Equity Analysis /

International Steels Ltd: FY19 analyst briefing takeaways

    Intermarket Securities
    26 September 2019

    FY19 performance

    • In FY19, ISL increased its revenues to PKR55bn, up 16% yoy but NPAT came down by 39%yoy to PKR2.7bn (EPS: PKR6.12) due to PKR depreciation and higher finance cost. During FY19, company sold 525k tons of flat steel, down 3%yoy.
    • ISL more than doubled its capacity to 1.0mn tons per annum. It is also setting up a service centre in Karachi which will commence operations in 3QFY20. The service center will be used to supply value added products, particularly for the auto sector.

    Demand outlook

    • Domestic consumption of flat steel is around 1.2mn tones with around one-half of Cold Rolled Coils (CRC) and the other half of Galvanized Products (GP). Together they declined by 9%yoy in FY19 and management expects another 8%yoy decline in FY20 with only moderate recovery in FY21. Current challenges in terms of sales are lower economic growth, impact of CNIC condition over purchases of more than PKR50k and SRO641. The CNIC condition is impacting the retail customers, which are outside documented economy and makes c.30% of the market. 
    • For CRC, major customers are pipe-makers (40%) and auto industry (25%). In GP, most of the users are in rural economy (40%) which use it for boxes and agricultural implements. Another 10-15% demand comes from roofing sheets.
    • SR0 641 (effective from Jul’19) allows CRC/GP makers (including ISL) to import HRC at concessionary custom duty of 5% (vs 11% custom duty and 7% additional custom duty). However, flat steel producers cannot use this duty advantage if they sell directly to pipe-makers. ISL sells c.15% to International Industries (INIL), which is a pipe-maker and ISL is presently in talks with the government to allow the duty concession for sales to pipe-makers as well. The only work-around for ISL at present is to sell to dealers, which then can sell to pipe-makers.
    • On the positive side, local flat steel market, particularly CRC, will likely enjoy higher protection after anti-dumping duty of 19% being imposed on Russia and Canada. Note that this duty is preliminary and final decision is awaited. In GP, 30% of the local demand is still met through imports, which ISL and Aisha Steel are trying to substitute. Customs department is also more active on mis-declaration by commercial importers (to lower effective duty paid), which should benefit the industry. 
    • ISL asserts it is aggressive on export market. Export margins may be slightly lower, but they get other benefits such as lower interest rates on SBP’s export financing facility and income tax exemption.
    • Regarding competition, company thinks it will take 1.5-2 years for new players to gain major customers as quality issues make customer onboarding a lengthy process. With respect to other local player in flat steel, Aisha Steel (ASL), which has also expanded capacity, there is no surplus capacity in GP. In CRC, the industry will try to find new export avenues.

    Pricing & cost pressures

    • The axle load regulations does not impact the company directly as it sell on ex-factory basis. However, it increases the price for final customers.
    • ISL decides pricing after taking into account both the sales situation and import parity price. They set prices in order to keep imported products uncompetitive – a fruitful strategy so far.
    • Internationally, HRC prices have declined recently due to pressure from Indian steel industry. They might stabilize or increase as winter curbs will limit Chinese production due to their environmental prices. However, lower-than-expected growth from China may push prices further down in the interim.
    • ISL has to maintain 2.5 mths of inventory to ensure smooth supply chain. Freight charges are between US$25-30/ton from Japan (from where 50% of raw material is imported) while inland transport charges are US$15/ton.

    Buy recommendation with a target price of PKR50

    Our Jun’20 TP of ISL is PKR50/sh, which implies a Buy stance. Near-term pressure due to large expected decline in volumes (auto decline and no off-take from pipe makers) and higher finance cost could lead to better entry points than presently.

    Risks:  (i) PKR depreciation against USD, (ii) Rise in international HRC prices, and (iii) low pricing power due to surplus capacity in the sector.