The Sleeping Giant

There are some interesting points when I learned the records of Indonesian Trade Balance (exports and imports) for the period of full year 2012, which released by the Central Statistics Agency (BPS), in early February. The points, the import value of iron and steel for the year 2012 had increased significantly, specifically 18.2% compared to the year 2011. Similarly, the import value of goods of iron and steel also rose 36.8%. For other goods that also contain iron and steel components, such as engines, electronics, automotive products, and aircrafts, those import values were also significantly rose between 15 - 30%.

In fact, the value of Indonesian imports as a whole (including oil and gas imports) had increased by only 8.0%. That mean, Indonesia's need for iron and steel, including its derivative products, has increased substantially in the last year, including the need for iron and steel for construction and infrastructure projects. The import value of iron and steel and their derivative products in 2012 had covered 40% of the total import value of Indonesia, an increase compared to 37% in 2011.

Well, if the need for iron and steel in Indonesia has increased, but the need was fulfilled by iron and steel manufacturers from overseas, then guess who missed the train here? Yes, you’re right, it’s Krakatau Steel (KRAS). Until the third quarter of 2012, KRAS only able to record a 25.5% increase in it’s revenue, from Rp12.7 to 15.9 trillion (about US$ 1.8 billion). But that’s not the only point. What interesting from this company is its net profit that is very, very small, which is only Rp5 billion, or nearly loss. The reason? Due to the high cost of raw materials used. It was a classic problem actually, which until now has not yet been resolved.

Thus KRAS has two problems: 1. Not able to use the momentum of booming of iron and steel industry in local market, as their production capacity are still limited, 2. Still having trouble in terms of cost efficiency. In perspective of fundamental analysis, both problems certainly caused its stock to dumped, as the company could not afford to make profit. But if we are also consider that: 1. KRAS plays in a strategic industry, ie iron and steel, and it is the only State-Owned-Enterprise in Indonesia that plays in the industry, so it won’t be left bankrupt, 2. This company is just too big to fail, its assets reached Rp23.4 trillion or about US$ 2.5 billion, and, 3. The opportunity of the business is actually very good, now just how the company could use it or not, then: KRAS is still worth an attention. The question now is, does the company just remain idle and accept its status as a failed company, or are they being do something and trying to rise up? Fortunately, the answer is, they're do something. In fact, they are doing a plenty of things.

Steel coil warehouse of PT Krakatau Steel

Here are some strategic projects of the company, and its progress until March 2012 (it’s already quite long, so some of the projects may have been completed and are already in operation):

1. Increase the capacity of coil steel mills, from 2.0 million tonnes to 2.4 million tonnes per year. The project is completed. Going forward, the capacity will be increased again to 3.5 million tonnes per year, but the completion is scheduled in 2014.
2. Set up a joint venture company with PT Aneka Tambang (ANTM), to construct an iron ore processing facility in South Kalimantan. The JV company name is PT Meratus Jaya. The project has been complete and is operational. With this facility, KRAS will obtain supplies of raw materials that are cheaper, rather than importing iron ore from Australia.
3. The modernization of steelmaking facilities, one with the construction of blast furnace facility. If the project is completed, it will reduce KRAS dependency on iron ore pellets or steel scrap as raw materials for steelmaking, because the blast furnace would only requires iron ore as its raw materials (which will be met by the project no. 2 above ) to be processed into iron and crude steel, to then be further processed into coil steel. The management estimates that the blast furnace will be able to save on production costs of US$ 40 - 50 per ton of iron and steel produced. The project will complete in 2014.
4. Other modernization is the constructions of direct reduction plant, and slab steel plant, their progress are 96.7% and 84.3% respectively.
5. Last, and this is the main project of the company, the Joint Venture Company of Krakatau - Posco (Posco is a steelmaker from South Korea), to establish an integrated iron and steel factory, including supporting infrastructure such as ports, power plants, and reservoirs to provide water supply. Currently the land preparing is complete, while the establishment of the factory is scheduled to be complete by end of 2013. If this project goes well, then KRAS production capacity will increase significantly in 2014 or 2015.

Here is an overview of how KRAS will produce iron and steel in 2014 or 2015, assuming all of project above running well:

1. KRAS obtain supplies of iron ore from the mine and iron ore processing facility in South Kalimantan, which is owned jointly with ANTM.
2. The iron ore is then processed into iron and crude steel, using the blast furnace facility. This time, the company no longer needs iron ore pellets or steel scrap to making iron and steel.
3. Iron and crude steel produced then processed into steel coils. The output can be sold directly, or processed further into steel wire, steel sheet, etc.
4. To increase production capacity and added value of products sold, KRAS can also produce iron and steel through the production facility of Krakatau - Posco, as well as able to 'throw' the steel coils produced for further processing at the facility.

In addition to the above strategic projects, KRAS also has a few small projects that essentially aim to secure supply of raw materials, and increasing the added value of iron and steel products. These are:

1. KRAS working with PT Samator, a gas company, to secure the supply of gaseous fuel for the company. The two companies are also working together to establish water separation plant facility, which is scheduled to be operational in 2014.
2. KRAS working with Nippon Steel to set up steel plants of cold rolled coil, which will be sold to automobiles companies, and plants of profile steel, to be sold to construction companies. But there is no clarity on whether the plants has begun to be built or not, and when it will be complete.
3. KRAS established a new subsidiary, PT Krakatau National Resources, which is engaged in the processing of iron ore and other raw materials for the manufacture of iron and steel. The goal is to secure raw material supply for the company.

So if you notice, it is not only Garuda Indonesia (GIAA) who working hard to be able to use the momentum of the air transport industry, but Krakatau Steel is also trying to do the same thing to capitalize the booming of iron and steel industry in the country. The question now is, will the efforts be successful or not? Only time will tell. As a state-owned enterprise, the challenge for KRAS is not just from corporate governance, but also political issues. In May 2012, president director of KRAS, Fazwar Bujang, had had to meet the call of the Corruption Eradication Commission (KPK) to be a witness against the case of corruption of port development in Cilegon, Banten, with Mayor of Cilegon as the suspect. The problem is, the port is part of the Krakatau – Posco projects. Luckily, the case is over and the management of KRAS claim that this does not interfere with the progress of their work with Posco.

By the way, there may be a question, what if KRAS is finally managed to increase its production capacity, saving the cost of raw materials, etc, but at the time the iron and steel business is not booming anymore? Well, given that the level of steel consumption in Indonesia is still very low, at only 26 kilograms per capita in 2011, far below the average of the world's steel consumption at 215 kilograms per capita, and the various sectors that require the supply of iron and steel are also just starting to developing, then I think the iron and steel business opportunities in Indonesia are still very, very wide open. The steel industry in China and India may begin to burnout after continuously increasing since the early 2000s, so now it’s now Indonesia’s turn to boom, at least up to next 10 years.

Then, Mr. Teguh, why are you suddenly discussing this company? Because when I note, the decline of KRAS shares is stop at 650's positions. In valuation, the price is refexing 1.0 times of PBV, aka fairly cheap if we assume that the company is supposed to reap a huge success after all of business development projects we discussed above, so the stock should not go down lower. And if the stock was not able to drop further, that mean? Yup, at any time it could rise, just wait for positive sentiment, or if the company's performance later improved as expected.

Anyway, for now, of course KRAS still not recommended, as the shares would likely not going anywhere. But I can say that up to next year, this sleeping giant would finally wake up, and that's when we can collect the stock.

Original article was written at February 5, 2013