CSCI-Metals-Angang Steel (347 HK)：ROE recovery to continue into 2018 - 20180118

ROE recovery to continue into 2018

• The company issued a positive profit alert, expecting net profit to reach RMB5,678mn (+251% YoY) for FY17E, beating both the street and our estimates, thanks to the strong margin expansion in 4Q17.
• In our view, China steel industry’s profitability will continue to improve in 2018 amid deepening supply-side structural reforms.
• Based on the latest guidance, we have revised up our revenue and net profit estimates for FY18E by 10.1%/34.5% respectively. Our PT has also been revised up to HKD8.5 (from HKD8.0), based on a +2SD historical average in the past five years. Maintain Buy. We believe Magang’s earnings outlook would also benefit from the industry supply reform, prefer Magang.

Positive profit alert issued. According to the preliminary announcement, we expect the company has achieved record high earnings during the last five years, driven by higher steel product prices and substantial margin expansion. Meanwhile, the company has seen the highest net profit level of RMB2,395mn since 3Q08 on a QoQ basis, thanks to better-than-expected cost control execution. Based on our calculation, the company’s gross dollar margin has come in at RMB747/ton in FY17E, on a 22% YoY hike in its unit product selling prices and only a 11% increase in production cost.

Optimistic on 2018 industry outlook. China has achieved its steel capacity closure target ahead of schedule in 2017. We believe the winter production program and the overall market discipline would continue to provide support for the market. Also, we expect the ongoing industry consolidation would continue to help rein in further improvement of domestic industry demand-supply dynamics. Moreover, we believe export demand would stabilise on the back of growing export opportunities to the one-belt-one-road markets. Based on our calculated price spread between steel products and raw materials, the spread has been widening in the spot market as compared to the average level in 2017.

Steel inventory remains low from historical perspective. According to the National Bureau of Statistics of China, China’s crude steel production has increased 5.1% YoY during first eleven months of 2017. And according to China Customs data, China’s total net export of steel products has decreased 27% YoY in 2017, whilst imports of iron ore concentrates in China has increased 5.0% YoY and whereas China’s social steel inventory has remained at a historically low level.

Maintain BUY. The company is currently trading at 0.84x FY18E PBR. Based on our forecast that Angang’s ROE will recover to an estimated 11.6% in 2018, which is significantly higher than only 5.5% in 2008, we have pegged our price target to our bull case scenario at +2 SD above the company’s 5-yr historical average of 0.94x. Accordingly, our PT has been raised to HKD8.5 (from HKD8.0), representing 12.5% upside potential, and hence, maintain BUY.