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Monday, June 22, 2009

The Steel/Aluminium Industry 8.0

The Steel/Aluminium Industry 8.0

The Government’s decision to abolish certain import restrictions within the steel industry will allow finished steel product makers to competitively source their raw material needs.

The latest move by the Government, viewed as a step towards full liberalisation of the industry, was designed to “enhance competitiveness” of the local steel players.

Steel manufacturing licences will be granted “without restriction” effective Aug 1 2009 “to meet the demand for domestic and export markets”. By granting “free” steel manufacturing licences, steel millers would be able to produce any type of flat or long steel products that are in short supply at home, or in demand overseas.

Import controls on flat products – hot-rolled coils (HRC), cold-rolled coils (CRC) and electro-galvanised iron (EGI) – that are used for production of finished products for export market would also be lifted from Aug 1 2009.

For downstream players, the latest liberalisation means steel product manufacturers can now buy 100% of their flat steel requirement from overseas. Currently they are allowed to import up to 40% of their steel requirement duty-free while the balance is subject to a 50% tax.

Megasteel Sdn Bhd, a unit of the Lion Group, is the sole producer of HRC in the country. The move will allow HRC users to competitively source their needs for the production requirement.

The CRC producers in the country include Megasteel, Mycron Steel Bhd, CSC Steel Holdings Bhd and Yung Kong Galvanizing Industries Bhd. These semi-finished flat steel products – HRC, CRC and EGI – are then used by manufacturers to make pipes, furniture, cars and consumer durables.

Products meant for the export markets can enjoy free import duty on their flat steel imports. Raw materials imported to make end products for domestic use would be subjected to lower import duty.

Import duty on flat products imported from outside Asean countries would be reduced in stages, with the current duty slashed from 50% to 25% from Aug 1 2009. The rates will be further cut down to zero and 10% from Jan 1, 2018.

Contrasting Comments From Local Steel Manufacturers …

The government’s decision to liberalise further the domestic steel sector has received contrasting comments from local steel manufacturers.

Those making long products, which are used in the construction sector, warn of dire consequences from the liberalisation while the country’s sole producer of flat steel products sees the measures as an opportunity to enlarge market share.

The Case For Against …


Liberalisation of the steel industry is ill-timed and will not contribute positively to the development of the local steel industry.

The current restriction on imports was the only incentive for local steel manufacturers to continue to invest and expand in a capital-intensive industry, especially in the current tough operating environment.

The steel industry should be viewed as a strategic industry that has to be nurtured because domestic steel production has remained stagnant at around nine million tonnes annually for the last 10 years (1998-2008).

If the liberalisation of the industry is not done with care, the country might be beholden to imports to meet local steel demand in the future. With the lack of investment to expand and upgrade production, problems will arise when we have a global shortage like what happened last year (2008).

The Case for …

The move is positive, particularly for Megasteel Sdn Bhd, the sole producer of hot-rolled coils (HRC) in the country.

HRC is better known as flat steel and is used in a variety of industries. HRC is also the feeder material for cold-rolled coils (CRC). The other broad category of steel is long products, which are manufactured by several companies, including Masteel.

The easing of import and export duties and restrictions for both long and flat products will come into effect on Aug 1 2009.

The measures will help boost Megasteel’s HRC plant whose current capacity utilisation of about 45% will increase to 80% and, with increased export orders, to 100% within a short period.
The measures were a positive development for the local steel industry and, in particular, the flat steel sector, namely HRC and CRC.

The import duty review for all flat products will enable the industry to be streamlined and become more competitive. Notably, this will increase the consumption of locally produced CRC and thus benefit the cold-rolled mills whose total capacity now (Till June 2009) far exceeds local consumption.

Demand Of The Steel Product Makers …

Industry players see hot rolled coil price is likely to rise from August 2009 due to anticipated higher demand for flat steel products in the second half of this year (2009).

The speedier implementation of the government stimulus package was among the reasons for a boost in demand for steel products.

Hot rolled coil price is expected to hover between RM2,100 and RM2,200 per tonne between June and July. It price jumped to as high as RM3,800 per tonne in October 2008 before correcting sharply by 10% in November 2008, and subsequently fell to as low as RM1,600 per tonne in March 2009.

The surge in price is beneficial to secondary steel product makers as customers will place their orders in anticipation of the hike.

The local flat steel product makers, in particular electrical resistance welded steel pipe producers, include Hiap Teck Venture Bhd, Melewar Industrial Group Bhd, Choo Bee Metal Industries Bhd and Amalgamated Industrial Steel Bhd (AISB). Megasteel Sdn Bhd, a sister company of Lion Industries Corporation Bhd, is the sole supplier of hot rolled coils in the country.

This scenario will allow producers to adjust the market prices upwards quite immediately to help generate some positive margins they have not seen for more than six months.

It is learnt that there was a surge in steel pipe orders in April 2009, mainly due to the restocking by customers as inventories dropped. A near-term rebound in local steel consumption is primarily due to restocking activities amid a tight supply.

Most producers and customers have been aggressively destocking their inventory since late 2008, and bought much less materials or products to replace as market demands were seriously squeezed.

If the international steel commodity continues to move up gradually during the second half of 2009, we would expect that the demand for products to surge and margins to rise. The sector might see its bottom in the second quarter of 2009. Once the second half 2009 improves, it should provide the momentum to push 2010 into better times for business activities.

Industry players confirmed that there had been an improvement in local demand for its flat steel products over the 1A2009, mostly from stockists who were restocking and expecting prices to move up. A return of enquiries from certain export markets has also been seen.

Most steel pipe makers are currently (June 2009) still operating in the red. Gross margins remain negative as market prices and demand have not picked up fast enough.

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Local iron makers will likely enjoy cost savings when the proposed iron ore centre in Manjung, Perak, comes on stream, possibly by 2013.

This is certainly good news for local iron makers as freight charges constitute a major production cost.

Vale International SA, the world’s second largest diversified metals and mining company, had agreed to buy 165.5ha in Manjung from property developer KYM Holdings Bhd in a deal believed to be related to recent statements by the Perak government of a RM9bil South American investment in an iron ore centre in the state.

Mentri Besar Datuk Seri Dr Zambry Abdul Kadir had said that a South American company planned to make Manjung the production and distribution centre for its iron ore in the Asian region.

The company has a paid-up capital exceeding US$100bil and is among the largest in the world in iron ore mining and will provide at least 1,800 job opportunities for the people in the state.

Currently (June 2009), local companies such as Perwaja Holdings Bhd, Lion Industries Corp and Ann Joo Resources Bhd import iron ore pellets from Brazil to make their products of direct reduced iron (DRI) and hot briquetted iron (HBI).

The sudden surge in the Baltic Dry Index, the benchmark for commodity shipping rates, to above 4,000 points and its present level of about 3,500 points was pushing shipment costs to an average US$35 per tonne.

This means upon commissioning of the plant, local iron makers will potentially be able to enjoy savings of at least US$50 per tonne of finished DRI/HBI based on the estimation that for every tonne of DRI and HBI, about 1.5 tonnes of iron ore pellets are consumed.

However, estimated that the first phase of the iron ore mining and pelletising plant would take more than three years to be commissioned. Earnings enhancement will not be immediate for the local boys.

Zambry had admitted that the Vale iron ore plant investment was not yet a done deal.

It was still subject to “certain matters”.

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State Of The Domestic Steel Players …

The 1Q2009 was definitely a bad one for local steel players. Their bottom line tumbled into the red while their cash flow statement showed operating losses before working capital changes. A glance at their balance sheet also reveals a tight working capital situation, with capital tied up in stocks.

It would appear that steel players sacrificed their bottom line for cash flow in 1Q2009. In the steel industry, players employ most of their working capital (cash and short term trade financing) to stock up their raw materials such as scrap metal and iron ore. Hence, it is crucial for them to be able to convert these raw materials to semi finished or finished products and sell these for cash to sustain operations and pay back short term trade financing.

A steel market with lukewarm demand and immobile prices could tie up the companies’ working capital and hence their ability to sustain their operations, unless they bring in fresh working capital or further delay paying the suppliers and bankers.

But in general, the 1Q2009 results spelt out the dire straits the steel players were in. While some say the situation has improved in the current quarter (2Q2009), a meaningful recovery may come only in 4Q2009.

The share price of steel companies have rebounded in the recent market (April – May 2009) rally, but have these run far ahead of the fundamentals of the companies considering their tight capital situation.

Steel players hope both prices and demand will pick up sooner rather than later. Otherwise, they will be forced to pour in more cash to pay bills and sustain their operations rather than generating cash flow to sustain operating needs.

Of course, further improvement in steel prices in the coming months (June 2009 & Beyond) will inflate the value of inventories, enabling steel players to realise stocks at a higher value to cover their payables and short term obligations. But if steel prices and demand remain stagnant throughout 2009, perhaps it would be better to shift to players with a better balance sheet.

Going Forward …

The outlook for the domestic steel sector should be brighter going forward as the slump in the industry has bottomed out following losses of about RM485.9mil in the first quarter 2009 and even more in the fourth quarter of last year (2008).

The worst is clearly over for the steel industry and earnings are expected to stage a strong turnaround in the third quarter of this year (2009).

Most steel mills continued to be in the red in the quarter ended March 31, 2009. However, the quantum of losses for players such as Ann Joo Resources Bhd, Perwaja Holdings Bhd and Southern Steel Bhd had been reduced substantially in the absence of further write-downs in the value of their inventories.

Pump-priming efforts by both the (Malaysian) Government as well as (governments) overseas would boost demand for local steel going forward. Domestic demand would drive growth instead of export sales as the roll-out of select cornerstone projects under the Ninth Malaysia Plan gathered momentum.

Steel prices, which had bottomed out in the fourth quarter of 2009 and were on the uptrend, would be boosted by international prices due to the rising demand for infrastructure projects in China.

Prices of long steel products (used for construction works) rebounded by 25% to RM2,000 per tonne currently from a low of RM1,600 per tonne in April 2009. It peaked at RM4,000 per tonne in mid-2008.

Credit Suisse said in a note that steel prices would be on the uptrend as a result of the Government’s pump-priming initiatives.

It is also believed that the inventory cycle in key Asian markets is bottoming out, further boosting demand. The production of local steel products shrank from August 2008 and declined 48% year-on-year in the first quarter of 2009, the sharpest drop since the Asian financial crisis.

The price of steel bars could climb higher in the coming months (June 2009 & Beyond) in line with improved prices in the international market as well as increased cost of raw materials compared to the previous quarter (1Q2009). Earnings for the second half 2009 would improve on increased demand from the domestic market.

Meanwhile, recovery in the demand for steel in China has also raised plant utilisation at Sino Hua-An International Bhd, which produces metallurgical coke, a raw material used in the smelting of iron ore for the manufacture of steel. Sino Hua-An is a China-based company listed on Bursa Malaysia. Decisive efforts by the Chinese government to stimulate the economy had pushed up demand for its product. Due to the direct exposure to China’s steel industry, its orders had started to pick up since December last year, while our total production output capacity is up at 90% from 58% December 2008.

Masteel is known for being prudent its stocking and inventory strategy. While the others were stocking up on raw materials towards 3Q2008, the company actually trimmed its stocks.

Hence, when prices crashed late 2008 following global financial crisis, the other steel players were forced to write down the value of their overpriced inventories in 4Q2008 by the hundreds of millions of ringgit. Masteel was the exception.

Armed with a working capital surplus, Masteel is now (June 2009) in a comfortable position to gradually build up its inventory position, in anticipation of further improvement in prices and demand. The company may become more aggressive because inventory accounted for only 44% or RM134 million (trade receivables another 44%) of its total current assets as at March 31, 2009.

Ann Joo, which is sitting on a huge inventory of RM875 million marked at lower cost prices, may offer investors strong growth momentum to take advantage of an upswing in recovery.

Note that Ann Joo’s aggressive inventory strategy in 2008 resulted in it pilling up a massive holding of overpriced stocks. This forced the company to write down Rm335 million in inventory value in 4Q2008. As a result, its inventory value of RM875 million as at March 2009 had fully factored in current low market prices


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