Masteel sanguine on domestic steel demand

From The Edge Malaysia
4th Sep 2013

LOCAL steelmakers reported a mixed bag of results for the second quarter of 2013 (2Q13). While Malaysia Steel Works (KL) Bhd (Masteel; 91 sen) and Southern Steel Bhd reported improved earnings, Ann Joo Resources Bhd, Perwaja and Kinsteel Bhd saw profit deteriorate from 1Q13. This could be attributed to a combination of factors such as differences in capacity and utilisation, product range as well as gearing levels.

Steel bar prices in the domestic market have been relatively resilient year-to-date, averaging between an estimated RM2,100 and RM2,200 per tonne, thanks to sustained local demand while raw material prices have softened slightly.

Masteel fared comparatively well. Turnover was marginally down year-on-year (y-o-y) at RM342.3 million, due to lower average selling prices for steel products, but was 3.7% higher from 1Q13, thanks to stronger volume demand. Domestic sales improved quarter-on-quarter (q-o-q), picking up the slack in exports in 2Q13.

Pre-tax profit saw an outsized decline, by 42.5% y-o-y to RM10.9 million, from RM18.9 million in 2Q12. The company attributed this to lower selling prices coupled with higher raw material costs in the latest quarter.

Positively, margins improved q-o-q. Selling prices for steel bars have been relatively range-bound averaging about RM2,150 per tonne in 2Q13 — just 1% to 2% lower than in 1Q13 — while scrap cost is estimated to have fallen by a larger 8% or so over the same period.

Masteel’s net profit came to RM10.1 million in 2Q13, down from the RM19 million in the previous corresponding quarter, but improved from the RM3.6 million in 1Q13.

The company spent more in terms of capital expenditure in 2Q13, compared with 1Q, with the commencement of construction of a new rolling mill.

Prices capped by weak global steel market
Operating conditions in the steel industry are expected to remain challenging for the foreseeable future. While domestic steel bar prices should find support from ongoing construction projects, external risks remain amid expected weakness in the global steel market.

The outlook for global steel prices remains downbeat. This stems primarily from persistent oversupply in China, the world’s largest steel producer and consumer. Government efforts to shutter inefficient plants and reduce capacity have been largely ineffective, so far. Market observers estimate the country is looking at excess capacity totalling some 300 million tonnes.

China’s annualised production in the last three months is averaging nearly 790 million tonnes — well above the World Steel Association’s estimate for the country’s apparent steel use of about 670 million tonnes this year.

This has resulted in the rise of cheap Chinese exports in global markets and anti-dumping duties from various countries, including Malaysia. Baoshan Iron & Steel, China’s largest listed steelmaker by value, forecasts steel prices in the country to weaken in the second half (2H) of 2013 from the first six months of the year.

This does not bode well for local steel companies that are more dependent on exports. China’s overproduction also keeps raw material costs such as iron ore relatively high, which would, in turn, cap margins for steelmakers using iron ore as their primary feedstock.

Even though domestic demand for steel bars is expected to be strong, chances of any significant and sustained increase in selling prices are limited by this weakness in the global market.

Masteel upbeat on volume growth
Having said that, Masteel is still upbeat on stronger volume sales. Its meltshop is located in Klang and its rolling mill is in Petaling Jaya, so they are well positioned to capture growing demand within the greater Klang Valley — where many construction projects are ongoing.

These include the Klang Valley Mass Rapid Transit 1, LRT extension, new LCCT terminal as well as private and public property projects such as affordable housing projects under PR1MA. Lower transport costs give the company an edge in pricing its steel bars.

Furthermore, Masteel is focused on billets and steel bars. Billets are used as feedstock for its rolling mill, with the excess exported. So far, the steel bar market has emerged relatively unscathed from Chinese dumping activities, unlike the heavily affected wire rods segment. Imports of steel bars are still low relative to total consumption in the country, at roughly 6.5% in 2012. By comparison, imported wire rods accounted for almost 40% of total domestic consumption last year.

This will likely remain the case going forward given the steel bar industry dynamics — construction companies typically do not import and/or keep high inventory of steel bars, preferring to source their requirements on a timely basis from local steelmakers — and more stringent quality requirements. The government has also recently required approval for the import of certain long steel products.

We expect Masteel to report stronger volume sales over the next few years, supported by improving local demand and its plans to expand capacity. Despite the competitive external environment, the company has been busy cultivating longer-term export markets.

For example, it secured an offtake contract with Trafigura, one of the world’s largest traders in bulk and non-ferrous minerals, in June 2012. Under the three-year agreement worth some RM500 million, which could be a prelude to a longer-term relationship, Masteel will supply billets and steel bars to Trafigura’s regional clients.

Expanding capacity to cater to rising demand
Masteel is sufficiently upbeat on the outlook for the industry to embark on the next expansionary phase, with both its meltshop and rolling mill currently running at about 85% capacity.

To cater for future demand growth, the company has started construction on a new RM100 million rolling mill, adjacent to the existing billet plant. Upon completion — targeted by end-2014 — the company’s total milling capacity will be boosted to 550,000 tonnes, up some 57% from the current 350,000 tonnes.

Meanwhile, it has already spent some RM80 million to upgrade the billet plant, pushing capacity from the original 450,000 tonnes to 600,000 tonnes at end-2012. This will be further raised to 650,000 tonnes by end-2013 and 700,000 tonnes end-2014.

As mentioned above, Masteel exports any excess billets but prices are very competitive. Once the new rolling mill is up and running, by 2015, much of the billets will be re-directed as feedstock for the production of steel bars, thus enabling it to optimise value from both operations. Production at the new mill is also expected to be more efficient given its location right next to the meltshop.

Gearing reasonable at 45%Masteel’s gearing is reasonable relative to the other locally listed steelmakers such as Kinsteel, Ann Joo Resources, Perwaja and Southern Steel — at some 45% as at end-June. Net stood at RM240.2 million, down slightly from RM247.4 million at end-1Q13 — on the back of improved operating cash flow and lower working capital.

Its comparatively strong balance sheet will help temper the negative impact of future interest rate hikes.

Attractive valuations — PER of 6.7 times estimated 2013 earnings
We estimate Masteel’s net profit will total some RM29.7 million for this year, expanding to RM39.4 million in 2014. This translates into attractive valuations for its shares.

At the current price of 91 sen, the stock is priced at modest price-earnings ratios (PER) multiples of only 6.7 times for 2013 and 5 times for 2014. The stock is also trading well below its net asset value of RM2.47 as at end-June.

Looking further ahead, we expect sales growth to gain further momentum in 2015, supported by contributions from the new rolling mill. This should drive valuations even lower. Thus, there is room for capital gains.

In addition, Masteel has a good track record of rewarding shareholders with dividends, even maintaining payments through the global financial crisis, albeit at a reduced rate. In line with the improved outlook, the company raised dividend per share last year to 1.5 sen from 1 sen in 2011.

There are also indications the company will increase the frequency of payments, to at least twice a year. Indeed, Masteel proposed a first interim dividend of 0.5 sen per share. The stock will trade ex-entitlement on Sept 13.

We assume dividend payout would average around 15% of net profit going forward. Based on our estimates of 2 sen per share dividends for 2013 and 2.5 sen for 2014 shareholders will earn net yields of 2.2% to 2.7% for the two years.

Commuter rail network project scrapped?
Of late, there have been news reports that Masteel’s proposal to build and operate an intra-city commuter rail network in Johor, under a joint venture with KUB Malaysia, has been scrapped.

Such speculation is likely to have stemmed from the government’s intention to prioritise its infrastructure spending in order to reduce the fiscal deficit and public indebtedness. Masteel’s proposal assumes government funding for new stations, which will then be leased to the joint-venture company. The company indicates that it is currently discussing financing options with potential lenders.

There is no impact on our earnings forecast as we have not included contributions from the proposed rail project. Indeed, any contribution will only be over the much longer term.

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