MSW’s focuses  on steel bars, which  enjoy healthy demand growth on top  of  the  limited  threat  from  imports.  However,  there  is  no  escaping from the 18.8% hike in electricity tariffs, which will translate  into  a -58% earnings  cut  for  FY14.  With  potentially   poor  market  interest  on  steel counters  amid  other  negative  developments,  we  downgrade  MSW  to NEUTRAL, and lower our FV to MYR1.07.

• In a sweet spot.  Malaysia Steel Works (MSW) is  Malaysia’s  sole local integrated  long  steel  player  manufacturing  only  steel  bars.  Other companies that also produce wire rods are facing stiff competition from imports. Steel bars are normally delivered in smaller bundles as they are made  according  to  the  specifications  of  contractors  who  have  limited space to store this basic material. Therefore, steel bar users prefer local producers  that  can  better  accommodate  their  needs,  and  do  not  mind absorbing  the  10-15%  premium  over international  prices,  which  in  turn benefits MSW. We are also  relieved that  there was no mention of any cancellation of mega  projects in Budget 2014. Instead, the Government pledged  to  develop  more  affordable  homes,  which  will  stimulate  the demand for steel, particularly steel bars.  
• A  setback  from  higher  tariff.  Similar  to  its  peers,  MSW  uses approximately 600 kWhr of electricity to produce a tonne of billets  and 110-120 kWhr  for  a  tonne of bars from billets. As such,  electricity cost makes up about 10% of its production cost. The company falls under the “special  industrial  tariff’’  group  that is subject to a  18.8% electricity tariff hike  from  Jan  2014.  We  slash  the  company’s  FY14  earnings  by  58% after incorporating the new tariffs.
• Downgrade to NEUTRAL.  We see  the  electricity  tariff revision  causing investors  to  shy  away  from  the  sector,  especially  considering  the  two steel  counters  that  were  recently  designated  as  PN17  companies. We are also keeping a close eye on MSW’s proposed Iskandar rail project as this  first-of-a-kind  project  for  the  company  will  involve  high  capex  that could  increase  gearing  if  it  proceeds .  We  downgrade  MSW  to NEUTRAL,  with our  FV lowered  to MYR1.07  (from MYR1.08),  based  on a 0.4x (from 0.48x)  FY14 P/BV, or the mean  (from +1 SD)  of the stock’s 5-year historical trading range.

Recommendation Chart

Source: RHB