Sino Hua-An International - BUY - 25 Aug 2008

Sino Hua-An International - 1H08 below expectations (Results Note)



Price: RM0.545

Target Price: RM0.88

Recommendation: BUY



· 1H08 net profit of RM72.5m came in below expectations, accounted 41.4% and 43.0% of market consensus and our forecast, respectively, due to margin squeeze underpinned mainly by better pricing of coal compared to coke (variance between the pricing of the two commodities: 39.7% in 1H07 vis-à-vis 42.1% in 1H08).

· YoY, 2Q08 net profit increased by 13.6% to RM36.9m. The favourable uptrend pricing of coke boosted 2Q08 revenue by 106.9% to RM434.4m. However, this was mitigated by lower operating margin to 10.0% from 18.4% due to: (1) higher increase of coal price (+115.4%) compared to the increase of coke price (+104.5%); and (2) higher transportation cost in view of escalating fuel costs.

· 2Q08 net profit increased marginally by 3.8% QoQ due to margin squeeze as mentioned above. Coal price posted higher increase QoQ (+38.9%) vis-à-vis coke price (+28.1%). As a result, operating margin dropped to 10.0% from 14.4%.

· Expect short-term margin compression. The coke and coal price variance is driven mainly by: (1) the temporary shutdown of steel mills during the Olympics 2008 and (2) increase in production of thermal coal resulting in lower supply of coking coal in China. We expect the operating margin could still be suppressed in 3Q08, however, should improve when the steel mills resume business by end-Sept 2008.

· Earnings downgraded. The additional 600,000 tonnes of coke production successfully commenced in June 2008 will enhance Huaan's sales in 2H08. However, the margin compression has inevitably prompted us to lower our FY08 and FY09 net profit estimates to RM153.1m (-9.3%) and RM206.3m (-1.3%), respectively. Huaan still possesses the ability to pass on additional cost to customers as long as the spike in coal price (weekly basis) is within 3-5%. Nonetheless, substantial spike in coal price remains as the major key risk.

· Maintain BUY with lower Target Price of RM0.88 based on 6.5x PER, which is 10% discount to the regional markets' PER of 7.5x but in line with the Malaysian listed steel companies' average 2008 PER of 7.0x