Cover Story: Nerves of steel required to invest in steel stocks

This article first appeared in The Edge Malaysia Weekly, on March 4, 2019 - March 10, 2019.
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THE steel industry is not in the best shape these days, with most players hurt by the oversupply of steel products, especially from China. The year 2017 proved to be a false dawn for the industry, leaving investors wondering if the light at the end of tunnel at the time was actually that of an oncoming train.

Areca Capital Sdn Bhd CEO Danny Wong has steered clear of steel stocks for “a long time”, saying it is an unattractive sector with all the issues surrounding it.

“The oversupply situation continues to be a concern and the local industry players are not competitive enough,” he tells The Edge.

The head of a local research firm, who declined to be named, concurs. He points out that no steel stocks are under house coverage at the moment as most of its clients do not look at these stocks. “The steel industry is not attractive enough at the moment. Not many of our clients have steel stocks. Most of the steel companies have incurred massive losses and the same issues that led to these losses are still there,” he says.

For those who have been following the industry, it is no surprise why investors are shying away.

Local steel companies got a temporary reprieve in 2017 and reported strong earnings, mainly from higher prices. This was thanks to China’s policy of reducing production capacity in order to reduce the glut and curb pollution. Big gainers then included Ann Joo Resources Bhd, Southern Steel Bhd and Hiap Teck Venture Bhd.

However, the reprieve ended when the Pakatan Harapan-led government put on hold several large infrastructure projects amid mounting financial concerns last year. Already struggling with oversupply, the cutbacks were akin to pouring fuel on a fire.

Bloomberg data shows that only three steel counters — Ann Joo, CSC Steel Holdings Bhd and Choo Bee Metal Industries Bhd — are under analyst coverage, but none are recommending a “buy”.

Of the seven analysts who cover Ann Joo, two have a “sell” call and five, a “hold”.

Analysts downgraded CSC Steel after it reported its first quarterly net loss since 2014 as high raw material costs put pressure on margins, with three calling a “sell” and one, a “hold”.

As for Choo Bee, just one analyst covers the stock and has a “hold” recommendation. Despite the uncertain outlook, industry players remain optimistic.

CSC Steel, whose major shareholder is China Steel Corp, Taiwan’s largest steel producer, is cautiously hopeful about achieving profitability for the current financial year ending Dec 31, 2019, citing the political and economic growth in Southeast Asia and the resilience of world steel demand.

Hiap Teck Ventures Bhd is also confident about the outlook. It resumed production at its blast furnace at subsidiary Eastern Steel Sdn Bhd, after a halt of nearly three years. Operations were temporarily suspended to minimise losses due to the difficult market conditions.

It is worth noting that the cost for Eastern Steel to resume production is estimated to be RM82 million — a one-off amount of RM26 million for parts and equipment replacement, and RM56 million for five months of pre-operating overheads, comprising salaries, utilities and other daily expenses.

The group had to dispose of its 20% stake in Eastern Steel to Shanxi Jianlong Industry Co Ltd at a loss of RM21.8 million in order to fund the reinvestment in Eastern Steel for resumption works well as additional capital expenditure (capex) to improve production efficiency and increase its product range without additional cash outflow from Hiap Teck.

Investors who have been following the developments in the industry would have made handsome returns so far this year as steel stocks show signs of recovery. The average total return for steel players year to date was about 14.9%. This was in stark contrast to an average decline of 45.6% seen last year, and a decline of 2.03% over the last five years.

Part of the reason could be due to their valuation. At the time of writing, only one steel counter was trading above one times its book value while half are trading at a single-digit price-earnings ratio, indicating an attractive entry level for traders.

The head of research tells The Edge that most traders would only come in temporarily to ride the recovery.

“If you talk to investors, most are still sceptical about a sustained recovery. It is true that a resolution in the US-China trade war could be positive for the industry while the revival of some infrastructure projects is positive.

“But the core issues that affected the industry are still there. And let us not forget that more downside is expected with the power rate hike coming in,” he says.


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