MARC has affirmed the rating of Perwaja Steel Sdn Bhd’s (Perwaja) RM400.0 Million Murabahah Medium Term Notes (MMTN) Programme at AID and revised its outlook to developing from stable.

The affirmed rating reflects Perwaja’s competitive strength as a major local producer of direct reduced iron (DRI) and its strategic importance to parent company, Kinsteel Berhad, which has a long term rating of AID from MARC in respect of its Islamic debt securities. Moderating factors include weaker steel demand conditions and Perwaja’s high inventory buildup affecting the company’s liquidity position in the near to intermediate term.
 
The 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 weaker trading performance for Perwaja in 2009. As global steel prices have declined sharply owing to the slowdown in construction and steel-consuming industrial sectors such as automobile, local steel players have become pressured to cut production capacity as well as to price their steel products closer to global levels in order to maintain competitiveness. Accordingly, Perwaja has had to decrease its capacity utilisation rate to a current level of 50%, down from an average of 90% in FY2007 as well as cut its DRI and steel billets prices to US$320/t (mid-FY2008: US$480/t) and US$400/ton (mid-FY2008: US$1000/t) respectively. Perwaja has also had to defer expansion plans and trim its iron-ore purchases because of current conditions. At this juncture, 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 over the next six months.

Perwaja registered a robust performance in the year ended 31 December 2007 (FY2007), as reflected by a 43% revenue growth to RM1.69 billion (FY2006:RM1.18 billion) and operating profit margin of 13.5% (FY2006:11.2%). In the subsequent year, 2008, the company’s interim results for the 12 months ended December 31 (4QFY2008) showed sales of RM2.33 billion and operating income of RM180.79 million (operating margin of 7.74%), net of RM346.1 million worth of provisions for inventory impairment. Significant growth in sales and profitability for Perwaja up to mid-FY2008 was largely attributable to the heightened demand for steel driven by a global construction sector boom. However, as steel prices came down sharply shortly after, the company had to incur writedowns on its steel and iron ore inventory in 3QFY2008 and 4QFY2008. The earnings in 4QFY2008 were also negatively affected by a significant drop in sales volume.

Meanwhile, Perwaja’s liquidity profile has been boosted by the proceeds from Perwaja Holdings Berhad’s initial public offering, following its listing on Bursa Malaysia on August 20, 2008. Perwaja’s debt-to-equity ratio (excluding trade payables and inclusive of an interest-free loan of RM204.6 million) is moderate relative to its peers and stood at 0.87 times based on interim results as at December 31, 2008, compared to 1.12 times at end-FY2007. Working capital requirements should reduce in line with the company’s presently scaled-down operations.

MARC believes that while Perwaja is able to withstand a fair amount of stress to its credit profile, on account of its improved liquidity position, the likelihood of financial support from its parent company Kinsteel, and its ability to retain a degree of pricing power in local markets, the rating could face downward pressure if demand conditions continue to worsen.

Contacts:
Khairul Muzamel Perera 03-2090 2247/ kevinkhairul@marc.com.my;
Ruben Khoo, 03-2090 2265/ rubenkhoo@marc.com.my; Jason Kok, 03-2090 2258/jasonkok@marc.com.my