Stock Picks – Steel Sector – September 2010


Not Hot Enough. Recent news of steel prices and demand recovering globally prompt us to make a review on our sector rating. Our fundamental review tells us that the outlook for 4Q has improved as selling prices are recovering and there is potential restocking towards year-end, but the upside is limited. Although there is no earnings revision as the overall impact is well within our estimates, we are turning a bit positive by raising our PER multiple one notch up but continue to keep our P/NTA valuation at +1 standard deviation of the historical band. As this marginal fair value increase offers limited upside, we maintain NEUTRAL.

Steel prices tick up but upside limited. Average selling prices (ASP) of steel products have risen about 10% from the recent low. Nonetheless, we see limited upside for steel prices as: (i) the build-up in inventory at steel mills suggests that there is potential of dumping on any price escalation, (ii) buyers are likely to hold back on procurement in anticipation of lower 4Q iron ore contract prices, and (iii) the onset of winter and the rainy season in November will disrupt construction activities in China and Malaysia respectively, and dampen demand and ASP of steel. The potentially flattish steel prices for the rest of 2010 also suggests that the performance of steel stocks will remain sluggish considering the strong correlation of more than 0.8x.

Too early to turn bullish on profit margin. Indeed, with expectation of steel prices moving within a narrow range, the lower iron ore benchmark set for 4Q may widen margins. However, as Malaysian mills operate Electric Arc Furnaces (EAF) that use scrap metal as the main feed and whose selling prices may remain at around USD400 for the next few months, the local boys may not benefit from the lower iron ore cost. Apart from that, local mills that maintain inventory of between three and six months may still be caught with some high cost inventory purchased during the peak in April 2010.

Keeping estimates despite better 4Q. The drop in ASP from May 2010 was deeper and earlier than we originally projected and the degree of physical construction activities arising from the various stimulus packages implemented has been disappointing. However, this does not upset our estimates given that the recovery in prices also occurred earlier and the poor execution was within our projection. With some restocking expected in 4Q, we now expect 3Q to be possibly the worst quarter for steel mills for the year and visibility beyond six months remains poor.

Raising valuation by a notch. With the improved 4Q outlook, we are turning a bit more bullish in our valuation parameters by raising our PER multiple up one level. We also keeping our P/B valuation at +1 standard deviation of the historical trading band as we believe the industry’s underlying fundamentals have obviously improved from the last financial crisis. Our fair value estimates, based on FY10 estimates (except for Lion Industries’ FY11 as its FYE is in June), are nudged up slightly but offer limited upside, or even imply a small downside from the last closing. Hence we are generally NEUTRAL on the individual companies and the sector, except that we reiterate our Trading BUY call on Lion Industries and upgrade Perwaja back to NEUTRAL.

Below are the target price for steel sector

Stock Price (RM) Target (RM) Rating
Ann Joo 2.85 2.64 Neutral
Kinsteel 0.85 0.82 Neutral
Lion Industries 1.77 2.18 Buy
Masteel 0.94 0.94 Neutral
Perwaja 1.04 0.97 Neutral
Ssteel 2.24 2.15 Neutral

Source : OSK Research

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