20160714-三星证券-Steel_NEUTRAL_2Q_preview-Healthy_demand,strong_earnings_11页_493kb

Sector Update Summary - Steel (NEUTRAL)

Core Content

This document provides a detailed analysis of the performance and outlook for two South Korean steel companies: Daehan Steel and Korea Iron & Steel (Kisco), focusing on their financial results and market conditions for the second quarter of 2016 and beyond.

Main Points

• 2Q Performance: Both Daehan Steel and Kisco reported significant increases in sales and operating profit compared to the previous quarter. Daehan Steel's consolidated sales and operating profit rose by 30.8% and 147.8%, respectively, to KRW212.8b and KRW23.1b, with operating profit beating the consensus by 21.5%. Kisco's sales and operating profit increased by 26.7% and 99.9%, respectively, to KRW177.4b and KRW23.5b, which was 12.9% above the consensus.

• Performance Drivers: The strong performance is attributed to improving spreads and seasonally strong sales volume. The domestic market showed solid demand, even as Chinese rebar imports increased, indicating a resilient local market.

• 3Q Outlook: Demand is expected to remain strong in 3Q, which is typically a weak quarter, due to continued growth in the construction-start area. Negotiations over 3Q rebar reference prices will be a key factor for earnings, with rebar makers seeking a KRW20,000/tonne increase and the Korea Building Material Association advocating for a KRW20,000/tonne decrease. A middle-ground agreement is anticipated, which would prevent significant narrowing of spreads. The recent drop in scrap prices will also help to offset any potential price cuts.

• Valuation and Outlook for 2017: Despite the strong 2Q results, the analyst does not expect valuation premiums as high as those seen in 2015, as growth in the construction-start area is unlikely to continue into 2017. However, both companies are expected to deliver strong earnings at least through the end of 2016. Daehan Steel is currently trading at 2017 P/Bs of around 0.5x, with an expected ROE of 9.1% and Kisco at 6.4%.

• Financial Metrics:

  • Daehan Steel: Expected to maintain strong performance with a target price of KRW12,000 (29.4% upside).
  • Kisco: Target price of KRW52,000 (30.2% upside).

Key Information

Financial Performance

• Daehan Steel:

  • Sales and operating profit for 2Q16 are expected to be KRW212.8b and KRW23.1b, respectively.
  • Gross profit is expected to increase significantly, with operating profit beating the consensus.
  • Sales volume for 2Q16 is expected to be 360.9 thousand tonnes.
  • Gross margin is expected to be around 15.2%, with operating margin at 10.4%.
  • Net profit for 2Q16 is expected to be KRW17.1b.

• Kisco:

  • Sales and operating profit for 2Q16 are expected to be KRW177.4b and KRW23.5b, respectively.
  • Rebar sales volume is expected to be 272.7 thousand tonnes.
  • Gross margin is expected to be around 18.8%, with operating margin at 13.2%.
  • Net profit for 2Q16 is expected to be KRW18.1b.

Market and Industry Context

• Construction-start Area: Continued growth in this area supports strong demand, which is expected to persist through the end of 2016.
• Rebar Imports: Despite increased Chinese rebar imports, domestic demand remains robust.
• Spreads: The price spread between rebar and scrap is a key indicator of profitability. Recent drops in scrap prices help to reduce costs.
• Valuation: Both companies are trading at low P/B ratios, suggesting potential undervaluation.

Charts and Tables

• Chart 1: Rebar sales volume vs construction start area in Korea.
• Chart 2: Rebar imports in Korea.
• Chart 3: Daehan Steel's rebar sales volume vs construction start area.
• Chart 4: Daehan Steel's spreads.
• Chart 5: Daehan Steel's gross margin vs spread.
• Chart 6: Daehan Steel's P/B band.
• Chart 7: Kisco's rebar sales volume vs construction start area.
• Chart 8: Kisco's rebar prices and spreads.
• Chart 9: Kisco's gross margin vs rebar spread.
• Chart 10: Kisco's P/B band.
• Table 1: Daehan Steel's results and forecasts (parent).
• Table 2: Daehan Steel's results and forecasts (consolidated).
• Table 3: Kisco's results and forecasts.
• Table 4: Daehan Steel's income statement, cash flow statement, balance sheet, and financial ratios.
• Table 5: Kisco's income statement.

Conclusion

The steel sector in South Korea is showing robust performance in 2Q16, driven by strong demand and improving spreads. Daehan Steel and Kisco are both expected to maintain strong earnings through the end of 2016, with the analyst maintaining a BUY rating for both. Despite the anticipated slowdown in construction-start area growth in 2017, the current valuations suggest potential for future growth.