An improvement in international steel prices and anticipation of a rollout of stimulus projects have recently driven up the prices of steel stocks, including that of Lion Corp Bhd.

Its stock price has surged more than 30% over the past one month to about 40 sen now, bringing it back to its October 2009 level and giving Lion Corp a market value of about RM760 million.

But how much higher can the stock climb?

Observers say a major concern is Lion Corp’s still heavy debt burden of about RM3 billion, which comes with a hefty annual interest cost of over RM300 million. Such a debt level will continue to weigh down the group’s profitability and perhaps its appeal to investors.

No doubt the macros have improved for steel manufacturers. But because of its huge debt,
Lion Corp needs much higher steel prices and sales volume — and for them to be sustained for a few years — to generate more cash for debt repayment and enhance its bottom line.

If not, there won’t be much change to the group’s fundamentals, as the past years have shown.

Compared with a year ago, Lion Corp’s total debt is down by about 24% or RM900 million to RM3.01 billion as at Sept 30, 2009, comprising RM1.66 billion in bank borrowings and RM1.35 billion in bonds and debts.

But that was not due to the group generating RM900 million cash over the past one year to shrink its debt. Rather, it was due to Lion Corp having issued in FY2009 some 804.46 million new shares at RM1 each, pursuant to the conversion of RM900 million worth of redeemable convertible bonds.

The conversion of the bonds almost doubled the group’s issued share capital to 1.9 billion shares and resulted in significant dilution to shareholders.

Apart from the conversion of the RM900 million bonds into equities during FY2009, there hasn’t been much progress in the group’s debt repayment efforts over the past three years. Lion Corp’s total debt was about RM3.94 billion as at FY2008, ended June 30, RM4.08 billion as at FY2007 and RM4.09 billion as at FY2006.

Lion Corp continued to refinance its bank borrowings too. In 3Q2009, the group refinanced some RM933.4 million of short-term borrowings, which had supposedly fallen due last year, into long-term loans.

As at June 30, 2009, Lion Corp’s short-term borrowings stood at RM1.22 billion while long-term borrowings were at RM423.1 million. As at Sept 30, the short-term borrowings have been reduced to RM286.9 million but long-term borrowings jumped to RM1.38 billion, according to the group’s balance sheet.

“Lion Corp needs a commodities or economic bull run to last for at least a few years so that it can generate a much stronger cash flow to speed up repayment of borrowings. Otherwise, its current cash flow is only enough to service the loans,” says an observer.

With a heavy debt burden, top-line expansion is crucial for Lion Corp, whose finance and interest costs amounted to more than RM400 million a year when its total debt was at about RM4 billion, before coming down to about RM310 annually after it reduced its total debt to the present RM3 billion.

Only a steel price rally like the one seen between 2006 and early 2008, and which lasts longer, could help Lion Corp.

Note that during the previous commodity price rally, the group’s revenue reached RM4.62 billion in FY2007, which generated RM569.2 million in operating profit before working capital changes, indicating the strength of its operating cash flow.

The good times continued in FY2008 as Lion Corp’s revenue expanded further to RM5.23 billion, with operating profit before working capital changes amounting to RM424.8 million. Cash flow remained strong, though it was lower than in FY2007 due to a surge in production cost.

But then, commodity prices and demand took a pummelling one year later, following the onset of the global financial crisis. In FY2009, Lion Corp’s revenue collapsed to RM3.1 billion, and it posted an operating loss before working capital changes of RM266.6 million.

The group said prices for its hot-rolled coils fell to RM2,100 per tonne in 2Q2009 from RM3,800 in 4Q2008, while demand shrank.

More than a year after the crisis, things appear to be picking up again. But having said that, a steel price and demand rally like that of 2006 and early 2008 seems unlikely. What’s more, with China starting to curb bank lending and the continuance of  the US’ stimulus programme in doubt, the consensus is that the second half of 2010 will be tough.

“Without a major and sustainable rally, the outlook will remain tough for Lion Corp, given the size of its debt,” says an observer.

This article appeared in Corporate page, The Edge Malaysia, Issue 789, Jan 18-24, 2010