The stock has chalked up smart gains of roughly 22% year-to-date (YTD), from its 2010 year-end closing price of RM1.15, outperforming the benchmark index for the broader market.
This is unsurprising given the relatively upbeat outlook for domestic steel bar demand underpinned by expectations of a robust property sector and gradual rollout of projects under the government’s Economic Transformation Programme (ETP), coupled with Masteel’s underlying fundamentals and attractive valuations.
The improved sentiment may also be attributed, at least in part, to its proposed intracity commuter rail venture in Johor.
Sentiment boost from proposed rail venture
Last week, the Johor government approved a RM1.23 billion intracity commuter train project proposed by Metropolitan Commuter Network (MCN), a joint-venture company between Masteel and KUB Malaysia Bhd.
The commuter train network will link up to 23 stations — including seven new stations — in major towns in the Iskandar Malaysia region.
Based in Kempas Baru, which is expected to be the final terminal for all rail connections with the northern part of the country, the network will have two main lines running from Nusajaya to Kota Masai and Kulai to JB Sentral.
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The commuter rail will utilise existing KTMB tracks so no additional land acquisitions or track infrastructure are necessary, though a spur line linking Senai airport to the rail network may be added at a later stage.
MCN, in which Masteel has a 60% stake, is expected incur some RM370 million in capital expenditure, primarily for rolling stock. It is anticipated that roughly RM70 million of this would be funded through equity by the two partners, while the balance would be raised through a bond issue.
The other portion of the project, estimated to cost RM860 million, including the ticketing, signalling and communications system, electrification and transit stations, would be funded by project financing under the government’s Public-Private Partnership (PPP) scheme. The assets would then be leased to MCN under a long-term concession of up to 33 years.
Having received the state government’s endorsement, the proposal is now expected to go to the federal government for approval. If all goes to plan, the concession agreement could be finalised by mid-2011. Construction is targeted to commence by early 2012 and the rail lines would be operational by early 2014.
Steel will remain the primary income generator
We expect Masteel to capture some one-off construction profit from the rail project in 2012/13. More importantly, the project would provide the company with a recurring income stream over the entire period of the concession.
Having said that, we expect contributions from the project would only account for up to 10% to 15% of Masteel’s earnings when it is fully operational. Thus, the primary earnings generator will continue to be its steel manufacturing business.
In this respect, we are fairly upbeat on the outlook going forward. Demand for steel bars in the domestic market is expected to strengthen on the back of the rash of property projects launched since end-2009, which will be progressively completed over 2011/12.
Demand will gain further traction going into 2012, lifted by the rollout of projects under the various government initiatives including the PPP scheme and ETP.
Among the most high-profile projects are the RM36 billion mass rail transit (MRT) system for the Klang Valley and the light rail transit (LRT) extension.
Other notable projects include the RM10 billion Sungei Buloh mixed development on the 3,300-acre (1,335.5ha) Rubber Research Institute land and the RM5 billion Warisan Merdeka development, which will be undertaken by the Employees Provident Fund and Permodalan Nasional Bhd respectively, as well as the RM26 billion KL International Financial District project.
The proximity of these projects to Masteel’s plants — its melt shop is in Bukit Raja and rolling mill in Petaling Jaya — may give the company a keen competitive advantage.
Higher steel prices expected for 2011
Steel bar prices have been hovering between RM2,300 and RM2,500 per tonne YTD, compared with the average of roughly RM2,100 per tonne in 2010. The price hikes allow companies to pass on the rising cost of raw materials and help improve margins.
The higher selling prices appear sustainable and are in line with rising global steel prices. Despite the still somewhat fragile demand, prices are being forced higher by the rising cost of feedstock such as iron ore and coking coal on the back of growing demand amid tight supplies.
For instance, iron ore prices for the current quarter have risen to roughly US$180 per tonne (RM540), compared with the contract price of less than US$130 per tonne in 4Q10. Coking coal prices too have surged on the back of supply disruptions in flood-stricken Australia. Contract prices for 2Q11 are estimated at about US$330 per tonne, compared with about US$210 per tonne in 4Q10 and US$225 per tonne in 1Q11.
Prices for scrap steel — Masteel’s primary feedstock for its steel-making operations — have risen as well but to a lesser degree. Scrap metal is more widely available, and is thus less affected by the current supply constraints and the pricing structure for iron ore and coking coal, where the market is shared by a small number of producers and sellers.
We estimate the company is paying roughly 20% more for scrap metal so far this year, compared with prices in 4Q10. This gives Masteel some cost advantage over peers operating blast furnaces in the country which require iron ore and coking coal as feedstock.
Capacity expansion to cater for expected volume demand growth
Masteel is planning to expand its rolling mill capacity to cater for the anticipated growth in demand. It is in the process of evaluating the acquisition of a rolling mill. If all goes to plan, the move will add an additional 150,000 tonnes to its current annual production capacity of 350,000 tonnes by mid-2012.
It also intends to boost the melt shop capacity (feedstock for the rolling mill) to about 650,000 tonnes per year from the current 500,000 tonnes. Higher capacity will drive earnings expansion in 2012/13.
Capital expenditure is estimated at around RM180 million for the proposed capacity expansions over the next two years. Masteel’s financials are in fairly good shape — gearing has fallen to about 44% as at end-2010, from 53% in the previous year. Thus, the company will be able to leverage on its balance sheet to fund the expansions.
Expect outsized profit growth in 2011 on better margins
We estimate Masteel’s top line growth at 10% to 15% this year, underpinned by improvement in volume demand and higher selling prices. Net profit is expected to grow at an even faster clip, boosted by better utilisation and margins.
We forecast net profit will rise to RM49.1 million and RM63.3 million for 2011 and 2012 respectively. Based on our earnings estimate, the stock is still trading at modest price-earnings ratios of roughly 6 and 4.7 times for the two years respectively, despite having outperformed YTD.
Masteel’s share price also remains well below net assets of RM2.27 per share as at end-2010.
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