HSG [Non Rated] – Dream of Competing With HPG & Formosa

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Frenzied mid-month dissipates at month-end

August 20, 2015.

Hoa Sen Group (HSG), coated steel sheet producer

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– HSG is doing pre-feasibility study for a steel complex project with capacity of 5-8m tons (2x of HPG’s scale and a 2/3x of Formosa phase 1’s scale) to complete its production chain of producing coated steel sheet from iron ore to finished products, to expand into the USA market and to compete with HPG and Formosa.

– 9M15A’s NPAT soared by 72% vs. 9M14A, reaching 108% of full year target

– HSG is trading at PER of 9.6x based on the management EPS guidance of VND4,500.

An ambitious, somewhat overreaching strategy. HSG is working on pre-FS on a steel complex project concept with capacity of 5-8m tons (including hot rolled coil (HRC), construction steel, etc.), located anywhere which can accommodate a deep-water port. Such investment is to self-supply HRC which is the main input for their coated steel line, therefore, becoming the first-ever in the market with 100% fully-integrated production chain & sales. HSG will produce steel from iron ore and sell directly to end users via their established distribution network (which they are targeting to nearly double by 2017). In addition, this is to expand into USA market where Chinese, Taiwanese, Korean, Indian and Italian producers are under anti-dumping investigation with possible punitive tax reaching up to 80%.

According to HSG, this strategy comes from the fact that HSG’s sales volume is estimated to reach 2m tons by 2018 which supports a break-even utilization rate of 50% for their steel complex. Other supportive arguments for expansion includes:

– Their factories are currently running at full capacity;
– Australia has stopped anti-dumping investigation on HSG’s products;
– HSG’s main export market of Indonesia is still growing despite dumping suits and HSG has taken Indonesia to WTO for imposing “safeguard” action against its coated steel; and
– Opportunity to acquire cheap machinery & technology when commodity market is collapsing.

With this strategy, HSG hopes to compete with Formosa as well as HPG. Of note, HSG is also competing with BMP and NTP in the plastic pipe market and claimed to be the third biggest player in this sector. HSG claimed its advantages vs. these competitors are its retail distribution networks nationwide (which they own vs the agents their competitors use), their brand-name as well as their product quality.

We see such a strategy as daring and risky to some extent. In our opinion, huge capital financing for that project is a head-ache issue, especially with HSG’s current net gearing ratio of 2.3x. In addition we see other problematic factors including:

– We suspect the production cost advantage with the scale a fourth of Formosa phase 2’s scale;
– Large –scale land to be acquired is not easy; and
– Doubling of distribution network is very aggressive.

Of note, this is a very long-term story which HSG just starts to study without execution ensured.

HSG is still confident to compete with Chinese steel by quality. Currently, in local market, HSG is protected by tariff of 5-10% imposed on Chinese steel. In export countries, tariff is up to 20-30%, so they think that a series of Yuan devaluation totaling roughly 2% in recent days will not have significant impact on their outlook.

Impressive 9mo result due to low input prices. HSG reported 9M15’s revenue and NPAT soaring by 23% and 72% vs. 9M14A, respectively. Gross margin has expanded to 13.3% from 11.4%. Such result accounted for 108% of full year target. HSG explained such a good result explained with four reasons: 1) Input material price falling more than ASP; 2) sales volume rising 29%; 3) a shift into higher – margin products; 4) the operation of two cold rolled coil production lines help to save outsourcing cost and improve margin. HSG’s fiscal year started at 1 October 2014.

Expansion is on-going. HSG is investing in a new factory in Nghe An to nearly double its current production to 2.2m tons by April 2017. Investment capital is VND4.5t (USD201m). They have secured bank loan at interest rate ~8% for the project. This plant’s products are expected to be exported to Thailand, Myanmar, Lao and Cambodia.

Financial Statements

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VCSC Information

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Valuation Methodology: To derive the target price, the analyst may use different valuation methods, including, but not limited to, discounted free cash-flow and comparative analysis. The selection of methods depends on the industry, the company, the nature of the stock and other circumstances. Company valuations are based on a single or a combination of one of the following valuation methods: 1) Multiple-based models (P/E, P/cash flow, EV/sales, EV/EBIT, EV/EBITA, EV/EBITDA), peer-group comparisons, and historical valuation approaches; 2) Discount models (DCF, DVMA, DDM); 3)Break-up value approaches or asset-based evaluation methods; and 4) Economic profit approaches (Residual Income, EVA). Valuation models are dependent on macroeconomic factors, such as GDP growth, interest rates, exchange rates, raw materials, on other assumptions about the economy, as well as risks inherent to the company under review. Furthermore, market sentiment may affect the valuation of companies. Valuations are also based on expectations that might change rapidly and without notice, depending on developments specific to individual industries.

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