Transformation underway at Kinsteel

Kinsteel Bhd
(June 28, 69 sen)
Maintain hold at 68.5 sen with revised target price of 65 sen (from 77 sen): Kinsteel's share price has been battered (-21% year-to-date) on its bleeding results (RM4 million 1QFY11 net loss). Though we think its venture into mining could be positive in the long term, near-term earnings are unlikely to turn around sharply. We cut our 2011 earnings per share (EPS) forecast by 83% and 2012/13 by 16% to 24%, on higher iron ore cost assumption from imports over the medium term. Subsequently, our target price is reduced by 16% to 65 sen (on unchanged eight times 2012 price-earnings ratio target).

Kinsteel has just kickstarted the construction of its 1.15-million tonne concentration plant and the 1.2-million tonne pelletising plant, with target completion dates set for 1Q12 and 4Q12 respectively. The new plants will enable Kinsteel to utilise local iron ore to produce iron ore pellet (instead of imported). The company is in the process of acquiring a mine in Bukit Besi, Terengganu, which has a potential iron ore reserve of 200 million tonnes (meeting more than 70 years of Kinsteel's internal requirements) and is also finalising a 1.4-million tonne iron ore supply from a mine in Bukit Ibam, Pahang.

We believe the new plants are transformative for the company as Kinsteel will be the lowest-cost long steel manufacturer in Malaysia. The total cost incurred from mining to processing into iron ore pellet is around US$100 (RM305) per tonne (against imported iron ore pellet: US$240 per tonne). Additionally, Kinsteel will no longer be susceptible to the price volatility in the tight iron ore market. Assuming Kinsteel continues to run its direct reduced iron (DRI) plant at the current 50% utilisation rate, we estimate that it will see massive cost savings of RM570 million annually (against our 2012 net profit estimate of RM84 million).

Even with the bi-annual gas tariff hike, the accumulated incremental cost (from now until 2015) of RM241 million (on 50% DRI utilisation level) can still be covered with the above-mentioned cost savings.

While we are positive on Kinsteel's venture into mining, we think it is too early to impute the cost savings into our model. We think the risk lies in execution, especially since the pelletising plant will be the first in Southeast Asia. We cut our 2011 EPS by 83% and 2012/13 by 16% to 24%, on higher iron ore cost assumption from imports which will continue over the medium term. ' Maybank IB Research, June 28


This article appeared in The Edge Financial Daily, June 29, 2011.