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Morningstar | Angang Steel’s Full-Year 2018 Slightly Above Prelim; FVE Raised; Shares Overvalued. See Updated Analyst Note from 19 Mar 2019

Angang Steel announced full-year 2018 earnings that were slightly above preliminary results, with net profit increased by 19.8% year over year to CNY 7.95 billion from CNY 6.64 billion in 2017, based on restated numbers after adoption of new accounting policy and the acquisition of Angang Chaoyang in September 2018. Dividend per share of CNY 0.22 was announced, representing a payout ratio of 20% and is a slight decline from CNY 0.232 declared in 2017. The board also proposed a bonus issue of three shares for every 10 shares that is subject to approval at the 2018 annual general meeting. We have not factored in the bonus issue pending its approval. We raised Angang Steel’s fair value estimate to HKD 5.30 (CNY 4.56) from HKD 5.00 (CNY 4.46), following minor adjustments to our valuation model and rolling forward our estimates. Our no-moat and stable moat trend ratings on the firm remains intact. Nonetheless, we still think that Angang Steel’s current share price is overvalued as we believe the steel industry is highly commoditized and will continue to suffer from overcapacity issues in the long run.

Management attributed the year over year improvement in full year profitability to better product mix leading to a higher average selling price for steel products, improving efficiency and its operational structure through the integration of the newly acquired Angang Chaoyang, cost cutting measures and better management of its raw material procurement which in our view, reduced its impairment charges. There was a write back of impairments of CNY 64 million compared to an impairment of CNY 331 million in 2017. In 2019, the firm will continue to focus on increasing its exposure to the special and higher quality steel grade markets to increase its competitiveness as well as expanding overseas to increase its profitability. Capital expenditure is expected to be around CNY 3.13 billion in 2019.

Steel production continue to be strong in the first two months of 2019 as winter production curtailment is now decided and imposed by local governments, different from what happened in 2017’s winter where there was a blanket curtailment on selected cities. While steel prices have been weak towards the end of 2018 and in the beginning of 2019, we note that steel prices have started to increase from the middle of February 2019 as demand picks up following Chinese New Year. In the near-term, we expect steel prices to continue to remain firm as demand picks up going into the summer months.

Nonetheless, our bearish long-term view for the steel sector remains intact. We think China is shifting towards producing steel from electric arc furnaces using steel scrap rather than the traditional blast furnace which uses iron ore and coking coal. We continue to believe that new electric arc furnaces can be built in the future to offset shuttered capacity helped by an increase in availability of steel scrap in China, and this drive ongoing overcapacity issues in China.