Perwaja Steel Sdn Bhd - 2013

MARC has lowered its rating on Perwaja Steel Sdn Bhd’s (Perwaja) RM400.0 million Murabahah Medium Term Notes (MMTN) programme to BBB-ID from A-ID. Concurrently, MARC has placed the rating on MARCWatch Negative. The rating actions affect RM110.0 million of current outstanding notes.

The rating downgrade reflects the steelmaker’s weak financial risk profile arising from the prolonged challenging conditions in the steel industry, high leveraged position, ongoing capital expenditure and high operating costs. The MARCWatch Negative placement reflects MARC’s views that Perwaja’s liquidity position would come under increasing pressure to meet its upcoming financial obligations.  

Perwaja is part of the Kinsteel Berhad (Kinsteel) group and is a major domestic producer of direct reduced iron (DRI), a steelmaking feedstock, and semi-finished long products such as billets, beam-blanks and blooms. MARC is currently undertaking Kinsteel’s annual rating review. Perwaja’s products are also sold internally to Kinsteel for the latter’s downstream manufacturing operations. The performance of both steel players in recent years has been plagued by weak demand and volatile raw material and finished goods prices that have been exacerbated by competition from cheaper steel imports. Notwithstanding some recent demand recovery evident in the domestic steel sector in 2012, MARC does not envisage any significant turnaround for Perwaja in the immediate term given the company’s prevailing weak financial metrics.  

For the nine months to end-September 2012 (9MFY2012), Perwaja registered revenue of RM1.4 billion (9MFY2011: RM1.2 billion) largely on better DRI exports, but thin operating margins, coupled with high financing costs, have led the company to register a pre-tax loss of RM17.0 million (9MFY2011: pre-tax loss of RM34.0 million). MARC notes that Perwaja’s cash flow from operations (CFO), which has been characterised by volatile movements in working capital and inter-company balances, declined sharply to negative RM169.8 million as at end-September 2012 (FY2011: RM133.1 million).

MARC observes that while Perwaja’s debt-to-equity ratio eased to 1.06 times as at end-9MFY2012 (FY2011: 1.44 times), this was mainly from a capital injection of RM280.0 million from its intermediate holding company Perwaja Holdings Berhad. The capital injection was largely utilised to settle working capital advances due to Kinsteel group rather than on external debt reduction. Total borrowings, including the outstanding RM110.0 million under the rated programme, stood at RM945.4 million as at end-9MFY2012 (FY2011: RM910.1 million), of which 76.5% are short term in nature. In addition, Perwaja is committed to meet the balance of its RM230.0 million capital expenditure for setting up the iron ore concentration and pelletising plants that are expected to mitigate the impact of global iron ore price volatility on its operations. Nonetheless, MARC notes that the recent downward trend in iron ore prices may weaken the potential cost savings of the company’s backward integration strategy.

Given Perwaja’s current liquidity position as reflected by cash balances of RM12.8 million as at end-September 2012 (FY2011: RM14.1 million) against a repayment of RM50.0 million MMTN due on September 25, 2013, MARC understands the company is seeking to refinance the notes.
 
The MARCWatch Negative resolution relies upon Perwaja’s ability to generate sufficient liquidity to meet the upcoming MMTN repayment and/or timeliness of the ongoing refinancing plan to somehow ease its capital structure. The rating would be lowered should the company’s liquidity position show further deterioration in the near term. 

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