KUALA LUMPUR (April 25): Hong Leong Investment Bank (HLIB) Research on Monday (April 25) initiated coverage of Hiap Teck Venture Bhd at 46 sen with a target price of 63 sen as it sees the counter as an undervalued gem.

HLIB analyst Chye Wen Fei said that at the current share price of 46 sen (last Friday's closing price), Hiap Teck is trading at undemanding FY22 (financial year ending July 31, 2022) to FY24 price-to-earnings of six times, 5.1 times and five times respectively.

“In our view, Hiap Teck’s undemanding valuation could be attributed to investors’ negative perception of the steel sector on the back of the volatile historical earnings trend (partly due to China’s overcapacity issue in the past), and [with it being] under-researched (with no sell-side research coverage),” she said.

With improving sector earnings prospects (thanks to the Chinese government’s initiative to transform the country’s steel sector) and Eastern Steel Sdn Bhd (ESSB)’s multi-year growth potential, she believes Hiap Teck’s valuation is due for a rerating.

Hiap Teck has a 27.3% stake in ESSB, a joint venture with Beijing Jianlong Heavy Industry Group Co Ltd. ESSB is an upstream steel-making plant with a rated annual production capacity for steel slabs and billets of 700,000 tons.

At the time of writing on Monday, Hiap Teck had fallen two sen or 4.35% to 44 sen, valuing the group at RM803.95 million. Year to date, the counter has fallen 13.73%.

Chye’s target price of 63 sen is based on Hiap Teck’s seven times 2023 core earnings per share of 9.1 sen, which offers an upside of 43.18% from the current share price.

According to Chye, China’s ongoing decarbonisation drive for the steel sector (which involves swapping existing steel capacities from the blast furnace-basic oxygen furnace route to the electric arc furnace route) will likely result in more stable profitability among steel players in the region.

“We see a multi-year growth potential in ESSB’s earnings, underpinned by its continuous efforts in enhancing its cost efficiencies, which will result in lower production cost, hence allowing ESSB to compete with its regional competitors on a level playing field, and the major capacity expansion of the blast furnace segment and venture into the production of hot rolled coils (which is under-invested in Malaysia),” she added.

Chye also said Hiap Teck’s net debt and net gearing ratios had been on a declining trend since FY19, mainly attributed to its improving financial performance and the absence of major capital expenditure (capex) commitments.

“It is also one of the lowest-geared compared to its peers in Malaysia. Moving forward, we project Hiap Teck’s net gearing to trend down further in the coming years (on the back of a stable operating cash flow and the absence of major capex spending), which will likely result in a more generous dividend payout,” she said.

She also noted that the relocation of Hiap Teck’s warehouses to the new location (expected in two to three years’ time) will allow Hiap Teck to crystallise value of the land bank (where part of its warehouses are currently situated at), given the sharp appreciation in land value over the years.

“We project Hiap Teck’s core net profit for FY22 to FY24 to expand by a three-year compound annual growth rate of 6.5%, underpinned by sustained earnings contributions from the trading and manufacturing segments, and a higher earnings contribution from ESSB, arising from higher production volume and better cost efficiencies (following the completion of the coke oven plant in phases),” she said.