Summary

Angang's profitability improved greatly due to economic recovery and drop iron ore purchase price. At the meantime, the company continues its capacity expanding momentum. Combined with the support of export recovery, we expect its profit of 2009 and 2010 will be RMB2.7billion and RMB6.5billion, suggesting EPS of RMB0.37 and RMB0.90. Recent policy tightness brought big decline of steel stock price, yet we look this decline as a good opportunity of buy. We conservatively give 2xPB of 2010F BVPS and 12m TP of HK$17.68, rating Buy.

Cost advantage improved profitability

According to the 3Qfinancial report released, in the first three quarters, Angang finished revenue of RMB49.2billion, drop 22% y/y; net profit attributable of RMB330million, drop 96% y/y; EPS of RMB0.046. For the 3Q alone, net profit attributable is RMB1.89billion, cut 17%y/y and EPS is RMB0.262.

Declined revenue was mainly due to ASP drop. In the first nine months, domestic steel price dropped 31.6% y/y. In the third quarter, however, the price rebounded obviously, which contributed to the improved profit and offset the loss in 1H09.

At the same time, cost cut largely contributed to performance improvement too. With most of the iron ore from Angang Group, the purchase price was set by the average iron ore import CIF price in last half year, which cut to US$76/ton from US$134/ton h/h in 1H09. Benefited from this, its margin greatly improved with stability which amounted to 23% in the 3Q. We believe this advantage will keep in the 4Q through 1H2010 with high gross margin.

Export rebound being a drive

Steel export has played an important role in domestic balance of steel supply and demand. In 2007 and 2008, direct export crude steel was 69.13million tons and 60.54million tons, 14% and 12% of the total crude steel production respectively. Furthermore, there was 10% export steel with the form of mechanical and electrical products. In 2009, however, export only amounted to 26.11millin tons, 5% of the total and indirect export also cut c.20%.

In the past few months, however, domestic export has warmed supported by economic recovery and oversea market restocking in Europe and America. Steel export in December improved for eight months in an end and net export amounted to 17.8million tons. We believe steel export will continue to improve due to this factor.

Among the listed companies in the sector, Angang's export has always taken a big share, with c.20% before 2008. In 2009, however, its export only covered 2.56% of the revenue, highlighting the crisis's impact. But considering the better outlook of import and export, the adding demand abroad will, we think, propel excessively the performance improvement.

Progressively expanding continues its growth

The company has increased fast since it listed with production adding to near 20million tons from the 2.93million tons ten years ago, with CAGR of 21%. Bayuquan project contributes obviously in recently years, and will launch to produce with full wing in 2010.In the first three years, Bayuquan produced hot rolled sheet of 2.34million tons, steel plate of 0.58million tons with revenue of RMB10.1billion and net loss of RMB 120million. In 2010, Bayuquan is expected to release more production which will not drag its performance yet contribute profit on the background of economic recovery and export rebound.

Furthermore, silicon steel will become the profit increase source in 2010. Angang will add 40,000tons oriented silicon steel and 100,000tons high-grade non-oriented silicon steel and therefore become the third oriented silicon steel manufacturer in mass produce domestic. Given the preferential policy for appliance going to county, we believe downstream market of silicon steel still extends.

Another to be noted, the company recently decided to establish a full holding company in Putian City, Fujian Province--Angang Cold Roll Plate Co. ltd.(Putian) to strengthen the market impacting in SouthEast China. The project is designed with capacity of 1million tons cold rolled sheet annually focusing to house appliance plate as well as auto and construction demand with total investment of RMB3.798billion. We look this as positive to Angang. First, the steel self-sufficiency ratio is only 67.2% in Fujian, with tech-plate production purchased almost from outside while Guangdong and Jiangxi around also short of high-end production. Therefore, this project is positioned to have regional market. Second, it also boasts of transportation convenience of ports, roads and railways.

Profitability will further improve

Angang's profitability is always leading the peer in fact, yet declined in 1H09 for the two impacts: the iron ore purchase price with Angang Group dragged its margin after the international ore price cut; hot rolled sheet and steel plate supply excess while these productions cover 50% of Angang's production.

Looking forward into 2010, we expect its margin will further improve to c.15%, because national steel supply and demand situation will be roughly balanced in 2010 and the steel manufacturers would own stronger capability of bargain. More than that, the plate excess should not be over concerned. Based on historical data, steel price is more related to macro economy. From the policy adjustment in recent two months, domestic economy growth couldn`t rely on construction only. Manufacturing is also expected to recover as construction revival and economic restructure adjustment, which will bring the demand of plate and then the price rise. As the plate takes big share, the price rebound will obviously improve Angang's performance.

Risks

Europe and America still are faced with risks with double dip.

Steel export is bad than expected.

Iron ore purchase price is beyond expected.

Valuation

Based on production expanding and margin improvement, we expect Angang's performance in the next two years will improve stably to finish RMB68.2billion and RMB86.3billion in 2009 and 2010 respectively, net profit of RMB2.7billion and RMB6.5billion, suggesting EPS of RMB0.37 and RMB0.90, BVPS of RMB7.33 and RMB7.78.

The stock price of Angang Steel had revolved around HK$17 since 2H09, which was in line with our last target price expectation. However, the steel stock prices slumped deep recently because of tightened policies. Taking Angang as the example, the share price has fallen 30% around. In our view, Price slump brings buy opportunity. We are inclined to valuate according to the Price/Book value ratio. Tracking the ratio of global, European, American and Japanese metal indexes, We give it the P/B at 2X 2010F BVPS conservatively, and the company's 12-month target price would be HK$17.68. We give Buy rating.

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