What to look at?
1. Price-to-book value (PBV)
Analysts say the PBV measurement is a more indicative of the performance of the steel sector, although the common measurement of the performance of a stock is the P/E ratio. This is because the earnings of steel players can be very volatile. The current down-cycle in the steel industry has shown that players are experiencing PBVs similar to those seen in 2008 and 2009, during last global financial crisis. Most analysts say a good way of evaluating a stock is to compare the company's current PBV with that seen in the last global financial crisis. If it is much lower, it means the stock might be undervalued. The PBV of steel players is between 0.2 and 0.8 times currently.
2. Gearing level
As the steel sector is considered capital-intensive, steel companies tend to have higher borrowings compared to their counterparts in other industries. The gearing levels are averaging about 1 time here. The levels are quite manageable, although they are still higher compared with Chinese steel companies listed in countries such as Hong Kong, which are currently about 0.4 times and 0.5 times. One reason why a company's gearing levels could be higher than usual is that it may be looking to expand. However, the returns made on the expansion should be reflected as soon as possible. For instance, Ann Joo Resources completed a new electric arc furnace last October - the first in the Asean region. "We always had levels below 1 time, but it is now slightly higher at about 1.4 times because of the furnace. Things should stabilise by 4Q2012. If there is no fresh expansion, a gearing of above 2 times for steel companies should be examined closely by the investors," says Datuk Lim Hong Thye, its group managing director. The rule of thumb is to be on the alert when gearing levels exceed 1.5 times.
3. Inventory management
Inventory management is just as important because this is a cyclical industry. Companies have to tread a fine balance between holding enough just before demand picks up and not holding too much. "If a company holds too much inventory and prices come down, they will make losses. It is considered prudent if a company keeps within two to three months' worth of inventory. If they keep stock of up to five or six months, they could be taking on a risky directional bet.
4. Strategic tie-ups
Other non-valuation indicators would be news of tie-ups and collaborations with strategic foreign investors, which are increasing in popularity among companies. Such tie-ups are expected to be positive for steel companies. "For example, Ann Joo Resources tied up with Tangshan Iron and Steel Company Ltd of China to build their blast furnace. Hiap Teck Resources Bhd has teamed up with Jinan Iron and Steel Group Corp to construct a new slab plant while Lion Industries has been trying to get suitors to invest in its blast furnace project."
Steel Industry in Malaysia
The steel industry in Malaysia can be divided into two segments - the long steel products and the flat steel products.
Long products are commonly used in the construction industry and include items such as rods, tubes, bars, wires and rails. The flat steel products are cold-rolled coils, hot-rolled plates and sheets, and boiler and pressure vessels. They are commonly used in the automotive, aviation, manufacturing, construction, appliances and oil and gas businesses.
In the long steel segment, the major integrated players are Lion Industries, Ann Joo, Southern Steel Bhd, Kinsteel Bhd, Perwaja Holdings Bhd and Malaysia Steel Works (KL) Bhd. The only flat steel integrated player is Megasteel Sdn Bhd, which is a subsidiary of Lion Industries. Integrated players produce steel products right from the raw material stage, mainly for local consumption.
In flat steel segment, Megasteel is the only producer of hot-rolled coils (HRC) and plates in the country. Its monopoly is further strengthened by the 20% import duty imposed by the government on high-grade iron and steel products in 2002. Those in industries such as automotive, electrical and electronics, oil and gas, shipping, iron and steel furniture are exempted from this tariff.Companies that still want to import these steel products are required to apply for special import licenses or approved permits (AP). Secondary steel producers that are listed on Bursa Malaysia include Mycron Steel, CSC Steel Holdings Bhd and Yung Kong Galvanising Industries Bhd.
Abstracted from: Investing in local steel stocks, Personal Money, October 2012