Abstract: Following an 84% year-on-year increase in net profit in the first half of the year, the company saw that gross profit per ton in July and August was still strong, and we were not surprised, because we saw that rebar prices continued to rise (12% increase since the second half of '18), and that iron ore and coking coal costs were relatively stable. We expect that government production restrictions and lower rebar inventories will continue to support rebar prices, which will lead to a moderate expansion in gross margin per ton in the fourth quarter. The company's net profit for the first half of the year accounted for 47% of the market consensus forecast for the whole year. We think the company is expected to meet the consensus forecast, because the second half of the year is generally the peak season for the steel industry. The company's predicted price-earnings ratio in 2018 is 2.8 times, compared to the Ma Steel and Angang Steel discount of 36%/58%. Considering the company's profit prospects and improved financial conditions, we believe the above valuation discount is expected to narrow.
Gross profit per ton has maintained its growth momentum. In the first half of 2018, gross profit per ton increased by 45% year-on-year to RMB 726. The company stated that gross profit per ton was higher in July and August. This is in line with our observations: 1) rebar prices have risen 12% since July; 2) costs are relatively stable, with imported iron ore (62% grade) CIF prices rising 6% since July, while average coking coal prices in major regions of China have risen 2% since July. Looking ahead to the fourth quarter, we think rebar prices will still be supported, as rebar stocks are still at a relatively low level of 4.01 million tons, 9% lower than the same period last year.
In addition to the increase in gross profit, the improvement in the cash cycle in the first half of the year was also a positive factor. The number of accounts receivable days fell from 5.16 days in the first half of 2017 to 2.81 days in the first half of 2018, while the number of inventory turnover days also dropped from 32.91 days in the first half of 2017 to 29.03 days in the first half of 2018, reflecting that the company improved the management of accounts receivable while orders were strong.
Infrastructure projects in Shandong support growth. The company still sees that infrastructure projects in Shandong (such as the Jiqing high-speed railway) will bring a certain demand for steel, which is expected to support the company's order flow over the next year. As for longer-term development, the company is cooperating with the Chinese Academy of Sciences to launch a rail project as part of its plan to expand its special steel business. The first phase of the project (300,000 tons of rails and 150,000 tons of railway uranium billets) is expected to be completed in mid-2019, while the second phase (400,000 tons of rails and 150,000 tons of steel profiles) will be completed in 2020. Due to the high strength, toughness and durability of the new rail products, it is expected that the average selling price will reach RMB 6,000 per ton, which is higher than that of existing special steel products (RMB 3,880 per ton).
The impact of production restrictions. In mid-September, there was an adjustment in the steel sector due to market rumors that domestic steel production restrictions might be relaxed. However, since there have been no policies to confirm the news since then, steel stocks have rebounded sharply. Since the adjustment, Xiwang Special Steel's stock price has rebounded 8.6%. In our discussions with the company, management believes that given the current industry environment, there is limited room for production limits to be relaxed.
On the other hand, since Tangshan City's earlier emission reduction campaign restricted some steel companies' production capacity for blast furnace ironmaking and sintering processes, plus heating season restrictions, Tangshan steel companies have attracted attention since mid-July. However, since Xiwang Special Steel's main production plant is located in Shandong, it is expected that this production limit will have no impact on Xiwang. The company said it has not received any notice of production limits during the heating season so far.
Performance review for the first half of 2018: Xiwang Special Steel's net profit for the first half of '18 was RMB 568 million, an increase of 84% over the previous year. The strong growth was mainly due to a 45% year-on-year increase in gross profit per ton to RMB 726. Revenue for the first half of the year was RMB 5.956 billion, an increase of 6.5% over the previous year.
Valuation. The company's net profit for the first half of the year accounted for 47% of the market consensus forecast for the whole year. We think the company is expected to meet the consensus forecast, because the second half of the year is generally the peak season for the steel industry. We currently predict 1) gross profit per ton will increase by 15% to 20% in FY18; 2) sales volume in FY17 will be 3 million tons (down 3% year on year). The company's predicted price-earnings ratio in 2018 is 2.8 times, compared to the Ma Steel and Angang Steel discount of 36%/58%. Considering the company's profit prospects and improved financial conditions, we believe the above valuation discount is expected to narrow. The company's output is only about 15% of Angang Steel's production, which is probably one of the reasons for the large valuation discount. However, in our opinion, based on annual net profit of RMB 1 billion, the current valuation of 2.8 times the price-earnings ratio is too conservative.
Risk: Potential fund-raising activities.
Company Background: Xiwang Special Steel is a steel producer, and about 68% of its revenue in 2017 came from Shandong. The company also produces general steel and special steel. Last year, the company sold 3.09 million tons of steel products (compared to Angang Steel's sales volume of 20.8 million tons in 2017). Xiwang Investment holds 66% of the company's shares.