Southern  Steel’s  9MFY14  net  profit  of  MYR5.6m  was  below  our  and consensus’  estimates.  The board proposed to issue up to MYR209.7m RCULS on a 1-for-2 basis, which we expect to lower its gearing, but with minimal  P&L  impact.  Meanwhile,  we  remain  watchful  on  its  outlook,especially  as  the  new  strip  mill  may  involve  a  long  learning  curve. Maintain NEUTRAL, FV trimmed slightly to MYR1.49 (from MYR1.50).

• 3Q  results  lacked  any  spark.  Southern  Steel’s  3QFY14  net  profit  of MYR7.5m  managed  to pull the company  out of  the red,  but  cumulative net  profit  of  MYR5.6m  for  9MFY14  only  represented  15.9%  of  our original  full  year  estimate.  The  results  were  below  our  and  street expectations.  The  hike  in  electricity  tariff  by  18.8%  (from  1  Jan  2014)may have capped  the improvement in  3Q  EBITDA margin  to only 5.7% from  5.0%  in  2Q,  we  believe.  Furthermore,  loss  from  associates  also extended into 3Q. Therefore, we  slash  our FY14  profit  estimate  by  49% but keep our FY15 numbers intact.
• RCULS to  improve balance sheet.  The board also  proposed  to issue up  to  MYR209.7m  in  nominal  value  of  five-year  5%  redeemable convertible unsecured loan stocks (RCULS) on the basis of 1-for-2.  The proceeds  are  to  go  towards  part  repayment  of  its  bank  borrowing  and working capital requirements,  however,  we believe this is  to  strengthen its balance sheet after  its  MYR850m spend on its  new hot strip mill.  For the  time  being,  we  expect  the  exercise  to  improve  its  gearing  ratio ,although impact to P&L is expected to be minimal.
• Maintain NEUTRAL.  While management  has  said the Government has taken measures to arrest the influx of cheaper steel products from China, we  think  it  is  still  premature  to  address  the  competition  from  importedsteel,  particularly  in  wire  rods.  Meanwhile,  disclosure  on  the  strip  mill project has been somewhat limited and we project its initial contribution may be marginal –  being  the  first of its kind in the country. As such, we keep  our  NEUTRAL  call,  with  FV  trimmed  slightly  to  MYR1.49  (from MYR1.50), as we lower our earnings estimates but keep valuation based on -1 SD to the stock’s historical five-year P/BV at 0.7x FY15 P/BV. 

Company Profile
Southern Steel is an integrated long steel manufacturer.

Source: RHB