Kisco puckers up for IPO

Kunming Iron & Steel pre-markets $175 million to $200 million IPO.

Yunnan's largest industrial concern, Kunming Iron & Steel (Kisco), began pre-marketing in the US late last week for a $175 million to $200 million H share IPO.

The Credit Suisse First Boston led deal has a standard Hong Kong IPO structure, with a 90.9%/9.1% split between primary and secondary shares and a 90%/10% split between institutional and retail investors. Joint leads are Core Pacific Yamaichi and Kingsway, with CIBC and South China Securities as co-managers. Formal roadshows are expected to begin around February 23, with pricing around March 9 and listing the week beginning March 14.

Based on a pre greenshoe freefloat of 33% and syndicate consensus 2005 profit forecast of Rmb1.2 billion ($145 million), the deal is being pre-marketed on a P/E range of 3.7 to 4.2 times earnings.

This valuation appears compelling relative to comparables and reflects sectoral concerns that earnings are peaking, as well as the poor performance of recent offerings from the Chinese steel sector. The company will be hoping that sentiment has changed since early December when Red Chip China Guofeng failed to complete a similarly sized IPO via JPMorgan.

Both Kisco and Guofeng operate at the bottom end of the steel sector, producing long steel products for the construction industry. Both companies have been valued at similar levels and been pitched at a similar discount to China Oriental the main comparable.

In turn, China Oriental has had a dismal trading performance since it listed last February at 6.1 times forward earnings. The impact of China's austerity programme hit the stock hard and it dropped 70% in the space of just two months between March and May. Since then it has been fairly rangebound, although it has perked up 10.46% since the beginning of the year.

It is currently trading at around 5.4 times 2005 earnings, which means Kisco is being pitched at a relatively steep discount of roughly 23% to 33%. The big three Hong Kong listed steel companies - Angang, Chongqing and Maanshan - are respectively trading on 2005 P/E multiples of eight times, six times and 8.7 times.

Of the three, Maanshan is the most direct comparable since it also produces long steel products, although it is much larger in scale than Kisco, the country's 25th largest producer. In 2004, Maanshan produced 8.5 million tonnes of steel products relative to Kisco's 2.6 million.

Specialists say Kisco has been ramping capacity up strongly since 2002 when it produced two million tonnes. Volume growth is expected to range between 20% to 30% during 2005, with analysts predicting final output around the 3.3 million tonne level.

About 80% of production is long products such as billets, strips and re-bars and about 20% flat products such as steel plates and hot and cold rolled steel.

One the company's biggest selling points is said to be its geographical location. Kisco is being pitched as a good proxy for the industrial development of South West China, one of the government's main priorities. Kisco has an 80% market share in Yunnan and specialists say the IPO should be of far greater interest to China specialists than steel specialists.

The region's growth dynamics may enable the company to withstand slowing domestic demand for steel and an anticipated drop in prices. The China Iron & Steel Association (CISA) is predicting slower demand growth in 2005 compared to 2004 when growth topped 13%.

Yunnan province recorded GDP growth of 11.3% during the third quarter of 2004 compared to a 9.5% average for the entire country. Over the coming decade, analysts are forecasting the province will achieve a CAGR of at least 8%.

CISA also says prices are unlikely to climb much further in 2005 given an expected surge in output. However, some analysts have taken a contrarian view and note that steel prices have remained resilient both to slowing demand (thanks to the austerity measures) and production increases. A number of houses have put out strong buy recommendations on cyclical commodity stocks, although most have emphasized the flat steel sector rather than the more volatile long steel sector.

Specialists believe Kisco may also score an advantage from its SOE status relative to Guofeng and China Oriental, which are both Red Chips.

It is also said to derive a slight advantage from being able to source of some of its iron ore at spot prices from government-affiliated producers in Yunnan province. Most of its iron ore is still imported, however and the company recently said it wanted to double Indian imports from 500,000 tonnes to one million tonnes. It is also said to be considering acquiring a CRC plant in the country.

Like most of the Chinese steel producers, Kisco is offering a relatively high dividend yield. Based on its indicative range and a 30% pay-out ratio, it should yield between 5% and 7%. Both Angang and Chongqing currently yield around 6%.

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