MASTEEL : NEUTRAL at RM0.85, TP of RM0.88

Masteel earnings surge, but risks linger

Malaysia Steel Works (KL) Bhd (Sept 1, 85.5 sen)
Maintain neutral at 85 sen with revised target price 88 sen (from RM1): Masteel's 2Q net profit improved by 27.1% compared with the preceding quarter, which boosted its 1HFY2010 bottom line to RM14.4 million. The number matched our estimates when annualised, but we are not overly excited given a potentially weaker 2H outlook.

The satisfactory 2Q can be attributed to higher average selling prices, especially after price increases of 90% and 55% for iron ore and coking coal contracts respectively for 2Q that were concluded in March. The transactions were mainly recognised during the reporting quarter.

Masteel's cost of material, particularly scrap metal, is still below market cost given that production cost is averaging up due to the delivery lag of two to three months. While this led to higher earnings before interest, tax, depreciation and amortisation (Ebitda) of 6.1% in 2Q, it would have been better if not for the scarce supply of domestic scrap metal.

We expect a less rosy industry outlook moving into 2H as Masteel may have been caught with some high cost scrap metal when prices surged to US$500 per tonne in May. Although we are not able to quantify the company's average scrap cost at this juncture, we suspect it is likely to be above US$400 per tonne (HMS 1:2) considering the last plunge in steel prices was rather quick and sharp.

We also see limited room for steel prices to pick up further despite the recovery since end-July, which in our view was caused by: (i) the build-up of high inventory by steel mills, suggesting possible dumping on any price escalation, and (ii) buyers are likely to hold back on procurement in anticipation of lower 4Q iron ore contract prices based on spot prices in recent months. As the risk of margin compression in 2H still remains, we reduce our FY2010 estimates by 16.3% but keep our FY2011 profit projection.

The potential inverse position following the drop in selling price to gradually increasing scrap metal costs prompts us to reiterate our neutral call. We are also tuning down our valuation parameter from five times to four times PER but retain our 0.59 times NTA/share, or +1 standard deviation of its historical trading band on FY2010 numbers, from which we derive a new target price of 88 sen. — OSK Investment Research, Sept 1

This article appeared in The Edge Financial Daily on Sept 2.