Southern Steel - Rough FY13 Start Likely

We expect Southern Steel to slip back into the red at the start of FY13 as the recent drop in steel prices may yet again result in a price/cost mismatch, especially with product prices falling faster than material costs. Meanwhile, the government’s provisional measures to curb wire rods dumping may stop non-genuine imports but the overall impact on the company is not significant. In view of these and the near-term headwinds, we maintain our NEUTRAL call on Southern Steel, with our FV cut slightly to RM1.72 as we trim our estimates.

Red ink likely in 1QFY13. After returning to the black in 4QFY12, Southern Steel may slip back into the red at the start of FY13. Scrap metal prices have tumbled and stayed mostly below USD400/tonne since the beginning of summer, while steel prices have also come under pressure due to falling international prices and lacklustre demand. We believe this will eventually give rise to the typical price-cost mismatch, since steel prices are plunging far more than scrap metal costs due to a delivery time lag. As such, we slash our FY13 estimates by 32.7% but leave our FY14 numbers unchanged.

Measures to curb wire rods dumping. The International Trade and Industry Ministry (MITI) announced in October 2012 that the Government has completed preliminary anti-dumping investigations on steel wire rods imports from various countries. While it may need more time (a maximum 120 days) to conclude the study, we welcome the provisional measures that now require importers of wire rods to pay a provisional anti-dumping duty ranging from 0% to 33.62%. We believe this will deter non-genuine imports of wire rods as importers face the risk of their deposits being forfeited should the Government find sufficient evidence of dumping activities.

Near-term outlook remains weak. The implementation of the provisional measures, which should curb imports, is positive for major local wire rods producers such as Southern Steel. Nonetheless, since our sources reveal that wire rods imports have declined since the petition was submitted to the Government, we see limited impact from the imposition of a new duty. Furthermore, we see limited recovery in local steel prices despite a rebound in international steel prices over the past few weeks, given that domestic long steel product prices have held steadier than international prices in the recent down cycle. In addition, some investors may have held on to their shares on expectations that the projects rolled out under the Economic Transformation Programme (ETP) could potentially spur steel demand. As a result, local steel counters are trading at some premium to their regional peers. We maintain NEUTRAL on Southern Steel, with our fair value revised down slightly to RM1.72, as we lower our FY13 estimates.

Source: OSK