Is CSC Steel one of the better Bursa Malaysia stocks?

Value Investing Case Study 04-3: I first covered CSC Steel in Sep 2020. This is an update taking into account the financials for FYE 2020 and the Q2 2021 results.

Is CSC Steel one of the better Bursa Malaysia stocks to invest in?

In Sept 2020, I had concluded that CSC Steel Holdings Bhd (CSC Steel or the Group) was not a value trap. At that juncture, it was trading at RM 0.835 per share compared to its Graham Net-Net of RM 1.53 per share.

The price has since increased to RM 1.42 per share as of 3 Sep 2021. At the same time, the Graham Net-Net has also increased to RM 1.72 per share.

If you are not familiar with the Group, please refer to the following articles as this post assumed such knowledge.

There has not been any significant change to the business prospects since last year. Yes, the market price has increased by 63 % since then. Have you missed the boat?

Join me as I argue why CSC Steel is still one of the better Bursa Malaysia stocks to invest in. At the current price, it is still not a value trap. It means that there is still an investment opportunity. 

Should you go and buy it? Well, read my Disclaimer.

Contents

  • Investment thesis
  • Rationale
  • Financial strengths
  • Current performance
  • Cyclical sector
  • Management
  • Shareholders’ value creation
  • Risks
  • Valuation
  • Why CSC Steel is one of the better Bursa Malaysia stocks.
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Investment Thesis

As of 3 Sep 2021, CSC Steel was trading below its Graham Net-Net. The Net-Net is often considered a shorthand for the liquidation value. There is no reason for CSC Steel to be liquidated. Furthermore, there is no reason for any impairment of its assets.

CSC Steel valuation
Chart 1: Valuation

The Asset value is a good indicator of the intrinsic value. Even if you consider the EPV, there is a 29 % margin of safety. 

CSC Steel is a company with strong fundamentals. As such CSC Steel is not a value trap.

The global steel sector is currently going through the uptrend part of the price cycle. I expect this to be a catalyst for re-rating once the Covid-19 pandemic is brought under control.

Rationale

  • CSC is financially sound with zero Debt. It has cash of RM 0.72 per share.
  • It has managed to be profitable in 2020 despite the Covid-19 pandemic restrictions.
  • Its 2021 performance has been boosted by the current uptrend in the price cycle.
  • There has not been any major change in the way the Group is managed. Management still has good operations and capital allocation track record.
  • But it did not create any shareholders’ value over the past 13 years. Part of the reason for this is that it has substantial cash that generated low returns.
  • There is less risk today to invest in CSC Steel compared to last year.
  • It is trading below its liquidation value. Even if you ignore the Asset Value, there is still a margin of safety based on the EPV of RM 1.83 per share. Although it is in a cyclical sector, I have taken this into account by computing its EPV based on the past 12 years’ earnings.

The supporting details are presented in the following sections. 

Financial strengths

As of the end of June 2021, the Group had a Total Capital Employed (TCE) of RM 851 million. All of this was funded by Shareholders’ Equity.

CSC Steel Capital structure and its deployment of funds
Chart 2: Sources and Uses of Funds

About 63 % of the TCE was used for the operations. Of the balance, RM 268 m was in cash, and RM 41 million was in Investment Properties. This RM 41 million has been reclassified into Assets for sale in the Jun 2021 Financial Statements. Refer to the article “Is CSC Steel a value trap (Part 1 of 2)” to see how the Investment Properties came about.

As you can see, the Group has zero borrowings. This meant that in the event of any prolonged slump in the business, there is no repayment issue to worry about.

Current performance

As of the end of Jun 2021, the Group had a YTD revenue of RM 740 million compared to RM 406 million for the same period last year.  It achieved a YTD PAT of RM 37 million compared to RM 3 million for the same YTD of last year.

Management had attributed the better performance to supply constraints and an uptrend in steel prices. Of course, the performance in 2020 was impacted by the Covid-19 pandemic lockdown measures. Nevertheless, the Group achieved a PAT of RM 36.4 million in 2020. It is possible that the results for 2021 would exceed that of 2020 despite still having the Covid-19 pandemic measures in 2021.

It remains to be seen whether the 2021 performance can exceed that of 2008. Over the past 12 years, there have only been 3 years where the PAT had exceeded that of 2008 as can be seen from the Performance Index chart. 

If nothing else, the chart illustrated that there was no revenue growth over the past 12 years. It supports the case that CSC Steel should be viewed through a cyclical sector lens.

CSC Steel performance index
Chart 3: Performance Index

From 2008 to 2020, the average ROE was about 5 %. You may think that this is not a sufficient return on investment. This low return is because only about 2/3 of the TCE was used for the operations. The rest of the balance was mainly cash which generated low returns.

If I separated out the earnings from the operations with those from other sources, we have the picture as shown in Table 1. The return from Operations was 9.0 % compared to the WACC of 9.5 %. This is of course a back-of-envelope analysis, but it does show that the overall returns were pulled down by the large non-operating assets.

CSC Steel segment results
Table 1: Sources of performance
Notes
(a) This was based on the PBT excluding the interest income and/or interest expenses and gain/loss from associates.

(b) Derived by deducting the EBIT from Operations from the Consolidated EBIT. The Others here included the results from associates. 

(c) Return = Ave EBIT / TCE

Cyclical sector

Steel is a commodity and product prices and raw materials (hot-rolled coil in the case of CSC Steel) prices are cyclical as can be seen from the chart below.

CSC Steel global steel price trends
Chart 4: Cold Roll Steel Prices      Source: Steel Benchmarker

Currently, the industry is facing an uptrend in prices. The price as of Aug 2021 appears to be at the 20 year high. 

The industry is such that steel companies will be very profitable when steel prices are high. This is because the spread between the raw materials and finished products will widen.

Give this uptrend, I would expect CSC Steel's performance in 2021 to be near its historical best.

Steel is a global commodity and as Chart 4 shows, prices in different markets move in tandem.

I have also covered some US Steel companies such as Steel Dynamics, Worthington Industries, and Timken Steel.  They are all experiencing good profits this year.  Refer to my various articles in my blog or in Seeking Alpha.

I would expect the profits of Malaysian steel companies to perform well this year compared to the past.

Management

CSC Steel is managed as if it was part of the Taiwanese parent company.

Over the years, the Managing Director of CSC Steel has always been seconded from the Taiwanese parent company.  And each served only between 1 to 2 years in CSC Steel.  

In its 2016 Annual Report, the CSC Steel went as far as to state:

“… stakeholders can be rest assured that the frequent changes of the Managing Director will not adversely affect the organizational effectiveness...”

For more insights into management refer to “CSC Steel: When you have a good horse, the jockey is not critical”. This was published in Focus Malaysia in Feb 2021.

In 2020, there were 7 members on the Board of Directors comprising:  
  • The Group Managing Director. He was seconded from the parent company and was appointed in May 2019.
  • The Executive Director cum Vice President of Finance. He was also seconded from the parent company. But he left CSC Steel in Dec 2020. There was a replacement Executive Director for finance seconded from the parent company in Jan 2021. 
  • 3 Non-Independent Non-Executive Directors and 2 Independent Non-Executive Directors. These were the same people as reported in the 2019 Annual Report.

There were also changes to the senior management team towards the end of 2020. 
  • The team was increased from 5 members in 2019 to 6 members in 2021.
  • In 2019, there were 3 Taiwanese in the team - the 2 Executive Directors and the Vice President for Production. This was reduced to 2 moving into 2021. In Dec 2020, the Malaysian who served as Asst Vice President of Production was promoted to be the Vice President of Production. 
  • There were 2 new appointments. One was the Asst Vice President of Production and the other was the Special Assistant to the MD. Both were Malaysians.

How did management perform from an operations perspective compared to its peers? 

There were 3 other Bursa Malaysia listed companies in the steel sheet sector - Mycron, Eonmetal, and YKGI. I compared CSC Steel's revenue and ROA with these 3 as shown in the 2 charts.
  • In terms of revenue growth, I rate CSC Steel's performance as average.
  • However, CSC Steel is the best performer in terms of ROA.

CSC Steel peer revenue index
Chart 5: Peer Revenue Index

CSC Steel Peer ROA
Chart 6: Peer ROA

When it came to capital allocation, from 2008 to 2020, the Group generated RM 890 million cash from operations. Of these:
  • RM 433 million was paid as Dividends. Compared to the total PAT of RM 561 m for the period, this was equal to 77 % of the PAT.
  • RM 288 million was spent on net CAPEX (CAPEX less sale of PPE).
  • RM 107 million was spent on increasing the working capital (Inventory + Receivables - Payables).
  • Cash only increased by RM 9 million.

I would conclude that this was a good capital allocation programme. 

Shareholders’ value creation

I looked at the following metrics when assessing shareholders’ value creation:
  • Comparing returns with the cost of funds.
  • Comparing the gains by an investor who bought a share at the end of 2008 with the cost of equity.
  • The Q Rating.

Overall, the returns were lower than the respective cost of funds. Furthermore, the Q Rating was not better than 2/3 of the panel.  I would conclude that the Group did not create any shareholder value. 

CSC Steel shareholders' value creation
Table 2: Shareholders' value creation
Notes
(a) Based on average EBIT/TCE from 2008 to 2020 assuming 24 % tax rate. I compared it with the WACC.

(b) This looked at how the SHF at the end of 2007 would have grown by the end of 2020 assuming that no Dividends were paid. I compared it with the cost of equity.

(c) Computed assuming that an investor bought 1 share at the end of 2007 and held onto it till the end of 2020. His gain would be 4.1 % CAGR as shown below compared to the cost of equity.

CSC Shareholders gain
Table 3: Shareholders gain


CSC Steel had an overall Q Rating of 0.47. This places it just below the 67 % position among the panel companies. But it is better than average. Its position was pulled down by the low growth score although it did well financially. 

CSC Steel Q Rating
Chart 7: Q Rating

The main reason for the poor shareholders’ value creation is because only about 2/3 of the TCE were deployed for the operations. The balance was mostly in cash which generated low returns.

I could not understand why CSC Steel has such a high cash position. The Group is able to generate positive cash flow from operations. At the same time, there is no aggressive expansion programme requiring a large amount of investment. Even if such an investment is required, there is the option of the funding part of it with debt.

The best course of action would be to return some of the extra cash to shareholders. 

Risks

In my 2020 analysis, I stated that the 2 main risks that you have to be aware of when investing in CSC Steel were :
  • Privatization risk.
  • Cyclical risk.

Both the risks are reduced today compared to the situation a year ago. 

Since there was no privatization exercise last year when the stock was trading at RM 0.835 per share, the privatization risk today has been reduced. Today it would cost about 63 % more to privatize it. I do not think it makes sense to privatize it at the current price.

As for the cyclical risk, my view last year was that steel prices then may not have bottomed. I was wrong. Today the price is on an uptrend.

The conclusion is that there is less risk today to invest in CSC Steel. 

Valuation

I determined the intrinsic value of CSC Steel based on the following:
  • Asset value. This is broken down into the Graham Net-Net, NTA and Book Value.
  • Earning value. This is broken down into Non-Operating Assets and Earnings Power Value (EPV).

In deriving the Earning value, I assumed that the future will be similar to the past 12 years' performance. If you believe that the future is better, then you will ascribe a higher value than that derived and vice versa.

I have ignored the Earning value with growth. This is because the returns are less than the cost of funds. As such growth will not create value. In other words, the Earning value with growth will be lower than the EPV.

CSC Steel valuation metrics
Table 4: Valuation metrics

As can be seen from the table and chart, the Graham Net-Net will provide a 27 % margin of safety. The Graham Net-Net is often considered as a shorthand for the liquidation value.

The fundamental analysis has shown that there is no reason to expect CSC Steel to be liquidated. At the same time, there is no reason to expect any impairment of its assets. As such the Asset value is a good indication of the intrinsic value.

CSC Steel valuation
Chart 1: Valuation (reproduced)

In addition to the margin of safety based on comparing the stock price with the intrinsic value, you can also enjoy dividends while waiting for a re-rating.

From 2008 to 2020, CSC Steel has paid an average of RM 0.09 per share Dividend. At the current price, this is about a 6.3 % dividend yield. This is much better than putting your money in a Malaysian bank.

Case Notes

According to Damodaran, cyclical and commodity companies share a common feature.  Their value is often more dependent on the movement of a macro variable (the commodity price or the growth in the underlying economy) than it is on firm-specific characteristics. 

Thus, the value of a steel company is inextricably linked to the price of steel just as the value of a cyclical company is tied to how well the economy is doing. 

The biggest problem we face in valuing cyclical companies is that the earnings and cash flows reported in the most recent year are a function of where we are in the cycle. Extrapolating those numbers into the future can result in wrongful valuations.

To overcome such an issue, I took the average value of the cycle to represent the expected value. There are two approaches to estimate such average values. Using the example of determining the earnings, you can:
  • Take the actual average earnings over the cycle.
  • Take the current revenue and multiply this by the average profit margin over the cycle.

If there is growth during the cycle, the latter method would provide a better estimate.

As you can see, fundamental analysis is more than just using some formula. There are choices to be made in terms of which approach to use and what to assume. 

So, if you are just starting out to analyze and value companies, it may be helpful to supplement it with third-party analyses and valuation.  

There are several financial advisers who provide such analyses. 

Those who do this well include people like Seeking Alpha.* Click the link for some free stock advice. If you subscribe to their services, you can tap into their business analysis and valuation.




Why CSC Steel is one of the better Bursa Malaysia stocks.

The above analysis has shown that CSC Steel is fundamentally strong. Management has a good track record as an operator and capital allocator.

While it has not been able to create shareholders’ value, if you invest at the current price, you have a sufficient margin of safety. At the same time, you can expect a 6.3 % dividend yield.

So, while waiting for the market to re-rate, the dividends will provide a return that is much better than keeping your money with a bank.

I expect the results in 2021 for the Group to be one of the better ones compared to the past 12 years. This is because steel prices are in the uptrend part of the price cycle. This will provide the catalyst for re-rating.

There is another potential upside. The Group currently has about RM 268 million cash. Over the past 12 years, the lowest cash position was about RM 160 million cash. And this was only for one year. Most of the time, the annual closing cash was above RM 200 million. 

This meant that there is excess cash that could be returned to shareholders as I do not foresee the Group investing in new ventures. There is currently excess capacity in Malaysia. I do not see the parent company authorizing any new investments (except for the usual CAPEX).

For these reasons, I consider CSC Steel one of the better stocks in Bursa Malaysia to invest in. There is a potential upside while the Asset value provides the downside.



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Disclaimer & Disclosure
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 on this website may not be suitable for 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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