Summary

Latest financial report of Chongqing Iron & Steel Company Limited (Chongqing Steel or Company) showed, in Q3, the Company achieved turnover RMB 13.438 billion, rose 48.63% YOY, net profit was about 796 million, gained 96.53% from a year earlier, and EPS for the first three quarters totaled RMB 0.46. Performance in Q3 was better than expectation, while dragged by downtrend industry atmosphere, we lowered forecast for 2009 and 2010.Advantageous products structure, regional industrial diversion continuation and local government’s policy support are the core competitive edges for Chongqing Steel, steel plate is the main resource of revenue and profit, respectively accounted for around 40% and 80% in the total.In the following 1 or 2 years, on the Company’s total revenue and profit structure, with small proportions for Steel sectionss, wire rod, cold-rolled plate, while steel plate products will still be the decisive part.We forecast that the Company’s achieved EPS in 2008 and 2009 will be RMB 0.417 and RMB 0.413, and give P/E 4 x 2009 EPS. Therefore corresponding 12-month price will be HK$ 1.877, 21.10% higher than current price. We give Chongqing Steel “Buy” rating.

Competitive advantages

Chongqing Steel is one of a few steel mills located in Southwest China. Drove by post-earthquake construction, infrastructure demand for this region is getting strong. Other steel makers announced production cut in succession, while Chongqing Steel did not encounter the identical reduction pressures.At present, the Company’s production capacity is about 3.5 million tons. The Company’s steel output was 3.1418 million tons, ranked in around 30 places among domestic steel enterprises in 2007. Expected steel production for Chongqing Steel in 2008 will be 3.5 million tons. After entirely moving into the new plant in 2010, it is estimated that steel output for the Company will reach up to around 5 million tons.On products structure, Chongqing Steel maintains a relative high position in domestic steel plate market. Among its products, steel plates for specific use, including ship and boiler plate, container board, accounts for a high proportion, The ship plate in particular, whose major clients are China’s mainland feasible ship and vessel manufacturers, including Guangzhou Shipyard International Co., Ltd. (extra-feasible tanker, 3-6 million tons), Xiamen Shipbuilding Factory, Nanjing Shipbuilding Factory and others, They have long-term cooperation and stable supply.

On the demand of ship plate industry, according to statistics, in 2007, on aspects of shipbuilding and repair, ship section and ocean project construction, China’s ship enterprises consumed 9.41 million tons ship steel products, with 75% steel consumed by shipbuilding sector. For the 7.11 million tons steel consumed by shipbuilding sector, there were 5.91 tons steel plate, 0.68 million tons Steel sections and 0.52 million other types’ products.Calculated on basis of 158.89 million dwt. contract for China’s ship enterprises, nationwide shipbuilding construction in 2008 will reach up to 25 million dwt., and further rise to 40 million dwt. in 2009.

Furthermore, regional advantage also provides favorable development space for the Company. Chongqing Steel’s target market concentrates in Southwest China, where contributes almost 50% of the Company’s revenue. Due to Renminbi appreciation and labor costs increase and other factors, China’s mainland manufacture and relevant industries are moving from Guangdong, Jiangsu, Zhejiang and other areas to Southwest and Northwest China in trapeziform shape. As the leading acceptance places in Southwest China, geological location of Chongqing and Chengdu provides favorable opportunity for the Company’s further development. Chongqing area is a steel input region in China’s Mainland for a long time, therefore, local government takes steel industry as a pillar industry, plans to move Chongqing Steel to Changshou Yanjia Industrial Zone, meanwhile makes use of the relocation fee (around RMB 1.5 – 2 million/mu) for more than 7,000 mu land in Dadukou District to build a new plant. From 2001 to 2010, Chongqing Steel enjoys the 15% preferential income tax rate for large-scale enterprises in Western Development Drive, meanwhile, the Company’s partial expenditure on domestically made equipments can be used for its corporate income tax credits. These local government supportive policies will considerably reduce Chongqing Steel’s partial operational costs.

Highlighted and sustained profitable Steel plate

Chongqing Steel mainly operate steel plate, Steel sections, wire rod, cold-rolled steel plate and other steel products, with relative diversification. On the structural proportion, Steel plate is the main contributor for the Company’s turnover and profit. Gross margin for Steel plate in 2007 was around 27.12%, much higher than that of Steel sections, wire rod, cold-rolled plate and other products. We estimate that in 2009, steel plate will respectively account for around 40% and 80% in total revenue and profit.

Chongqing Steel has a set of 2,450mm medium plate production line, and product size is 6-40mm×1500-2500mm with 1.2 million production capacity at present. Another set of 4,100mm wide and heavy plate project (ownership capital and banking finance) is under construction, planned total investment is RMB 1.9 billion, in which fixed assets accounts for around RMB 1.87 billion, liquidity is about RMB 30 million, and scheduled production scale is 1.3 million tons/year. After completion, Steel plate production will reach to 3 million tons as a whole. In Q3 2008, the Company’s 4100mm wide and heavy plate project was still under construction, with preliminary inspections took on main equipments, partial non-standard equipments, and electricity-related equipments, meanwhile RMB 859 million were accumulatively invested. Scheduled construction term for wide and heavy plate project was 22 months, suggested little possibility for massive production before 2011, at the same time imposed rare impact on Steel plate production capacity from 2009 to 2010.At the same time, China’s shipbuilding industry presents apparent trend on size expansion and weight reduction, with single ship tonnage keeps rising. At present, there mainly are 150,000 tons or above large scale ship. The largest tonnage has reached up to 300,000 tons or above, demand on wide (3000mm or above ) ship Steel plate (low alloy, high tension Steel plate) is rising significantly. Chongqing Steel shows no obvious production increase sign, while market demand expansion is a bullish factor.

Industrial development greatly impact profitability

AnSteel signed annual ship plate supply contracts with several shipbuilding enterprises, preconditioned “Guarantee amount but not price”, having marketized pricing and offering certain discount and preferential treatment for these enterprise. However, different from Ansteel’s movement, Chongqing Steel mainly through signing supply contracts in batches to realize “Guarantee amount but not price”. Namely, to ensure the supply firstly and then completely adopts marketized pricing. Therefore, market prices swing may significantly influence the Company’s profitability.

Steel products’ prices keep sliding, domestic and foreign demand on steel also dropped continuously, while after getting into the winter, domestic steel plate demand will further shrink, which will also weight steel prices. It is expected that flat steel price can hardly be reversed in a short period of time.In order to simulate economy growth, Chinese government introduced almost 4 trillion investment package in early November. However, the promotion on real estate investment is not evident. In addition, tariff exemption will also hard to boost steel products exportation increase. As a result, steel industry is still likely to sustain the low profit condition in the coming year.Opposite from the continuous mediocre steel industry, new investment keeps flowing into without deceleration. The BaoSteel participated, RMB 19.3 billion invested HanSteel new plant’s phase 1 iron has officially started operation, hence then, Hansteel has the annual production capacity of 4.5 million tons high-grade hot-rolled plate.However, from July, domestic steel price has declined for consecutive 12 weeks until now and dropped by 40%. Previously tight supply automobile and household appliances plates also present demand shrinkage, while steel enterprises and downstream enterprises inventories are comparative large.Steel industry is in the face of over-supply situation, once the large scale investment for the steel mill transferring into actual production, the steel industry with existing surplus production capacity will suffer huge impact and the entire steel industry may be exposed to great crisis.Something worthy of expectation is that minerals ore prices decrease in 2009 is expected to dwarf steel prices drop, for the industrial listing companies, their profitability is hopefully to be improved. Current imported ores portal spot prices have reached to RMB 610 – 680/ton, dropped 59.33% comparing with the beginning of 2008. We forecast that the long-term contract ore will also slide in certain extent to around 30% in 2009. Current steel plate price is about RMB 3,500/ton, possibility for a continuous more than 30% decline in 2009 is rare, therefore, as a major proportion for the steel costs per ton, iron ore prices’ decline exceeds that of steel prices, this may boost the Company’s gross margin.

Valuation

We forecast that EPS for Chongqing Steel in 2008 and 2009 will respectively at RMB 0.417 and 0.413.Current international steel companies’ stock prices are almost closing to 4 times P/E, meanwhile taking the global recession into consideration, we conservatively give the Company P/E 4 x 2009 EPS, with 12-month target price at HK$ 1.877, 20% higher than current price. We give “Buy” rating.