Is CSC Steel a Value Trap? (Part 1 of 2)

Case Study 04-1:  Company analysis and valuation of CSC Steel, a cold roll company listed on Bursa Malaysia. This post focuses on the business fundamentals

CSC Steel Holdings Berhad (CSC Steel) is currently trading at RM 0.835 (as of 1 Sep 2020) per share compared to its Graham Net Net of RM 1.53 per share (as of 30 Jun 2020). 

The Graham Net Net is often considered a proxy for the company’s liquidation value. 

In fact, Ben Graham spent most of his time investing in Net Net companies. 

Why is CSC Steel trading below its liquidation value then? Is the market suggesting that it is not even worth its liquidation value? 

Is this a value trap or a steal? 

A value trap is one side of the value investing coin. The other side is that it is a steal, a hidden gem.

CSC Steel has RM 0.80 cash per share (as of 30 Jun 2020), zero borrowings, and a good operating track record.  Its value is intact.  It is not a value trap. 

Join me in a 2-parts post as I lay out my case on why the market is wrong. 

There is definitely an investment opportunity given the mispricing. Does it mean that you should go and buy – well read my Disclaimer? 

Part 1 is presented here while Part 2 was published on Sun 27 Sep 2020.


Contents

  • What is so unique about CSC Steel?
  • Has it used its Funds in the Best Way?
  • Can you describe the Current Performance as Outstanding?
  • Is there a Rich and Unique History?
  • Is there a Great Future?
  • Pulling it all together - is this a Value Trap?

Valuation Date

1 Sep 2020

Company Name

CSC Steel Holdings Berhad

Stock Name in Bursa Malaysia

CSCSTEL

Company’s Bursa Co

5094

Bursa Malaysia Sector

Industrial Products and Services

Listing Date on Bursa Malaysia

Dec 2004

Financial Year-End

Dec

Latest Quarterly Results

2nd Quarter 2020, 30 Jun 2020

Shareholders’ Equity

RM 803 million (30 Jun 2020)

Market Capitalization

RM 308 million (1 Sep 2020)

Corporate Website

http://www.cscmalaysia.com/

                                         Table 1: Company Info


Is CSC Steel a Value Trap?



What is so unique about CSC Steel?

The iron and steel sector in Malaysia can be classified into two major product groups:
  • Flat products such as hot-rolled coils, cold-rolled coils, and coated coils. These are used as intermediate raw materials for downstream applications. Examples are automotive parts and components, equipment, and fabricated products.
  • Long products such as steel bars, wire products, angles, and sections. These are used in the construction and civil engineering industry. 

Flat products are produced by rolling metal billets.  Billets are thick cross-section metal produced by steel mills. The metal billets are then reduced in thickness in the hot roll mills.   They can further be reduced to thinner sheets by cold rolling. 

CSC Steel is the leading cold roll mill in the country. The plant in Melaka has the capacity to annually produce 
  • 440,000 metric tons of cold-rolled steel, 
  • 40,000 metric tons of pickled and oiled steel, 
  • 240,000 metric tons of galvanized steel (GI) and 
  • 120,000 metric tons of pre-painted galvanized (PPGI) steel

Its products are branded as 
  • ‘Realzinc’ and ‘Realzinc Enhance’ for GI products and 
  • ‘Realcolor' for PPGI products.

CSC Steel's main raw material, hot rolled steel, is mainly supplied by its parent company and related companies in Taiwan and Vietnam. They are in the upstream of the steel value chain and involved in iron making, steel making, casting, and hot rolling. 

CSC Steel downstream customers are those that use steel coils. Examples are steel pipe makers, steel drum makers, roofing sheets and cladding roll formers as well as steel service centres.

Its main market is in Malaysia (89 % of sales in 2019) and the balance is exported mainly to the South East Asian region. 

The China Steel Corporation of Taiwan, the largest steel company in Taiwan, is the controlling shareholder of CSC Steel.  It manages it as part of the China Steel Corporation of Taiwan’s group of companies. 

Has it used its Funds in the Best Way?

CSC Steel’s SHF accounted for all the total capital employed (TCE) of RM 803 million as of the end of June 2020.  

But only about less than 2/3 of the TCE is deployed for its operations.  The balance is held as cash, investments in securities as well as investment properties.  These are captured as Net-Financial Assets and Non-Operating Assets respectively in the table. 

 

Items

Ref

RM million

Shareholders’ Equity

SHF

803

Minority Interests

MI

0

Total Debt   

Debt

0

TCE

 

803

    

Items

Ref

RM million

Net Operating Assets

Net OA

464

Net Financial Assets

Net FA

295

Non-Operating Assets

Non OA

44

Total

 

803

Table 2: Sources and Uses of Funds (2nd Quarter, 30 June 2020)



CSC Steel - Sources and Uses of Funds
Chart 1: CSC Steel Sources and Uses of Funds


Can you describe the Current Performance as Outstanding?

The Group reported a YTD PAT of RM 2.9 million for Q2 2020, about 83 % lower than that for the same period last year.  

This is mainly due to the very low sales achieved in the second quarter of 2020 as a result of the Movement Control Order instituted in Malaysia to control Covid-19. 

Malaysia has transited to the Recovery Movement Control Order staring 10 June 2020 and this is currently expected to be in force till the end of the year.

This will thus be an unusual year for CSC Steel. 

CSC Steel Performance Index
Chart 2: CSC Steel Performance Index



Notwithstanding the Covid-19 issues, the performance of CSC Steel over the past 12 years can be described as “standstill”:
  • The revenue in 2019 is about the same as that in 2008 and over the past 12 years, the revenue was below that 2008 level most of the time.
  • The profits have shown a bigger variance c/w with the 2008 profits. During the past 12 years, the profits were above the 2008 level for only 1/3 of the time.  CSC Steel even sustained a loss in 2014.
  • Gross profitability has declined over the past 12 years.
  • From 2008 to 2010 the average ROE was 10 %, but for the past 3 years, it averaged 5 %.  

CSC Steel Past 3 years Performance
Chart 3: CSC Steel Past 3 years Performance



What would be the returns from just the steel operations?

The chart below shows that over the past 12 years the steel operations generated an average PBT of RM 41 million.  This is about a 6 % return (after-tax basis) on the TCE employed.  

Not very good considering that its cost of capital is 10%. 

On a positive note, CSC Steel has generated an average positive free cash flow of RM 29 million annually over the past 12 years.


CSC Steel Segment Performance
Chart 4: CSC Steel Segment Performance

Note:  a) TCE was estimated = SHF + MI + Loan.   b) The PBT for the steel business excluded associate income, rental income, interests, and gains from investments c) The average Revenue and PBT is 12 years’ time-weighted. 



Is there a Rich and Unique History?

In December 2000, China Steel Corporation of Taiwan acquired its first offshore steel companies, namely CSC Steel Sdn. Bhd and Group Steel Corporation (M) Sdn. Bhd both in Malaysia. 

In January 2004, China Steel Corporation of Taiwan established Ornasteel Holdings Berhad.   In the same year, Ornasteel Holdings Berhad acquired both the above-mentioned Malaysian companies. 

Ornasteel Holdings Berhad was subsequently listed on Bursa Malaysia in December 2004.  China Steel Corporation of Taiwan with 45 % interest became the major shareholder. 

Ornasteel Holding Berhad was renamed CSC Steel Holdings Berhad in 2008.

Over the period from 2008 to 2019, the revenue has not grown as can be seen from the chart
  • On average about 18% of the revenue is from exports. 
  • In 2009 the market was affected by the US financial crisis. Then in 2004/15, the market was affected by the excess steelmaking capacity in China.

CSC Steel Revenue Profile
Chart 5: CSC Steel Revenue History


The Performance Index as per Chart 2 showed that the variation in profits is far greater than that in revenue. Over the 12 years period, the coefficient of variation (defined as the standard deviation divided by the mean) was
  • 0.15 for revenue
  • 0.77 for the operating profits

This was due to the large variation in the gross profits over the 12 years period.  This meant that CSC Steel had problems matching product prices with raw material costs.
  • During 2008 – 2010, the average gross margin was 11 %.
  • During 2017 to 2019, the average gross margin was 5 %

Apart from the revenue and profit challenges, CSC Steel had 2 poor investments both of which were made in 2012 into:
  • CSC Bio-Coal Sdn Bhd
  • Tatt Giap Steel Centre

CSC Bio-Coal

CSC Steel initially invested RM10.2 million in a pilot bio-coal plant. This was its very first venture into renewable energy. 

The plant uses palm fibre, a waste product of palm oil mills, to produce bio-coal (charcoal) using the torrefaction process.

However, the bio-coal production was discontinued in 2015.  CSC Bio-Coal was disposed to the China Steel Corporation of Taiwan Group for RM 1 million.

By then CSC Bio-Coal had RM 14.5 million of liabilities compared with RM 12.2 million of total assets ie a loss of RM 2.3 million. 

China Steel Corporation of Taiwan Group rescued CSC Steel turning the losses into RM 3.3 million gain on disposal.  


Tatt Giap Steel Centre

Tatt Group Berhad is a steel group that was listed on Busa Malaysia in 2010. It has been a customer of CSC Steel for many years before this listing. 

In 2012 Tatt Giap Group Berhad divested 49% of Tatt Giap Steel Centre Sdn Bhd to 3 parties.  They were CSGT International Corporation Taiwan, CSC Steel, and Hanwa Co Ltd Japan. 

CSC Steel invested RM 8.3 million to purchase 20% equity of the Tatt Giap Steel Centre. The goal of the investment was stated as:

“.. the business co-operation between the two companies could be further strengthened and enhanced thereby benefiting both companies in the long run”.

The acquisition was completed in April 2013 and from the start, Tatt Giap Steel Centre experienced operating losses.

CSC Steel started making provisions for impairment and by 2018, it had fully written off its RM 8.3 million investment.


Investment Properties

Tatt Giap Steel Centre was not the only “assistance” provided by CSC Steel to the Tatt Giap Group.

On December 31, 2015, CSC Steel agreed to buy from Tatt Giap Group two pieces of leasehold land together with a factory building for RM 41 million. 

The transaction was completed in 2016. The total consideration together with RM 1.5 million of other related costs was paid via the following:
  • The utilization of trade debts owed - RM 21.0 million
  • Cash payment - RM 21.5 million
  • Total - RM 42.5 million

These properties have been classified as Investment Properties in CSC Steel’s Balance Sheet. 

As you can see, the purchase of this investment property is to recover RM 21 million of debt owed by Tatt Giap Group. (Refer to Note 2)


Is there a Great Future?

Steel is an alloy of iron with typically a few percent of carbon to improve its strength and fracture resistance compared to iron.

Today, steel is one of the most common manmade materials in the world.   The steel industry is often considered an indicator of economic progress.

The Malaysian steel industry can be classified into the following sub-sectors and product types
  • Primary - billets, and slabs
  • Rolling/finished - plates, hot roll, and cold roll coils
  • Secondary (longs) - wire mesh, bars
  • Secondary (flats) - galvanizing, colour coatings

CSC Steel is a mid-stream steel producer with its cold roll, galvanized and pre-painted galvanized flat sheet steel. 

It is in a sector characterized as follows
  • Margins affected by the spreads between international hot roll coil and imported cold roll coil
  • Steel products are commodities
  • The industry is cyclical 
  • It is heavily intensive in both materials and energy
  • Its profitability is very dependent on government trade policies

Imports challenge

The chart below shows that over the past 6 years, there is a base demand for cold roll steel products. 

This is irrespective of the economic performance of the country. However, the Malaysian demand for steel can be met by both local producers and imports.


Malaysia Cold Roll Consumption Profile
Chart 6: Malaysia Cold Roll Steel and Related Products Consumption



The biggest challenge faced by the Malaysian steel cold roll industry is from imports. The chart shows that over the past few years, domestic consumption from the local mills has been declining due to imports.


Margins being squeezed

Steel products are commodities.  They are manufactured according to several global product standards and design specifications.

In many instances, the “quality” of the products is dependent not only on a company’s manufacturing process but also on the “quality” of the raw material.

CSC Steel is a commodity producer in the global industry.  

Its margins are affected by the international prices of the raw materials (hot roll coil) and the finished cold roll coils. As the chart below indicates, the margins were thin for the past 2 years.

CSC Steel - Margins being squeezed
Chart 7: Malaysia Prices for Hot Roll and Cold Roll 
Source:  Mycron Steel Bhd Annual Report 2019


The chart below illustrates how the prices for hot and cold roll coils have fluctuated considerably over the last 12 years. We will continue to see these price fluctuations in the future.

Historical Hot Roll and Cold Roll prices
Chart 8: Hot Roll and Cold Roll Price History
Source: US FRED Research Price Index


Competitors profile

Currently, there are 3 public listed local cold roll coil producers operating in Malaysia
  • CSC Steel
  • Mycron Steel Bhd
  • Eonmetal Group Berhad

Until April last year, YKGI Holdings Bhd was a large cold roll coil player.  But it sold its plant to Japanese outfit NS Bluescope Malaysia Sdn Bhd.

The problems faced by the Malaysian cold roll sector is very aptly described in Mycron Steel Berhad 2019 Annual Report. 

“The last decade has truly been a harsh and hostile environment for Malaysian Steel mills, with rising domestic cost of electricity, natural gas and minimum wage, whilst grappling with the turmoil caused by surging steel imports that manipulate Free Trade Agreements (“FTA”) and World Trade Organization (“WTO”) laws.”

Globally, steel companies need around 70% to 80% capacity utilization to be sustainable. 

In 2018, Malaysia’s total installed capacity for cold roll coils was 2.51 million metric tons.   But consumption from the local mills was a mere 0.59 million metric ton or less than 23 % utilization.


Malaysia Cold Rolling Industry performance
Chart 9: Malaysia Cold Rolling Industry Statistics
Source: Mycron Steel Bhd Annual Report 2019


Trade protection

The local cold roll mills' main complaint is that the Malaysian Government has not protected them.  For example, there is no duty on foreign imports.  

This is in stark contrast to other countries such as 
  • Indonesia, which in 2019 levied anti-dumping duties on hot-rolled plates from China.  These duties also covered steel products from Singapore and Ukraine. 
  • Thailand, which in December last year extended the anti-dumping duties on cold roll coils from China, Vietnam, and Taiwan.  

Mycron Steel Bhd is leading the discussions with the Malaysian Government about protecting the domestic steel industry. The industry wants the government to address the dumped and subsidized steel imports.

The Malaysia CRC industry believes that the survival of the domestic CRC industry will be assured once the government agencies move away from their “Open Market Liberal Free Trade” stance and follow the Government’s “Buy Malaysia” policy.


Industry performance

If you look at the performance of the peer companies in this industry as per the chart, you will conclude that it has been tough for the past 12 years.

CRC Steel - Peer Revenue Index
Chart 10:  CRC Peer Revenue Index
Note: For Mycron and Eonmetal, we only looked at the flats and steel business respectively


CSC Steel has been able to maintain its revenue and be profitable in spite of the various challenges highlighted above.  This is due to the following strategies
  • Moving up the value chain by increasing its market share into the higher-grade steel products and also beefing up its overseas market.
  • Enhancing existing product quality and new product development. This is achieved with the support from its parent company
  • Continual upgrading of its production facilities.  This ensures that the Group is able to maintain its competitiveness

In the event the Malaysian Government put in place some protective measures, CSC Steel's profitability will be enhanced, provided of course that MegaSteel does not come back in a big way. 


Pulling it all together - is this a Value Trap?

For a definitive answer whether CSC Steel is a value trap, you need to consider its intrinsic value.  

But I would argue that you can make an educated guess even at this stage. Not only is the price below its Graham Net Net, but there are other positive factors 
  • It is profitable
  • It is financially sound
  • You are buying at the bottom of the cycle

Nevertheless, if you want a definitive answer about whether CSC Steel is a value trap or a steal, a hidden gem, join me in Part 2.


End of Part of 1of 2

Part 2 was published on Sun 27 Sep 2020



Notes
1) Gross profitability = gross profit margin / total assets

2) Tatt Giap Group was listed on Bursa Malaysia in 2010 with SHF of RM 77.9 million. By 2016, its SHF had been reduced to RM 24.9 million.  Tatt Giap Group Berhad has been renamed Dynacite Group Berhad following the emergence of Dynaciate Engineering Sdn Bhd as the largest shareholder in January 2019.



Reading guide
If you are a first-time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation.  I suggest that you check up the Foundations series - Fundamentals 01,  Fundamentals 02, and Fundamentals 03.   I also have a Definitions page in case you are not familiar with the terms I have used. 




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Disclaimer
I am not an investment adviser, security analyst or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned in this website may not be suitable to you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.



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