[The Edge Daily] Masteel: Challenges to cap near-term gains

Global steel market suffering glut The World Steel Association forecasts that apparent steel use globally will grow by just 2.1% this year, improving only slightly to 3.2% in 2013. The crude steel capacity utilisation ratio in October, meanwhile, stood at only 76.5%. A recent news report indicates that despite prevailing excess capacity, an estimated 100 new mills, capable of producing up to 350 million tonnes of steel products, are expected to come onstream by 2016.
China continues to be a key focal point, as the world’s largest consumer and producer of steel. Positively, recent data suggests a stabilisation of the world’s second largest economy. Increased stimulus spending on select infrastructure projects next year should support a gradual increase in steel demand. However, the pace of increase is expected to be tepid, in the low single digits.
Given the fragmented nature of the Chinese steel industry and rampant excess capacity, steelmakers are likely to continue to struggle. This will result in a supply overhang for the rest of the world.
Indeed, despite many Chinese steelmakers suffering losses this year, there appears little will to cut back on output. This is causing depressed domestic steel prices and keeping raw material costs comparatively elevated. For instance, after rebounding (for about a month) from the lows in September, local rebar prices are now off their recent peak by about 6%. Iron ore prices have rebounded from as low as US$90 per tonne to the current US$130 (RM398) or so.
Persistent price weakness in the international market will cap domestic selling prices, even though demand is expected to stay comparatively resilient, underpinned by new property, construction and infrastructure projects. 
Continuing expansion to cater for rising domestic demand Malaysia Steel Works (KL) Bhd (Masteel) is pushing ahead with its expansion plans, with an eye to the expected growth in volume demand. Construction of its new rolling mill is expected to commence very soon. The new plant will raise total capacity to about 500,000 tonnes from the current 350,000.
Masteel is currently outsourcing part of its milling operations due to in-house capacity limitations. So once its mill is operational, targeted by early 2014, it can divert production back to its own mill.
The company also expects better margins from the new rolling mill, which will be adjacent to the melt shop in Klang, through savings from transport and energy costs. The current rolling mill is located in Petaling Jaya.

To cater for the higher rolling mill volume, Masteel plans to increase its melt shop capacity to 650,000 tonnes from the current 550,000 through various production enhancement processes.

With these factors in mind, we expect to see double digit top line growth for Masteel, though margins may well remain volatile especially from quarter to quarter. 

3Q results underscore margin volatility Masteel’s weaker earnings for the third quarter (3Q) of financial year 2012 ending Dec 31 (3QFY12), following a strong second quarter, were within our expectation.

Turnover was up 4.2% year-on-year (y-o-y) to RM312.9 million but was lower on a quarter-on-quarter (q-o-q) basis. This was due, in part, to the expected slower demand during Ramadan and Hari Raya Aidilfitri. Volume sales dipped lower as did  average selling prices for steel bars.

Cost of production was higher during the quarter resulting in weaker margins. Pre-tax profit fell 56.7% y-o-y to RM7.6 million, down from RM17.5 million in the previous corresponding quarter. Earnings were also sharply lower than 2Q, which reported pre-tax profit of RM18.9 million on the back of higher average selling prices.

Net profit for 3Q came up to just RM7 million, compared with RM16.2 million in 3QFY11 and RM19 million in 2QFY12.

Despite the weaker earnings, the company fared comparatively better than some of its larger peers such as Ann Joo Resources Bhd and Lion Industries Corp, both of which dipped into the red in the last quarter.

We attribute this in part to Masteel’s limited exposure to the wire rod segment, where prices suffered heavily due to dumping by Chinese steel producers. By contrast, selling prices in the steel bar segment held up better in the absence of a substantial influx of cheap imports. Decent valuations but near-term gains likely limited

We are keeping our forecast broadly unchanged. Net profit totalled RM21.2 million for the first nine months of the year. We hold modest expectations for the current quarter. Selling prices for steel bars have weakened slightly in recent weeks. Full-year earnings are estimated at RM28.7 million — up 17% from RM24.5 million in 2011. Net profit is expected to improve to RM39.7 million in 2013.
Still, Masteel’s valuations remain decent with price-earnings ratios (PER) of about 6.5 and 4.7 times — 9.1 and 6.7 times on a fully diluted basis — for the two years. 
The stock should fare better over the longer term but we suspect upside gains will be capped in the near term. On a positive note, the downside risks are also likely limited with the shares trading at only 0.36 times book value of RM2.38 per share.

In other developments, discussions for an intercity commuter train project in Johor — under a 60:40 joint venture with KUB Malaysia Bhd — are still ongoing with the various government departments. We have not included any impact from the project in our earnings forecast.

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