Annjoo Q2 2019 Review

Annjoo reported its new Q2 result with a net loss of RM37.75mil on the back of higher revenue of RM574.32mil. This result is definitely shying shareholders away. Sadly, no dividend was issued in this quarter, understanding that the group is having a challenging business condition.

Higher revenue in the second quarter of 2019 (“2Q2019”) and first half of 2019 (“1H2019”) was
mainly due to higher export tonnage sold. International and domestic selling prices remained
depressed, and domestic demand continued to be weak. The revenue has increased 12% (YoY) and 6% (QoQ).

However, operating expenses for this quarter has badly hurt the company profit. In the report the group has mentioned that:
Losses in 2Q2019 and 1H2019 were mainly attributable to:
i) Lower selling price coupled with rising raw material and fuel costs;
ii) Higher-than-usual production cost in 2Q2019 due to the scheduled Blast Furnace (“BF”)
shutdown; and
iii) Other costs in 2Q2019 including allowance for inventories written down of RM22.54 million
and overhead cost for plant temporary shutdown on the BF relining exercise and plant
upgrading activities amounted to RM4.98 million.

We can see that moving forward, the expenses will reduce significantly in coming quarters. So far, those expenses were just one off maintenance process. 

Looking back on FY 2015 where steel sector was in the down trend as steel market was flooded with china imported stocks, Annjoo had written down inventories. History happens again. We can observe that, when inventories start stacking up, it is no good to the company and it means the market is going to slow down.

  

Looking on the group cash flows performance, net cash flows from operating activities have slightly improved from -RM46.6mil to -RM1.9mil comparing to Q1 FY19. It might be the net change in current assets that cushion the loss in operating activities.

The group's prospects continues to depend on the outlook of the international and domestic demands. The management has forecast that the third quarter of 2019 is expected to be remain challenging due to the uncertainty of global economic and lacklustre in construction market locally. The group is still in talk government to resolve the issue facing by the steel industry due to competition with foreign owned local steel makers.

Comment:
It is definitely not a good time to invest in steel industry stocks. However, I believe the market has bottomed out, price would not go low any further. The recent decline in key raw material prices, particularly iron ore and coking coal, will drive lower production cost going forward. The news of the revival of mega infrastructure projects and government action to resolve the current challenges would be catalysts for the stock price.

Technical Analysis

 The stock price is moving in a bearish trend. No signal of rebound. Next support line will be around RM1.16

Annjoo Q1 2019

Annjoo posted net losses for its 1st quarter report for FY 2019. A stark contract of its net profit compared to Q1 FY18 and Q4 FY18 as much as -111% and -120% respectively.

Look in detail of its financial statement showing that the group operating expenses have surpassed its revenue which is severe as every single tonnage that send out from production has already losing money.

Lower revenue and the loss incurred in the first quarter of 2019 (“1Q2019”) as compared to the previous year correspondence quarter were mainly due to lower tonnage sold coupled with depressed selling price in domestic market despite higher export tonnage in 1Q2019.

Lower revenue and the loss incurred in 1Q2019 as compared to fourth quarter of 2018 (“4Q2018”) were mainly due to lower sale tonnage coupled with depressed selling price arisen from the oversupply condition in the domestic market. 

Based on business segments review, manufacturing segment is turning red for 2 quarters; it started since last quarter (Q4 2018) when the group claimed that the decline in selling price which mainly attributed to the over supply situation due to a new competitor that foreign owned steel mills entering into domestic market. Manufacturing segment losses turn more severe in Q1 2019.  

Trading segment can consider still doing fine amid the slow economic growth situation. The group has increased their export volume as it can see from the geographical segment. Which is a good strategic from the management. 

Overall the company prospect is not encouraging.

Bad Points from Prospect: 

1. severe domestic oversupply situation (still unsolved)

2. expects a lower second quarter of 2019 due partly to seasonal factors that typically affecting construction activity, including the Ramadan month and Raya holiday. (Management does not look good on next quarter result)

3. oversupply situation in the domestic industry is still a main concern as steel prices continue

to be depressed by foreign-owned steel mills. (Domestic sales been threaten by foreign owned steel mills)

4. discussions with the relevant government authorities to resolve the current issues faced by the steel industry (Currently still in the midst of discussing with related government authorities, no solution and timeline at this moment yet)

Good Points from Prospect:

1. domestic sentiment has improved with the revival of selected mega infrastructure and large scale

development projects, for example the East Coast Rail Link and Bandar Malaysia.(coming second half year mega projects will revive.)

2. the industry is constantly in proactive discussions with the relevant government authorities to resolve the current issues faced by the steel industry. (At least some approaches to resolve the price war issue)

3. The Group remains highly responsive to market changes and agile in sales mix to meet international demand and targets to increase export sales (goods sold has shifted to export)

Comment:
Annjoo Q1 FY19 result is very disappointing, the domestic steel price competition issue remains unsolved for 2 quarters and no concrete solution to counter it. Therefore, the group will remain in red for the following quarters until the domestic demand recover again.

Technical analysis:

Annjoo price is currently making the 3rd Elliot downtrend wave. The price has dived below MA 9 and 200 meaning that in short and long term the stock is moving in a bearish trend.
The next support line I will see it at RM 1.30.

It is not a good sign to bottom fish now. I will wait until the demand boosted by those revival mega projects

Annjoo (6556): Temporary Bullish? Or Brighter Prospects' Steel Player?

Following the release of ECRL progressive news, the entire construction industry in Malaysia has undoubtedly been boosted up by the mega project.
With reference of graph above, Annjoo, as a material supplier to the industry, is performing bullishly ever since the beginning of year 2019.

Recently, steel industries are not making good business, though.
This is due to most players are facing oversupply issues and therefore incurred of massive losses.

Retrace to year 2015, where local steel companies had a tough time when steel products from China spread and eventually flooded the local market.
In their financial reports we could find that the industry was stacking up their inventories during that period due to noncompetitive pricing.

In year 2016 and 2017, local steel companies experienced a temporary reprieve.
It was reported that, strong earnings arose mainly from higher steel prices.
Thank to China government's policy of withdrawing 100 to 150 million tons of crude steel making capacity over a period of five years to battle excess capacity problem in China.

Annjoo was especially outperformed over other local steel players.
The Group has successfully brought in hybrid blast furnace electric arc furnace which helped the Group to improve its cost structure vastly.
Upon investment in this new technology, Annjoo was easily became the lowest costs' steel producer across the region.

The reprieve ended after the government switched over in year 2018.
Local market demand has soften, due to weak market sentiment.
It has been reported that inventories started to pilling up again among local steel players.
Whilst, the Pakatan Harapan government on hold several large infrastructure projects, this were akin to pouring fuel on a fire over local steel companies.

The competition among locals became more severe when China-backed Alliance Steel (M) Sdn Bhd set up the country's largest steel mill in Gebeng, Kuantan with an annual production capacity of 3.5 million tonnes of long steel products.

"
The local steel industry is centered on two major types of products — long and flat.
Long products — including billets, bars, beams, iron bar, rebars and wire rods are used in the construction and civil engineering industries.
The major local producers of long products are Masteel, Ann Joo Resources Bhd, Southern Steel Bhd and Alliance Steel.
Flat products such as steel slabs, hot rolled coil (HRC) and CRC are mainly used as raw materials for downstream applications in the automotive, oil and gas, machinery and equipment as well as other manufacturing sectors.
To put things into perspective, there are only two major steel players operating blast furnaces currently — Alliance Steel and Eastern Steel.

Annjoo is adopting the hybrid blast furnace and BF-EAF (blast furnace-electric arc furnace) technology and Masteel is also scaling up its operations in line with the installation of a new technological package.

In general, a blast furnace is three times more capital-intensive than an electric arc furnace (EAF) but its steel-making cost composition including raw materials is about 25% lower than the latter’s.

A quick check on steel industry portal www.steelonthenet.com shows that the conversion cost for basic oxygen furnace steelmaking was US$327.56 per tonne in 2018, lower than EAF’s US$430.60 per tonne.

In a nutshell, a blast furnace will have a better competitive edge than an EAF in the long run.

Note that an EAF uses 100% steel scrap as a source, whereas a blast furnace uses 95% iron ore and 5% steel scrap.
Scrap metal and iron ore are commodities and their prices tend to fluctuate, depending on supply and demand as well as international trade policies.
Interestingly, scrap prices diverged from iron prices last year as the Chinese environmental clean-up gained momentum and Chinese mills were encouraged to use more scrap than iron ore.

Also, the 25% tariff on steel imports into the US — one of the largest exporters of scrap has buoyed scrap prices internationally.
US mills are able to pay higher prices for scrap due to high domestic steel prices.

EAF offers more flexibility when there is a need to reduce output sporadically. “A blast furnace has bigger capabilities but is less capable of shutting down in times of soft demand, resulting in huge inventory holding costs."
"
Source: https://www.theedgemarkets.com/article/cover-story-better-times-ahead-steel-sector

Based on the latest quarter report from Annjoo Q4 FY2018, the PBT has became thinner due to the decline in selling price and inventories written down, mainly attributed to the oversupply situation domestically.
Excluding the recognition of compensation recorded in this quarter, Annjoo is actually making loss.
Management has yet to come out solutions to counter the price war with Alliance steel.

Therefore, I believe the current price movement will be just a short term rally.