Steel Hawk Berhad (KLSE:HAWK) – Is Strong ROE Enough to Justify the Recent Stock Decline?

Steel Hawk Berhad (KLSE:HAWK) has long been a standout in Malaysia's energy services sector, boasting a return on equity (ROE) of 32.2% in recent quarters—nearly double the industry average of 16%. This metric, coupled with a 108.3% year-over-year earnings surge and a 44.2% five-year growth rate, paints a picture of a company leveraging equity capital with remarkable efficiency. Yet, the stock has plummeted 6.2% over the past three months, raising a critical question: Is this decline a buying opportunity for value hunters, or a warning sign of deeper structural risks?

The Allure of High ROE and Earnings Growth

Steel Hawk's ROE of 32.2% underscores its ability to generate robust returns for shareholders. For every ringgit of equity, the company produces 32.2 cents in profit—a figure that outpaces even the most aggressive benchmarks in the Oil & Gas Equipment & Services sector. This strength is amplified by a net profit margin of 15.8%, up from 11.1% in prior periods, and a trailing twelve-month ROE of 46.39%. These numbers suggest a business that not only retains a healthy portion of its revenue but also reinvests it effectively to drive compounding growth.

The company's earnings trajectory further bolsters its case. In Q1 2025, earnings per share (EPS) jumped to RM0.017 from RM0.006 in the same period in 2024, reflecting a 183% year-over-year improvement. Over five years, net income has grown at a 44.2% annualized rate, far outpacing the industry's 27.3%. Such performance typically warrants a premium valuation, yet Steel Hawk trades at a P/E ratio of 13.1x—below the Malaysian market average of 13.9x. This disconnect hints at undervaluation, but only if the fundamentals hold up under scrutiny.

The Dark Side of the Equation: Cash Flow and Dilution Risks

However, the company's financial health is not without cracks. A closer look at operating cash flow reveals a troubling pattern. For the twelve months ending March 2025, Steel Hawk burned RM27 million in free cash flow despite reporting RM17.6 million in net profit. This discrepancy points to a high accrual ratio of 0.77, indicating that a significant portion of earnings is non-cash in nature. In other words, the company's profitability is largely paper gains, not hard cash.

Quarterly operating cash flow has been equally volatile. While Q1 2025 saw RM20 million in positive cash flow, the prior quarter (Q4 2024) recorded a RM16 million outflow. Over 2024, operating cash flow averaged RM-16 million annually, a stark contrast to the RM1 million reported in 2023. This inconsistency raises red flags about the sustainability of earnings and the company's ability to fund operations without external financing.

Compounding these issues is the recent shareholder dilution. In August 2024, Steel Hawk completed an IPO that issued 90 million new shares, raising MYR13.5 million. This increased the total share count by 18.37%, diluting existing shareholders' ownership and earnings per share. While the IPO was oversubscribed 276 times, the dilution erodes per-share value and signals a reliance on equity financing—a risky strategy for a company with weak cash flow.

The Investment Dilemma: Undervalued or Fundamentally At Risk?

The key to evaluating Steel Hawk lies in reconciling its strong ROE with its cash flow and dilution challenges. On one hand, the company's ability to generate high returns on equity suggests a competent management team and a competitive edge in the energy services sector. On the other, the lack of consistent cash flow and the aggressive dilution of shares indicate a business that may struggle to sustain growth without external support.

For investors, the critical question is whether the ROE can be maintained while addressing these structural weaknesses. If Steel Hawk can improve its operating cash flow—perhaps by optimizing working capital or securing long-term contracts—the current valuation could represent a compelling opportunity. However, if the company continues to rely on non-cash earnings and equity financing, the risks of a prolonged decline in shareholder value are significant.

Strategic Considerations for Investors

1. Monitor Cash Flow Trends: Watch for improvements in operating cash flow in upcoming quarters. A shift from negative to positive cash generation would validate the company's earnings quality.
2. Assess Debt Management: Evaluate whether Steel Hawk can reduce its debt burden or secure better financing terms. A debt-to-EBITDA ratio above 3x would be a cause for concern.
3. Track Shareholder Dilution: Any further dilution should be scrutinized for its impact on EPS and per-share value.
4. Compare with Peers: Benchmark Steel Hawk's performance against industry peers like Deleum Berhad and Bumi Armada Berhad to gauge its relative strength.

Conclusion

Steel Hawk Berhad's strong ROE and earnings growth are undeniably impressive, but they must be weighed against the company's weak operating cash flow and shareholder dilution. While the stock's current valuation appears attractive, the risks of a cash flow crisis or further dilution cannot be ignored. For patient investors willing to monitor these dynamics closely, the stock could offer long-term upside. However, those seeking stability or immediate cash flow should tread cautiously. In the energy services sector, where volatility is the norm, Steel Hawk's future will hinge on its ability to convert paper profits into real, sustainable cash.