Equity Analysis /
Egypt

Ezz Steel: 4Q20 – Topline and margins recover; finance charges pressure bottom-line

  • Strong top-line growth trims bottom-line losses

  • Margins recovered, GPM still below c.12-13% breakeven mark, Net debt balance slightly higher rate cuts provided relief

  • Price increases and wider spreads are key for profitability outlook

Al Ahly Pharos Securities Brokerage
4 April 2021

Strong top-line growth trims bottom-line losses

Ezz Steel’s attributable net losses recorded EGP346 million in 4Q20 compared to EGP2,715 million in 4Q19 (due to restructuring costs) and EGP929 million in 3Q20. Net losses before minority interest for the quarter recorded EGP574 million, softer than the EGP2,715 million of 4Q19, and the EGP1,339 million of 3Q20.NLM dropped to 2.8% during the quarter (+7.9pps QoQ). The company’s losses were significantly better on a quarterly basis due to stronger profitability on the gross level with a GPM of 7.9% (+5.7pps QoQ) leading to a positive EBIT of EGP311 million, however, the hefty net finance charge of EGP942 million (10.6% effective interest rate), and FX losses of EGP58 million were the drag on the bottom line during the quarter.

FY20 attributable net losses recorded EGP3,119 million down from EGP6,305 million showing a  50.5% improvement despite the weaker top line, due to the company’s 1) positive margins (due to natural gas price cuts, lower electricity tariff, and better pricing) coupled with 2) 4pps interest rate cuts during the year, where both factors led to softer losses by the end of 2020.

We expect FY21 to witness improvements in the topline driven by better volumes on recovering building activity, strong global steel prices, and especially flat steel, however, we still need multiple factors of lower interest rates, cheaper energy prices, or a weaker EGP to see the company ending the year in profitability.

Ezz Steel's consolidated revenue recorded EGP12,168 million (+16.4% YoY, +41.0% QoQ). The company saw a surge in top-line resulting from stronger prices on both a sequential and annual basis and due to a c.10-11% sequential volume increase.

FY20 consolidated revenues recorded EGP38,625 million (-15.5% YoY) due to a drop of c.12% YoY in average prices and a decline of total volumes by c.12-13% YoY, mainly due to the challenges seen in 1H20 amidst the country lockdowns due to the pandemic and halt of building activity for 6 months.

Margins recovered, GPM still below c.12-13% breakeven mark

Gross profit came in the green for the second quarter in a row, where gross profit recorded EGP957 million in 4Q20 versus a gross loss of EGP1,504 million in 4Q19, and gross profit of EGP185 million in 3Q20. 

GPM came in at +7.9% versus GLM of -14.4% in 4Q19 and a GPM of 2.1% in 3Q20. The improvement in margins is mainly attributed to stronger sequential pricing after successive price increases totaling EGP3,500/ tonne implying a c.35% increase in 4Q20 alone (reaching EGP13,654/tonne including 14% VAT) which was preceded by an EGP550/tonne, increase in 4Q20 production during the quarter regaining some of the economies of scale lost and as management shuffles raw material and feedstock use depending on the cheaper sources to evade losses on the gross profit level.

The company turned to a positive EBITDA recording EGP672 million versus LBITDA of EGP1,975 million in 4Q19 and LBITDA of EGP80 million in 3Q20. EBITDA margin came in at +5.5% versus -18.9% in 4Q19 and -0.9% in 3Q20. Losses narrowed because of the positive gross profit and decline in SGA by 1.2% QoQ and 7.8% YoY where SG&A/sales came in at 4.7% (-1.2pps YoY, -2.0pps QoQ).

Net debt balance slightly higher rate cuts provided relief

Net debt came in at EGP33,145 million on December 31, 2020, from EGP32,474 million on September 30, 2020. Net Debt/Market Cap stands at 6.7x. On the bright side, the consecutive interest rate cuts enacted in mid-March 2020, at the end of September and mid-November, accompanied by the CBE's low-cost financing initiatives for the industrial sector acted as a breather for the company and the rest of the group.

Finance cost ate up positive margin development

Margins improved both sequentially and annually trickling down to positive EBITDA and EBIT figures of EGP672 million and EGP311 million, respectively. However, 1) the hefty net finance charge of EGP942 million; and 2) FX loss of EGP58 million, weighed down on the bottom line and ate up positive margin development, however, the tax benefits of EGP115 million acted as a cushion against more severe losses.

Price increases and wider spreads are key for profitability outlook

We reiterate that a game-changer for the company and the recommendation would be a major hike in import tariffs, significant recovery in global steel prices or steel/iron ore spreads, or a major weakness in the EGP/USD exchange rate, in addition to further cuts in natural gas costs, electricity tariffs, and interest rates. The company’s profitability fate is reliant on the aforementioned catalysts. 

On the bright side, we started seeing a clearer picture on the prospect of the company’s profitability after seeing positive GP and EBIT figures during the fourth quarter post recurring price increases by the company in tandem with both surging global steel price & raw materials, which has resumed in 1Q21 (Turkish Rebar 1Q21 average of USD632/tonne, +46.6% YoY and 23.8% QoQ) & raw materials (Iron ore 65% 1Q21 average of USD224/tonne, +72.9% YoY and 37.1% QoQ) and Scrap 1Q21 average prices recorded USD422/tonne, +51.5% YoY and 39.7% QoQ). 1Q20 Steel/iron ore spreads averaged USD295/tonne versus USD262/tonne in 4Q20, which could mean GPM and EBITDA margin expansion sequentially, but we do not think that bottom line will be in the green yet. We need spreads to sustain c.USD330-350/tonne and GPM to hit c.12-13% in order for the bottom line to break even.