MARC has lowered its ratings on Kinsteel Berhad’s (Kinsteel) RM100 million Murabahah Commercial Papers/Medium Term Notes Programme (CP/MTN) and RM100 million Murabahah Medium Term Notes (MTN) Programme to MARC-2ID/A-ID and A-ID from MARC-2ID/AID and AID respectively. The outlook for the ratings is negative. Concurrently, the rating agency has removed Kinsteel’s ratings from MARCWatch Negative where they were placed on February 3, 2012. The rating actions incorporate Kinsteel group’s deteriorating financial performance on the back of raw material price volatility and subdued demand for steel products, increased borrowings and weakening liquidity position from extending financial support to fully subscribe to subsidiary Perwaja Holdings Berhad’s (PHB) loan stock issue.

For the financial year ended December 31, 2011 (FY2011), Kinsteel group registered unaudited pre-tax losses of RM228.6 million mainly due to disproportionate increases in raw material costs, in particular iron-ore prices, relative to finished steel product prices, as well as impairment costs and higher financing costs of RM132.7 million (FY2010: RM123.6 million). MARC notes that the average purchase price of billets used in Kinsteel’s downstream activities rose by 11.1% in FY2011 from the previous year against an increase in the average selling price of steel products of 8.6% in the same corresponding period. For FY2011, Kinsteel had recorded a write-down on inventories of RM94.2 million following the sharp decline in iron-ore price in 4Q2011. MARC observes that operational cash flow (CFO) has been positive over the last three years owing largely to reduced working capital utilisation due to declining production levels in light of persistently weak demand. However, the group has increased its reliance on bank borrowings, particularly trade financing, which has risen by 70% from RM733.5 million in FY2007 to RM1,248.4 million in FY2011, to support stock build-up during the same period.

In tandem with increased borrowings, Kinsteel group’s leverage position as reflected by debt-to-equity (DE) ratio increased to 1.38 times (x) in FY2011 (FY2010: 1.12x). MARC expects the group’s leverage position to worsen in the near term following the financing of its upstream expansion into construction of an iron ore concentration and pelletising plant by Perwaja Steel Sdn Bhd (Perwaja), which manufactures direct-reducing iron (DRI) and semi-finished steel products. Funding requirements for the plant are expected to be met from a combination of internally generated funds and term loans.

At the holding company level, Kinsteel’s pre-tax profit declined to RM9.2 million (FY2010: RM16.3 million) while CFO was in deficit of RM6.9 million (FY2010: surplus of RM42.9 million) on the back of decreased payables and intercompany balance. MARC remains concerned on the elevated DE ratio at holding company level of 1.95x as at end-FY2011 (FY2010: 1.96x).  Kinsteel has fully subscribed to RM280.0 million redeemable convertible unsecured loan stocks (RCULS) issued by PHB, the holding company of Perwaja, using internally generated funds. About 175.5 million nominal value RCULS or 62.7% were subsequently offered for sale to other existing PHB shareholders but received an initial subscription of 3%. Kinsteel has now managed to place approximately RM64.7 million nominal value RCULS which translates to 36.9% of the potential cash inflow of RM175.5 million. Consequently, Kinsteel’s inability to recover the substantial costs incurred to subscribe to the RCULS is expected to weigh on its liquidity position. MARC notes that proceeds from the RCULS issuance will be utilised at Perwaja’s level to meet its working capital requirements, including paying off intercompany loans to Kinsteel.   

The negative outlook incorporates MARC’s concerns on the uncertain immediate prospects the Kinsteel group faces to strengthen its business and financial profile to a level that would commensurate with the current rating band. The ratings could be lowered if further deterioration in Kinsteel’s financial metrics were to occur in the near term.

Contacts:
Thian Chow Di, +603-2082 2280/ chowdi@marc.com.my;
Rajan Paramesran, +603-2082 2233/ rajan@marc.com.my.