HUAAN dragged down by steel sector's correction

HUAAN is involved in the production of metallurgical coke and related by-products. Coke is used as the main fuel in iron-making blast furnaces. HUAAN's plants are located in Linyi City, Shandong Province. Shandong Province & the nearby provinces are the center of steel making in China.



Recent Financial Results

HUAAN had recently announced its results for 2Q2008 ended 30/6/2008. Its net profit increased by 3.8% q-o-q or 13.6% y-o-y to RM36.9 million, while its turnover jumped by 49.4% q-o-q or 106.9% y-o-y to RM434 million. The huge increase in turnover was attributable to the sharp increase in selling prices of its products. Unfortunately, HUANN's raw material prices had also increased substantially. This-- coupled with escalating fuel costs and under-utilization of the additional production capacity of 600,000 tonnes (completed in May)-- led to a drop in its gross profit margin from 18% in 1Q2008 to 13% in 2Q2008.



Prospect

The current global slowdown in demand for steel could lead to the lower demand for metallurgical coke. In addition, HUAAN's results for 3Q2008 could be affected by the recent Beijing Olympic in 2 ways:
1) A possible drop in the demand for steel as all Games-related construction projects were nearing their completion; and
2) A possible drop in the demand for coke because of plant shutdown around Beijing during the Olympic Games (because of heavy pollution).

Valuation

Based on its closing price of RM0.445 today, HUAAN is trading at a trailing PE of 3.4 times (based on its last 4 quarters' EPS of 13 sen). While this may look cheap, the current correction in the steel sector could mean lower profit for HUAAN going forward.

Technical Outlook

The share price broke below its horizontal support of RM0.54-55 on September 2nd. As such, its downtrend is very much intact, contrary to my earlier call that this stock has broken its downtrend (go here).


Chart: HUAAN's daily chart as at September 4th, 2008 (source: Tradesignum.com)

Conclusion

Based on possible drop in its profit level in the coming quarter & continued bearish outlook, it is advisable to avoid HUAAN for now.