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Morningstar | CSC’s FY18 Results in Line with Prelim; FVE Raised to TWD 24; Shares Remain Slightly Overvalued

We raised China Steel Corporation’s, or CSC’s, fair value estimate to TWD 24 from TWD 23 after revising and rolling forward our valuation model. We now expect less of a decline in steel prices, leading to higher profitability because we expect iron ore prices to remain high in 2019 owing to supply disruptions following the accident at Vale’s iron ore mine in Brazil in early 2019. Our no-moat and stable moat trend ratings for the firm remain intact. CSC’s full-year 2018 earnings were in line with preliminary results announced, with EBIT increasing by 35% year over year to TWD 33.6 billion. This implies fourth quarter 2018 EBIT of TWD 8.55 billion, which was largely flat compared with TWD 8.44 billion during the same period last year. The year-over-year increase in profitability is mainly driven by higher average steel selling prices and steel shipments. A dividend per share of TWD 1 has been proposed, which is a 14% year-over-year increase from TWD 0.88 in 2017. The ongoing supply side reform (started since 2016) and the strong steel demand in China in 2018 resulted in a tighter steel market and higher profitability for the steel industry. However, we think CSC’s current share price is slightly overvalued because we believe the steel industry will continue to suffer from overcapacity issues in the long term.

While steel prices have been weak towards the end of 2018 and in the beginning of 2019, 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 remain firm as demand picks during up summer. This is in line with the second-quarter 2019 pricing data announced by CSC, where we see the firm increasing the prices for hot-dip galvanized sheets, electro-galvanized sheets, electrical sheets, hot-rolled and cold rolled products by about TWD 300 to TWD 490 per tonne, while keeping the prices for plates, bars and wire rods flat.

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 new electric arc furnaces can be built in future to offset shuttered capacity, helped by an increase in availability of steel scrap in China, and this will drive ongoing overcapacity issues in China.