Vietnamese Steel a Strong Buy

August 01, 2016

Disclaimer: the opinions expressed herein are that of HSC Securities and not of VietnamAdvisors. This is NOT a solicitation to buy or sell securities.

• HPG 1-H results strong as expected showing net sales of VND15,191 billion, (+12.64% y/y) and NPAT of VND3,050 billion, (+60.4% y/y).
• The top line strong growth was mainly driven by the higher sales volume plus the contribution from the animal feed segment. Meanwhile the bottom line jumped driven by the GPM improvement thanks to the recovery in ASP plus the cheap input material.
• Steel sheet plan is ahead of initial schedule and expects to launch their 1st steel sheet factory by FY2017-end. In addition, HPG further plans to build more steel factories in the future for both construction steel and steel sheet.
• Regarding agricultural business, HPG now is focusing on 2 main segments including Feed and Farm. HPG expects to sell their first commercial hogs in FY2018 while beef cattle will be sold soon next year or so. The company also raises chicken and then sell eggs to the market later on.
• FY2015 dividend payment. HPG will pay including VND1,500/share (15% of par value) in cash and 15% of par value worth of stock dividend will be paid in September this year. Given the strong 1-H results, HSC revised up our full year forecasts to net sales of VND31,158 billion, (+13.5 y/y) and NPAT of VND4,990 billion, (+42.4% y/y). FY2016 diluted EPS would come to VND5,594 and giving us a forward P/E of 6.6 times.
• Reiterate BUY.

HPG 1-H results strong as expected. Reiterate BUY

Hoa Phat Group (HPG – Buy) held their analyst meeting today. Here are our key takeaways from the meeting;

1-H results decent with net sales growth at 12.64% while NPAT surged 60.4% y/y – At the meeting, HPG released their 1-H preliminary results with net sales of VND15,191 billion, (+12.64% y/y) and NPAT of VND3,050 billion, (+60.4% y/y). The top line strong growth was mainly driven by the higher sales volume plus the contribution from the animal feed segment. Meanwhile the bottom line jumped 60.4% y/y driven by the GPM improvement thanks to the recovery in ASP since March this year and the fact that the company stocked more iron ore than usual at cheap prices at the beginning of the year.

This result enables the company to complete 54.3% of their top line target and 95.3% of the bottom line plan. For Q2 only, the company saw record net sales of VND8,048 billion, (+5.23% y/y) and NPAT of VND2,030 billion, (+62.14% y/y).

Top line growth was driven by sales volume of steel products and higher contribution from animal feed segment – In 1-H this year, the company sold 785,006 tonnes of construction steel, (+16.2% y/y) and 211,200 tonnes of steel pipe, (+32.1% y/y) or so. The ASP of construction steel in 1-H this year was estimated at around VND9,561 million/ton, (-14.5% y/y). Currently ASP is stable at around VND9.75 million/ton after climbing to VND10.2-10.3 million/ton at the beginning of June. This is 11% from the bottom of VND 8.8 million tons in January this year.

During the period, the company also sold 151,000 tonnes of billet, of which, 140,000 tonnes of billet were consumed domestically and the remaining 11,000 tonnes were exported to ASEAN countries. Domestically, HPG sold this billet to local rolling factories. This helped the company to maximize the utilization rate of the new factory (Phase 3) which was launched in early April this year. At the moment, the Phase 3 is running at 80% of designed capacity. Then, animal feed segment is doing fairly well with sales volume ahead of targets. However, this segment hasn’t reached the breakeven point yet.

GPM was the key driver for the bottom line of HPG in this period – At the meeting, the company announced that 1-H GPM improved sharply to 26.34% from 20.1% in the same period last year. Due to cheap input material plus the recovery in ASP since March this year.

Recall that the company stocked on average of 4 to 6 months’ worth of iron ore and at least 2-months’ worth of other raw material inventories at low cost. Thus GPM of the core construction steel and steel pipe segment both spiked. In addition, agricultural sector then also showed an improvement in margins although still slight below their breakeven point.

HSC revised up our full year forecasts to net sales of VND31,158 billion, (+13.5 y/y) and NPAT of VND4,990 billion, (+42,4% y/y) – This compares to our previous forecasts of VND30,757 billion in net sales and VND4,238 billion in NPAT. And based on the following assumptions;
1. HSC assumes sales volume of construction steel and steel pipe of 1,627,461 tonnes, (+17.9% y/y) and 420,000 tonnes, (+20% y/y) respectively. We further estimate the sales volume of billet then would be around 300,000 TPA or so, 6 times higher y/y.

2. And that the ASP of construction steel will decline by 7.1% y/y to VND9.8 million/ton from VND10.55 million/ton in FY2015.

3. Based on this, we forecast steel sales of VND25,813 billion, (+18.9% y/y). We expect animal feed sales to expand to VND1,700 billion, (+30.8% y/y) as the company sells branded finished products from Q2.

4. Regarding real estate segment, we assume nothing this year. For all other minor segments, we assume sales growth rates of 7-10%.

5. All in all, we forecast the company will report net sales of VND31,158 billion, (+13.5% y/y).

6. Further assume GPM will be improved to 22.6% from 20.3% last year as we saw a recent sharp recover in steel segment margins since ASP has been bottomed out in March this year. We also assume the GPM of animal feed will turn slightly positive to around 7% this year from the negative in FY2015.

7. We expect the net financial loss to narrow to VND(218.4) billion from VND(318) billion last year on the lower forex loss plus the slight increase in financial income.

8. HSC further forecasts SG&A expense of VND1,137 billion, (-3.9% y/y) on a 17.9% drop in administration cost as the extra-ordinary cost (good will booking as in FY2015) drop outs. While we estimate selling expense then increases by 21.2% y/y to support sales of additional steel and animal feed capacity. We project SG&A as a % of net sales will be around at 3.7% comparing to 4.3% last year.

Finally, HSC forecasts the company will earn a pre-tax profit of VND5,671 billion, (+42.1% y/y) and net profit of VND4,990 billion, (+42.4% y/y). FY2016 diluted EPS would come to VND5,594 and giving us a forward P/E of 6.6 times.

Steel sheet plan is ahead of initial schedule – In late April this year, HPG announced that they plan to enter the steel sheet segment in the Hung Yen factory, northern market. By building a new factory to produce steel sheet products with a total capacity of 400,000 tonnes per annum (TPA). At a total capex of around VND2,000 billion. The output will include standard steel sheet, galvanized steel sheet, aluminum-zinc alloy coated steel sheet and pre-painted steel sheet. To be sold through the wholesale market in the North.

HPG is speeding this up. In late June, HPG signed the contract with Danieli (Italia) to buy the assembly lines for steel sheet production. This is the first steel sheet plant in Vietnam which has synchronization investment in modern technologies and assembly lines using the European standard. The contract value accounts for 70% of the total capex for machinery and will be set up within 13 – 20 months. The factory started construction in May in Hung Yen and the company expects a launch by FY2017-end. This factory will come to full commercial production by FY2018. According to the company, internal equity will fund around 50-80% of total capex while the remaining 20-50% will be debt funded. HPG expects the steel sheet sales would come to VND6,000 – 8,000 billion from this project once it runs at 100% capacity. It is equivalent to 20% of net sales at this moment of HPG.

HPG sees a market gap in this segment – HPG believes that there is a gap in the market with just two Northern based player at the moment. And that with a growing number of FDI industries setting up in the North they feel that demand for steel sheets will grow. However there were less specific about who the potential buyers would be. Traditionally automakers; white goods; processed food companies and furniture companies are heavy users of steel sheets. Not to mention steel pipes where steel sheets are an input. For production of steel pipe, currently HPG imports CRC from the outside to produce.

Once they build the new factory, they will instead import HRC and make CRC. Boosting margins in steel pipe production by the integrated system value chain. In fact, most of the biggest steel sheet factories are located in the South of Vietnam. Where demand is strongest. However demand for steel sheets from the North has increased recently thanks to the habit changes. And steel sheets is now more used as construction material for building houses. Plus the increase in FDI factories.

HPG plans to build more steel factories in the future for both construction steel and steel sheet – At the meeting, the company announced that they are consider building another bigger construction steel factory in the future with an additional capacity of up to 2-4 million TPA or so. Note that the current construction steel capacity of HPG is 2 million TPA. The company also plans to kick off the 2nd steel sheet factory in the Southern market near Ba Ria Vung Tau with the same size (400,000 TPA) as the 1st factory over the next 2 years. In terms of steel pipe capacity expansion, the company will continue to increase their capacity every year to meet the demand of the market. The location of these new factories would be near a port.

Regarding agricultural business investment and status updated: HPG now is focusing on 2 main segments as bellows including Feed and Farm;

(1) 3 animal feed plants are in various stages of completion with an M&A in the works as well –The company launched their first animal feed factory in Hung Yen in April and started to sell their in-house products since June this year while the second factory based in Dong Nai started construction in Q4 last year and will be launched by the end of this year. The Dong Nai factory is 50% complete. Total capex for these 2 factories is around VND600 billion and they will produce 600,000 tonnes of feed per annum. HPG is planning to construct a 3rd animal feed factory in Phu Tho in March this year adding another 300,000 TPA. With 3 factories, the total capacity will be 900,000 TPA. In addition, it appears HPG will soon complete an M&A of an animal feed company based in the South of Vietnam (Mekong Delta area). By FY2020, the total capacity of animal feed will reach 1 million TPA.

(2) HPG has just kicked off hog raising – At the meeting, HPG announced that they are importing 1,450 great grandparent (GGP) from European countries and will raise the hogs in 2 locations including Yen Bai and Binh Phuoc. The plan is to import GGP hogs from abroad; raise them at their farms to F1 generation before selling them to the farmers. The company also plans to sell their pigs to meat processing mills in future but the timeline is unclear at this stage. HPG expects to sell their first commercial hogs in FY2018 and by FY2020, have a total hog herd of 1 million. According to the company, margins for this sub-segment are the highest in their agricultural business.

(3) First cattle to be imported in Q3 with the herd to number 50,000 head by next summer – in late June, the company announced that they will import their first 3,000 head of beef cattle from Australia in August this year and then expect to increase the number of their beef herd to 50,000 head by June FY2017. The total capex for this build-up is estimated at around VND1,000 billion. HPG will raise the beef cattle on 6 feedlots across Vietnam. This includes 4 feedlots in the North, 1 in the Central Region and 1 in the South.

These feedlots are being built to the ESCAS standard used in Australia. The average land lot per feedlot is estimated at around 10 ha. HPG will establish 6 subsidiaries for the feedlots whereby HPG will hold a 100% stake in 5 companies and then a 72% stake in 1 company with the remaining 28% held by an SOE. We understand that this SOE will contribute the land bank for the feedlots and allowing some grass growing. However in the eventuality that HPG uses 100% of this land for the feedlots then they will contract out the grass feed using 5-6 year contracts. HPG will raise the cattle for 4-6 months before selling them on for processing. So if the first of the herd arrives in August, so HPG will look to sell these by the end of this year or so. The average weight of imported beef cattle is around 300kg/unit and once the weight of cattle reaches 500kg/unit, the company will sell. HPG will sell their beef cattle to qualified slaughter houses closest to their feedlots cross Vietnam.

(4) Lately, HPG is doing some research on poultry raising especially chicken – HPG will start to raise poultry soon and expect the total counts will come to 1 million. The company then will sell chicken eggs to the market after that. According to the company, once the Feed – Farm segments have some achievements, the company will carry out the 3rd segment in this business namely Food. It could be in the next 10 years or so.

Demand for Mandarin Garden 2 real estate project looks very good – This project is located in 493 Truong Dinh, Hanoi with the total capex of around VND1,500 billion. The company launched the units for sale in the 1-H this year and the demand on this project is good. This residential apartment project lies on 1.25 ha of land in Tan Mai, Hoang Mai District Hanoi. The plan calls for a total of 624 apartments and targets the mid-end segment. Each unit will be less than 100m2 with an expected selling price of VND25-26 million per square meter. In the first launch, the company already sold 300 apartments out of total of 624 units. This project has been built up to 5th floor. At the meeting, HPG will hand over the units and start to book sales in FY2018 or so.

Reasonable FY2015 dividend payment another short term driver of the stock – Today, HPG also released their BOD resolution regarding FY2015 dividend payment. HPG will pay including VND1,500 (15% of par value) in cash and 15% of par value worth of stock dividend to be paid in September this year. The new share issuance will be at 109.9 million shares. The new chartered capital then comes to VND8,429 billion. The ex-right date is expected on August 25th this year.

Investment thesis – Reiterate BUY. HPG’s share price has risen 42% YTD but the shares aren’t expensive. HPG shares are now trading 64.9% above the 12 month low. So while the stock have run up a lot recently; the valuations still aren’t expensive on a long term view given a forward P/E of 6.6 times. Although GPMs will likely normalize next year.

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