EUR 850.00 For Business Accounts Only

Morningstar | NS’s FY19 Largely in Line While Balance Sheet Weaker than Expected; FVE Lowered to JPY 2,000

We lowered our fair value estimate for Nippon Steel, or NS, to JPY 2,000 from JPY 2,300 after factoring in higher raw material prices from our latest commodities price deck, higher net debt and lower investments on its balance sheet. The higher net debt is due to the higher working capital requirements and acquisitions. In addition, the recent change in accounting standards to IFRS also resulted in higher capital expenditure and the change in the scope of consolidation of the newly acquired Sanyo Special Steel group. Our no-moat and stable moat trend ratings on the firm remains intact. In our view, NS’s share price is slightly undervalued, even after taking into account the long-term overcapacity issues in the steel industry.

NS’s fiscal 2019 (ending March) business profit, or EBIT (including charges and associate income but excluding extraordinary items) increased by 17% year over year to JPY 337 billion from JPY 289 billion in fiscal 2018, largely in line with guidance of JPY 330 billion. This is mainly driven by higher contribution from associates and other operating income. Among the divisions, steel, chemicals and materials, and system solutions performed strongly. The robust performance in the Steel division is driven by higher steel prices, better product mix and cost-cutting measures. The solid performance in the chemicals and materials division is driven by ongoing demand for needle coke and strong sales in carbon fiber composite materials used for the civil engineering and construction sectors, while partly offset by some weakness in styrene monomer prices and the sales of the materials used in the smartphones and semiconductors industries. There is also increasing demand for IT systems and solutions for Internet of Things, artificial intelligence and other technology which resulted in the improvement in the System Solutions division. DPS of JPY 40 has been proposed, leading to a full-year dividend of JPY 80, in line with its guidance.

In terms of steel demand in Japan for first quarter fiscal 2020, management is expecting a slight increase in demand from the construction and autos sectors, offset by a decline in industrial machinery sector. Management did not provide any guidance for fiscal 2020 due to uncertainty in raw material prices following supply disruption of iron ore caused by the accident at Vale’s mine in Brazil and a cyclone in Australia; and the firm is still under negotiations with customers regarding steel prices. For fiscal 2020, we expect steel shipments to continue to grow following the acquisition of Sanyo Special Steel, Ovako and Nippon Steel Nisshin as well as a recovery from production issues (due to operation disruption at one of its facility last year and the impact from natural disasters), but this is offset by a decline in steel margin on higher iron ore prices, resulting in a fall in business profit in the Steel division. In the long term, we expect the EBIT margin for the group to decline to 2.4% in fiscal 2024 from 3.5% in fiscal 2019 mainly driven by weakness in its steel division as it continues to suffer from overcapacity issues.