By Eu Hong Chew
WARREN Buffett has two well-known quotes regarding management and businesses:
- “The best jockey in the world is never going to win races riding a lame horse. But even a mediocre jockey can win races riding a champion.”
- “When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
The horse vs jockey question is related to economic theories of the firm. In a study of venture capital financed companies in the mid-2000s, Professor Steve Kaplan of the University of Chicago found that:
“… at the margin, investors in start-ups should place more weight on investing in a strong business (the horse) than on a strong management team (the jockey).”
This is a common question among stock investors – do you bet on the horse or the jockey?
While I do not want to get into the horse vs jockey debate, I want to share an example favouring the horse.
CSC Steel Holdings Bhd (CSC Steel) is currently Malaysia’s largest steel cold rolling mill.
Steel is an alloy of iron with typically a few percent of carbon to improve its strength and fracture resistance compared to iron. Today, steel is one of the most common man-made materials in the world.
The Malaysian steel industry can be classified into the primary producers of steel slabs and/or billets and the secondary producers of such products as bars, wire mesh and galvanised sheets. In between you have the cold rolling mills.
CSC Steel is in the mid-stream steel business with its cold roll, galvanised and pre-painted galvanised flat sheet steel.
The controlling shareholder of CSC Steel is the China Steel Corporation of Taiwan, the largest steel company in Taiwan.
- CSC Steel’s main raw material, hot rolled steel, is mainly supplied by its parent company and related companies in Taiwan and Vietnam.
- CSC Steel is managed as part of the China Steel Corporation of Taiwan’s group of companies. CSC Steel’s Managing Director and some of the key managers are seconded from the Taiwanese corporate shareholder.
- CSC Steel’s competitive edge, technology, and products know-how come from the parent company.
CSC Steel downstream customers are those that use steel coils such as steel pipe makers, roofing sheets and cladding roll formers as well as steel service centres. Its main market is in Malaysia (89% of sales in 2019) and the balance is exported mainly to the Southeast Asian region.
Steel products are commodities. The industry is cyclical and its profitability is very dependent on government trade policies.
Currently, there are three public listed local cold roll coil producers operating in Malaysia – CSC Steel, Mycron Steel Bhd and Eonmetal Group Bhd.
Until April 2019, YKGI Holdings Bhd was a large cold roll coil player before it sold its plant to a Japanese outfit.
If you look at the performance of the listed companies in this industry as per the Peer Revenue Index chart, you will conclude that it has been tough for the past 12 years. The current revenues for the industry players are at best about the same levels as those 12 years ago.
CSC Steel is in a sector where the margins are affected by the spreads between international hot roll coil (raw material) and imported cold roll coil (finished product). The margins were thin for the past two to three years.
The biggest challenge faced by the Malaysian steel cold roll industry is from imports. Domestic consumption from the local mills has been declining due to imports. Globally, steel companies need around 70% to 80% capacity utilisation to be sustainable.
In 2018, Malaysia’s total installed capacity for cold roll coils was 2.51 million metric tonnes. But consumption from the local mills was a mere 590,000 metric tonnes or less than 23 % utilisation.
Given this scenario, you should not be surprised to see poor returns among the industry players as illustrated below.
Bet on the horse
Over the years, the managing director of CSC Steel has always been seconded from the Taiwanese parent company and each served only between one to two years in CSC Steel.
In its 2016 Annual Report, CSC Steel went as far to state
“… stakeholders can be rest assured that the frequent changes of the managing director will not adversely affect the organisational effectiveness…”
You would have thought that with such frequent changes at the top, there would be problems for CSC Steel.
But CSC Steel has performed well as it topped the peer companies in 10 years out of the past 12 years. It has a strong track record of being profitable during the past 12 years which covered two peaks and two troughs of the price cycle.
The performance appears more credible when you compare the size of the total assets of these companies. CSC Steel Total Assets is about two to four times larger than its Malaysian peers.
It is still profitable in 2020 notwithstanding the COVID-19 pandemic. CSC Steel is financially strong with zero borrowings and RM312 mil cash (as of end-December 2020).
The evidence seems to suggest that the “horse” is more important than the “jockey” in this case.
I am not suggesting that management has no role or that all the managing directors of CSC Steel are not top-notch managers. You could also argue that the “jockey” in this case has always been the China Steel Corporation of Taiwan.
Leaving aside the horse vs jockey debate, I am suggesting if you invest in CSC Steel, you are betting on its business economics. – Feb 25, 2021
This article was re-purposed from “Is CSC Steel a value trap?” that was first published on i4value.asia. Refer to the article for more details of the fundamental analysis.
Datuk Eu Hong Chew was on the board of i-Bhd from 1999 till 2020. He has led the Group’s transformation from a digital appliance manufacturer into the developer of i-City, the Selangor Golden Triangle.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.