Steel Sector Report By HWangDBS

Stronger steel demand ahead

• Steel demand is currently being supported by restocking activities. And in FY10-11, steel producers will benefit from pump-priming activities kicking off and USD weakening.
• Expect 3Q09 earnings to improve q-o-q.
• Upgrade Southern Steel (TP RM2.40) and Kinsteel (TP RM1.30) to Buy.

Demand recovering. Steel demand has improved recently due to re-stocking activities. Utilization at most steel mills has risen since Jun09 - Kinsteel's upstream utilization jumped to 100% from 50%, while Southern Steel’s overall utilization has risen from a low of 50%. Mega projects arising from government pump priming should deliver meaningful new demand in FY10-11F. In addition, the sector should benefit from a weaker USD vs RM. 60-70% of domestic scrap requirement (mainly denominated in USD) and all iron ore are imported.

Re-stocking activities supporting steel prices. Steel bars and rods are trading at RM2,200- M2,300/MT, while international prices of iron ore and scrap averaged USD103/MT and USD250/MT, respectively. Iron ore prices have been relatively stable for the past ten months, which is good for steel producers as it reduces price volatility.





















Operating parameters improved. We expect 3Q09 to show positive operating earnings compared to losses in 1H09, driven by margin improvement as a result of

1. recovering steel prices, and
2. higher capacity utilization.

Inventory holding period has also improved to 3 months from 4-6 months at the start of the year. Following that, both Southern Steel and Kinsteel have stronger cashflow positions.

Upgrade to Buy. We upgrade Southern Steel (TP: RM2.40) and Kinsteel (TP: RM1.30) to Buy from Hold. Our target prices are based on 1.3x NTA, consistent with +1SD of the respective historical means. We expect government pump-priming to help drive profitability over FY10-11F. At our target prices for Southern and Kinsteel imply they should be trading at 12.1x and 13.7x CY10F earnings.