Delong Holdings Ltd: Resilient performance despite rough industry

Resilient performance. Despite government regulatory cooling measures
in the steel industry through sudden tax rebate cuts in May 07, hot-rolled
steel coil (HRC) producer Delong Holdings (DLNG) gave a credible showing
with 1H07 sales rising 37% YoY to S$646.2m. 1H07 net profit rose 26.1%
YoY to S$77m despite incurring its first year of tax expense of 15%. On a
quarterly basis, 2Q07's bottomline came in 8.1% YoY lower than 2Q06 due
to rising raw material costs and slightly lower ASPs as the supply of steel
increased locally.
Outlook for Chinese steel industry. China's macro control policies have
somewhat cooled the red hot construction and machine building industries,
slowing the demand for steel consumption. Despite these measures,
industry watchers anticipate a 4-5% YoY increase in steel consumption in
China for FY07 and even stronger consumption in FY08.
Optimistic of prospects in 2H07. DLNG has reported that its diverse pool
of customers from the booming Bohai Economic Circle continue to display
strong demand for its HRC products despite the rise in supply. Management
has indicated that its HRC ASPs have already stabilised in Jul 07 (just 1
month after government intervention) and is expected to maintain or even
rise incrementally in 2H07 as it focuses on selling better grade HRCs.
Rising raw material costs will also be mitigated when its Phase 3 technical
enhancements are completed.
Waiting for the big acquisition. Management has updated that it is in
deep discussion with 2 potential acquisition targets to incrementally achieve
10m ton/yr capacity by 2010. In our last report, we forecasted that DLNG
will need to acquire about 2m tons/yr to achieve this target. We anticipate
that DLNG will not acquire any plant with capacity larger than 3-4m tons/yr
in its maiden M&A to prevent overwhelming integration issues.
Strong outlook. As capacity reaches 3m tons/yr by year end with the
plant at full utilisation and M&A to increase output, we are confident that
FY07/08 will be strong years. DLNG's exposure to raw material price
increases will also be mitigated when its 2 new furnaces to process pig
and molten iron come online progressively by end FY07. We maintain our
BUY rating and fair value of S$4.56.(