FerroChina - Waiting for completion of acquisition

acquisition within two to three months from the time of announcement. The
delay is due to the longer time needed to obtain the whitewash waiver from the
Security Industry Council (SIC). With the number of reverse takeover
transactions announced ytd, the number of cases pending SIC’s approval is
likely to be high. Hence, it is reasonable that the transaction is taking longer to
complete. We do not expect the deal to fall through as the minority shareholders
are not prejudiced by the transaction. Judging from the share price after the
announcement of the deal, the market has reacted positively.
Date of consolidation is pushed back. We highlighted previously that 2007
is a transition year and the reported profit would depend on the exact date of the
completion of the acquisition. Therefore, we maintain our forecast for 2007
since there is no change to our estimates for 2008 and 2009. For the purpose
of monitoring, we would track the financial performance of FerroChina and Super
Team separately, rather than the reported figures.
Facing headwinds. China’s steel export grew 117% yoy in the first five months
of this year. Hence, the Chinese government has imposed a number of
measures, such as reduction or withdrawal of VAT rebates and implementation
of export quotas, to slow the growth of steel exports. While FerroChina’s VAT
rebate is reduced from 8% to 5%, this should be a manageable price risk as the
company has been raising prices to compensate for the rebate reduction.
Global steel demand has remained firm and the slowdown in supply from China
would probably help keep prices stable. We are more concerned about the
quota system. Even though FerroChina’s high-end galvanised steel and cold
rolls are not affected by the current quota requirements, imposition of quotas on
these products could hurt FerroChina’s growth as FerroChina exports make up
more than 30% of its output.
Aiming to grow via acquisition and capacity expansion. We see FerroChina
as a beneficiary of the consolidation in the China steel sector. FerroChina plans
to acquire under-utilised galvanised steel companies and apply its strong
technical capabilities to turn around these companies.
Accumulate on weakness. As the risk of oversupply in China has heightened,
investors’ sentiments are turning cautious on the China steel sector and
FerroChina’s share price has pulled back from its recent high. We like the
company for its market leadership in galvanised steel, good management, clear
growth strategies and strong execution capabilities and advise investors to
accumulate the stock on price weakness. When sentiments on the China steel
sector turn positive, we believe FerroChina would be in play again. Catalysts for
the stock price would be the completion of the Super Team acquisition,
newsflows on the commencement of new production line or merger & acquisition
activities. Based on our valuation of 9x FY08 PE, our 12-month target price is
S$2.90. Reiterate BUY