Summary

The increase of Angang Steel's products were below the market average and the steelmaking cost kept rising in 1H11, dragging the Company's profitability, which has kept low, and its net profit was down 92% y/y to RMB220 million. Looking forward into 2H11, the plate demand could not be optimistic, but crude steel capacity limitation may drive up steel prices, expected to hedge the rise of iron ore price. We expect the Company to realize net profit of RMB1.243 billion in 2011 and RMB1.809 billion in 2012, which is converted to EPS of RMB0.17 and RMB0.25 respectively, and the BVPS will hit RMB7.49 and RMB7.66. Considering its valuation standing at low level in past years, we give it 1X P/B of 2011F BVPS and the 12-month target price of HK$9.03, rating Hold.

Cost pressure inhibited the performance in 1H11

Performance notice recently released by Angang Steel indicates its net profit attributable to shareholders dived from RMB2.75 billion a year ago to RMB220 million in 1H11, at 92%, EPS slumped from RMB0.38 to RMB0.03. The drastic decline was mainly caused by the reason that gains brought by steel hikes were far from covering cost rise caused by raw material and fuel hikes. Meanwhile, the new 1# blast furnace trouble shooting drove down the March-May output below expectation, and consequently H1 output below expectation.

Although most plate prices rose, e.g., hot rolled plate and medium plate prices rose by over 13%, but cold rolled plate prices declined. Furthermore, the price adjustment of Angang Steel's products lagged behind, so its prices were lower than the average market price. The hot rolled plate hiked by only 7%, but cold rolled plate fell by 7%.

Against constant all-time highs of China's steel output, production cost of steel mills kept rising. By July 8, Grade 2 metallurgical coke spot prices accumulatively rose by 10%, up 16% y/y, and scrap steel accumulatively rose by 18%, up 30% y/y. Although the price of iron ore purchased from the group company was relatively favorable, it is noteworthy that iron ore spot price rose by 25% in Benxi in 1H11, far from the 14% rise over imported iron ore, which means increasing cost pressure over some of the Company's spot iron ore.

Plate demand not optimistic, but steel price may have support

Angang Steel's product mix is primarily steel plate, and sales of hot rolled plate, cold rolled plate and medium plate made up 85%-88% in recent three years. However, as national plate capacity expanded by a large margin over recent years, their supply-demand situation and profitability were not as good as long products. Take 1H11 as an example, although the total inventory of steel products declined from the peak 18.9 million tons in early March to 14.05 million tons, down 25%, long products and plate performed differently. By July 8, steel bar and wire rod inventory declined from the peak by 29% and 52% respectively, while hot rolled plate, medium plate and cold rolled plate declined by 18%, 13% and 2% respectively. By comparison, cold rolled plate inventory rose by 16% y/y, the worst performer.

From demand perspective, growth of global key economies slows down, and the debt crisis also inhibits demand. In China, with disappearance of the stimulus policy effect and rising fuel cost, H1 car output started to slide from the high level, which broke the past decade rule, namely, H1 next year car output is generally higher than H2 of the last year.

However, from previous sales of home appliances and washing machines, the busy season is generally in H2. Also, completion of millions of public housing flats is expected to stimulate home appliance demand. We believe the plate demand situation will be neutral in 2H11.

However, be noted that in early July the Ministry of Industry and Information published a list of enterprises to phase out outdated capacities in 2011 for 18 industries, but the phase-out index rose from the May-published information, e.g., iron smelting rose from 26.53 million tons to 31.22 million tons, steel melting rose from 26.27 million tons to 27.94 million tons, up 17% and 5.2% respectively. According to the plan, by the end of 2011, domestic crude steel capacity will be 770 million tons, slightly up 1.07% y/y. Therefore, H2 steel supply can hardly grow substantially and the US may launch QE3 policy, which may brace up steel prices.

Cost pressure remains heavy

Looking forward 2H11, we believe Angang Steel will still face big cost pressure: first, iron ore needed by the company is purchased from its group company in the form of related party transaction, and the pricing model is 5% discount of the average iron ore CIF port of the previous half year. From the average iron ore import price at Qingdao port, the 2H11 iron ore pricing benchmark of related party transaction will rise by over 10% from 1H11, cost pressure will remain heavy.

Second, resource tax reform may drive up coke cost. Future coal resource tax levy method may not change, but resource tax rate will rise from RMB0.30-5.00 per ton to RMB0.30-8.00 per ton.

Combining steel price and cost estimation, we predict Angang Steel's profitability will remain weak and gross margin will stay between 5%-10%.

Risks

Global economy becomes weaker than expected;

Steelmaking cost increases substantially.

Performance cautiously optimistic, continuously hold

The steel plate demand can hardly be optimistic in 2H11, but crude steel capacity limitation may drive up steel prices. We expect the company to realize turnover of RMB103.2 billion in 2011 and RMB106.6 billion in 2012, net profit of RMB1.243 billion in 2011 and RMB1.809 billion in 2012, which is converted to EPS of RMB0.17 and RMB0.25 respectively, the BVPS will hit RMB7.49 and RMB7.66.

Due to drastic fluctuations of cyclical industries` performance, we`d like to take the P/B method to perform the valuation. Referring to global peers of Angang Steel, the P/B of large steel mills and plate manufacturers is below 1X nowadays. Considering the Company's valuation standing at low level in past years, we give it 1X P/B of 2011F BVPS and the 12-month target price of HK$9.03, rating Hold.

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