Investors have generally been sceptical about our call to bottom-fish long steel counters that were overly de-rated back in October 2008. While the recent rally finally lent some colour to our recommendation, we are now revisiting the steel industry’s macro outlook, key assumptions as well as valuation parameters. We find minimal impairment risk but suspect there may be some operational losses in 1H. Real demand may return from 2H but we only expect normalised profit in FY10. As we think next year’s numbers may better reflect steel mills’ earnings and thus will be more meaningful for valuation purposes, we have decided to roll over our valuation to FY10 but retain the same parameters.
Despite the higher fair values post-revision, we are slashing our recommendations for those stocks that have run ahead of their fundamentals and lack re-rating catalysts. Investors should switch to Lion Industries (TP: RM1.90), Southern Steel (TP: RM1.93) and Masteel (TP: RM1.09), which still offer decent upside, and SELL Ann Joo (TP: RM1.25), Kinsteel (TP: RM0.59) and Perwaja (TP: RM1.11). However, as we have downgraded half of the stocks under our universe to SELL, we are downgrading our steel sector recommendation to NEUTRAL.
Confidence improves but still fragile. There are signs of confidence returning to the steel sector on a spate of improving leading indicators. We feel that near term replenishment orders and capacity discipline have had a hand in this supply-demand balance. However, we suspect the heavy inventory of over 3m tonnes in the local market may create a temporary overhang as any recovery is likely to be followed by enormous local supply in the form of inventory or new production flooding the market, which will weaken pricing power. Stimulus packages a wild card. Local long steel consumption has been holding steadily since 2000. While we expect the on-going projects to perhaps help to sustain 70% of the previous year’s long steel requirement, we think the balance may be compensated if most of the public projects are executed in a timely manner. Local steel mills have been exporting on average more than 1m tonnes since China’s steel boom, escalating in the last 2 years after the imposition of export tax on billets from China, created a vacuum of 5m tonnes in the billet market in South East Asia (SEA) as China previously supplied 75% of requirements. Middle East, Australia, Pakistan, Bangladesh, etc will also be a boon to Malaysia’s billet exports if these economies improve.
Goodbye FY09, hello FY10. We expect most of the steel mills to be able to avoid further impairment but suspect there would be some operational losses in 1H due to lacklustre steel demand and volatile steel prices. While real demand may begin to flow in gradually from 2H, we think the companies may only return to normalised profit levels in FY10. Other than the numbers reflecting steel companies’ earnings, the market also prices in a company’s future outlook 6 months ahead. Hence investors should shift their focus to FY10.
NEUTRAL: BUY cheap, SELL expensive. The recent rally in steel counters did not surprise us as we have been advocating that the worst may be over. Considering market is always forward-looking, we roll over our valuation to FY10, which translates into higher target prices. While the prospects remain bright, half of the steel counters appear to have run ahead of their fundamentals and now lack fresh re-rating catalysts. This prompts us to downgrade those counters to SELL. Investors should switch their portfolio to the cheaper alternatives, namely Lion Industries (TP: RM1.90), Southern Steel (TP: RM1.93) and Masteel (TP: RM1.09), which still offer decent upside.