We reiterate our NEUTRAL rating on the sector. We believe prices for both ferrous and nonferrous metals will remain stable despite the economic challenges in China given supply constraints arising from stricter environmental regulations coupled with Western sanctions against Russian producers. Water pipe makers stand to gain from the revival of water projects locally following water tariff hikes that strengthen cash flows of water operators. Our sector top picks are low-carbon ferrosilicon (FeSi) and silicomanganese (SiMn) producer OMH (OP; TP: RM1.80) and water pipe maker ENGTEX (OP; TP: RM1.41).

Commodity prices have bottomed out. We project a slightly higher average aluminium price of USD2,350/MT in CY24 vs. USD2,255/MT in CY23, while slightly lower average FeSi and SiMn prices of USD1,300/MT and USD920/MT in CY24 vs. USD1,437/MT and USD962/MT in CY23, respectively. We see slightly better aluminium prices after a 2-year lull, but remain cautious on FeSi and SiMn prices given the protracted downturn in China’s steel sector. Generally, the demand outlook for these commodities is unfavourable due to economic challenges in China, though partially cushioned by supply constraints due to the decommissioning of fossil fuel-powered smelters (especially by coal) on stricter environmental regulations coupled with Western sanctions against Russian producers. Overall, we expect FY24 earnings growth for aluminium smelter PMETAL (MP; TP: RM4.90) to be driven by better aluminium prices, while FeSi and SiMn alloy producer OMH by higher production volumes.

We expect a slow recovery in China's steel sector amidst a deepening property debt crisis, partially cushioned by a robust automotive sector driven by the adoption of EV backed by extended tax breaks and investment in RE infrastructure. Nonetheless, we believe steel prices have bottomed out and hence there will be no significant inventory write-downs in CY24.

Pipe makers in a bright spot. We like ENGTEX on expectations of high demand for water pipes following water tariff hikes translating to strengthened cash flows of water operators, allowing them to kick start their capex programmes including nonrevenue water (NRW) reduction initiatives. This will be in addition to a significant allocation for pipe replacement programmes under the Twelfth Malaysia Plan (12MP). The demand for water pipes will also be driven by the development of Sungai Rasau Water Supply Scheme Phase 2 in Selangor. We also see better margins as pipe makers will not be weighed down by high-cost steel inventory (which happens when steel prices are in a persistent downtrend) given that steel prices have bottomed out. For instance, in Mar 2024, local long steel price eased slightly to c.RM2,766/tonne (-2% MoM) while local flat steel price inched up to RM3,164/tonne (+1% MoM).

Our sector top picks are:

1. OMH given: (i) its structural cost advantage over international peers due to access to low-cost hydropower under a 20-year contract ending 2033, (ii) its strong growth prospects underpinned by plans to expand its capacity by 30%-36% to 610,000- 640,000 metric tonnes per annum over the medium term, and (iii) its appeal to investor given its clean energy source.

2. ENGTEX given: (i) the huge potential in the water pipe replacement market locally, (ii) its dominant market position in both large-diameter mild steel (MS) pipes and ductile iron (DI) pipes, and (iii) its strong earnings visibility underpinned by significant order backlogs and a strong pipeline of new projects.

Source: Kenanga Research - 29 Apr 2024