Unsurprisingly then, shares in Malaysia Steel Works (KL) Bhd (Masteel; RM1.35) have outperformed the headline benchmark index, gaining over 44% in the past three months. Even so, we remain upbeat on the stock’s prospects for further gains the next one to two years, at least.
Its valuations are attractive. Based on our earnings estimate, the stock is still trading at modest P/Es of roughly 6.2 and 5.6 times for 2011-2012, respectively, lower than prevailing average valuations for the steel sector. Its share price also remains well below net assets of RM2.14 per share at end-3Q10.
Masteel will be releasing its results for the final quarter of 2010 in late February. We expect sales to be around the same level as that achieved in the preceding quarter, but net profit should be higher without the one-off charges. That should bring net profit for the full year to about RM30 million. (Recall that profits in 3Q10 included one-off losses totalling some RM9.7 million, which consisted of write-off for its bond investment and loss on disposal of a 53% stake in its biotech venture).
Astute stock management kept company in the black in 2010
For the first nine months of 2010, sales for Masteel totalled RM712.8 million, up 44% from the previous corresponding period while net profit totalled RM19.2 million, a reversal from the net loss of RM19.1 million recorded over the same period.
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Positively, Masteel fared comparatively well amid an uneven industry recovery, especially in 3Q10 where most of its peers reported sharp drop in profits, some even falling into the red. Excluding its non-core business related one-off charges, Masteel’s underlying earnings rose in 3Q10 from the immediate preceding quarter.
Clearly, being one of the smaller steel operators has its advantages in terms of production flexibility, lower overheads and shorter inventory cycles. The company has also proven to be fairly astute in terms of seeking out niche markets and managing its stock levels.
Domestic demand expected to pick up steam
Demand for steel bars in the domestic market is expected to gradually strengthen, especially towards the later half of this year and going into 2012-2013.
In addition to some RM49.2 billion allocated for development expenditure under Budget 2011 — for hospitals, schools, infrastructure, and so on — some RM12.5 billion of the 52 high impact projects under the private-private partnership initiative are to be implemented this year. The latter includes several highways, oil and gas facilities and a coal-fired power plant.
We could also see some of the recently announced large-scale projects kick off later in the year, including the RM36 billion mass rail transit system for the Klang Valley and the first phase of the light rail transport extension.
Some of the other development projects on the drawing board include the RM10 billion Sungei Buloh mixed development on the 3,300-acre Rubber Research Institute land and the RM5 billion Warisan Merdeka development, which will be undertaken by the Employees Provident Fund and Permodalan Nasional Bhd, respectively, as well as the RM26 billion KL International Financial District project. In January 2011, the government identified another 19 projects under the ETP worth some RM67 billion.
Thus, we would expect volume demand for building materials such as steel bars to register fairly good growth for the next few years.
Outlook for steel prices less clear
On the other hand, the outlook for steel prices is less clear. Local steel makers raised steel bar prices earlier this month primarily due to higher costs rather than improved demand. Steel bars are currently selling for around RM2,200-RM2,300 per tonne, compared with the average of just over RM2,000 per tonne in 4Q10 and RM2,100 per tonne in 2010.
Nevertheless, we remain cautious on whether the recent price hike will stick. Recall that steel makers tried to push prices higher in 1H10 but the move eventually proved unsustainable with prices falling back in the later half of the year.
To be sure, the prospects are better this time around on the back of expectations for strengthening domestic demand. On the other hand, developments in the global steel market may yet influence the direction of local prices.
Improved global outlook but potential pitfalls remain
For the moment, global steel prices are trending higher, supported by rising input costs, including that for fuel, iron ore and coking coal on tight supplies. There is also some stocking up activities by traders on expectations of further price increases.
For example, spot prices for iron ore have risen above US$180 (RM549) per tonne in recent days, compared with the contract price of roughly US$130-US$140 per tonne in 4Q10-1Q11.
And much has been written on the coking coal supply disruption in Australia where the worst flooding in decades has resulted in miners declaring force majeure on their contracts. The flood-affected areas are estimated to account for up to a quarter of the world’s output for coking coal. Prices have surged in response. Most now expect prices to breeze past US$400 per tonne in the coming days, compared with the contract price of US$225 per tonne in 1Q11.
Still headwinds for the global economy
The World Steel Association estimates steel demand growth will moderate to 5.3% this year, from the growth forecast of 13.1% in 2010. But the market could still sour quickly if demand growth fails to meet expectations.
The sharp rebound in 2009-2010 was spurred by massive stimulus programmes and inventory rebuilding, the effects of which will fade this year. Although consumer confidence is up, businesses are still, by and large, reluctant to spend. It remains to be seen if private consumption can grow fast enough to offset the drop in public spending. In particular, austerity plans in Europe and policy tightening in China will start to bite.
The average utilisation rate for global steel makers has fallen back to around 75% at end-2010, down from a high of almost 83% in April 2010. Intense competition for customers may keep the pressure on prices — despite rising costs. This will be particularly telling should there be a shortfall to prevailing demand growth expectations.
The steel industry in China, for example, remains fragmented despite the government’s efforts to consolidate and close outdated plants. The country’s demand growth is likely to cool somewhat with prevailing tightening policies. That raises the risks of cheap exports given that the industry remains in an overcapacity situation.
Malaysia’s imports of steel bars are fairly negligible at the moment. However, following our own government’s liberalisation measures, local producers will have to be wary of competition from imports. The stronger ringgit exacerbates competition, making for even “cheaper” imports.
Help from the government?
Local steel millers, via the newly formed Malaysia Steel Association, are in discussions with the government on various proposals to help buffer against rising costs.
These include the possibility of reinstatement of the 5% import duty on steel bars, higher duty on the export of iron ore and scrap steel, as well as the allocation of economic-sized land for mining activities. The steel manufacturers are also proposing to extend off-peak electricity rates to weekends and public holidays.
Expand capacity to cater to rising volume demand
On balance, we expect to see continued improvement in volume demand for steel bars but margins and earnings for the local steel makers may gyrate amid heightened cost inflation and competitive pressure. As mentioned above, industry profits slumped in 3Q10 due to weaker global selling prices and higher feedstock costs.
Masteel is planning to expand its rolling mill capacity to cater to the expected demand growth from the government’s announced development and infrastructure projects. It is in the midst of evaluating the acquisition of a rolling mill. If all goes to plan, the move will add an additional 150,000 tonnes to its annual production capacity by 2012.
It is also planning to boost its meltshop capacity (feedstock for the rolling mill) to about 650,000 tonnes over this period. Capital expenditure is estimated at around RM180 million for the proposed capacity expansions over the next two years.
At present, the utilisation rates at its meltshop and rolling mill have improved to roughly 80% and 85%, respectively.
The company raised about RM35.4 million last year from a private placement of 16.1 million shares and rights issue of warrants to shareholders on the basis of one warrant for every two shares held. Most recently, it proposed a further placement of up to 10% of its share capital, targeted for completion by 1H11.
Even so, gearing will rise with the planned capex, from the 46% at end-3Q10 where net debt totalled RM206.8 million. However, we expect it to remain within relatively comfortable range. We forecast gearing to peak at roughly 64% by end-2012. This is still fairly modest compared with the gearing levels for most of its peers in the sector.
Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.
This article appeared in The Edge Financial Daily, January 26, 2011.
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