Key highlights from our recent meeting with HTVB’s management include (i) near-term earnings headwinds remain, with China holding the key to recovery. Longer term prospects remain favourable, supported by China’s policies to reform its steel sector will result in more stable profitability among steel players in the region, (ii) Phase 2 of ESSB’s is scheduled for completion and commissioning by end-Jul, and (iii) ESSB’s major expansion plan has started and on track for completion by early-2024. We maintain our FY22 core net profit forecast, but cut our FY23-24 core net profit forecasts by 18.8% and 18.2%, respectively, mainly to account for lower associate earnings assumption. Post earnings revision, we maintain our BUY rating on HTVB with a lower TP of RM0.52 (from RM0.63 earlier) based on 7x revised CY2023 EPS of 7.4 sen

Recap on 3QFY22 results. 3QFY22 core net profit fell 53.0% YoY to RM30.7m, as higher sales volumes at both trading and manufacturing segments were more than offset by higher costs of inventories. Earnings contribution from ESSB (Eastern Steel, a 27.3%-owned associate) declined by 83.2% to RM3.3m in 3QFY22, dragged mainly by lower average selling price, high steelmaking input costs (in particular, iron ore) and shareholding dilution (from 35% to 27.3% since Nov-21).

Near term earnings prospects remain uncertain; China holds the key to steel price recovery. Management shared that near term earnings prospects will remain uncertain, due to (i) ongoing tension between Ukraine and Russia with sanctions imposed on Russia resulting in Russian steel products flooding the global market at low prices, while European region re-directing its coal demand from Russia to Asia. These have resulted in a mismatch between prices of steel and coking coal (the main source of energy in blast furnace); (ii) growing recession fears resulting in cautious business and consumer sentiment; and (iii) weak construction activities domestically (which management expects to only improve from 2024 onwards). Having said the negatives, management reckons China holds the key with expected economic recovery given its authority's concerted efforts in re-suscitating economic growth and gradual re-opening of borders with easing concerns on Covid, which will help underpinning demand for steel. Over the longer term, China’s (the world’s largest steel producer and consumer) policies to reform its steel sector will result in more stable profitability among steel players in the region.

Phase 2 of coke oven plant to complete by end-Jul. We understand that phase 2 of ESSB’’s (Eastern Steel, a 27.3%-owned associate) is scheduled for completion and commissioning by end-Jul. While narrower price spread between coking coal and coke has resulted in diminished cost savings from coke oven plant over the past few months, management remains optimistic on the longer term economic viability of its coke oven plant investment (particularly, when coking coal supply improves).

Status on ESSB’s expansion plan. We understand ESSB’s major expansion plan has started. Slated for completion by early-2024, the capacity expansion plan will transform ESSB into an integrated steel producer, with (i) an enlarged steelmaking capacity to 2.7m tonne p.a. (from 0.7m tonnes p.a. currently), and (ii) a HRC plant (with a rated capacity of 2m tonnes p.a.).

Forecast. We maintain our FY22 core net profit forecast, but cut our FY23-24 core net profit forecasts by 18.8% and 18.2%, respectively, mainly to account for lower associate earnings assumption (arising from narrower spread between prices of steel products and raw materials).

Maintain BUY, with lower TP of RM0.52. Post earnings revision, we maintain our BUY rating on HTVB with a lower TP of RM0.52 (from RM0.63 earlier) based on 7x revised CY2023 EPS of 7.4 sen. Despite the near-term earnings headwinds, we continue to like HTVB for its (i) favourable longer term prospects (supported by ESSB’s major expansion plan, and China’s policies to reform its steel sector, which will result in more stable profitability among steel players in the region), (ii) healthy balance sheet (net gearing of 0.17x as ar 30 Apr 2022), and (iii) commendable valuations. At RM0.305, HTVB is trading at current P/B of 0.42x (which is 0.5x standard deviation below its 5- year historical average).

Source: Hong Leong Investment Bank Research - 4 Jul 2022