by no1@email.com (InsiderAsia)
MALAYSIA Steel Works (RM1.08) is upbeat that the current environment of rising steel prices and strengthening demand will be positive for its margins and earnings.
The company, which saw its business dipping into the red in 1H09 as the result of the global downturn, has since turned around nicely in line with the global economic recovery. Demand for steel products has been trending higher, spurred both, by expectations of stronger end-user demand as well as rising costs.
Notably, purchases over the past weeks were fuelled by expectations of higher prices as the quantum of price hikes for the key steel-making raw materials, iron ore and metallurgical coal became increasingly clear.
Rising raw material costs
Mining companies appear to be holding all the aces when it comes to negotiating contract prices, at least for now — their bargaining power cemented by the global economic rebound and strong demand from China as well as the oligopolistic nature of the industry.
Case in point, in a historic turn of events, miners have successfully shifted to quarterly supply contracts, instead of the traditional once-a-year review in April, to take advantage of rising spot prices. The three biggest producers, Vale, Rio Tinto and BHP Billiton, collectively control almost 69% of the global seaborne iron ore market.
For the April-June 2010 quarter, iron ore has been priced at about US$100-US$110 (RM321-RM353) per tonne, well above last year's contracted price of US$60 per tonne. Given that spot prices for iron ore are currently hovering around US$150 per tonne, it is likely that the benchmark price will rise further in the next quarter. Similarly, the current quarter's benchmark price for metallurgical coal has been agreed at about US$200 per tonne, up from last year's US$128 per tonne.
Passing on costs through higher prices
An environment of rising steel prices is generally positive for steelmakers, provided they can pass on the additional costs. For the moment, this appears to be the case.
Steel bars in the domestic market are currently selling for roughly RM2,300-RM2,400 per tonne, up from the average of about RM1,850-RM1,950 per tonne in 4Q09. Meanwhile, billets for export are selling for about US$640 per tonne, up from about US$450 per tonne at the end of last year.
Furthermore, it appears that prices will continue to head higher in the coming weeks. As such, we believe Masteel will report fairly good profits in the first two and even three quarters of 2010.
The higher selling prices are made possible by strengthening demand, which is underpinned by stimulus spending as well as the recovery in business and consumer spending. The pace of inventory restocking has picked up as confidence in the sustainability of the recovery grows. Companies are now inclined to buy more on expectations of stronger underlying demand going forward. Given that most have cut inventory levels to the bare minimum during the worst of the downturn, we are seeing a stronger than average upward stock adjustment.
Nonetheless, we are mindful of the potential for downside risks further down the road. If steel prices rise too much, too fast, they could exert downward pressure on underlying demand, particularly as spending from stimulus packages peters out towards the end of the year. The impact from inventory restocking is also expected to fade over the course of the next few months. Cost-push inflation and tightening of monetary policy are among the key factors that could potentially derail the still fragile global economic recovery.
Earnings turnaround in 2010
For the current year, we estimate Masteel's net profit at roughly RM32.8 million, a smart reversal from last year's net loss of RM8.5 million. This prices the stock at attractive valuations of about 6.8 times forward earnings. Plus, its shares are trading well below book value of RM2.14 per share as of end-2009.
In terms of longer-term growth prospects, the company is planning to gradually expand its billets plant capacity, from the current 450,000 tonnes per annum to 650,000 tonnes by 2012. The additional billets output would be used as feedstock for a new plant, to produce higher valued added steel products, which will complement its existing product range and allow the company to tap new export markets. If all goes to plan, Masteel envisions exports would exceed its domestic sales within the next three years.
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.