3Q24 results miss our expectations

Baoshan Iron & Steel announced its 3Q24 results: Revenue fell 6.5% YoY to Rmb79.61bn and net profit attributable to shareholders fell 64.8% YoY to Rmb1.34bn, missing our expectations due to a sharp decline in steel prices in 3Q24.

Steel sales volume stable; upgrading of product mix continues: In 3Q24, sales volume of steel products fell 3% YoY to 12.99mnt, flat QoQ, and sales volume of "1+1+N" products was 7.46mnt, accounting for 57% of total sales volume (up 6ppt YoY). Falling steel prices weigh on earnings of the steel business: In 3Q24, the decline in ferrous metal prices accelerated, and the price spread between purchases and sales of steel products narrowed significantly, with industry earnings at the bottom. The firm's steel price per tonne fell 8% QoQ to Rmb4,587 (price of steel plates and pipes fell 6% QoQ and 2% QoQ to Rmb4,277 and Rmb6,995), and its gross profit per tonne fell 36% QoQ in 3Q24 to Rmb242.

Production cost stable; expense per tonne rose slightly: The firm strengthened cost reduction, and its cost per tonne of steel fell 6% QoQ to Rmb4,497. Expense per tonne of steel rose 8% QoQ to Rmb132 due to lower interest income. Cash collection from operations continued to improve, underscoring high-quality cash flow: In 3Q24, the firm's operating cash flow rose 13% YoY and 41% QoQ to Rmb9.9bn, and its free cash flow grew 36% YoY and 135% QoQ to Rmb5.7bn. Other income rose sharply: In 3Q24, the firm's other income reached Rmb1.02bn (vs. Rmb120mn a year earlier).

Trends to watch

Enhancing internal capabilities amid the industry bottom; upbeat on earnings growth of core assets in the medium term. 1) Continuing to optimize and upgrade product mix; continued sales ramp-up of high- end products to contribute incremental earnings: The firm continues to promote its product differentiation strategy to enhance brand value. In 1- 3Q24, sales volume of the firm’s "1+1+N" products rose 11% YoY to 22.55mnt, with sales volume of oriented silicon steel up 27.5% YoY. In September, new production lines for ultra-high-strength steel and aluminum-silicon coatings at the Zhanjiang base were put into operation, and major breakthroughs were made in trial production of ultra-high carbon tool steel at the Meishan base. We expect the ramp-up of high-end products to contribute incremental earnings for the firm. 2) Strengthening cost control to improve cost competitiveness: The firm stepped up efforts to control costs of economical furnace charge and logistics and transportation. In 3Q24, the firm reduced costs by Rmb2.88bn, exceeding the annual target. As the firm continues to reduce costs, we expect its profitability per tonne of products to improve further.

No need to be overly pessimistic about cyclical bottom; upbeat on earnings and valuation recovery in 4Q24. In 3Q24, the steel sector faced headwinds from weak demand and accelerated destocking. Prices of ferrous metals plunged, and the price spread between purchases and sales of plate products shrank sharply. The sector's earnings and expectations were at a trough. Since the start of 4Q24, the futures and spot prices of various steel products have risen sharply, boosting market confidence. Steelmakers' earnings have significantly recovered. We expect market expectations to continue improving with the implementation of pro-growth policies, driving a rebound in steel prices, and the firm may see recovery in both earnings and valuation.

Financials and valuation

Due to the sharper-than-expected decline in steel prices in 3Q24, we lower our 2024 and 2025 net profit forecasts by 16.4% and 14.9% to Rmb8.97bn and Rmb11.53bn. The stock is trading at 17x 2024e and 13x 2025e P/E. As the firm has shown strong operational resilience at the cyclical bottom as an asset with high-quality cash flow, we maintain an OUTPERFORM rating and TP of Rmb9.05, implying 22x 2024e and 17x 2025e P/E with 34% upside.

Risks

Real estate downturn; accelerating global economic downturn.