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Krakatau Steel

In the IDX, the sector of iron and steel is not so popular if compared to other metal sectors such as nickel and tin. The cause is because Indonesia is not among the country's largest steel producer in the world, such as India and China. Therefore, companies in the business of iron and steel in this country is only a few, and Krakatau Steel is the only major player in Indonesia in this field. In the fist half 2010, the company recorded total assets of Rp 13.3 trillion, or about US$ 1.4 billion.

Although the iron and steel sector is not popular in the stock market, but this sector is actually the backbone of industrialization, and even the development of a country and the world as a whole. Without the presence of iron and steel, then there will be no auto industry, electronic industry, industrial machinery, aircraft industry, oil refinery industry, household furniture industry, and so forth. Iron and steel are also important for construction, to build houses, skyscrapers, bridges and highways, and factories. Military stuffs required to maintain the state sovereignty such as tanks, guns, and rockets, also made of iron and steel. In short, if there is no such things that we call 'iron and steel', then the world would not be as we see today.

Because the main consumers of the iron and steel are the industry (particularly manufacturing industry) and the state itself, the performance of iron and steel companies is easily influenced by demand from the two fields, which is heavily influenced by macro-economic conditions.

And how about the performance of Krakatau Steel?

Before we discuss the company from fundamental side, there are few points about Krakatau Steel you need to know: 

  1. Because Krakatau Steel sell its products to the domestic market, the condition of the national economy (Indonesian economy) is more influential on corporate earnings than global economic conditions.
  2. Krakatau Steel is only producing iron and crude steel with a variety of forms, which must be reprocessed before it can be used as raw materials for various industries. Krakatau Steel cannot produce stainless steel, or other ‘fancy kinds’ of steel. As a result, the company is unable to determine the selling price of its products, but depends on the global price of steel, as Krakatau Steel can only sell their products to downstream steel companies and not directly to consumers. It may be a different story if Krakatau Steel mastering the steel industries from upstream to downstream, so that they can directly sell their products to various industries.
  3. Krakatau Steel's iron ore supply is quite depends on imports. The company is also gets its own iron ore supply from small mines in Cilegon, but few in number. So if the supply of iron ore have stalled, or the price is getting expensive, then the costs of goods will increase, and eventually lower the net profit.

In conclusion, Krakatau Steel's earnings each year is determined by the following three factors: 1. Economic conditions, especially the national economy, 2. World steel prices, and 3. Operational costs, that may be volatile. Sounds a risky company, right?

Now take a look at the performance of the Company. In 2005, Krakatau Steel reported net profit of Rp184 billion. In 2006, this figure actually drop to minus Rp135 billion, aka loss, while the revenues actually rose from Rp11.6 to 12.1 trillion. As you may guess, the cause of loss is the significant increase of total operating costs, from Rp11.0 to 12.3 trillion. Probably at the time the price of iron ore was increase substantially, while steel prices was stagnant

In 2007, the company
was back to the game with a net profit of Rp313 billion. In 2008, Krakatau Steel's net profit still grew to Rp460 billion despite the global crisis had occured, and became Rp495 billion in 2009. And finally on First Half 2010, the company’ net profit was Rp998 billion. And that was, of course, a good recordThe question is, what about the future?

According to the Managing Director of the company, Fazwar Bujang,
the increase in net profit in first half 2010 is underpinned by the rising demand of steel in line with the improving economy, and because of the rising world price of steel (exactly as we discussed above). So what if the steel demand starting to lower, and the steel price is lower too? Then of course Krakatau Steel’ earnings will be depressed. So even though the company's performance in the last three years was fairly good, but there is no guarantee at all that the company's future performance will be the same. It all depends on economic conditions, the increase/decrease of steel price, as well as operating costs, especially the price of iron ore as raw material for steelmaking. In short, this is a high risk company.

The Prospect: For trading only?

In Indonesia, public company engaged in natural resources/commodities, its stock price generally easily influenced by the price of the commodity. The cause is the same: because those enterprise are engaged in the upstream only, taking the natural resources from the ground then immediately sell them, or process them into intermediate goods and then sell them, without processing it into ready-for-use goods.

So, if the commodity prices rise, then usually the relevant company's stock price will also rise. For example, Medco Energi (MEDC) is easily affected by oil price, or International Nickel (INCO), which influenced by the price of nickel, or PT Timah (TINS) which affected by the price of tin, and so on. As a result, the movement of related stock prices in the market in the long term will contonue to up and down, depending on the rise and fall of the prices of commodity concerned.

For example, MEDC, that when this article was written, the price is high (reached 3,400) because oil prices are once again above US$ 80 per barrel, in addition to the issue of acquisition by state-owned Pertamina. If we look back, one year ago (October 12, 2009), MEDC also was in a position 3,125, not so distant from the current position. Why so? Maybe because the price of oil at that time (a year ago) was in the range of US$ 65 - 75 per barrel, aka not much different from the current price. Some time ago when oil prices fell to US$ 60, MEDC price was also stuck at 2,500. So certainly MEDC is only suitable for short-term trading.

And how about Krakatau Steel? Fundamentally, its performance is quite good in first half 2010. But once again, because of Krakatau Steel's future performance is easily influenced by the price of steel, then its shares will also be easy to go up and down, depending on the price of steel. Meaning? Krakatau Steel should be collected only for the short term: Buy when the steel prices are low, and sell when prices are high again. 

Actually, as already discussed above, the condition of the national economy and operating costs will also play an important role against the development of Krakatau Steel's share price in the market. However,
those two points are somewhat cumbersome in measures, making it difficult to research whether it ups or downs. In contrast to the price of steel which the measurement is simple and clear: some US Dollar per ton, so the price of steel is more inflential to the stock prices compared to two other points. 

Maybe that's why, when we look at the press release or announcement that routinely issued by companies, many of which are
entitled, 'The steel prices are predicted to rise', or 'Steel prices are expected to go up', and so on, even if the price is already very high. The hope is of course, that the investors would rush to invest their money. 

Then what about the stock price? When this article was written, Krakatau Steel has not announced the stock price for its IPO. But how much it is, you should careful if there a lot of opinion that says that the price is expensive. Two previous IPO on expensive prices, Harum Energy (HRUM) and Indofood CBP (ICBP), their prices in fact are failed to climb, because from the beginning the prices are already overvalue.
 
B
y the way, on the internet there are many sites which provide the data of steel price, but the best in my opinion is www.steelguru.com, because it uses steel prices in India and China, a major steel producers of the world, as the benchmark.

The analysis would be different, if.. 

One of the main reasons
that you cannot buy Krakatau Steel for long term investment is, because the company has a weak profitability ratios. In first half 2010, net profit value Krakatau Steel did reach 11% of its revenue. But in the last 5 years, the average value of sales was Rp15 trillion a year. But the net profit? Only Rp 300 billion, or only 2% of revenue. Why so? The problem is back again to raw materials: The company had to import iron ore from abroad, so that the production becomes costly. The question is, do Indonesia not have adequate iron ore mine? The answer, we do! Mostly located in Kalimantan. And although the production is not as much as in India and China, but it is enough to supply the needs of Krakatau Steel's iron ore. After all, the production capacity of Krakatau Steel i only about 2.5 - 3 million tons of steel per year. 

Unfortunately, for some reason the entire iron ore is exported to China, while Krakatau Steel
have to import the ore from Australia. Strange, is not it? But yes, that's how it happened. 

That is, if viewed from the upstream side. From the downstream side, Krakatau Steel does not produce ready-
use steel, but only crude steel. We certainly know that Krakatau Steel is not a newly established company. This state enterprise has been standing a long time ago since the 70s. So the company should already has enough experiene to explore the downstream side of the steel business. But if we look at its subsidiaries, none of them that played in the ready-to-use steel making, and the plan to build one is also doesn’t exists. So I think we have a problem of poor management here.

So, when
if Krakatau Steel is good enough for an investment and not just for trading? The answer is if later the company is no longer importing raw materials, and if the company has been able to make a derivative of its steel products, not just raw steel.

Well, that's from me about Krakatau Steel. 
For journalist or anyone, you are allowed to quote part or all of this article, of course by mentioned the name of the author, as an independent analyst.


Original article was written in October 12, 2010.

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