KUCHING: The steel sub-sector remains subdued due to the risk of a sharper than expected slowdown in the global economy and also the medium to long-term issue of overcapacity, particularly in China.
Despite the recent plant closures, excess capacity in China’s steel sector was still high and it would take a while before the impact from the Chinese government’s efforts to consolidate the highly fragmented steel sector in the country could be felt.
RHB Research Institute Sdn Bhd (RHB Research) in its report made a comparison between two long steel producers in Malaysia; Ann Joo Resources Bhd (Ann Joo) and Southern Steel Bhd (Southern Steel). This was mainly due to the similarities in terms of plant operation, production capacity and market capitalisation.
Both Ann Joo and Southern Steel operate electric arc furnaces, with scrap being the main feedstock. This was unlike Kinsteel Bhd that used direct reduced iron as its main feedstock.
Since the privatisation of Ann Joo Steel in 2007, it had traded at a two to three times multiple premium to Southern Steel in terms of historical one year forward price earnings ratio. RHB Research believed this was mainly due to Ann Joo being a more efficient producer than Southern Steel.
“Ann Joo had been able to consistently improve the production efficiency and output of its electric arc furnace plants without any significant capital outlay. This was done through process improvements such as shortening the tap-to-tap time, reducing plant offline time as well as energy optimisation,” RHB Research analyst Toh Woo Kim pointed out.
As such, it was not surprising that Ann Joo had higher operating margins compared with Southern Steel.
In terms of absolute operating profit, Ann Joo numbers were just slightly below Southern Steel’s numbers in 2007 and 2008 despite its lower revenue base. In 2009 and the first half of this year, Ann Joo managed to achieve a higher absolute operating profit than Southern Steel.
In addition, Toh believed the premium could also be partly due to Ann Joo’s largest market capitalisation and shares liquidity among the five listed long steel producers in the country.
He also identified two key differences between Ann Joo and Southern Steel that distinguished Ann Joo as the preferred steel stock going forward, namely flexibility in raw material input with the commissioning of its mini blast furnace plant and a higher export ratio of its sales volume.
“With the expected commissioning of its mini blast furnace plant this month, Ann Joo would now have the flexibility in the usage of feedstock versus relying mainly on steel scrap for Southern Steel,” he added.
To recap, Ann Joo’s mini blast furnace plant produced hot metal which would be directly charged into its electric arc furnace to produce steel billets. This would benefit Ann Joo in terms of lower electricity cost, higher steel output and better product quality.
“In other words, this means that Ann Joo’s operations would be more efficient with a lower cost of production, thus making it more competitive compared with its peers,” he opined.
RHB Research estimated exports to constitute close to 50 per cent of Ann Joo’s total sales volume, the highest among the five long steel producers in Malaysia. On the other hand, it estimated Southern Steel exports to constitute only about 30 per cent of its total sales volume.
Toh believed having a high export ratio was positive to Ann Joo as exports helped to cushion the decline in domestic sales during a downcycle. In 2009, Ann Joo managed to expand its export market with a two-fold increase in sales tonnage and this helped to partially offset the impact of a lacklustre domestic market with the absence of major infrastructure projects.
He said that this could likely be the case again during the early part of 2011 given the potential delays in the roll-out of infrastructure projects.
“With the added capacity from the commissioning of its mini blast furnace project, Ann Joo’s expansion is timely and the company is in a strong position to capture the pick-up in domestic long steel consumption, while at the same time still maintain its export sales to key steel importing countries in the Asean region, particularly Vietnam, Singapore and Indonesia,” he pointed out.