KINSTEEL : NEUTRAL at RM0.865, TP of RM0.78

Kinsteel down but not out

Kinsteel Bhd
(Aug 30, 86.5 sen)
Maintain neutral at 86.5 sen (Aug 27) with a revised target price of 78 sen (from 86 sen): Post-restatement of 37% associate Perwaja Holdings Bhd’s cost of goods sold, we make the corresponding adjustments to Kinsteel’s figures.

The 38.5% drop in Kinsteel’s net profit in 2QFY2010 ended June 30 compared with that of the previous quarter saw the numbers for 1H2010 fall short of our and consensus’ estimates. The dismal 1H performance was attributed to lower-than-expected contribution from Perwaja, which was affected by untimely procurement and selling plus higher-than-expected conversion costs.

The lower consolidated revenue compared with Perwaja in 2Q also suggests poor sales from Kinsteel’s downstream operations. We suspect management may have been trying to keep inventory for future trading as it expected selling prices to escalate, but was caught by the weakening of the steel market in May.

We are turning cautious on upstream margins, especially with 3Q iron ore pellets price rising quarter-on-quarter despite the drop in selling prices of direct reduced iron (DRI) and billets, which would presage a possible loss for Perwaja in 3Q.

While the recovery of steel prices since end-July, together with the potential drop in 4Q iron ore benchmark pricing, provided relief to Perwaja. The continued disappointment suggests that conversion margins were higher than expected. Hence, we do not expect any significant contribution post-3Q.

Bad news aside, we expect Kinsteel’s downstream operations — which traditionally generate stable but lower margins — to play an important role in cushioning group earnings during this difficult period. The challenging environment may also present Kinsteel the opportunity to acquire semi-finished steel at distressed pricing, and potentially expand its rolling margin.

Despite the gloomy outlook, we think Kinsteel’s share price could get support from its stable rolling margin. Nonetheless, we have toned down our projection after incorporating the lower contribution from Perwaja.

Our estimates for Kinsteel in FY2010 and FY2011 ending Dec 31 are lowered by 24% and 4.7% respectively. We are keeping our valuation parameter, which is derived from seven times FY10 earnings per share and 1.27 times price-to-net tangible assets ratio or +1 standard deviation from its historical trading band, which translates into a new target price of 78 sen. In view of the limited downside, we maintain our neutral recommendation. — OSK Research, Aug 30


This article appeared in The Edge Financial Daily, September 1, 2010.