in China and Australia to cut production to control prices.
Saving grace is
dividends. While cement stocks offer
limited upside in terms of capital appreciation, they do offer decent dividend
yields, which provide a cushion considering the uncertain market environment.
LMCEMNT offers a 4.4% dividend yield based on the consensus’ FY13 DPS estimates
of 42 sen while TASEK offers a 3.9% dividend yield of based on the consensus’ FY13
DPS estimates of 50 sen. Cement companies namely LMCEMNT and TASEK have ample
capacity to sustain their dividends as they are in net cash positions.
Valuation and
recommendation. We are maintaining
our Neutral outlook on the building material sector for 1Q13. On the cement
sector, our Neutral recommendation is due to the rich valuations of cement players,
which currently trading at their upcycle valuations. However, decent dividend
yields will provide the support to their valuations considering the current
uncertain capital market environment. We favour LMCEMNT (Not Rated) as it offers a decent dividend yield of 4.4%
coupled with the fact that it may announce a potential dividend hike or a
capital repayment exercise. We are looking to initiate coverage on LMCEMNT in
the near term. As for the steel sector, we do not expect steel players’
earnings to recover in the near term despite the increase in the local demands.
This is due to their high operating costs as a result of their excess capacity
and higher inventory costs.
Source: Kenanga
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