Maintain overweight: Despite the challenging 2009, most steel companies declared higher-than-expected dividends, which is likely an indication of optimism on 2010 outlook and an end to cash conservation mode. This also reaffirms our view that earnings turnaround for steel companies this year remains intact.
The much-improved 4Q09 earnings were primarily fuelled by a lower cost base as higher-priced raw material inventories were exhausted in 1H09. Moreover, we note 4Q09 operating margins have reverted to pre-crisis levels (2007).
While sales tonnage remained flat due to sluggish domestic demand, we take comfort that domestic steel bar prices have held steady at RM2,000/tonne due to more disciplined pricing strategies undertaken by steel millers. However, international steel prices softened in 4Q09 due to the winter season, where construction activities are kept to a minimum. This led to lower export sales in 4Q09, but has since picked up in 1Q10.
With the uptrend in selling prices, we believe operating margins are set to expand in the coming quarters, given the mismatch of higher spot selling prices and lower raw material cost purchased earlier.
Coupled with an uptick in steel demand, underpinned by infrastructure works like the Second Penang Bridge, LRT extensions as well as the construction of the new LCCT, we believe steel millers are on track to deliver sizeable earnings growth for 2010 (average of 160% year-on-year). This is consistent with our projection of a 4% y-o-y growth in construction GDP for 2010 followed by 5% y-o-y for 2011.
Given the strong earnings momentum, we believe current valuations for steel companies, trading at CY10 price earnings (PE) of 7-11 times, are undemanding. We are more optimistic on long steel players (Ann Joo & Kinsteel) compared to flat steel players (Choo Bee, Hiap Teck & Tong Herr) as demand for flat steel typically lags behind long steel, which is largely used for construction activities.
Hence, our top picks are Ann Joo (buy, target price RM3.41) and Kinsteel (buy, RM1.24). — Affin Research, March 8
This article appeared in The Edge Financial Daily, March 10, 2010.
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