Background on four years of headwinds
The steel industry has been suffering a lot in the past few years starting from 2017 after China exported c.115 million tonnes of steel in the global markets, The USA responded at the time by taking serious protective measures against Chinese steel and aluminum since April 2018 which impacted the global trade heavily.
North of 100 countries followed the US moves by imposing different types of protection measures, not only on Chinese steel but on their imports of steel by large traders to protect their local manufacturing from a potential flood of imported steel.
Egypt enacted temporary protective measures against three countries in April 2019 and was confirmed into permanent measures in October 2019 which is 18 months behind. Hence, leading to the bombardment of the Egyptian market with imported steel from several markets in the form of semi-finished products like billets (c.90% completed Rebars). The company was able to withstand the challenges and defend its market share
Egypt's Integrated steel producers (on top of them Ezz which has a market share of 40-45% in local Rebars) took the largest hit due to having to deal with "unfair" competition in the market.
Other factors that caused the pressure on profitability were: 1) the highly-priced natural gas that recorded USD7/MMBTU in 2015 dropping to USD5.5/MMBTU in Oct 2019 and then to USD4.5/MMBTU in Apr 2020 along with the high electricity tariffs, which led to inflated costs, which wasn't the case with their global competitors. 2) In Jan 2019 the disaster that occurred at Vale's (world's leading iron ore producer) dam in Brazil led to fears of supply disruptions about the world's supply of iron ore accordingly the commodity price has soared since then which wasn't reflected in steel prices as the two commodities relationship decoupled further pressuring integrated steel manufacturers. 3) The Covid-19 pandemic spread in 2020 and the halt of building permits and construction activity imposed in May 2020 contracting the sold volumes, especially of rebar since the residential segment represents >60% of it, and local sales of rebar range between 95-96%, while HRC (c.50% exported) demand shrunk due to the spread of the pandemic and the fierce competition weighing down on prices leading to reduced exports. 4) The high-interest rates were seen in 2018 that caused the average EGP finance costs to reach 20-22% at some point.
The light at the end of the tunnel
Management stated that they foresee a new upcycle for the steel industry being formed and they think that things started to change starting 4Q20.
Regarding the local rebar market, they have seen demand increasing starting Oct 2020 on the back of the expiry of the six months ban on construction activity which caused stocking up by the wholesalers, which gives the management confidence that volumes will get back to at least the levels of 2018 which are at least about 400k-500k tonnes above the consumption of 2020 which the company can easily match by increasing production and they are aiming towards the 100% utilisation.
Due to the rising demand and increasing global steel prices, the company and the Egyptian steel market has been able to pass down the inflating raw material costs (iron ore and scrap) to the consumers and gain a small margin through 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 3Q20
A new phenomenon in HRC and flat steel prices are seen, where the company used to sell HRC at about USD470/tonne six months ago while currently, prices soared to the level of USD810-820/tonne for Mar 2021 deliveries, this is in addition to the premium obtained on the thin gauges that their configurations are capable to produce. This indicates not only the ability to pass down inflating raw material costs but the beginning of a new cycle where HRC prices are higher than rebar prices. This is supposed to be normal as it is a premium product that costs more to produce and demands better technical abilities. They are currently seeing a sustainable appetite for their product accompanied by improving global trade activity outlook
In addition to the flat steel facility in EZDK, the company has increased the usage of the flexible capacity melt shop at EFS in flat steel production in 4Q20 and is planning to maintain this direction in 2021 to meet the rising HRC demand
Approximately a year and a half ago, the company has started producing B500DWR, a high tensile grade of steel that has been used internationally for several years but wasn't adopted by the Egyptian code, required certain technical abilities, and allows c.8-10% of reduced steel consumption in buildings and is optimal for tall buildings and was used in the towers of the administrative capital and El Alamein. In Nov 2020, this type of steel was added to the Egyptian code and the company believes that this will be the new norm of steel consumption in Egypt and this would be a competitive edge for them over other local competitors especially rolling mills who would incur added costs to keep up with them, which would support prices
Volumes are expected to recover
In 2021, management is hoping for 1.8 million tonnes of flat steel and about 3.5 million tonnes of rebars. Actual demand in the coming period would be followed closely to fine-tune the production plan.
The company is expected to report 2020 production as follows: c. 3.1 million tonnes of rebar compared to 3.2 million tonnes in 2019. While for flat c. 1.4 million tonnes compared to 1.1 million tonnes in 2019.
When it comes to sales, expected quantities come to about 3.2 million tonnes of rebars out of which about 9% were in exports versus 3.5 million tonnes of rebar sales of which (7%) were exported in 2019.
Flat steel sales in 2020 were c. 1.3 million in total sales out of which about 48% were exports versus 1.1 million tonnes in total flat steel sales out of which 542 thousand tonnes (49%) were exported in 2019.
Updates on feedstock mix and costs
The mix of iron materials is crucially important for the company and they continually monitor that mix based on the quality/cost optimisation and the melt shops have the flexibility in using different mixes.
The management gave guidance on the recent mix used for products, where long steel consumes 55-60% of DRI and 35-40% scrap, while the mix used for flat steel is 70-75% DRI and 30-25% scrap as this gives them better control on the quality of the product.
The company sources iron ore from several suppliers in Brazil, Sweden, Russia, India, South Africa, and a little bit from Canada. The company usually maintains four different ores at any point in time to optimise the best mix for DRI production. The on-ground iron ore stock usually suffices two months of production, and there are in transit vessels, and finally, there are vessels that are being loaded at ports.
Concerning utility prices, the company is pushing towards reducing natural gas and electricity prices. The government has postponed the decision to reduce gas prices from Oct 2020 to Jan 2021 and the industrial sector is eagerly waiting for their decision, especially that Egypt's production cost is much lower than the price charged to heavy industries. The company is also pushing forward towards lowering electricity tariffs for heavy industries and changing the pricing formula since Egyptian steel producers are incurring higher electricity costs than in western European steel producers in countries like Germany or France.
Integrated producers are not reducing prices (not creating price war), only some of the small rolling mills are doing so in order to meet their liabilities and for liquidity management due to a seasonal liquidity crunch.
The company is aiming to reduce SG&A going forward. However, it is noted that higher exports are associated with logistics expenses when selling on FOB (and sometimes on CIF) basis
The debt level is not a concern, finance costs are to decline
Total Ezz steel group debt as of December 2020 is expected to become just above EGP36 billion, out of which c. 20% is USD denominated. Approx. 60% of the EGP denominated debt benefits from the 8% initiative of the CBE while the EGP balance is at an average interest rate of approx. 11%
After recurring interest rate cuts, the average finance costs of the company currently stand at the 10% mark and are expected to decrease going forward to 8% thanks to a shift to the industrial sector initiatives by the CBE.
Each 1% of lower interest leads to savings of c. EGP170 million per annum) and the management sees another 1-2% of interest rates cuts in 2021 which will bode well for Ezz steel
The company had planned three phases to manage their debt: Phase one was converting most of it to the 8% initiative which they succeeded to achieve in 4Q20. Phase two is restructuring the long- and medium-term debt balance of Ezz Steel, EFS, and ERM with the new prevailing lower margins and allowing longer tenors; this is currently almost completed. Phase three is restructuring part of EZDK's permanent level of working capital facilities.
As stated in 3Q financials, the group succeeded in securing an EGP 3 billion to finance the working capital needs of EFS and ERM
They believe that 2021 will see financials improving in terms of managing the WC and its related ratios, currently, they sell a big portion of their production on a cash basis and they don't have issues with collection.
Raising new capital is not on the table, for the time being