Taiwan Steel Sector
INITIATION
Flat product demand to pick up in 2H09
■ We are expanding our Taiwan steel coverage to include flat products
by initiating coverage of China Steel Corp. (CSC), by far the biggest
steel producer in Taiwan, with an OUTPERFORM rating. This is in
conjunction with our upgrade on Chinese steel producers, following
the expected completion of the destocking cycle by mid-2009. While
CSC is likely to experience a lag in recovery, due to Taiwan steel
industry’s high exposure to exports – likely the weakest link in GDP in
2009 – we deem improving Chinese demand as positive. The prompt
production cuts/exits of the competition should also help re-stocking
demand to return in 4Q09, in our view.
■ While the company could suffer quarterly losses during 4Q08-2Q09,
due to fewer shipments, a write-down of inventory values and declining
ASP, we believe these are well-known by the market and a
considerable amount of the negatives have been factored into the
share price. We expect a turnaround in 2H09, due to improving volume
and spread, taking the ROE back to 19% (annualised) during the
second half and this should provide support to the share price.
■ Our preferred sub-sector in Taiwan’s steel space is long steel, in which
we see an earlier recovery in volume and margin versus the flat
products, due to infrastructure-related demand across both sides of
the straits. Two long steel producers under our coverage are Tung Ho
(2006.TW) and Feng Hsin (2015.TW). Nevertheless we see corrections
in CSC shares (which we deem likely in 1H09, as the company reports
negative results) as good opportunities to accumulate a quality name.
■ Our target price for CSC is NT$29, which is based on the mid-cycle
multiple of 1.65x 2009 BVPS.

Taiwan steel sector
Initiating coverage of CSC with an OUTPERFORM
We are initiating coverage of CSC, Taiwan’s leading steel producer, with an OUTPERFORM
rating and a 12-month target price of NT$29. This is in conjunction with our upgrade on
Chinese steel producers, which is made on the back of the expected de-stocking cycle
completion by mid-2009. While some lag in recovery for CSC is likely, due to the Taiwan
steel industry’s high exposure to exports – likely the weakest link in GDP in 2009 – we deem
improving Chinese demand to be positive, as 1) Chinese steel prices are the major factor
behind Taiwan’s average sales price (ASP) trend and 2) China is the biggest export market
for Taiwan’s steel industry and for CSC. Our target price is based on 1.65x BVPS, or midcycle
multiple, and is also justified from an (ROE growth)/(COG growth) perspective, using
both annualised 2H09 and 2010 ROEs.
Focus is on the 2H09 recoveries
While the company could suffer quarterly losses during 4Q08-2Q09, due to fewer
shipments, the write-down of inventory values and declining ASP, we believe these are
well-known by the market with lots of the negatives factored into the share price. We
expect a turnaround in 2H09, which would take the ROE back to 19% (annualised) and
provide support to the share price. While we expect pressure on the share price from time
to time, due to the announcement of weak results in the next six months, we also see
news of steel demand/prices bottoming out emerging in the coming months to supply
some momentum. CSC’s share price tracks domestic hot rolled coil (HRC) prices with a
high 0.92 correlation. There are a number of reasons that supports our thesis of a 2H09
turnaround and investor willingness to focus on the positives of the longer horizon (as
opposed to the near-term weakness). These include: 1) a substantial percentage of its
losses comes from non-cash items; 2) CSC’s ability to pay decent cash dividends is still
sound; 3) ROE is expected to rebound from negative territory in 1H09 to 19% (annualised)
in the second half, due to improved spread and shipments; 4) we believe there is hidden
value in CSC’s investment portfolio; and 5) CSC’s advantageous positioning within
Taiwan’s steel industry which helps it weather the downturn.
20% plus fall in flat demand; CSC more resilient
Taiwan’s steel industry is highly geared towards exports, with around 57% of total supplies
exported directly or indirectly (steel used to make goods). We see such high export levels
as being disadvantageous in this environment and expect around a 20-25% decline in
exports and domestic steel consumption for flat products. For CSC, the decline should be
less at around 16% YoY in 2009, due to the company’s strong positioning in the domestic
industry. Industry demand/supply dynamics in 2H09 should improve from 1H, as CSC
sees better sales volumes (+4% HoH) and spreads, helped by new raw material contract
prices. On a pre-tax basis, we expect more than NT$2 bn losses in 1H09 and profit of
NT$25 bn for 2H09.
Our preferred sub-sector is long steel
Our preferred sub-sector in Taiwan’s steel space is long steel, where we see an earlier
recovery in volumes and margins versus the flat producers due to infrastructure-related
demand across both sides of the straits. Two long-steel producers that we cover are
Tung Ho (2006.TW, NT$22.0, OUTPERFORM) and Feng Hsin (2015.TW, NT$35.7,
OUTPERFORM). Nevertheless, we see a correction in CSC shares (likely in 1H09, as
negative news flows are expected to emerge) as a good opportunity to accumulate the
name, as we consider it a low-cost regional producer, due to its high operating efficiency
and low transportation costs. We also believe CSC stands out in the sustainability of its
high dividend payout ratios in the long term.