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Maanshan Steel (323 HK) Summary

Core Content Overview

Maanshan Steel (323 HK) is a Chinese steel company with a current share price of HKD1.64 and a target price of HKD2.00, implying a 22% upside. The company has a market capitalization of USD1.7B and an average daily trading volume of USD2M. The stock is currently rated as BUY by Maybank Kim Eng, and it is considered a better investment than Angang (347 HK), which is rated as SELL.

Maanshan is benefiting from the recovery in China's railway sector, where it holds a 45% market share. The company recently acquired Valdunes, a French railway wheel producer, for €13m, which is expected to enhance its position in the high-speed rail market and improve its product mix and profitability. The company's railway components business is a significant contributor to its gross profit, generating 22% of GP in 2014E.

Main Profit Drivers

• Lower iron ore costs: The company has lowered its 2014 iron ore price forecast by 12% to USD102/tonne, with a -24% YoY change.
• Rising railway sales volumes: The railway sector is experiencing a 25% YoY increase in gross profit, driven by increased government spending.
• Stable steel prices: Steel prices are expected to remain stable relative to raw material costs, allowing for profit improvement.
• Acquisition of Valdunes: This acquisition is expected to bring in higher-margin products and support the company's expansion into high-speed rail markets.

Financial Highlights

Investment Thesis

• Maanshan is the best play in the steel sector due to its high earnings leverage and strong position in the railway components market.
• The company is expected to return to breakeven in 2Q14 and earn CNY0.08/sh in 2H14E.
• A 50bps increase in EBIT margin to 2.6% would significantly improve net profit and EPS, raising them to CNY450m and CNY0.04/sh respectively.
• The target price of HKD2.00 is based on a 0.5x P/BV multiple, which is higher than the current 0.4x. The TP also equates to a 6.1x EV/EBITDA, up from 5.4x.

Risks and Concerns

• Steel sector oversupply: This remains a long-term concern and could negatively impact profitability.
• Weak property market: This affects the construction steel business, which is loss-making.
• Antidumping duties: Increased in China, which may impact export volumes and profits.
• Uncertainty in Valdunes integration: The financial impact of the acquisition is unclear, and it remains a risk to the profit forecast.

Industry Analysis

• The Chinese steel sector is expected to see moderate improvement in profit margins due to lower input costs and stable steel prices.
• Railway spending has increased significantly, with China Railway Corp raising its budget by 21% to CNY800b in 2014.
• The transportation sector accounts for 11% of total steel consumption, with railway steel representing 1.5% of that.
• Despite its niche position, the railway market is a key driver for Maanshan's profitability and growth.

Valuation and Performance

• Maanshan's current P/BV is 0.4x, but it is expected to improve, supporting a higher valuation.
• The company's ROE is expected to double from 2014 to 2015, despite a low base.
• The stock is a high-beta laggard, with a beta of 1.3, slightly higher than Angang's 1.2.
• Maanshan's share price has underperformed, making it an attractive opportunity for those looking to capitalize on the recovery in the steel sector.

Key Data

• 52-week high/low (HKD): 2.29 / 1.54
• 3-month average turnover (USD m): 1.8
• Free float (%): 49.5
• Issued shares (m): 7,701
• Market capitalization (HKD): 12.9B
• Major shareholders:
  • Fidelity Management & Research (Hong Kong): 6.1%
  • Dimensional Fund Advisors LP: 2.8%
  • The Vanguard Group, Inc.: 2.5%

Sensitivity Analysis

• Steel price is the major variable affecting profitability, with a 50bps increase in EBIT margin significantly improving net profit and EPS.
• Raw material costs are also highly correlated with steel prices, and their impact is significant.
• The company's financial leverage is high, but interest coverage remains comfortable with EBITDA at 4.8x net financial expense.
• Currency fluctuations can impact the cost of imported iron ore and the competitiveness of domestic steel production.

Conclusion

Maanshan Steel is positioned to benefit from the recovery in the railway sector and the decline in raw material costs. The recent acquisition of Valdunes adds value to the company's product portfolio and provides a pathway to higher-margin markets. While the steel industry faces long-term challenges, Maanshan's niche position and strong government support make it a compelling investment with significant upside potential. The target price of HKD2.00 reflects a 0.5x P/BV multiple and is based on the expectation of a moderate improvement in profitability and ROE. The company's financial health remains solid, with healthy cash flow generation and a strong position in the railway components market.