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Maanshan Iron & Steel Company Limited (0323.HK) - Steel price hit bottom and rebounded, thus helping boost the company's performance

Tuesday, February 3, 2009

5205

Maanshan Iron & Steel Company Limited(323)

Recommendation on 3 February 2009
Recommendation	Buy
Price on Recommendation Date	$2.500
Target Price	$4.090

Weekly Special - 000157.SZ Zoomlion

Summary

The domestic iron and steel market went through a big rebound in 2008 Q4. As of Jan 22nd, the steel composite price index rose 9.7% compared to the previous low point, among which long product price index went up 7.3% and flat steel price index up 13.3%. This round of rebound restored to some extent the confidence of steel factory and traders.

Since December, the steel factory's profitability began to increase significantly, and has returned to the lowest position as 2008 beginning. Steel plates and wire rods are its main business contributing operating income and profits, which account for 80%. The rise of steel price especially construction steel and flat steel uphold the company's performance.

Besides, the importance of train wheels and wheel rims business in the company's profit structure is largely increasing. This is because the railway bureau implemented strict quality certification mechanism, which composed huge barrier to the potential competitors of the industry. Train wheel of Ma Steel owns absolute competitive advantage in the industry.

We forecast in 2008 and 2009 the company will realized EPS of RMB 0.35 and RMB 0.60, based on 6 times of P/E in 2009, we estimate its 12-month target price at HKD 4.09 and recommend to “buy”.

Steel price hit bottom and rebound, hope to uphold company's performance

The main business of Ma Steel is construction steel. After several years' of product mix adjustment and New Area construction, the company is now capable of producing seven category of steel products including hot-rolled plates, cold-rolled plates, galvanized plates, cold-rolled silicon steel, medium plates, heavy section steel, high-speed wire rod materials and wire rods and more than 500 types of steel products. Its products are relatively diversified. The domestic leading iron and steel manufacturers such as Bao Steel, An Steel and Wisco seldom or almost never produced wire rod products which are at less entry, low engineering level and low value added, but for Ma Steel, wire rod products are its traditional business and it occupies a very significant position in the company.

In view of Ma Steel's segment operating income in 2008, steel plates and wire rods are its main segments contributing operating income and profits. In 1H08, the operating income of steel plates and wire rods accounts for 49.12% and 29.31% respectively of the total, and we forecasted in 2009 the operating income of steel plates and wire rods will account for 80% around of the total.

For the upcoming long period, steel plates and wire rods will still have critical impacts on the company's overall operating income and profit. The fluctuation of steel price will directly determine the company's fundamental aspects and is the most important index to watch over.

In view of domestic steel demand in 2009, the government is taking measures to stimulate the economy, which will make up for the voluntary sliding demand from the downstream industries. The progress in implementation of 4 trillion investment plan will determine the change of demand for steel, one half will be put into the sectors like property, communication and airport, which will directly increase the demand. From Q1 to Q3 in 2008, China's urban fixed asset investment reached 9.99 trillion, and the relative steel demands were 350 million tons. Simply estimating, the 2 trillion investments will bring up the demand of about 100 million tons. Thereafter, the mainland steel market is far from saturation, and the long product and plat steel price will go up largely from the level of 4Q08. For Ma Steel, the section steel and wire rods are the necessary steel types for the investment plan, which are good for the company's performance.

With regard to the profitability, because of the sharply declining domestic steel price in 2H08, the upstream material products present a weak market, the prices for iron ore, coal and coke went down continually. We forecast the imported iron ore contract price will decrease over 30%, which will uphold the profitability by reducing the smelting costs.

Significance of train wheels and wheel rims business largely increased in company's profit structure

The trial operation of Ma Steel's core project of train wheel expansion and reconstruction – the third wheel rolled production lines will drive Ma Steel's high speed train wheel output reach 1.1 million units, and becoming the largest train wheel manufacturer in the world.

In addition, the railway bureau carried out strict quality certification mechanism, which constructs huge barrier to the industry's potential competitors. Currently, there are only 4 train wheels manufacturers certified by the railway bureau in mainland, and Ma Steel's train wheels occupies absolute competitive position in the market: its market ratio in railway passenger train wheels and cargo railway train wheels reached 90% and 50% respectively.

In view of urban railway transportation, the number of multiple units train and urban railways and subways in mainland by 2010 will reach 8333 units (about 1042 trains) and 12000 units respectively, three-year composite growth rate to be 94.47% and 45.76% respectively. In 2009 the purchase and rebuild demand for multiple units train and urban railway and subway in mainland will be 1.2 million units, corresponding to 400K ton, representing a yoy growth of 33% around.

The industry of train wheels and wheel rims has unique pricing mechanism. The biggest buyer of train wheels is the Ministry of State Railway. As the most important customer, the Ministry of State Railway carried out strict certification mechanism for manufacturing of railway equipment. Its purchase is made through bidding or negotiatable bidding (negotiatable bidding refers to the way of final pricing after communication and negotiation by the railway ministry and the customer based on the history price). Project trading center of the Ministry of State Railway is responsible for bidding collectively. The bidding is not subjective to “win by lowest price”, the project trading center will examine the manufacturers' past performance and business scale and etc. Thus, the overall industry is relatively low market oriented. The unique pricing mechanism decided that the price of train wheels receives less impact from steel price fluctuations. The sales price has shown steady wind up trend in past years.

In 2009, benefited from the enlarged productivity and the hot demand, the sales of train wheels and wheel rims for Ma Steel will increase rapidly. The average sales price under such unique pricing mechanism will remain stable, only seeing a slim decrease. We forecast Ma Steel will sell 300K ton of train wheels and wheel rims in 2009. Basing on the average sales price at around RMB 10000/ton, the operating income will get a yoy growth of 7%.

Technical analysis

Per above chart, the current price has got ride of the axle line of pressure in the large drop channel, but it has also broken through the support of under line in the new up channel, not seeing obvious support. Besides, during the period of dipping into bottom and rebound, the trend shows a small head and shoulders bottom, it still needs to confirm if neck line could further support and drive the price further up.

The recent trend has broken through the 60 days' moving average line, moreover, the 5, 10 and 30 days' moving average lines have all lined up in bear, there is not big possibility that the price will go strong in the short term. But in view of the pressure chart, the current share price has sit at the biggest support line of a long period, also at the 2.5 year' platform of Mar end 2004 to Sept end 2006. Therefore, there's not too much room for a further drop. Considering the company's fundamentals have started to turn good, it is worth expecting a good performance in the near future.

Financial Date

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