This year has been characterised by a lacklustre demand and low capacity utilisation on the lack of large infrastructure projects and competition from Chinese imports, as well as squeezed margins due to high feedstock prices.
However, analysts warned that industry players might still face headwinds in the near term given the prevailing high and volatile prices of raw materials. This includes scrap and iron ore pellets.
Perhaps this explains why most research houses are remaining neutral and have yet to turn very bullish on the steel sector.
Much of this year was challenging for steel players, as they had to contend with both weaker demand and higher raw material prices.
The third quarter ended Sept 30, turned out to be the worst in the year for most players, with several such as Kinsteel Bhd and Lion Industries Bhd posting losses.
Kinsteel, for instance, posted a net loss of RM19.36 million in 3QFY10, from a net profit of RM19.79 million a year earlier. This dragged its net profit for the nine-month period to RM11.37 million from RM30.7 million in the first half.
Analysts say local steel millers have probably seen the worst in the third quarter of this year.
They are confident the steel players can look forward to a much better 4Q, and a better 2011.
OSK Research, for example, is expecting an improvement in the coming quarter, especially with selling prices showing signs of recovery.
The research house notes that the price of scrap is back to the US$400 (RM1,250) per tonne level, and steel players are also witnessing more enquiries from traders since early November. However, it says the improvement is nothing to shout about, especially with the unappealing spread between iron ore pellets and hot briquetted iron (HBI) prices, which is expected to persist.
It is worth noting that over the past year spot prices of iron ore have more than doubled.
AmResearch believes that, moving forward, the price of iron ore fines will still strengthen and trade in the band of US$150 to US$170 per tonne until 2012.
“Any potential dip below US$120 per tonne and China’s present short iron ore position would trigger re-stocking and thereby lend support to global prices, in our view,” the research house writes in a recent note.
AmResearch estimates that for every US$10 per tonne increase in the price of iron ore pellets, the earnings per share of companies such as Kinsteel can be eroded by as much as 23%.
Nonetheless, the research house says significant steel orders for Budget 2011 projects as well as the longer-term 10MP would start emerging in 2H2011 at the earliest, allowing selling prices to better match current high iron ore markets.
Another relief is the strength of the ringgit, which helps cushion the higher prices of iron ore traded in US dollars.
Additionally, they note that the expected appreciation of the yuan, albeit a gradual pace, should see local steel players, whether domestically focused or otherwise, facing less competition from Chinese steel dumping.
How big a catalyst is the 10MP?
Large government projects, a hallmark of the administration of former prime minister Tun Dr Mahathir Mohammad, were a major driver of steel demand in the 1990s. The consumption of steel bars in Malaysia rose from one million tonnes in 1993 to 2.5 million tonnes in 1997.
AmResearch says, based on initial estimates, the proposed mass rapid transit (MRT) project in the Klang Valley, for instance, will require a minimum of two million tonnes of long steel — with the bulk of long products needed in the initial tunnelling works.
The 156km-long rail project is estimated to cost RM36 billion and will take at least 10 years to complete. It is understood that 30% of the project’s cost will consist of tunnelling works.
Other notable cornerstone projects from the 10MP include the Light Rail Transit (LRT) extension project, the Kuala Lumpur International Financial Centre, and Warisan Merdeka Integrated Development.
These projects will certainly spur medium-term demand for construction-grade steel bars and wire rods.
Interestingly, the corporate moves of tycoon Tan Sri Quek Leng Chan of the Hong Leong group suggest he too is seeing a potential turnaround for the steel sector.
In mid-July, Hong Leong Group-linked Signaland Sdn Bhd launched a mandatory general offer (MGO) of RM2.05 per share for Southern Steel Bhd, pricing it at 1.08 times book value. The MGO was triggered after Signaland acquired a 27% stake in Southern Steel for RM232.4 million from NatSteel Holdings Pte Ltd, raising the stake of the Hong Leong Group to about 70.25%.
After the exercise, the Hong Leong group holds about 72.5% of the company.
Except for Southern Steel and Ann Joo Resources Bhd, which trade at 1.1 and 1.5 times book value, respectively, the rest of the major listed steel companies are trading well below book value (see table). Three companies — Lion Industries, Malaysia Steel Works (KL) Bhd (Masteel) and Perwaja Holdings Bhd — trade at 0.5 times book.
With low price-to-book valuations and a better demand outlook, does the steel sector warrant a second look? Analysts say investors looking for exposure should consider stock-picking, as there are still many challenges ahead for the sector.
What to look for
So which are the few favourites that investors may want to nibble on?
AmResearch for one says, only players with sufficient cash and efficient inventory management will be strong and quick enough to endure and take advantage of feedstock price fluctuations in the spot market.
“While we believe steel demand will be boosted by the government’s expansion plans, investors are better exposed to companies with cleaner balance sheets,” added the research firm.
It also said upstream players stand to benefit more in the current environment of high commodity prices, but any significant re-rating catalyst for the sector will be driven by an increase in demand.
The flexibility to cope with raw material costs is also an area that investors may want to watch out for when investing in a steel player.
RHB Research Institute, for instance, prefers Ann Joo Resources as it is one company that can manage better in the face of volatility in raw material prices.
Additionally, it said that Ann Joo’s higher export ratio of its production will help to cushion sales when the domestic market is lacklustre, as was the case in 2009 and potentially during the early part of 2011 as well. Furthermore, with the abolishment of the annual iron ore pricing system in April and a move towards quarterly price contracts, it expects greater volatility in iron ore prices globally.
RHB said Ann Joo is therefore able to manage input costs better compared with companies such as Southern Steel, which has similar plant operations, production capacity and market capitalisation.
“With the expected commissioning of its mini blast furnace plant this month, Ann Joo will now have the flexibility in the usage of feedstock (iron ore and scrap) versus relying mainly on steel scrap for Southern Steel,” it added.
Interestingly enough, apart from Ann Joo, other steel millers are also upping their capacity in anticipation of rising demand.
Kinsteel, for one, will be constructing a steel pelletising plant that is expected to cost some RM200 million.
When asked about concerns of over-capacity in the industry, Kinsteel CEO Datuk Henry Pheng Chin Guan said, “Demand for steel products is expected to grow in view of the large-scale infrastructure projects pending, so the question of overcapacity will probably not be an issue.”
“We need to plan our capacity within the demand of the overall industry, not only for domestic consumption but also for export,” he added. - by Isabelle Francis
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