Thursday, January 25, 2007

Kinsteel's Fortunes

The Accidental Investor said...
Dali, Actually sold half the warrants at 2.65 (top for the morning session - hence causing resistance) for a nice piece of biz (+348% gain). If the rest of the warrants drop to zero, I am still holding on to close to 150% net profit. Not too shabby. Kinsteel is a story that is as yet unfolding. Analysts put it at a target price of 4x FY07 earnings at RM2.40. But I am not convinced. Already the last Q results with one month of Perwaja contribution was sensational -even though all Perwaja mills were not fully operational yet. I also believe that the analysts are wrong on the target EPS and it should be higher. And I don't think we should be valuing a market share leader at 4X earnings especially in an environment of rising steel demand and prices. Valuing is at a reasonable 8X PE for a market share leader (assuming EPS targets are correct) would actually lead to a valuation close to the RM5.00 you mentioned. This will be interesting.

The Mumbling Priest said...
Disregarding the recognition of -ve GW, I'm rather curious about Kinsteel's Q3 performance. Operating margin for Q3 is 30% compared to 11.4% for the 9mths (incl Q3). Sales actually dipped 2.8% from Q2 (see note B2. But operating expenses dropped like a brick - to yield the 30% operating margin. Notice that Q3's operating margin is 70m vs 89m for the cum 9 mthsMy question is how does assimilation of Perwaja for just one month have such a wonderful effect on operating expenses? Don't get me wrong - I think there's still upside - but I'm very curious.

The Accidental Investor said...
IMHO, the Opex stated in their accounts definitely includes Cost of goods sold. Being "integrated" now, they have access to cheaper feedstocks from the Perwaja mills and no longer have to cost their supplies at market rate. It would be interesting when true economies of scale or further operating efficiencies kick in.

The Mumbling Priest said...
Thanks AI, that sounds pretty reasonable. Except that the 30% operating margin is the average for the 3 mths to end-Sept. And the acqn was completed 7 Sept. Is it therefore reasonable to say that Kinsteel has moved to a whole new super duper level from Sept 7th? Up to June 06, its operating margins were only 3.5%. FY05's was 5.7%. Now, assuming monthly sales were even thru out Q3, that would mean an operating margin of 83% for Sept alone? If sustainable, it deserves a very much higher PEuhh that's (83+3.5+3.5)/3 mthsIf there were no sales in Jul & Aug, yeah 30% is believable. Time to call in sifu Dali. I must be missing something here.

To call someone sifu in the movies usually means an imminent death for the sifu, so no need to do that. I am not in fengshui, I will not decorate myself or proclaim myself to be Grand Master Dr.... blah-blah-blah. Back to Kinsteel. Some important factoids:

1) Yes, the merger is very good for Perwaja and Kinsteels, and yes, they are enjoying 30% margins, but what I am more certain about is it won't last.
2) The company now is a fully integrated steel player. What does that mean? They now have upstream and downstream products.
3) Production capacity at Kinsteel used to be just 800,000MT, now it has 4,500,000 MT p.a.
4) What about demand and operations - well, the Perwaja plant is operating at full capacity while the Kinsteel plant is at around 70%. The only bad side is the Gurun plant, operating at below 20%. But bear in mind that before the merger, the Gurun thing was at zero. This is one of the major reasons why after the merger, the results were so solid - that is, before the merger, Perwaja had a lot of under-utilised assets, which was also why Kinsteel agreed to the buyout and issuance of shares to Maju at such a low price.
5) Good timing. The global steel market was consolidating in 2005 and 2006 but the outlook for 2007 have improved sharply. Global steel market is looking at a y-on-y growth of just over 5%.
6) No selling by major shareholders - The company is almost equally held by Maju and the original Kinsteel owners. As both parties have worked hard to produce results, no one is selling their shares... not yet anyway. Beyond RM4.00, I think the temptation to sell some will increase significantly.
7) The high margins won't last, right now they are enjoying very cheap feedtsock, which won't last. It is easier to squeeze great returns from inefficiencies in the first phase of integration. The story is good but not that good. Still, margins may still be maintainable at 12%-15% for the next few years barring a collapse in global steel markets. It is the most profitable steel operations in the country.
8) Why can they do that when Amsteel/Megasteel finds the going tough? Well, Abu Sahid got his money from dealing in scrap metals way way back, no one knows the market better than him. He has a strong understanding of the feeder stock network.
9) The stock also got a recent boost when the world's largest iron ore exporter, Cia Vale do Rio Doce, decided to raise prices by 9.5% this year. They locked in a good price for the rest of the year.
10) Smart usage of capital - Unlike Mr. Cheng, who likes to leverage like nobody's business, the company recently sold RM400m Islamic bonds , and half went to pay down debts. Cash flow will be very good this year and we can expect more prudent debt reduction as they still have loads of inefficiencies to improve on.

Valuation RM4.00-RM5.00 in 2007. Makes the 28 November recommendation entry price of RM1.40 looks kinda ridiculous, but the company did have a few surprise news boosts from external sources following that period.


The Accidental Investor said...

Cheers Dali for agreeing with my valuation. Sometimes professional analysts can get it very wrong. Normally they are too optimistic.

Read in the Edge today that Hwang DBS latest Kinsteel report is now at Rm4.30

P.S I do remember your short-term target for Kinsteel less than 2 months ago was RM1.70. He he. Sometimes its good to be very wrong.

ttm said...

Sold off the day before all this news came out. Was hoping for more info to justify hanging on in the face of the steep climb... still, very glad to have been in on the run. :)

The Mumbling Priest said...

Dali, thanks for your indepth write up. Looking back at your post in Nov, i can see that it was a quick and dirty in response to the Q3 results that were announced the previous day.

Looking at your 10 points, I think the only new developments since Nov were the improved outlook for steel and the 9.5% iron ore hike. Nevertheless, I really do appreciate the information revealed in the other 8 points, which can only be uncovered with diligence. Haha how did you find out they had locked in their raw mat contracts?

As I said, your Nov post was probably a q&d and frankly you did not place a "target" on Kinsteel then. There's nothing ridiculous about the 1.40 entry price.

So once again, thanks for your effort. And not to forget, your repeated caution on the sustainability of the supercharged margins.

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