Management has turned more upbeat on its earnings prospects, underpinned by (i) several positive developments in China have boosted demand sentiment for steel products, and (ii) declining coking coal prices, coupled with the worn out of high-cost inventories in 1QFY23 are pointing towards lower production cost from 2QFY23 onwards. Besides, management is optimistic that the coal coke spread will continue to widen in the coming months (which will in turn result in cost savings from coke oven plant utilisation), on the back of improved availability of coking coal. Maintain earnings forecasts, TP of RM0.33 (based on unchanged 7x FY07/24 core EPS of 4.8 sen) and BUY rating on HTVB.

More details on ESSB’s 1QFY23 performance. Eastern Steel Sdn Bhd’s (ESSB, a 27.3%-owned unit) core contribution to HTVB declined to RM4.8m in 1QFY23 (from RM8.3m in 4QFY22), as higher sales volume (+6.9% QoQ) was weighed down by lower average selling price and high steel material costs.

More upbeat undertone. While near-term steel demand will likely weaken (due to slower construction activities during Lunar New Year month), management has turned more upbeat on its earnings prospects, as (i) several positive developments in China (which include, amongst others, Covid policy reversal and stimulus plans) have boosted demand sentiment for steel products, and (ii) declining coking coal prices (a part of the key cost components in producing steel), coupled with the worn out of high-cost inventories in 1QFY23 are pointing towards lower production cost from 2QFY23 onwards. As for China’s recent decision to consolidate iron ore purchases on behalf of ~20 of the largest Chinese steelmakers (starting from as early as 2023), management believes such move will result in more stabilised iron ore prices going forward, hence benefitting other smaller iron ore consumers including ESSB.

Coking coal-coke spread to widen further. We understand that ESSB is currently running all its 4 coke oven plants, as the price spread between coking coal and coke has started widening since Nov-22. Management is optimistic that the coal-coke spread will continue to widen in the coming months (which will in turn result in cost savings from coke oven plant utilisation), on the back of improved availability of coking coal. Besides, the Chinese government’s recent decision to allow 3 central government-backed utilities and its top steelmaker – for the first time since Beijing imposed an unofficial ban on coal trade with Australia in 2020 – have reignited hopes that China would be lifting its ban on the import of Australian coal. If this materialises, this will allow Australian coking coal to enter China, hence easing supply and price of coking coal, and thus lowering steelmaking costs.

Forecast. Maintained. While margin will likely recover from 2QFY23 (when inputs acquired at high costs are depleted), demand will still remain weak due to seasonal factors (as demand for steel products normally slows down during Lunar New Year month, which will in turn have an impact on HTVB’s trading and downstream segments). We believe a more meaningful improvement in performance will only happen from 2HFY23 onwards.

Risks to our call. These include (i) full blown global economy slowdown, (ii) hiccups in China’s stimulus plan implementation and economy reopening, and (iii) recovery in key steel input prices (in particular, iron ore and coking coal) outpacing steel product prices.

Maintain BUY with unchanged TP of RM0.33. We maintain our BUY rating on HTVB, with an unchanged TP of RM0.33 based on unchanged 7x FY07/24 core EPS of 4.8 sen.

Source: Hong Leong Investment Bank Research - 9 Jan 2023