Kinsteel Bhd - 2007

MARC has affirmed the ratings of Kinsteel Berhad’s (Kinsteel) RM100.0 million Murabahah Commercial Papers/Medium Term Notes (Murabahah CP/MTN) and RM100.0 million Murabahah Medium Term Notes (MMTN) Programme at MARC-2_ID /A_ID  and A_ID respectively. The ratings carry a stable outlook, reflecting the company’s above average competitive position in the local steel industry supported by its wide distribution network, access to scrap supply and recent synergies derived from its acquisition of Perwaja Steel Sdn Bhd (Perwaja) and certain assets located in Gurun, Kedah (Gurun assets). These factors are however moderated by the low utilisation of the Gurun plant, legacy liabilities of Perwaja, the cyclicality of the steel industry and its large ongoing working capital requirements which have delayed improvements in cash flow accretion and necessitated an increase in its trade finance facilities.

On 7 September 2006, Kinsteel completed the acquisition of a 51% shareholding interest in Perwaja, which manufactures direct reduced iron (DRI), steel billets, beam-blanks and blooms. Concurrently, Kinsteel via a special purpose vehicle, Perfect Channel Sdn Bhd (PCSB) acquired a 51% shareholding interest in the Gurun assets, which produces steel bars, wire rods, beams and sections. With these acquisitions, Kinsteel has transformed itself into an integrated steel player.

At present, Kinsteel produces mild steel round bars, high tensile deformed bars, U-channel bars, angle bars and flat bars (collectively known as long products), servicing the construction and infrastructure industries. With the addition of Perwaja and the Gurun assets into Kinsteel Group, Kinsteel’s product lines have been expanded to include DRI, billets, beam-blanks, blooms, sections and wire rods.

The group currently owns seven steel mills in Gebeng, Kuantan, a plant located in Kemaman, Terengganu and another plant located in Gurun, Kedah. The Gebeng mills have an installed capacity of 500,400 metric tons which by September 2007, is targeted to increase by another 300,000 metric tons with the commencement of the eighth mill (bar and wire rod mill). The Kemaman plant has an annual production capacity of 1,300,000 metric tones for the production of steel billets, beam-blanks and blooms and an annual production capacity of 1,200,000 metric tones for the production of DRI. Meanwhile, the Gurun plant has an annual capacity of 700,000 metric tones for the production of beams and sections and an annual production capacity of 450,000 metric tones for the bars and wire rods.

The Group’s financial performance improved significantly in FY2006, with the consolidation of Perwaja’s and PCSB’s financials as of September 2006. Group revenue of RM1,213.5 million was more than double FY2005’s revenue. Excluding non-recurring income from negative goodwill on consolidation of RM317.2 million, the Group’s operating margin was at 13.5%, up from FY2005’s 5.7%. The improvement in revenue and profit was offset by the current weakness in its cash flow measures. At Group level, net cash generated from operating activities (CFO) was negative RM193.4 million in FY2006. The acquisition of Perwaja has resulted in below-average cash flow measures in the immediate term although at Company level, a positive CFO of RM44.4 million was generated.

PCSB has been offered trade financing facilities (TF Facilities) of RM250.0 million by Standard Chartered Bank Malaysia Berhad and RHB Bank Berhad. Kinsteel has written to the Noteholders for consent to amend  the  terms  of  the security under the Programmes. MARC is of the view that the amendments do not adversely affect the interest of the Noteholders. The TF Facilities will be used largely to finance the working capital requirements of the Gurun plant and facilitate sales growth, which in turn should improve plant utilisation.  

The stable rating outlook incorporates expectations that credit protection measures will improve to a level that is consistent with the required credit metrics for the ‘MARC-2/A’ rating category. This improvement is expected to stem from modest capital spending levels after the commissioning of the new mill, positive demand and pricing trends for its steel products which would aid free cash flow generation and more rapid debt reduction. However, ratings could be lowered if earnings falter and credit protection measures recede. Slower than expected improvement in the CFO for Perwaja (Kemaman plant) and PCSB (Gurun plant) will hurt the Group’s credit measures while the low utilisation rate at the Gurun plant’s beam, section and wire rod production capacities at 19% as at June 2007 would constrain improvements in its cost structure.