Period  3Q14/9M14

Actual vs. Expectations Malaysia Steel Works (Masteel) reported 9M14 core net profit (CNP)* of RM19.3m which came in at 62% and 63% of consensus and our, expectations of RM31.1m and RM30.7m, respectively.

 We deem the results as below expectations. Although 9M14 revenue was in line at 70% of our estimates, 3Q14 was affected by lower-than-expected 3Q14 EBIT margins of 2% vs our expected full-year margin of 3%. This was due to the installation and ramping up period for Masteel’s newly upgraded electric arc furnace which took place during the quarter. Furthermore, the company was hit by a higher-thanexpected effective tax rate.

Dividends  No dividend was declared for the current quarter, as expected. For FY14E we expect to see total dividends of 1.3 sen per share implying 1.3% dividend yield.

Key Result Highlights YoY, 9M14 CNP declined 18% to RM19.3m despite revenue rising 4% on better steel demand. We believe the CNP decline was due to upgrading works and plant maintenance taking place over the festive season in 3Q14. This as well as lower steel average selling prices (ASP) narrowed 9M14 margins to 3% from 4% previously.

 QoQ, 3Q14 CNP declined 47% to RM4.7m which was mainly due to the aforementioned upgrading and maintenance works. The reduced productivity resulted in operating margins declining from 4% to 2%. The company also incurred a one-off deferred tax charge of RM8.9m which resulted in a sharp spike in 3Q14 taxation to RM9.6m (262% effective tax rate) vs. RM0.7m (6%) in 2Q14.

Outlook  As Masteel ramps up billet production post-upgrade, we expect the company to enjoy better economies of scale and hence should see better operating margins from FY15 onwards.

 Masteel’s sales volume should be supported by good construction demand in the Klang Valley and its manufacturing capacity expansions. Masteel also plans to increase its rolling capacity to 650k metric tons (MT)/year (+19-22% yearly) by FY16E.

Change to Forecasts Reduce FY14E-FY15E CNP by 10%-3% to RM27.6m–RM35.1m as we impute higher fixed costs post-upgrade. We do expect to see a stronger 4Q14 as the recent upgrade should contribute to higher billet production volume (+50k MT/yr or +8% to 700k MT/yr) and improved energy efficiency, which will continue into FY15.

Rating Maintain OUTPERFORM

Short-term upside is still favourable due to Masteel’s strong revenue growth potential and the improving steel industry outlook.

We also note that Masteel is currently trading at 0.39x PBV which is on par with its 3-year historical average PBV. Long-term catalyst should come from potential trade remedies on excessive Chinese steel imports that have artificially depressed prices. We believe the move should materialise by early-2015.

Valuation  Minor adjustments to TP to RM1.20 (RM1.22 previously) based on 0.43x PBV applied on lower FY15E BV/sh of RM2.80 post-earnings adjustment. The 0.43x PBV reflects a +1.0SD premium justified by Masteel’s strong revenue growth potential of 10%-21% in FY14E-FY15E due to significant capacity expansion. Note that Masteel’s net gearing at 0.4x is also the lowest among domestic steel producers.

Risks to Our Call Lower-than-expected steel prices.

 Higher-than-expected raw material and electricity costs.

Source: Kenanga