Analysts mindful of Kinsteel’s gearing

KUALA LUMPUR: While Kinsteel Bhd’s proposed subscription of redeemable convertible unsecured loan stocks (RCULS) in Perwaja Holdings Bhd is deemed an earnings accretive move, analysts caution that the cash call will strain the former’s balance sheet.

According to OSK Research, Kinsteel’s full subscription of Perwaja’s RCULS would raise its gearing from 2.2 times to 2.6 times.

OSK Research analyst Ng Sem Guan said Kinsteel’s confidence in Perwaja might have stemmed from the associate’s upcoming iron ore concentration and pelletising plant. The facility is expected to result in cost savings of up to US$50 a tonne for iron pellets, the raw material for steel products.

“We also suspect that management may be very confident of securing an iron ore mine as any such concession would certainly prove lucrative.

“The local cost of mining iron ore is less than US$50 (RM147.50) a tonne versus the current iron ore selling price exceeding US$160 per tonne,” he said.

An iron ore concession, Ng said, might translate into a discounted cash flow-based valuation of RM775 million, which in turn results in an additional value of 89 sen for Kinsteel shares based on its stake in Perwaja in the future should things turn out as expected.

As at press time, Kinsteel and Perwaja officials had not responded to queries from The Edge Financial Daily yesterday.

To recap, Perwaja announced on Monday that it was making a cash call to its major shareholder Kinsteel to raise RM280 million under a planned restricted issue RCULS.
Perwaja and Kinsteel's latest financials are in the red as they contended with costlier production inputs and higher financing expenses.

Perwaja is also proposing an issue of free warrants on the basis of one free warrant for every two existing shares held. The gross proceeds will be used to finance the working capital needs of Perwaja, in which Kinsteel owns a 37.34% stake.

Kinsteel has said it would finance the subscription of the RCULS with its internal funds and bank borrowings. Upon completion of the exercise, Kinsteel will undertake a renounceable restricted offer for sale (ROS) of the RCULS it owns to the entitled shareholders of Perwaja.

An analyst believes that Perwaja’s decision to undertake a restricted issue of RCULS to Kinsteel could also be due to concerns that the securities might not appeal to other shareholders in Perwaja.

Kinsteel is the largest shareholder of Perwaja, followed by Equal Concept Sdn Bhd with 27.84% equity interest and Maju Holdings Sdn Bhd with 3.87%.

HwangDBS Vickers Research analyst Hon Seow Mee said assuming Perwaja shareholders fully subscribe their entitlements under the ROS, Kinsteel would need to fork out about RM105 million for the RCULS.

Should Kinsteel decide to finance half of the securities by borrowings, its net gearing would increase to 1.12 times from 1.09 times as at March 31, Hon said.

“We believe the RCULS will help finance the construction of Perwaja’s pelletising plant. We estimate savings of US$20 per tonne in production costs if Perwaja uses its own pelletised iron ore.

“In the near term, Kinsteel will continue to face higher interest, natural gas and iron ore costs, and accordingly we cut our FY11-FY12F earnings per share by 13% to 48%,” Hon wrote in a note yesterday. HwangDBS is maintaining its “buy” call and target price of RM1.10 for Kinsteel shares.

According to Hon, the key catalysts to Kinsteel’s performance include a pickup in construction activities, which will spur steel demand and lift the company’s valuations.

“We believe share price downside is limited and current trough valuation offers good buying opportunity,” Hon said.

Kinsteel shares fell 1.5 sen to close at 73 sen yesterday for a market capitalisation of RM706.68 million. Perwaja shares lost one sen to finish at RM1.06, valuing the firm at RM593.6 million.

Kinsteel and Perwaja’s latest financials were in the red as both companies contended with costlier production inputs and higher financing expenses.

During the first quarter ended March 31, Kinsteel incurred a net loss of RM3.56 million against a net profit of RM22.55 million a year earlier. Revenue however rose 3% to RM555.6 million from RM540.4 million.

Perwaja, meanwhile, saw a net loss of RM24.28 million against a net profit of RM22.63 million previously. Revenue, however, was up 14% to RM426.11 million from RM373.74 million.

As at end-March, Kinsteel had debt obligations of RM1.85 billion compared to a cash pile of RM80.84 million, translating into a net debt of RM1.76 billion.

Perwaja had RM934.39 million worth of debts against cash of RM20.51 million, hence, net borrowings of RM913.88 million.