Event: Share price of Shougang Concord Int?l has dropped 21% since last Friday.
Share price of Shougang Concord Int?l (?SCI?) has dropped 21% since last Friday. It is now trading at 0.6x book value. SCI is unlikely to be loss-making although the outlook for the steel industry is pretty negative. We believe this undervalued stock deserves a trading buy recommendation in the near term.
Compared to the average 24.6% drop of steel price in October, SCI?s heavy plates being made from its Shouqin plant only dropped 9.4% in October, and is still selling 44.2% higher compared to October 2007. Meanwhile, sales volume of company?s heavy plates only decreased 10.9% month-on-month, despite the quick economic downturn in October.
At the same time, price of coke, one of the major raw materials of company?s steel-making process, has dropped more than 50% since reaching its peak in August. This helps to ease part of company?s production cost. Thus we believe company only experience a slight margin squeeze in 4Q08.
SCI has come into an agreement with Australia-listed iron ore miner Mount Gibson to lift its stake to 10.2-14.4% through share placement and underwriting its right issues. We believe the deal is a big bargain to SCI as SCI can gain a controlling stake of Mount Gibson at a much cheaper price compared to A$2.65 per share it offered to acquire a 19.7% stake early this year.
Company also comes into an offtake agreement with Mount Gibson to purchase iron ore at a discount price giving an opportunity for SCI to have a secured source of iron ore at a much cheaper price. We estimate that if the deal goes through, the amount of iron ore provided from Mount Gibson will completely fulfill SCI?s iron ore needs even after company?s 750kt expansion plan to be completed in 2010.
The deal is subject to the approval from shareholders of both Mount Gibson and APAC which with results expected in late December. The deal is also conditional upon approval by the Foreign Investment Review Board. We believe there is a big chance that the deal will go through.
We believe SCI?s value emerged from its unique product mix, which is less affected by the slowdown of economy. Around 50% of SCI?s steel plates is for shipbuilding while others are mainly used for infrastructure projects such as bridge and oil pipeline. Compared to a 30% drop of steel price in general, price on ship plates only dropped by 10% in October. Combined with a drop of coking coal price, we believe company?s gross margin only slightly squeezed in 4Q08 as well as 1H09 and is unlikely to make any losses.
6-month target price of $1.1, representing a 5x 2009 PER and a 1x book value.