PERWAJA (FV RM1.21 - TRADING BUY) FY11 Results Review: Huge Impairment, Writedown Surprise

We were stunned by Perwaja’s RM238.4m FY11 net loss, attributed to a weak steel market, larger-than-expected inventory value impairment and reversal in deferred tax assets. Although we are discouraged by  the result, we are holding out hopes of the company’s upstream makeover via its upcoming pelletization plant, as well as it  securing the  lucrative  iron ore mining concession. Considering  the  higher execution risk after many disappointments, we cut our call on Perwaja to Trading BUY, with our FV slashed to RM1.21.  We are now adding only 10% instead of 20% of the iron ore DCF to our base valuation of 0.56x FY12 BV.

Unkind cut from impairment and write-downs. Perwaja made a hefty RM238.4m loss in FY11 after a sharp loss in 4Q. We had earlier anticipated a loss in its core operation as the steep fall  in  the  prices of iron ore, steel scrap and steel may  have  given rise to a negative mismatch between lower selling prices and still-high raw material costs  due to the  inherent time lag before the latter starts to decline. However, the huge  inventory writedown to realisable value amounting to RM94.2m  was indeed deeply disappointing. Iron ore fine price has plunged from USD180 to a low of USD116.50 before bouncing back to consolidate at around USD140 a tonne, We had earlier thought that Perwaja may renegotiate the ore prices to the immediate 4Q average rather than the normal practice of benchmarking the  preceding quarter’s average to minimise the impairment.  Elsewhere,  the reversal of deferred tax assets totaling RM60m in the prior year exacerbated the loss and marred its books although there was no physical cash outflow.

Upstream makeover  – hope or hype? The  company’s  slow progress  in securing official mining rights has been a big letdown. While we  have been waiting patiently for the award to materialise, after the  Terengganu Menteri Besar’s  second  verbal confirmation in December 2011 on awarding the concession provided some assurance, that official word on the award is just around the corner. Meanwhile, Perwaja is building its pelletizing plant which is hoped will boost the profitability of its direct reduction plant. This  plant will  allow it to meet its own iron ore pellet needs,  as well as  achieve total 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. As for  its  existing iron and steel making operation, we suspect that the  kitchen sinking carried out in 4QFY11 may have reconciled the material costing to present levels and thus do not expect another impairment, unless there is another drop in material prices. Nonetheless, we are keeping our original estimates of a marginal profit in FY12 before the  new iron processing plant  starts to contribute  significantly. As we are keeping our hopes alive on Perwaja’s upstream makeover, we are only cutting our recommendation to Trading BUY, although our fair value is nudged lower to RM1.21. We are adding only 10% instead of 20% of iron ore DCF to our base valuation of 0.56x FY12 BV.

Source: OSK188