CSC Steel Holdings Bhd TP: RM1.70 (+19.7%)

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1 I N I T I A T E C O V E R A G E Thursday, March 22, 2018 FBMKLCI: 1, Sector: Building Materials, THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* CSC Steel Holdings Bhd TP: RM1.70 (+19.7%) An Attractive Dividend Yield Play Last Traded: RM1.42 BUY Chan Mun Chun Tel: mcchan@ta.com.my We initiate coverage on CSC Steel Holdings Berhad (CSC) with a Buy recommendation. We derive our target price of RM1.70 based on a target PE multiple of 10x. This represents a potential total return of 26.3% (including a 6.6% estimated dividend yield). CSC is principally involved in manufacturing of flat steel products, which include Pickled and Oiled Steel (PO), Cold Rolled Coil (CRC), Galvanized Steel (GI), and Pre-painted Galvanized Steel (PPGI). Investment case: Dominant position in Cold Rolled Steel Products; Protection from anti-dumping duties; and Healthy balance sheet with attractive dividend yield. Forecast We estimate the company to record core profit growth of 7.7%, 2.7% and 1.5% to RM64.4mn, RM66.2mn, and RM67.1mn for FY18, FY19 and FY20 respectively, supported by higher plant utilization rate. The Malaysia operation will still remain as the main revenue generator and we foresee the revenue contribution from other regions will remain flattish. Nevertheless, we believe this stock remains as an attractive dividend yield play due to its generous dividend policy of paying not less than 50% of its annual profit after tax, together with its consistent profit track record, with FY14 as the only exception. Valuation We initiate coverage on CSC with a target price of RM1.70, based on 10x CY18 EPS. With a potential upside of 19.7%, we recommend a BUY call on CSC. Earnings Summary Share Information Bloomberg Code CSCS MK Bursa CSCSTEL Stock Code 5094 Listing Main Market Share Cap (mn) Market Cap (RMmn) wk Hi/Lo (RM) 2.05/ mth Avg Daily Vol ('000 shrs) Estimated Free Float (%) 36.1 Beta (x) 0.7 Major Shareholders (%) China Steel Asia PAC Lembaga Tambung Haji Tan Kit Pheng Forecast Revision FY18 FY19 Forecast Revision (%) - - Net profit (RMm) Consensus (RM'mn) TA's / Consensus (%) Previous Rating - Financial Indicators FY18 FY19 Net Debt / Equity (%) net cash net cash CFPS (sen) Price / CFPS (x) ROA (%) NTA/Share (RM) Price/NTA (x) Share Performance (%) Price Change CSCSTEL FBM KLCI 1 mth (11.8) mth (6.6) mth (19.3) mth (21.2) 6.3 (12-Mth) Share Price relative to the FBM KLCI Source: Bloomberg Page 1 of 16

2 About the Company CSC Steel Holdings Berhad (formerly known as Ornasteel Holdings Bhd) is principally involved in manufacturing of flat steel products. The group was incorporated in Malaysia on 20 January 2004, and subsequently it was listed on the Main Board of Bursa Malaysia Securities Berhad on 30 December Based on the value chain of the steel industry, the group is considered as a midstream player that imports raw materials from the upstream steel players and sell it to the downstream steel manufacturers. The main source of its revenue is generated from 4 main core products, which are PO, CRC, GI, and PPGI. The GI products are sold under the brand name Realzinc and Realzinc Enhance whereas the PPGI products are sold under the brand name Realcolor. Exhibit 1: Core Products and Applications Source: Company, TA Research The core products mainly serve the steel service centres, drum makers, roll formers for roof sheet and cladding, and pipe and tube makers. The sales revenue is mainly domestic driven with about 18% of export sales for FY16. The group has only one manufacturing plant in Melaka with a total capacity to produce 480,000mt (inclusive 40,000mt of PO) of cold rolled steel. The group also has the capacity to produce 240,000mt of GI and 120,000mt of PPGI annually. For more information on products and services, please refer to Exhibit 13. Page 2 of 16

3 The Shareholders and Management 22-Mar-18 The management is led by the Group Managing Director, Mr. Chen Huo-Kun, who has more than 30 years of working experience in steel manufacturing industry as he had been employed with China Steel Corporation, Taiwan since 1983 before being appointed to the Board of CSC in He is supported by Executive Director cum Vice President of Finance Division, Mr. Tan Chin Teng, who is mainly responsible for the group s finance & accounting function. He has more than 30 years of finance and accounting experience of which more than 25 years are in a managerial position overseeing financial matters. Besides, the management team also includes Mr. Hsu Tse-Wei, Vice President of Production Division, Mr. Ten Ling Piew, Vice President of Commercial Division, Mr. Koh Kang Huan, Assistant Vice President of Product Division, and Mr. Juang Der-Feng, Assistant Vice President of Product Division. All of them have vast working experience for their respective functions. Based on latest available data, the group is 46.3%-owned by China Steel Corporation, which is the main shareholder and supplier of raw materials to CSC. Investment case Dominant position in cold rolled steel products; Protection from anti-dumping duties; and Healthy balance sheet with attractive dividend yield. Dominant Position in Cold Rolled Steel Products The temporary closure of Megasteel, which used to be the largest cold rolled steel player in Malaysia with a production capacity of 1.45mnmt, presented a great opportunity for CSC together with other smaller cold rolled steel producers to fill in the supply gap. Exhibit 2: Plant Capacity of Domestic Cold Rolled Steel Players Exhibit 3: Installed Capacity of Domestic Cold- Rolled Market Source: Malaysia Iron & Steel Federation (MISIF), TA Research *Megasteel has ceased its operation since year 2016 Source: MISIF, TA Research Excluding the installed capacity from Megasteel, with the annual cold rolled steel production capacity of 480,000mt, CSC has since become the dominant cold rolled steel player by enjoying 45% share of the estimated total annual production capacity of 1.06mnmt. Page 3 of 16

4 Exhibit 4: Domestic Cold-Rolled Sheets and Coils Source: MISIF, TA Research Based on our channel checks, the current annual consumption for cold-rolled sheets and coils in Malaysia is hovering about 1.6mnmt but the domestic actual annual production is only about 700,000mt 800,000mt. The gap has been consistently filled in by imports, partly due to the grades and qualities, which are not available locally. The wide supply and demand gap has presented an attractive opportunity for the domestic cold rolled steel players. With the temporary absence of Megasteel and potential more stringent safeguard measures to be implemented in due course, the domestic cold rolled steel players are expected to fill in the supply gap. We believe CSC, being the dominant cold rolled steel player in Malaysia, will set to benefit the most. Exhibit 5: Overall Plant Utilisation Rate of CSC Source: Company, TA Research Based on latest available data from management, the plant utilization rate has been consistently surpassed 80% for the past few years. We believe the utilization rate will continue to improve due to strong demand and wide applications of cold rolled steel products given that limited large-scale cold rolled steel players in Malaysia. Previously, Megasteel was the major supplier of Hot Rolled Coils (HRC), the major raw material, for the domestic cold rolled steel players. The shutdown of Page 4 of 16

5 Megasteel has created some impacts to the domestic cold rolled steel players as they need to source the raw materials from foreign countries, which require longer lead time. Hence, one of the core competitive advantages CSC has over its competitors is it can enjoy the benefit of uninterrupted supply of raw materials from its major shareholder, China Steel Corporation, and its related companies in Vietnam, which are the upstream players that involve in iron and steel making. Therefore, with the support from the parent company in terms of raw materials, technology, management and technical expertise, CSC manages to become one of the most efficient cold rolled steel players in Malaysia. 22-Mar-18 Exhibit 6: Price of Hot Rolled Sheet vs. Cold Rolled Sheet in China Source: MISIF, TA Research Since China is the largest steel producer in the world, it sets the benchmark for the international prices. The spread between the HRC and CRC may provide good reference point on the potential margin that cold rolled steel players may be able to extract. Generally, the price of steel products have been trending up ever since the capacity elimination exercise in China. The spread has been stabilising for the past 2 years, giving some indications that the future earnings for cold rolled steel players may likely to maintain, as China has reaffirmed its commitment to perform the supply-side reform. Protection from Anti-Dumping Duties Due to petitions filed by some of the cold rolled steel players, Malaysia government has finalised several safeguard measures in order to provide additional layer of protection to the domestic flat steel players. Exhibit 7: Anti-Dumping Duties Imposed by Malaysia Source: MISIF, MITI, TA Research Page 5 of 16

6 Given most of the core products under CSC are protected under the antidumping duties, we believe the group is the primary beneficiary from safeguard duties as it should help them to ease off the competition from China, Korea and Vietnam. However, the media recently reported that the domestic cold rolled steel players were complaining about the increasing cold rolled steel imports from India and Japan as it had been hurting the industry. As a result, the domestic cold rolled steel players have recently filed a petition to the Ministry of International Trade and Industry (MITI) with the following proposed measures: Restrictions on imports or the implementation of quotas; Import licensing by MITI; Anti-dumping duties be made retrospective to the date of the breach; Any application for cold rolled steel imports be made through Mesyuarat Mingguan Besi Keluli (a technical committee to evaluate import duty exemption applications for raw materials of iron and steel products); and An independent, tier-one audit firm be appointed to ensure importers do not manipulate specifications or quality standards. The final decision will be made in due course. Should any of the proposed measure is being materialised, it will provide some relief to the domestic cold rolled steel players. We expect CSC, being the domestic market leader with about 45% share of the total production capacity in cold rolled steel, to benefit the most as it will help to maintain its margin and profitability. Healthy Balance Sheet with Attractive Dividend Yield Since steel industry is highly cyclical and the profitability is highly correlated with the international steel and raw material prices, having solid balance sheet could act as a buffer to withstand any shock from the market dynamic. We notice that CSC has been in net cash position since Based on the latest 4QFY17 results, the group does not have any borrowings with a net cash per share of RM44sen. In addition, CSC has fixed a dividend policy of paying not less than 50% of its annual profit after tax. Exhibit 8: Historical Dividend and Dividend Payout Ratio Source: Company, TA Research If we assume a constant dividend payout of 55% for FY18-FY20 respectively, it will translate into 9.3sen/share, 9.6sen/share and 9.7sen/share, or dividend yields of 6.6%, 6.7% and 6.8% for FY18, FY19 and FY20 respectively. Page 6 of 16

7 Target Market More than 80% of CSC s sales revenue is derived from domestic market. Its primary local customers are service centres, drum makers, manufacturers, and pipe and tube makers. Meanwhile, we believe export sales will remain flattish as we foresee more and more countries might be implementing anti-dumping measures in order to protect their local steel players from dumping of steel products. Moving forward, we believe the group will put more effort in promoting the value added products such as GI and PPGI as both products are able to generate better margins. Industry Outlook Being a mid-stream steel player, the outlook of CSC is highly dependent on the raw materials cost and the momentum of its downstream customers from various segments such as automotive and manufacturing industries. Since the steel consumption for cold rolled steel products is expected to remain firm at about 1.6mnmt per annum, with the domestic annual production of 700,000mt 800,000mt, we believe the market demand is sufficient to be shared among the few domestic cold rolled steel players. While we are slightly concerned on the cheap influx from foreign countries, we believe Malaysia government will intervene if there are evidences that the local cold rolled steel players are significantly affected by the dumping activities. On the other hand, China has reinforced its commitment to perform the supply-side reform on its steel industry, which will provide a strong support to the steel prices. According to the media, China had already eliminated 76.7% of its targeted 150mnmt of capacity cut on the general steel production. Nevertheless, the implementation of hefty import tariffs against all the steel products imported into US is expected to affect the global steel trading landscape. Thus, the international prices for all the steel products are expected to be volatile. Financial Performance Exhibit 9: Historical and Projected Financial Performance Source: Company, TA Research Page 7 of 16

8 For FY12-FY16, CSC s revenue had been consistently hovering between RM1bn and RM1.2bn. However, the net profit fluctuated in tandem with volatility in the prices of steel products. For FY12, the group s net profit declined 5.2% YoY to RM28.0mn from RM29.6mn as the prices of flat steel products had generally trended downward. In the subsequent year, the group managed to maintain similar net profit of RM29.4mn as the steel prices remain depressed due to oversupply of steel products internationally and the influx of cheap imports into Malaysia. Net margin was relatively low at about 2% level. FY14 perhaps was a challenging year for CSC as it had incurred first net loss of RM7.8mn since it was listed from The financial performance was still highly affected by the imbalance of demand and supply globally due to dumping from China, which had caused the steel prices to tumble. The impact of unsustainably low pricing environment had caused steel producers worldwide, including CSC to bleed. To rub even more salt to the wound, the exports sales of CSC remained lacklustre due to weakening currencies of major economies in the South East Asia region. Nevertheless, the group still managed to maintain more than 80% of plant utilisation rate as the group adjusted the product mix accordingly and focused on promoting coated steel products in order to cater for wider market segments. The group returned to the black in FY15 by recording net profit of RM39.1mn. This was a result of lower material cost as the group sourced lesser higher priced HRC locally due to supply disruption from the domestic HRC supplier. The gross profit margin shot up to 7.6% in FY15 from 1.0% in FY14 although steel prices remained at depressed level. For FY16, the group recorded a strong performance as net profit surged 75.8% YoY to RM68.7mn as a result of further reduction in cost of production as the group shifted to source more HRC from its major shareholder instead of relying on the domestic supply. This can be evidenced from the expansion of gross margin to 10.0% from 7.6% a year ago. For the following year, the group posted an impressive 27.8% YoY increase in revenue to RM1,323.3mn thanks to higher steel prices, despite sales volume was marginally lower. However, the higher steel prices also resulted in higher raw material cost since the group was using HRC as the main feedstock to produce all the core products. Coupled with higher overhead and distribution costs, the net profit declined 12.9% YoY to RM59.8mn. Moving forward, we expect the group would be able to maintain its earnings backed by i) sustainable domestic demand for cold rolled steel products, ii) capacity elimination from China, and iii) existing or new anti-dumping duties protection in Malaysia. Capex As far as capex is concerned, we expect CSC to allocate about RM20mn to RM30mn a year for maintenance capex and plant automation. Forecast We estimate the company to record core profit growths of 7.7%, 2.7% and 1.5% to RM64.4mn, RM66.2mn, and RM67.1mn for FY18, FY19 and FY20 respectively, supported by higher plant s utilization rates of 90%, 91% and 92%. The Malaysia market is expected to remain as the main revenue generator for CSC and we foresee the revenue contribution from other regions to remain flattish. We see CSC as an attractive dividend yield stock due to its generous Page 8 of 16

9 dividend policy with a dividend payout ratio of not less than 50%. 22-Mar-18 All in, our FY18-20 earnings projections are premised on the key assumptions below: Exhibit 10: Key Assumptions for Earnings Projections Source: TA Research Key Risks Potential risks to our recommendation include: i) Dumping from Foreign Countries The current anti-dumping duties are only applied to selected countries such as China, Vietnam, and South Korea. Therefore, there is a potential risk that increasing import from those foreign countries that are exempted from current duties will affect the profitability of the domestic cold rolled steel players. ii) Escalation of Raw Material and Energy Cost CSC is currently relying heavily on HRC, zinc, electricity and natural gas for its manufacturing processes. As such, the group is exposed to the risk of escalation of raw materials and energy cost, which might adversely affect its margin, if it is unable to pass on the cost escalation to its clients. iii) Foreign Exchange Risk Given the major raw materials such as HRC and other chemical substances together with the export sales are denominated in USD, the fluctuation of USD against MYR will affect the bottom line of the group. Valuation Peer comparison is made between CSC with other cold rolled steel players listed on Bursa Malaysia. We have assigned a target PE multiple of 10x for CSC after considering: a. Dominant position in cold rolled steel industry with 45% share of the estimated total industry production capacity; b. Strong support from its major shareholder, an integrated steel player, for raw material sourcing, technical and management expertise; c. Attractive dividend policy with minimum 50% of pay-out ratio; and d. Healthy balance sheet with net cash of 44sen/share. We derive a target price of RM1.70, based on 10x CY18 EPS, and initiate coverage on CSC with a BUY recommendation. Page 9 of 16

10 Exhibit 11: Peer Comparison Stock Share price Market Cap EPS* P/E ratio DPS Div Yield^ Net gearing P/B ratio (RM) (RMmn) (sen) (x) (sen) (%) (%) (x) MYCRON Net Cash 0.3 YKGI N/A EMETALL AVERAGE CSC Net Cash 0.6 Note: *based on latest 4 rolling quarters of core earnings ^based on previous financial year [THE REMAINING OF THIS PAGE IS INTENTIONALLY LEFT BLANK] Page 10 of 16

11 Earnings Summary Profit & Loss (RMmn) Balance Sheet (RMm) YE Dec 31 (RMmn) F 2019F 2020F YE Dec F 2019F 2020F Revenue Fixed assets EBITDA Others Dep. & amortisation (32.6) (34.2) (31.9) (30.9) (30.0) NCA Net finance cost Cash PBT Others Taxation (13.4) (16.3) (19.2) (19.8) (20.0) CA Net profit Core net profit Total assets GDPS (sen) Div Yield (%) ST borrowings Other liabilities Cash Flow (RMm) CL YE Dec F 2019F 2020F Shareholders' funds PBT LT borrowings Non cash expenses Other LT liabilities Non Operating expenses (18.3) (18.5) (19.2) (19.8) (20.0) NCL Changes in WC 9.4 (142.1) 59.5 (13.7) (21.8) Total capital Operational cash flow (43.9) Capex (26.4) (21.9) (25.0) (25.0) (25.0) Ratio Others (15.6) YE Dec F 2019F 2020F Investment cash flow (42.0) (14.3) (17.2) (17.2) (17.2) EBITDA Margins (%) Debt raised/(repaid) Core EPS (sen) Dividend (29.5) (51.7) (35.4) (36.4) (36.9) EPS Growth (%) 76.5 (13.1) Others (0.1) PER (x) Financial cash flow (29.6) (50.3) (35.4) (36.4) (36.9) GDPS (sen) Forex effect Div Yield (%) Net cash flow 38.1 (108.5) Beginning cash Net cash (RMmn) Ending cash Net gearing (%) (33.3) (19.7) (30.3) (31.8) (32.2) ROE (%) ROA (%) NTA (RM) P/NTA(x) Page 11 of 16

12 Appendix: Exhibit 12: Corporate Structure Source: Annual Report 2016 Page 12 of 16

13 Exhibit 13: Core Products and Applications Page 13 of 16

14 Source: Company, TA Research Page 14 of 16

15 Exhibit 14: Overview of the Manufacturing Process Flow Source: Company Website Exhibit 15: Manufacturing Process Flow for Hot-Dipped Galvanized Steel Source: Company Website Page 15 of 16

16 Exhibit 16: Manufacturing Process Flow for Pre-Painted Galvanized Steel 22-Mar-18 Source: Company Website Stock Recommendation Guideline BUY : Total return within the next 12 months exceeds required rate of return by 5%-point. HOLD : Total return within the next 12 months exceeds required rate of return by between 0-5%-point. SELL : Total return is lower than the required rate of return. Not Rated: The company is not under coverage. The report is for information only. Total Return is defined as expected share price appreciation plus gross dividend over the next 12 months. Gross dividend is excluded from total return if dividend discount model valuation is used to avoid double counting. Required Rate of Return of 7% is defined as the yield for one-year Malaysian government treasury plus assumed equity risk premium. Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy and/ or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein. As of Thursday, March 22, 2018, the analyst, Chan Mun Chun, who prepared this report, has interest in the following securities covered in this report: (a) nil Kaladher Govindan Head of Research TA SECURITIES HOLDINGS BERHAD (14948-M) A Participating Organisation of Bursa Malaysia Securities Berhad Menara TA One 22 Jalan P. Ramlee Kuala Lumpur Malaysia Tel: Fax: Page 16 of 16