Kinsteel Bhd - 2008 / 2009

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-2ID /AID and AID respectively with a revision in outlook from stable to developing. The rating affirmation reflects the company’s competitive business profile, supported by its wide distribution network and competitive advantages derived from access to direct reduced iron (DRI) feedstock through related company, Perwaja Steel Sdn Bhd. However, MARC views with concern presently weak demand conditions as well as Kinsteel’s significant debt burden, scaled-down production volumes, and heavy inventory stockpiles.

The rating outlook revision reflects a lack of visibility regarding the potential severity and duration of the current downturn in steel demand in addition to MARC’s expectations of a weaker trading performance for Kinsteel in 2009. Key to any further rating action would be the performance of the group and company and its ability to maintain credit metrics consistent with its current ratings.

Kinsteel registered strong results in financial year December 31, 2007 (FY2007), owing to strong steel prices and demand from the local construction sector, posting revenues and profit-after-tax margins of RM2.13 billion and 10.3% respectively. For the year ended December 31, 2008, FY2008 (unaudited), the group reported revenues of RM2.46 billion, 15.5% up from RM2.13 billion recorded in the previous year. Despite the improvement in sales performance in the first half of FY2008 - owing to higher demand and price of local steel products as well as an increased contribution from foreign exports to countries such as Singapore and the Middle East - operating profits fell 36.3% on a year-on-year basis as the group had to incur provisions for RM427.8 million worth of inventory value impairment due to a sharp drop in steel prices after mid-FY2008. Looking ahead, group profitability is expected to remain pressured by the challenging operating environment. Furthermore, lower profits are attributable to Kinsteel due to its smaller equity interest of 37% (previously 51%) in Perwaja Holdings Bhd’s (PHB), owing to a sale of shares during PHB’s initial public offering and listing on Bursa Malaysia on August 20, 2008. Kinsteel is able to regain its 51% controlling interest upon exercising its ICULS in PHB, but the group has shown no intention of doing so in the short term.

In FY2008, consolidated net cash flow from operations after working capital reductions was negative RM240.69 million, attributable to extensive purchases of iron ore inventory during the year. Despite the cashflow absorbed by the inventory build-up, the group’s liquidity position remains supportive of its MARC-2ID ratings, as evidenced by its cash and cash equivalents of RM184.06 million as at December 31, 2008. This amount is supported by proceeds of approximately RM161.32 million from PHB’s listing and proceeds of RM96.36 million from the sale of its shares in PHB. Meanwhile, Kinsteel’s debt burden, at a consolidated level, remains a concern as reflected in its gearing ratio (includes an interest-free loan of RM204.6 million) of 0.90 times as at December 31, 2008. While the burden should be lessened by reduced working capital requirements at current production levels of 50% and the deferment of expansion plans, credit ratings will depend on Kinsteel’s ability to demonstrate adequate debt protection going forward.

Major Rating Factors

          Strengths 

• Integrated production capabilities and enhanced output quality through the use of direct reduced iron; and
• Access to buyers in the Middle East, Singapore, and Indonesia.
  
  Challenges/Risks 
  
  
• Exposure to a volatile and capital-intensive industry;
• Demand concerns locally and abroad owing to slowing construction activity in China and the global credit crisis; and
• Managing the heavy costs of iron ore and energy usage.