Equity Research Report on China Steel Corporate

juliamtw20
Feb 8, 2024
20 min read

Updated: Jun 5, 2024

This is a website version of the equity research paper I've crafted in CFA competition in 2021.

Company Information

Sector : Industrials

Industry : Steel industry

Stock Exchange : Taiwan Stock Exchange

Ticker : 2002

Valuation Date : December 15th , 2021

EXECUTIVE SUMMARY

We issue a BUY recommendation for CSC with a target price of NT$44.25, presenting a 29.20% upside on the closing price of NT$34.25 on December 15th, 2021. Our valuation is based on P/B method, and is supported by Discounted Cash Flow model. We forecast that CSC‘s EPS will grow to 4.29 in 2022, mainly owing to 1) improved fundamentals and a favourable policy tailwind, 2) lower operating expense brought by outstanding management capability, 3) foreseeable profits from CSC’s development of advanced premium steel and4) green energy development as long-term catalyst.

CSC’s revenue will grow by CAGR 24.58% FY20~FY22 with a higher GM

We believe the steel industry has entered a new upcycle,with improved fundamentals and a favourable policy tailwind. As for demand, CSC stands to benefit from the recovery of global economies. Moreover, We expect China to implement further steel production controls in an effort to align with lower carbon emissions goals, tightening the steel supply and increasing the steel prices. We also anticipate a decrease in material price. We believe that iron ore price will remain low at an average around US$100/ton in 2022 and metallurgical coal price will ease from the highest US$227/ton in 2021 to US$162/ton in2022. With the down trend of material price and the increasing demand of the steel industry,we believe that CSC will keep earning profits in the next few years.

Diversified investmentsdecrease operating expense and lower downside risks

CSC implements a diversification strategy such as overseas expansion, industrial materials business, and services investments business.These investments not only help CSC reduce freight charges, sell products, and handle industrial wastes but also reduce its operating expense, especially in administrative and selling expenses, making CSC’s EBITDA margin reached 21.9% in 1Q21, rank first among competitors in Asia. Overall, we believe CSC’s various investments can bring diversified revenue and lower its operating risks.

Advanced premium steel (APS) will ensure future competitiveness and profits

CSC has seta goal to increase the sales proportion of advanced premium steel (GM>20%) to 10% in 2025 and 20% in 2030. Currently, the proportion of APS has reached 7.24%, which is even higher than CSC’s goal (4.2%) in 2021. Besides, CSC is also developing electrical steel, which is the most important part of an electric vehicle. With the continuously growing popularity of electric vehicles, CSC can thus increase sales revenue. Therefore, we believe CSC will not only generate stable profits and high margins but also improve its competitiveness with active development in APS.

Green energy investments will become a long-term catalyst

The steel industry is seeking for transition in order to follow the global sustainable trend. To avoid the potential risks and costs, CSC has conducted several forethoughtful programs such as offshore wind power and solar photovoltaic energy to increase energy efficiency:

1)Solar photovoltaic energy: The annual power generation capacity of CSC Solar can create more than NT$400 million electricity sales revenue. Although the system is only on CSC’s plant now, we expect that CSC Solar will extend the business of building power plants outside the group to bring profit and fulfill CSR due to their carbon dioxide reduction of solar energy.

2) Offshore wind power: Singda finally created the first 100% domestically-made underwater infrastructure in July 2021 and is preparing for massproduction. Besides, the price of steels for underwater infrastructure is 8 to 10 times more than that of original steels, which can contribute to higher GM for CSC. Overall, we believe that Singda will not only drive CSC profits but also have the opportunity to expand to the international market in the foreseeable future.

Business Description

China Steel Corporation ( located in Kaohsiung, Taiwan, was established in December 1971 CSC became nationalized in 1977 and was listed on Taiwan Stock Exchange in 1974 CSC is also the largest steel mill in Taiwan with approximately 10 million tons of crude steel production per year, which account for 68 of Taiwan’s total production.

Businesses and Market

79.01% of CSC‘s revenue comes from selling steel products, and the rest are attributed to other businesses such as engineering and logistics CSC provides various products, including steel plates, bars, wire rods, hot rolled steels, and cold rolled steels Hot rolled and cold rolled steel make up 29.81% and 29.65% of steel sales revenue apparently (Figure 1) Most of the customers are domestic 88.72% and the other customers are from Vietnam, Malaysia, China, and India (Figure 2) Though the domestic market contributed to most of the revenue CSC’s operating performance will still be influenced by the international market since their customers sell products not only in Taiwan but also overseas Sources of Raw Materials CSC imports the majority of raw materials including coal, iron ore, and limestone from abroad, especially from Australian (Figure 3) To keep the acquisition stable, CSC usually signs long-term (3~5 years) contracts with its suppliers such as BHP Group Limited and Vale S.A. the world's largest iron ore mining company Besides CSC also raises the ownership rate of minerals through overseas investment

Business Strategy

To enhance its competitiveness as well as to hit the sustainable goals CSC invests in researching advanced premium steel products, developing intelligent production technology, and establishing other businesses (Appendix 4) such as engineering, wind power, and services to expand its scope of operations and to reduce risks.

Industry Overview

The steel industry is susceptible to the global economy. Due to the economic crisis

caused by Covid 19 the steel industry’s profit has plunged in 2020. However, the increasing vaccination coverage and the financial policies are driving the growth of global steel demand (Figure 4). and the profit of the steel industry. The short supply of global steel is attributed to the policies of the major exporting countries.

Demand Drivers

The global demand will increase steadily by 2.2% in 2022: Although China, standing about 56 of the world steel demand, is expected to show no growth in 2022 due to the overnment policy stance on rebalancing and environmental protection, we forecast the global steel demand will grow by 2.2% in 2022 (according to WSA) owing to the factors below (1) Steel demand of some developed countries in 2021 hasn't returned to their pre pandemic level, we forecast that the steel demand in these countries will increase by 1~2% in 2022 (Figure 5). (2) The U.S. 1.2 trillion infrastructure is estimated to bring about 5.46 million tons of steel demand per year (Appendix 5). (3) Since steel demand of developing countries is highly related to GDP, we estimate India’s steel demand will grow by 6.5 ~ 6.8% in 2022 according to OECD’s prediction (Figure 6). (4) The global construction industry is expected to show a robust recovery fueled by low interest rates resulting in the increase of steel demand.

The infrastructure policy and the growing export orders of the downstream market maintain domestic steel demand: The third period of the Forward looking Infrastructure Development Program invests NT$102 billion in 2021~2022 which will directly creates steel demand (Appendix 5). Besides, Taiwanese businesses have returned to Taiwan to invest and buil d new factories and production facilities, driving the floor area of building permits increased in 2020 and 1H2021 (Figure 7). As a result, the domestic steel demand for constructions will maintain high in the next 2 3 years. Moreover, the export orders of the downstream markets such as basic metal products, machinery and transportation equipment grew by 20.6%, 1.9% and 15.7% in 1Q2021~3Q2021 making domestic steel demand remain high in 2022 (Figure 8).

Supply Drivers

We believe that the steel industry will face a undersupply of steel because of (1) export restriction policies and (2) carbon reduction targets in 2021. However, compared to the situation in 2021 the undersupply of steel is expected to slow down in 2022 owing to the recovery of production capacity.

Export restriction policies: Because of the rapid recovery of steel demand in 2021 steel prices have soared. In order to stabilize domestic steel prices and ensure domestic steel supply, China raised its export tariffs on ferro chrome and high purity pig iron to 40% and 20% respectively and canceled export tax rebates in August, and Russia increased the export tariffs. Since China and Russia are the top 2 steel exporters in the world (Figure 9) the supply of steel in the international market has been drastically reduced.
Carbon reduction targets: The global carbon neutrality trend has affected steel production policies. As the carbon emissions of China’s steel industry accounts for 15% of the country’s total carbon emissions, China needs to curtail crude steel production to reduce the carbon emissions China, which represents 56.7% of global production (Figure 10) curtailed production from July to keep their 2021 annual output below 2020 levels resulting in the reduction of global steel production. We believe that China's steel supply will not increase unless production technology improves In addition to China, Europe and the United States will also reduce steel supply to achieve carbon reduction targets.
Recovery of production capacity in 2022: Although China's production capacity is limited, we still believe that the world crude steel production will grew in 2022 mainly driven by the following two factors (1) In 2021 the production of the countries with mature steel industry such as the European Union and North America haven’t returned to their pre pandemic level (2) Countries where steel industry in growing period like the Middle East and Southern America will continue to grow after the epidemic. Overall, we believe the production capacity of steel mills will increase and gradually meet the global demand after the better control of pandemic in 2022 (Appendix 6).

Raw Materials

Iron ore price has been falling due to the Chinese government’s policies: The key cost of raw material is iron ore (46%) and coking coal (34%) (Figure 11). Iron ore prices in Nov. 2021 have fallen to an 18-month low (around US $90/ton, 60% lower than the peak reached in Jul. 2021) reflecting (1) China’s stated goal of no growth in steel output in 2021 and (2) the tightened supply from Australia and Brazil gradually relieved as the pandemic slows down. Since the supply after the Brumadinho tailings dam collapse is recovering and the demand of China, the largest iron ore importer in the world, will remain weak, we believe that iron ore price will remain low at an average around US $100/ton in 2022, which is about 30% lower than the average in 2021, and will decrease CSC’s cost of iron ore by 7.7%.
Metallurgical coal price will slightly fall but remain historically high in 2022: The Chinese government banned its main coal supplier, Australia (which accounts for 54% of world coal exports) last year and revised imports from other countries. However, due to the demand of countries that have economic stimulus measures, the price of Australian metallurgical coal didn’t decrease. As supply from Australia and other exporters gradually picks up, we expect the price to ease from the highest US $227/ton in 2021 to US $162/ton in 2022. We believe CSC’s average cost of metallurgical coal in 2022 will maintain at almost the same level as 2021 due to relatively low prices at the beginning of 2021.

Competitive Positioning

As the largest steel company in Taiwan, CSC has been the leader of Taiwan’s steel market owing to: 1) its significantly higher steel output compared to domestic peers, 2) stable sources of raw materials, and 3) outstanding operating capacity. Since the Taiwanese steel industry has been fully developed, CSC attempts to expand its market abroad. With its smaller business scale compared to its main overseas competitors, NSC, BAOWU, and POSCO, CSC enhances its competitiveness through: 1) overseas expansion and 2) development of intelligent manufacturing and high-quality steel products.

Long Term Contracts and Overseas Investment

Due to the lack of natural resources in Taiwan, CSC guarantees its acquisition of raw materials through signing long-term contracts with its suppliers such as BHP Group Limited and Vale S.A. For the same purpose, CSC also invests in mining companies, including 5% equity of the Sonoma coal project, 2.5% equity of the Roy Hill iron ore project in Australia, and 40.8% equity of HHCEC in Taiwan to increase its ownership rate of the raw materials (Appendix 8). Besides, in order to reduce its material costs and risk, CSC develops a transportation subsidiary, China Steel Express Corporation, to prevent fluctuation of sea freight. Compared to other steel companies in Taiwan, CSC owns stabler raw material sources and is more able to deal with the risk of transport.

Higher EBITDA and Outstanding Operating Capacity

Compared to steel companies in East Asia, though with a relatively lower EBIT owing to its higher depreciation and amortization expenses, CSC had an EBITDA margin of 15.9% on a 5-year average, which has performed better than its peers in the past 5 years (Figure 12), attributing to its lower operating costs. This mainly shows that CSC has great performance in product profitability. Moreover, CSC’s net operating cycle is shorter than its peers owing to its excellent accounts receivable turnover (Figure 13), indicating that CSC has the ability to avoid bad debts and operate efficiently.

Overseas Businesses

Since 2011, CSC has been continuously expanding its overseas businesses (Appendix 7) in order to seize emerging markets. CSC’s expansion mainly focuses on ASEAN countries and India to enjoy zero tariffs through the ASEAN free trade area (Figure 14). Although CSC’s overseas net income declined due to COVID-19 since 2020, it began to grow and has reached total profits of NT$2.35 billion in 1H21 (Figure 15). Overall, the recovery from COVID-19 and the market potential of ASEAN can help CSC spread the risk of its high market concentration and increase overseas revenue in the future.

Future Innovation Strategy

Intelligent Manufacturing: CSC has been integrating traditional production processes with intelligent manufacturing systems developed by CSC’s subsidiary ICSC, using big data regression to analyze past experiences. In addition, CSC’s new intelligent blast furnace can search for abnormal activities and automatically adjust the production process. With this new AI system, CSC can ensure quality performance and enhance production yield, reducing energy costs by NT 32.7 million and carbon emissions by 2,217 tons a year, eventually increasing profits.

Electrical Steel: Since 2007, CSC has begun developing electrical steel, the most important part of electric vehicles. Due to increased environmental awareness, the proportion of electric car sales to total car sales has increased from 5.54% in 2019 to 9.29% in 2020 (Figure 16) and is expected to grow exponentially. Moreover, CSC is the exclusive provider of advanced electrical steel (25 CS 1250 HF) for Tesla’s Model 3, the most popular e-car in the world. Recently, the U.S., EU, Chinese, and other governments have formulated regulations that in the next 15 years, electric cars must replace traditional fuel cars to reduce carbon emissions. Furthermore, CSC also joined the MIH platform to develop potential customers. Therefore, we believe that the tendency of electric vehicle development will help CSC increase premium steel profits, raise its gross margin, and expand visibility in the international market.

Valuation

We issue a Buy recommendation on China Steel Corporation (CSC) with a target price of NT 44.25, which represents a 29.20% upside from the closing price of NT 34.25 on December 15th, 2021. Our target price calculation is based on the P/B multiple method and backed up with a Discounted Cash Flow (DCF) model.

Price to Book Value Valuation Model

Currently, the steel industry is experiencing an upward trend, reminiscent of the 2009-2010 period (Figure 17), when the global economy was recovering from the financial crisis. Moreover, the Return on Equity (ROE) and Earnings Per Share (EPS) of CSC estimated in 2022 closely resemble those of 2010. With the aforementioned conditions, we calculate the Price-to-Book (P/B) ratio by multiplying 1.70 by the book value of NT 26.03 per share, resulting in a P/B target price of NT 44.25.

DCF Model

We adopt a two-stage DCF model to forecast our DCF target price of NT 44.05, which approximates the P/B method target price and should serve as confirmation. In the first stage, we projected the cash flow from 2021 to 2031. In the second stage, we forecast a terminal growth rate of 1.53% (Figure 18). As the COVID-19 pandemic slows down, we assume that CSC’s cash flow will maintain a stable business cycle in the next ten years, just as CSC’s cash flow after the peak of the European debt crisis. Therefore, we refer to the cyclical trend of CSC during 2013-2019.

WACC

We forecast a WACC of 8.71% for CSC, with our cost of debt at 1.83% (derived from the pre-tax cost of debt of 2.21% multiplied by (1 - tax rate of 82.69%)) and our cost of equity at 8.72% by CAPM (Appendix 12) (Figure 19).

Residual Value

The final value is calculated through the sustainable growth model. We estimated the sustainable growth rate at 1.53% (Figure 18) based on our forecast GDP and the CPI of CSC’s main operating regions, multiplied by the revenue contributing percentage.

Revenue

We forecast CSC’s revenue by dividing it into the steel department, construction department, and shipping department. For the steel department, we break down the revenue into rolled steel and bar steel. Although domestic sales accounted for 88% of CSC’s revenue, CSC’s downstream manufacturers sell most of their products to the United States and Europe regions. Therefore, CSC’s revenue is also driven by steel demand from both the United States and Europe regions. Due to the historical high of Taiwan’s construction floor areas in 2020 and the average construction time being more than two years, it is reasonable to forecast that the steel demand of Taiwan construction will increase CSC’s domestic revenue. Owing to the demand for infrastructure plans in various countries and stable demand in Taiwan, we forecast that CSC’s revenue for FY22 will reach NT$488.618 million, implying a 3.59% YoY growth.

Sensitivity Analysis

Based on our insights, we conducted a sensitivity analysis on the key inputs of our valuation. Risks that might lead to our valuation not meeting expectations include the fluctuation of ASP of steel, iron ore, and coal. We forecast the P/B ratio under downside and upside situations to determine their effect on our recommendation. If the steel industry faces an extremely declining situation with a 1.15x P/B multiple, implying a 21% return, we may change our recommendation to SELL.

Financial Analysis

CSC’s assets are mainly composed of non-current assets since the steel industry is highly capital-intensive. Non-current assets account for 75-77% of its total assets, among which PP&E (Property, Plant, and Equipment) has the largest share. Inventory, on the other hand, is the main component of CSC’s current assets, accounting for 50-60% of its current assets. Backed up by its positive growth of GM (Gross Margin) and its great operating performance, we have an optimistic view on CSC’s future profitability.

Profitability

Revenue is expected to grow in 2021 and 2022 due to long-term infrastructure demand and policies

Although CSC’s revenue fell by 14.05% in 2020 (Figure 22) due to the COVID-19 pandemic, because of the increasing demand driven by infrastructure policy, we estimated that CSC's total revenue will grow by 49.84% and 3.59% in 2021 and 2022 respectively (Appendix 13).

Gross Margin will reach a ten-year high in 2021 and 2022

CSC’s gross margin has increased to 22.8% in 3Q21, far higher than the lowest point at 1.17% in 1Q20. We forecast GM would be at 21.15% and 22.89% in 2021 and 2022 (Figure 23). Overall, we believe GM will remain high end in recent years because of the following reasons:

The steel price would be at a high level: Steel prices have soared since the world‘s steel demand exceeds supply. The domestic sales price of CSC’s hot rolled steel products rose from NT 24,728 /Ton to NT 32,878 /Ton by 32.9% from Jan 2021 to Sep 2021. We forecast the ASP of CSC’s 4 main steel products in 2022 would be at high levels compared to the price in 2020 (Figure 24, 25).
Decreasing trends of the two main materials’ prices: Iron ore and metallurgical coal account for 46% and 34% of CSC’s cost. We forecast the price of iron ore will remain low because China has intensified production curbs (Figure 26). As for metallurgical coal, we forecast that the price will slightly fall but will remain relatively high in 2022 since the supply from Australia and other exporters are recovering and the coal demand remains strong except in China (Figure 27). In conclusion, we believe that the prices of raw materials are in a downward trend. However, the total COGS will remain at the same level as we anticipate an increase in the sales volume of steel in 2022.

Great operating performance leads to higher EBITDA.

CSC has a great EBITDA margin compared to its domestic and overseas peers, which is related to its low operating expense. Although CSC’s revenue was heavily hit by the pandemic during 2019 and 2020, its outstanding operating ability ensures its income. Owing to CSC’s strategy of diversification, its SG&A expense ratio usually remains at 3-4%, which exceeds its competitors (Figure 28).

Increasing net profit margin brings ROE growth in 2021-2022.

CSC has a relatively stable financial structure, hence its financial leverage and total assets usually remain at the same level. Therefore, the main driver of ROE is CSC’s net profit, and we forecast a high ROE due to its strong profitability in 2021-2022.

Efficiency

Efficiency in management increases CSC’s future competitive advantage A shorter operating cycle shows CSC’s efficiency in both inventory and receivables management. Using five years’ average data, CSC performs better than Tung Ho with 101 days sales of inventory and 16 days sales outstanding. This advantage allows CSC to make better use of its capital.

Stable Cash Flow

Stable cash flow guarantees enough funds CSC's investing cash outflow is mainly attributed to PP&E purchasing. Since CSC has no plans for new mills, most of the capital expenditures come from updates for plants and equipment. As for CSC’s financing cash, it has become negative since 2014, implying that CSC is intent on repaying debt and distributing high cash dividends. In conclusion, CSC’s stable operating cash flow can support both investing and financing cash outflows (Figure 29).

Financial Structure

CSC has a sound financial structure, diversifying its funding resources to decline its financing risk (Figure 30). CSC's main funding sources are bank loans, corporate bonds, and capital stock, and its debt ratio is maintained at around 50% steadily. Otherwise, CSC’s debt ratio has gradually decreased through repaying its bank loan since 2016.

Investment Summary

Tightening supply, increasing demand, and lower material prices lead to higher revenue and GM.

The world steel demand is expected to rise in 2021-2022 due to recovery from the pandemic, the U.S. $1.2 trillion infrastructure plan, demand from developing countries, and low interest rates. As for the domestic steel market, given the Forward-looking Infrastructure Development Program, the return of Taiwanese businesses, and growing export orders of the downstream market will boost domestic steel demand. Consequently, increasing demand brings benefits to CSC.

On the supply side, China, the biggest steel production country, conducted policies limiting production and restricting exports. This policy would eventually lower China’s steel exports and demand for raw materials. Therefore, we believe that the prices of the two main materials will both be in a downward trend.

In conclusion, the increasing demand in the steel industry, the tightening supply, and the downtrend of material prices ensure CSC’s revenue by CAGR 24.58% in FY20-FY22 with a historically high gross margin of 22.89% in 2022.

Strong operating performance from well-diversified investments.

CSC’s EBITDA margin reached 21.9% in 1Q21 with a low SG&A expense ratio around 3.4%, ranking first among competitors in Asia. Besides, its net operating cycle is shorter than its peers owing to its excellent accounts receivable and inventory turnover.

CSC shows a higher EBITDA margin, lower expense ratio, and shorter operating cycle. The operating efficiency might be attributed to its well-diversified businesses. For instance, the investment in raw materials suppliers and trading businesses can help CSC establish a complete supply chain and eventually increase CSC’s operating efficiency.

Advanced premium steel products can increase GM and ensure competitiveness

As the leading steel manufacturer in Taiwan, CSC has the most complete resources to develop advanced premium steels, steels that have a gross margin higher than 20%. Recently, CSC has set a target of the proportion of premium steel to 10% in 2025 and 20% in 2030 (Figure 31) and it has already reached the target of 2021. Moreover, the development of APS can also reduce carbon emissions since the steels are lighter and more durable, making transportations made by APS more fuel efficient. Consequently, CSC will produce less carbon dioxide and can benefit from selling carbon credits. Also, CSC has developed electric steel that is essential for electric vehicles and is the largest supplier of TESLA for electric steel. Overall, with the rise of environmental awareness, CSC can increase its gross margin and enhance competitiveness.

CSC’s strategy fulfills sustainable prospects and reduces environmental risk

Steel producers generate significant greenhouse gas, air pollutants, and waste while consuming large amounts of natural resources such as water and energy. In order to hit the goal of net zero emissions in 2050, authorities are eager to formulate laws and regulations to induce enterprise transformation, which will have a huge impact on the steel industry. The risks caused by the regulation compliance include the infraction penalties/punishment and increasing cost. Reduction of emissions requires innovation in management and technology, which leads to higher costs such as R&D and waste disposal. Fortunately, CSC turns the risks into opportunities through several forethoughtful programs, including advanced premium steel, offshore wind power, and solar photovoltaic energy.

1) Advanced Premium Steel Since the electric vehicle industry is a pioneer in sustainable development, CSC enters this booming industry through electric steel.

2) Offshore wind power CSC’s subsidiary, Singda Marine Structure, completed the first all domestically made underwater infrastructure in July 2021 consuming about NT 200,000 per metric ton (about 8-10 times the price of the original steel), which is expected to bring potential revenue to CSC. Besides, offshore wind power development in Taiwan is more advanced than in Japan and South Korea. Thus, CSC has the opportunity to access the East Asia market.

3) Solar Photovoltaic Energy CSC Solar Corporation has installed a 84.8 MW solar photovoltaic energy system, which generates 102 million kWh and more than NT 400 million of revenue per year. Moreover, CSC Solar is planning to extend the business, hoping to become the largest rooftop power generation company in Taiwan.

Environmental, Social, Governance

Since sustainability has been a highly discussed international issue in recent years, governments are on their way to set up policies. Therefore, the steel industry is facing transformation. CSC has been deeply involved in environmental, social, and corporate governance. Furthermore, CSC announced its goal as a green energy industry in 2020. We believe that CSC will continue progressing in sustainability. According to credible institutions’ ratings, CSC's sustainability performance is among the top 16-18 of the steel industry (Figure 32) and is also better than its international peers (Appendix 15). In addition, CSC does well in all three dimensions, especially outstanding in the Environment (Figure 33).

Environmental & Social

The following table applies to the SASB standard for Iron Steel Producer (table) and TCFD framework, showing the main financial risks and opportunities that might be caused by environmental and social topics.

Energy Management Greenhouse gas emissions: CSC improves energy utilization efficiency through regional energy cooperation and investment in renewable energy such as rooftop solar PV plants, which can reach 848 MW per year. These have successfully reduced greenhouse gas emissions by 362,000 to 386,000 tons of CO2 equivalent per year (Figure 34) and 51,000 tCO2e per year). Moreover, CSC will develop offshore wind power with a capacity of 300 MW in 2024.

Air Pollutants: CSC’s air pollution management has reduced SOx, NOx, and particulate emissions between 2016 and 2020 (Figure 35). CSC expects to go a step further through investing 44.7 billion NT in 8 air pollution improvement projects.

Workforce Health Safety: CSC has established an OSH Committee to improve occupational safety through training and observation. The employee disabling frequency rate had significantly declined from 0.32 in 2018 to 0.14 in 2020.

Supply Chain Management: CSC conducts annual supplier CSR performance evaluations to control supply chain risk.

Physical Risk: CSC establishes an emergency plan, recycled water system, and wharf safety assessment reinforcement to deal with crises.

Changing Customer Behavior: Advanced premium steel products such as electric steel strengthen CSC’s ability to meet customer needs.

Governance

We analyze CSC’s governance performance in four sections: Board Structure and Operation, Management, Shareholders’ Equity, and CSR Strategy (Figure 36). CSC’s board of directors has 11 members, including 3 independent directors, and the average term of office hasn’t exceeded 10 years. CSC conducts performance appraisals against the board members annually and links personal performances to salaries, which brings positive effects to corporate operation.

However, female directors account for only 9%, which needs to be improved. Foundational committees are well-operating. CSC sets up departments to deal with not only corporate governance issues but also emerging issues such as risk and information security. The high score in Shareholder’s Equity is due to the achievement of equal treatment as well as the perfect disclosure of information. CSC releases CSR reports under GRI standards every year, which is certified by the British Standards Institute (BSI) (Figure 37).

Investment Risk

Market Risk

[MR1] Over-reliance on Australian raw materials

The undersupply of raw materials might trigger increasing production costs and an imbalance between supply and demand. Currently, 78.8% of coal and 83% of iron ore used by CSC are sourced from Australia. Any unexpected natural disasters or political changes in Australia could significantly affect export business, potentially leading to substantial impacts on CSC's production costs and profit margins.

[MR2] Covid-19 variants of concern

Although Covid-19 vaccinations worldwide have reached about 75 doses per 100 people, leading to a rise in global steel demand and increasing CSC's revenue in 2021, uncertainties surrounding new variants such as Omicron might delay infrastructure plans globally, consequently reducing the demand for steel. Additionally, national lockdowns may halt CSC's production, both of which could negatively impact CSC's revenue (NT$).

[MR3] Foreign exchange rate

The recent recognition by the FED of high inflation threats and plans to raise the target interest rate may strengthen the value of the dollar. CSC is particularly exposed to currency risks associated with the USD and RMB due to heavy reliance on imported raw materials and substantial overseas investments. The appreciation of the USD could increase total costs, as most raw materials are denominated in USD. According to CSC, a 1% increase in the USD against the NTD would reduce pre-tax profit by 107,836 thousand NTD. However, considering the strong performance of the NTD, we believe that the impact of foreign exchange rates would not be too significant.

Financial Risk

[FR1] The excessively high cash dividends payout ratio

Regardless of the profitability of CSC, the cash dividends payout ratio has always been higher than 80 on average since 2010 (Figure 38 39). Such a high dividends policy has been very attractive to those investors seeking high cash dividends. However, when we look through the ratio between expenses on cash dividends and free cash flow, it shows that maintaining such a high dividend payout ratio is quite a burden on CSC. This can be a potential risk when the company‘s financial status is in deficit. On the other hand, CSC may lose investors if their dividends policy turns out to be unsustainable.

Operational Risk

[OR1] Highly concentration on Taiwan market

Taiwan is one of the freest markets in the world with zero import tariffs on steel. Under this circumstance, if countries such as China dumped massive amounts of products into Taiwan with lower prices, CSC’s profit would be significantly harmed.

Policy Risk

[PR1] Global trends on sustainable policy

With the extreme climate change among the world, countries like US, EU passed their carbon neutral targets into law, and implement a system such as carbon trading Thus, sustainability has become a business imperative To reduce the emissions of greenhouse gas, waste, air pollutants, and so on, CSC’s cost might rise.