This article first appeared in Corporate, The Edge Malaysia Weekly, on May 16 - 22, 2016.

THE conundrum facing the hot-rolled coil (HRC) manufacturing industry, anchored by Lion Corp Bhd’s subsidiary Megasteel Sdn Bhd, calls for a review of the government’s policy on the iron and steel industry, says a seasoned industry executive.

The executive, who leads a downstream steel manufacturing company, says Megasteel’s insolvency should be looked at holistically, whether the company is indeed operating inefficiently or whether the policy on HRC imports has crippled its ability to operate sustainably.

“When you are talking about heavy industry, the start-up investment is very high. Usually, investors would require some form of protection by the government during the gestation period, which is normal.

“But Megasteel has been operating for about 15 years, is it still in gestation?” he asks. 

However, he adds that the policy of letting midstream players import HRC at zero duty should be looked at again in order to support the growth of the local HRC industry.

The government currently exempts import duty on flat products used for raw materials in the production of finished goods for export. And the import of flat products whose steel grades are not produced locally are also exempted from duty.

Flat steel is used for the manufacturing of electrical items, automobiles and household items, while long steel is used in the construction industry.   

“The government should open the market for imported HRC, but duty should be imposed on all types of products to control the flow. This way, HRC produced by Megasteel would still be able to compete with imported HRC, as the price of imported HRC would still be higher than the local product. The government could also earn some revenue from the import of HRC,” says the executive.

The question whether to safeguard Megasteel as the only HRC producing steel mill in the country has been debated for years. Megasteel had requested safeguard investigations on the import of HRC since 2011 and anti-dumping investigations in 2012, 2014 and 2015.

However, to the credit of the government, instead of continuing to protect Megasteel from foreign imports, industry regulations have been relaxed, albeit slowly.

The government has also rejected Megasteel’s request to be safeguarded against foreign HRC.

On Jan 8, the government decided to terminate a safeguard investigation of the increase in imports of HRC. Megasteel petitioned for the investigation and it was initiated by the Ministry of International Trade and Industry on Sept 10 last year.

Considering that Megasteel is bleeding losses, its requests for protection are not surprising.  

In the financial year ended June 30, 2015 (FY2015), Megasteel recorded a net loss of RM615.9 million, compared with a net loss of RM416.8 million in the previous year. It had short-term borrowings of RM841.2 million and cash of only RM2.9 million as at end-FY2015.

Megasteel was not always a loss-making entity. In fact, when import duties were as high as 50% before August 2009, there were years when Megasteel recorded huge profits. 

In FY2005, Megasteel made a net profit of RM375.4 million, on the back of RM3.88 billion in revenue. In that year, revenue from export sales was almost 40% of the total. However, this was not sustainable as Megasteel dipped into a net loss of RM182.6 million in FY2006.

Since then, Megasteel’s fortunes have been erratic. The company managed to emerge from losses in FY2006 and recorded two consecutive years of huge profits. In FY2007, Megasteel’s net profit was RM250.6 million and in FY2008, RM104.6 million. 

However, the company’s fortunes took a turn for the worse again in FY2009, when it suffered a net loss of RM950.2 million.

Megasteel’s export sales have dwindled over the years and by FY2015, export sales constituted less than 1% of its revenue of RM1.89 billion. Over the years, Megasteel has racked up RM2.43 billion in accumulated losses. 

Its deteriorating financial position led Megasteel to lay off over 200 workers in April. The company has also obtained orders from the court seeking protection against creditors — tantamount to bankruptcy protection.

Lion Corp announced to Bursa Malaysia on May 5 that the High Court had granted Megasteel a restraining order against its creditors, preventing them from taking any action or proceedings against the company or its assets for 90 days. 

Megasteel has also received an order from the High Court for separate meetings to be held between the company and its creditors within 90 days from May 5, to consider and if thought fit, approve without modifications, proposed debt-restructuring schemes.

While it was not stated in the announcement, it is believed that a creditor or a group of creditors had initiated a move to wind up Megasteel, after the company cross-defaulted on RM3.02 billion worth of loans in September last year.

To recap, Megasteel is the only producer of HRC in Malaysia. Tan Sri William Cheng Heng Jem, the patriarch of the Lion group, invested RM3.2 billion in building an integrated steel mill, which could produce 3.2 million tonnes of HRC and 1.45 million tonnes of cold-rolled coil per year, in Banting. Megasteel commenced operations in 1999.

As the sole producer of HRC in Malaysia, Megasteel was provided various protection measures, leading to objections from midstream flat steel players. 

Following the start of its commercial operations, the government imposed a 25% import duty on HRC. In 2002, the government tightened the regulation by increasing import duty to 50% and introduced import permits and a quota system. 

“When you close the market from foreign imports, there are grades which you cannot produce because the demand is too small, although there are applications for such grades. So the midstream and downstream players found that their raw material cost went up by 25%.

“Many in the steel sector — such as pipe manufacturing — found themselves hard-pressed to survive. The smaller producers eventually closed down, while the bigger ones struggled,” says the industry executive.

However, as the government ratified trade agreements with various countries, these protectionist measures were wound down. Effective August 2009, import duty on flat products was reduced to 25%, and the rates will be further reduced to between 0% and 10% in 2018.

In many countries, steel manufacturing is considered a strategic industry, to the extent that it receives extensive protection and subsidies from the government. Should Malaysia go down the same route?

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