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WIKI ANALYSIS
China Precision Steel Inc. (NASDAQ:CPSL) makes specialty steel products for use in other industries. CPSL essentially takes pre-made blocks of steel and turns this "raw" steel into precisely measured steel pieces that serve as components in automobiles, microelectronics, and other manufactured goods.[1] CPSL's products are also used in plane friction discs, appliances, food packaging materials, saw blades, and textile needles.[2]
Though it has no direct domestic competitors as of mid-2008, CPSL does compete with larger foreign exporters to China, which account for 85-90% of the premium steel industry in China.[3] However, due to technological and geographical advantages, CPSL offers its products at a 10% discount to international prices, and with shorter delivery times.[4] CPSL is also actively searching for new business in foreign countries. Although most of CPSL’s sales are made in China, it began exporting its cold-rolled steel products to Nigeria, Thailand, Indonesia and the Philippines in fiscal 2007. The company plans to continue its international expansion and establish itself in the global thin sheet metal manufacturing industry.[5]
In response to increasing demand for its steel products, China Precision has built a second mill and plans to build a third in 2008. CPSL, with its second mill, is the only company in the world that can manufacture 1400mm wide ultra-thin high carbon steel, which was introduced in 2007 and accounted for 27% of that year's sales.[6] The third mill will manufacture 1700mm wide cold rolled steel products, adding 150,000 tons of capacity.[7] China Precision has used stock sales (dilutions) to fund these expansions, which has diluted existing shareholder value.[8] China Precision has funded its acquisitions in this way for a reason, however; the cost of borrowing in China has increased as the government tightens credit by increasing interest rates, which explains CPSL's choice of stock sales to fund its expansion.
Business Overview
On December 28, 2006, China Precision Steel was created through a merger between OraLabs and Partner Success Holdings Limited.[11] The OraLabs division, which makes oral care products, was subsequently spun off in December 2006. All that remained was the steel-making business, which changed its name to China Precisions Steel. Proceeds from the spin-off explain the jump in revenue from 2005 to 2006.
Product Categories
China Precision produces a variety of specialty steel products. The main categories are low-carbon and high-carbon steel which are further delineated into the cold rolled and hot rolled categories.
Low carbon steel refers to approximately 0.05–0.15% carbon content while high refers to approximately 0.6–0.99% carbon content. [12] Low carbon steel is used in automobile body panels, tin plate, and wire products. [13] High carbon steel has greater hardness and can be used in high strength wires or springs. [14]
Hot and cold rolled refers to the temperature at which the steel is formed into shape. Hot rolled steel is formed while the steel is above the "scaling" temperature, or roughly 1700 degrees fahrenheit. Cold rolled refers to the opposite condition. [15] One major difference is that the final size of hot rolled steel has to be estimated, while cold rolled steel can be formed with greater precision. The size of the steel product changes as it cools. [16]
2007 Performance: New Product Line Offsets Lower Margin Steel
In 2007, CPSL produced a larger quantity of lower-margin low-carbon steel and less higher-margin high carbon cold-rolled steel. As a result, the gross profit margins decreased 1% to 27.6% compared to 2006. During the same time period, the company introduced a new product line, high end cold-rolled steel, first sold in fiscal year 2007. This new product line, which sold for around $17,000 per ton in 2007, helped offset lower margins on low-carbon steel.[17] High end cold-rolled steel generated 27% of FY2007 sales. [18]
Sales Breakdown By Region
For sales in 2007:
- Domestic China: $49,299,273 (about 91%)[19]
- Philippines: $2,919,304 (about 5.4%)[20]
- Thailand: $1,741,666 (about 3.6%)[21]
- China Precision also exports to Nigeria, though to a lesser extent.[22]
Expansion Plans
The company has built a second mill and plans a third for 2008. The company had an annual production capacity of approximately 115,000 metric tons as of June 30, 2007. [23] CPSL’s second mill began production in October 2006 and is operating at 30% capacity. Furthermore, CPSL plans to build a third mill with a similar 150,000 metric ton capacity. The two new mills will focus on producing high carbon, high strength cold-rolled steel products and more complex precision steel products, which cannot be manufactured in its current rolling mill.
Trends and Forces
CPSL Faces Higher Commodity Prices
In the first quarter of 2008, iron ore costs were up 65%, coking coal costs were up 300%, and scrap prices have also jumped from the same period in 2007.[24] Because raw materials were approximately 87% of CPSL's cost of goods sold (COGS), increases in commodity prices will decrease the company's profitability.[25] For Q3 2008, average cost per ton sold increased by $40, or 7.8%, from Q3 2007 to $552 per ton. In the same period, the average selling price per ton increased by $50 per ton, or 6.9%, period-on-period to $771 per ton in the same period.[26] If China Precision cannot continue to pass on higher production costs to its customers, its profits will suffer.
Increasing Interest Rates in China Costly for CPSL
China’s central bank increased interest rates six times in 2007 in an effort to reduce speculative lending.[27] In March 2008, China's central bank chief, Zhou Xiaochuan, said that there was room for further interest rate hikes.[28] CPSL does not hedge its interest rate risk. As of March 31, 2008, CPSL’s total bank debt was $17,400,194, all of which was interest-bearing.[29] Almost all of the bank debt was floating-rate debt with interest rates fixed to the standard rate set by the People’s Bank of China. Interest expense and the amount of cash required to pay for the debt will increase with higher interest rates. For the current financial year, annual interest on loans is anticipated to be approximately $1.6 million. The company estimates that a 1% increase in interest rates will increase interest expense by approximately $174,000.[30] Thus, further interest rate increases will be costly for the company.
Company Dilutes Stock to Fund Capital Needs and Expansion
China Precision has funded its expansion through selling additional shares, which it did twice in 2007. With the company’s cash reserves down from $40 million to $14 million and high interest rates in China, funding its third mill with a stock sale is a cheaper alternative for the executives.[31] The mill, to be built in 2008, is expected to cost $18 million. In April 2007, the company sold 8.8 million shares, followed by another 7.1 million shares in November 2007.[32] As a result of the dilutions, the stock price fell to a 52-week low of $2.58 in June and dropped by over 50% through October and November 2007.[33] Because CPSL has 46 million shares outstanding as of May 2008 with an average daily trading volume of 4.56 million shares, a similar sized sale would result in a 17% dilution.[34] If the company's management sells 8 million new shares to fund the new plant, the existing (46 million outstanding as of May 2008) shares will be worth less.
Competition and Market Share
CPSL competes primarily with importers, including Ton Yi Industrial Corp. in Taiwan; Shinwha Special Steel Co., Limited in Korea, and CEW, a German steelmaker.[35] CPSL does not have any direct manufacturing competitors based in China in the cold-rolled steel industry. However, the company warns that there are potential competitors who are currently constructing mills to produce precision and specialty steel products in China. CPSL has 50-70% of the China domestic production market share and about 10% of total production of specialty premium steel. [36] As of Q3 08, it is the only company in the world that can produce 1400 mm wide ultra-thin, high-carbon, cold-rolled steel.
Ton Yi Industrial had revenues of approximately $225 million in 2006.[37] It owns a mill in Jiangsu, China with 150,000 metric tons production capacity, producing coiled tinplate.[38] Shinwha Special steel is smaller with revenues between $5-$10 million (date not specified).[39]
References
- ↑ China Precision Steel 2007 Annual Report pg. 4
- ↑ China Precision Steel 2007 Annual Report pg. 4
- ↑ CPSL Profile pg. 2
- ↑ CPSL Profile pg.1
- ↑ CPSL Profile pg. 2
- ↑ China Precision Steel 2007 Annual Report pg. 42
- ↑ CPSL Profile pg. 2
- ↑ Google Finance: CPSL
- ↑ Google Finance: CPSL Income Statement
- ↑ China Precision Steel 2007 Annual Report pg. 42
- ↑ China Precision Steel 2007 Annual Report pg. 4
- ↑ Wikipedia--Carbon Steel
- ↑ Key to Steel: Steel Database--Classification of Carbon and Low-Alloy Steels
- ↑ Wikipedia--Carbon Steel
- ↑ Hot Rolled vs. Cold Rolled Steel, What’s all the Fuss About? 4/08/2005
- ↑ Hot Rolled vs. Cold Rolled Steel, What’s all the Fuss About? 4/08/2005
- ↑ China Precision Steel 2007 Annual Report pg. 42
- ↑ China Precision Steel 2007 Annual Report pg. 42
- ↑ China Precision Steel 2007 Annual Report pg. 42
- ↑ China Precision Steel 2007 Annual Report pg. 42
- ↑ China Precision Steel 2007 Annual Report pg. 42
- ↑ China Precision Steel Q3 2008 Report pg. 20
- ↑ China Precision Steel 2007 Annual Report pg. 4
- ↑ Supply Excellence: What’s Really Behind the Steel Price Surge? April 2008
- ↑ China Precision Steel Q3 2008 Report pg. 13
- ↑ China Precision Steel Q3 2008 Report pg. 23
- ↑ BBC News: Bank lifts China's interest rates Dec. 2007
- ↑ China Daily: PBOC chief treads with caution on interest rates Mar. 2008
- ↑ China Precision Steel Q3 2008 Report pg. 31
- ↑ China Precision Steel Q3 2008 Report pg. 31
- ↑ SeekingAlpha: Will Dilution Kill China Precision Steel's Rally? May 2008
- ↑ SeekingAlpha: Will Dilution Kill China Precision Steel's Rally? May 2008
- ↑ SeekingAlpha: Will Dilution Kill China Precision Steel's Rally? May 2008
- ↑ Google Finance: CPSL General Information
- ↑ China Precision Steel 2007 Annual Report pg. 11
- ↑ CPSL Profile pg. 2
- ↑ Ton Yi Company Website
- ↑ Ton Yi Company Website: Jiangsu Ton Yi Tinplate Co., Ltd. (J-TY)
- ↑ EC21: Shinwha Steel Company Info.
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