52-week price range (RM) 0.77-1.10
§ 2Q13 results within expectations
§ Beneficiary of rising construction activities
§ Steel bar prices supported by domestic demand
§ Future earnings to be driven by volume sales
Malaysia Steel Works’ earnings results for 2Q13 were broadly in line with our expectations.
Turnover was marginally down y-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 q-q, picking up the slack in exports in 2Q13.
Pre-tax profit saw an outsized decline, by 42.5% y-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-q. Selling prices for steel bars have been relatively range-bound averaging about RM2,150 per tonne in 2Q13 – just 1- 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 1Q13, with the commencement of construction for a new rolling mill. Nevertheless, its balance sheet strengthened slightly – net debt at RM240.2 million, from RM247.4 million at end-1Q13 – on the back of improved operating cashflow and lower working capital. Gearing stood at a fairly reasonable 45% at end-2Q13, the second lowest among listed steelmakers. Masteel proposed a first interim dividend of 0.5 sen per share, in keeping with plans to pay dividends on a more frequent basis. The stock will trade exentitlement on 13 September.
Steel bar prices in the domestic market have been relatively resilient in the 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.
Nevertheless, local steelmakers reported a mixed bag of results in the latest 2Q13. Whilst Masteel and Southern Steel reported improved earnings, Ann Joo Resources, Perwaja and Kinsteel 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.
Operating conditions in the steel industry are expected to remain challenging in the foreseeable future. Whilst domestic steel bar prices should find support from ongoing construction projects, external risks remain amid expected weakness in the global steel market.
Outlook for global steel price 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 totaling some 300 million tonnes.
China’s annualised production in the last three months (May-June) 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 attracting 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 2H13 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 over production also keeps raw material costs such as iron ore relatively high, which would, in turn, cap margin 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.
Having said that, Masteel is still upbeat on stronger volume sales. Its meltshop and rolling mill are located in Klang and Petaling Jaya, respectively, and are thus, well positioned to capture growing demand within the greater Klang Valley – where many construction projects are ongoing. These include the KVMRT 1, LRT extension, LCCT Terminal as well as private and public property projects such as affordable housing projects under PR1MA. Lower transportation costs gives the company an edge in pricing its steel bars.
Furthermore, Masteel is focused on billets and steel bars. Billets produced are used as feedstock for its rolling mill, with the excess exported. So far, the steel bar market had 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’s 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 permits 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 off take contract with Trafigura, one of the world’s largest traders in bulk and non-ferrous minerals, in June 2012. Under the 3- year agreement worth some RM500 million, which could be a prelude to a longer-term relationship, Masteel will supply billets and steel bars to the latter’s regional clients.
Expanding capacity to cater to rising demand
Masteel is sufficiently upbeat on 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 to future demand growth, the company has started construction works 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 and 700,000 tonnes by end-2013 and end-2014, respectively.
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 optimize 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. Its comparatively strong balance sheet will help temper the negative impact of future interest rate hikes.
Commuter rail network project scrapped?
Of late, there were 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 speculations are likely to have stemmed from the government’s intention to prioritise its infrastructure spending in order to reduce fiscal deficit and public indebtedness. Masteel’s proposal assumes government funding for new stations, which will be then 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.
We are keeping our earnings forecast unchanged.
Valuations and Recommendation
We estimate Masteel’s net profit will total some RM29.7 million for this year and 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 P/E multiples of only 6.7 and 5 times for 2013-2014, respectively. Its shares are 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, we are keeping our BUY recommendation. Masteel has a good track record of rewarding shareholders with dividends,even maintaining payments through the global financial crisis, albeit at a reduced sum. 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. We assumed dividend payout would average around 15% of net profit going forward.
Based on our estimates of 2 and 2.5 sen per share dividends for 2013-2014, respectively, shareholders will earn net yields of 2.2-2.7% for the two years.
Publish date: 02/09/13