- We downgrade our stance on ISL to Neutral from Buy with an unchanged TP of PKR50/sh. We see more volume decline in FY 20 due to a manufacturing slowdown (particularly in the auto sector) and implication of SRO-641 on sales to the pipe-making industry.
- However, our Neutral stance is balanced by more industry protection after preliminary anti-dumping duty on Russian/Canadian CRC imports. Moreover, stable PKR/USD and lower international HRC prices will limit margin compression amid higher depreciation and fuel cost.
- ISL is up 13.6% FY 20TD (vs -3.4% decline in the benchmark KSE-100) amid expectations of early monetary easing and declining HRC prices. However, finance cost for ISL is yet to peak due to high borrowings while it may continue passing the impact of lower raw material prices to improve demand.
Neutral on price rally and near-term volume concerns
We downgrade our stance on International Steels (ISL) to Neutral from Buy with a Jun’20 TP of PKR50/sh. This is following a 13.6% price rally in FY 20TD (vs -3.4% for the KSE-100) and fresh concerns on near-term volume growth. We expect the company’s volumes to decline by 10% yoy during FY 20 (vs 6% yoy declined assumed earlier) due to higher-than-expected decline in the manufacturing sector (auto sales in particular), and implications of SRO-641 on sales to the pipe-making industry. This is balanced by expected improvement in exports and latest anti-dumping duty (ADD) on Russian/Canadian CRC imports, which should allow more growth in the interim.
Sales to pipe-making industry in question, but ADD is positive
SRO 641 allows flat steel makers to import HRC at a concessionary custom duty of 5%. However, they cannot use this duty advantage if they sell directly to pipe-makers. ISL sells c15% to International Industries (INIL), its parent company, which is a pipe-maker and they are currently in talks with the government to allow the duty concession for pipe-makers too. The only workaround at present is to sell to dealers, which can then sell to pipe-makers. In addition, the decline in 2/3 wheeler industry has been severe, down 18% yoy during 2M FY 20 and is expected to continue throughout FY 20. Exports will grow in FY 20, as per management, but will not be sufficient to cover decline in local sales, as it is only 7% of volumes.
The National Tariff Commission has imposed a 14% preliminary ADD on Russian/Canadian imports. In FY 19, imports from these sources totaled c80k tons as per PBS data, representing 13% share in local CRC market. Near-term impact may not be material due to demand slowdown, but we see more positives in the medium term.
Gross margins may not decline much in FY 20
We expect ISL to record gross margins of 10.7% in FY 20, down slightly from 11.7% in FY 19, due to higher depreciation charges and increased gas prices (for CPP). Limited respite should come from lower international prices as partial benefit will likely be passed on to the customer. To recall, flat steel prices were reduced by c3% by ISL in Sep’19 due to lower HRC prices and slight PKR depreciation. ISL currently trades at FY 20 P/E of 9.9x, but is well stacked with FY 21-23 earnings CAGR of 22%, underpinning our Neutral stance.
Risks: (i) PKR depreciation against USD, (ii) Rise in international HRC prices, and (iii) low pricing power due to surplus capacity in the sector.