KINSTEEL (FV RM0.49 - NEUTRAL) FY11 Results Review: Pain All Around

Kinsteel posted a net loss of RM121.6m in FY11, largely attributed to the loss in its upstream operation (37%-owned Perwaja),  as well as  poor  showing at its downstream operation following the sharp drop in material and steel prices. Apart from expecting stable but thin rolling margins moving forward, we are pinning some hopes on  its upstream makeover  via  the  building  of  its own pelletization plant and potentially securing  an  iron ore mining concession.  That said, we suspect Kinsteel’s cash flow may come under strain as we see a low take-up for its  on-going fund raising exercise, and thus downgrade the  stock  to NEUTRAL. Our lower fair value of RM0.49 is derived from 0.72x FY12 BV, or  -0.5 standard deviation of its historical trading range.

2011 a painful year. Kinsteel posted a net loss of RM121.6m for FY11 on a drastic loss in 4Q. Although its downstream operation normally enjoys stable albeit low margins, we suspect the sharp  fall  in steel prices during the period may have eroded  the already meager margins, together with some loss in inventory value. However, it also suffered a major setback at 37%-owned Perwaja, which recorded a huge loss on the back of poor steel market conditions, which  gave rise to a negative mismatch  between lower selling prices and the still-high raw material costs, a writedown on inventory to realisable value amounting to RM94.2m, while a RM60m from reversal of deferred tax asset recognised in the prior year exacerbated loss.

Pinning hopes on  upstream makeover. There  are  no major  concerns over Kinsteel upstream operation as we expect the kitchen sinking in 4Q to have cleaned up the high cost inventory  plus stable rolling margin and  a  potential uptick in long steel demand in Malaysia. As for Perwaja,  the  second  verbal confirmation  from  Terengganu’s Menteri Besar  on awarding the mining concession to the company in December 2011  provided some assurance that the official award is around the corner. Perwaja is also building a pelletizing plant that it hopes will boost the profitability of its direct reduction plant. This plant will enable it to meet its own iron ore pellet needs and help it to achieve savings of up to USD50 a tonne from the procurement of local iron ore, logistics benefits, in-house value-adding and utilization of tax credits on accumulated losses.

Downgrade to NEUTRAL. Perwaja’s huge loss will certainly  douse the interest of minority shareholders  in  subscribing for  Kinsteel’s  ongoing  Restricted Offer for Sale, unless the concession is given before the subscription closing date. This may potentially mean that Kinsteel is likely to end up with majority of Perwaja’s RCULS costing up to RM280m, and hence drain the group’s cash flow. With that, we downgrade Kinsteel to NEUTRAL, with our FV cut to RM0.49. We are  removing our earlier 10% iron ore DCF which we included in our base valuation of 0.72x FY12 BV (-0.5 standard deviation). 

Source: OSK188