Source of opportunity
We upgrade Magang (H) from Sell to Buy and add the shares to ourConviction List. Our downgrade to Sell was premised on significant losseson a weak steel price. However, with sequential demand improvement wellon track and capacity restarts slower than expected, we now expectconstruction steel maker margins to remain healthy, and Magang has takendecisive action to cut losses. With c.50% of its products long steel (vs. lessthan 10% for Angang and Baosteel), we view Magang as well positioned inthe ongoing construction activity pickup. Since we added the shares to ourSell List Sept. 19, 2015, they have fallen 15.4% vs MSCI China -8.2%.
Catalyst
1) Continued high steel spot margin, with inventory well below avg level. 2)Positive high frequency data like construction machinery utilization hoursand cement price improvement (proxy for construction activity strength).
Valuation
We cut 2016-18E losses 47%-71% on: 1) 2%-4% higher steel price forecast,2) lower impairment losses on more stable commodity pricing, and 3) lowerlosses on closure of its loss making Hefei subsidiary. With this, our 12-m PBbased TP is now HK$1.9 (prev. HK$1.2), with 19% upside. This is based on0.8x FY17E PBR, in line with the historical avg. We remove 20% discount tobook value as we now expect the company to stay free cashflow positive in2016-18E.
Key risks
Weaker than expected demand, esp. for property; restart of idle capacity;raw material price strength.