Equity Analysis /
Egypt

Pachin: Paint it Black, Downgrade FV to EGP16.20/share

    Al Ahly Pharos Securities Brokerage
    17 February 2020

    Downgrade FV to EGP16.20; Recommend Underweight

    We downgrade our FV of Pachin to EGP16.20/share (down from EGP50.87/share), mainly as we exclude its 52,000 sqm land plot from our valuation given lack of developments, and revise down our FV for operations (from an initial EGP29.21/share), to EGP16.20/share. Despite the company’s efforts to regain market share, Pachin’s performance remains pressured by the persisting demand slowdown and heightened competition in the coatings market. To make matters worse, the company also experienced a fire at its resin plant in August 2019, which we believe will add further pressure to profitability this year. Therefore, Pachin’s recent fire accident along with its declining market share, now south of 25% versus 30% two years ago, compelled us to slash our assumptions of volume recovery and recommend Underweight on the stock. At its current market price, we believe the only upside potential to the stock could come from developments regarding its land plot.

    Plant fire adds to Pachin’s burdens

    The recent resin plant fire has put Pachin in a precarious situation. Not only has this put a halt to resin exports, the company’s main source of hard currency, but it has also forced Pachin to purchase resin manufactured at third party facilities at a much higher cost for use in the production of paints. Management presumes that recovery of the resin plant will cost at least EGP30 million, and should be completed by April 2020 in time for 4Q; Pachin’s high demand summer season. However, we are sceptical that the company will be able to get the plant up and running before the end of the year; we anticipate that the increased costs will pressure Pachin’s gross margin to 9.1% for the remainder of FY19/20, versus 13.5% in 1Q19/20. We then assume gradual recovery in gross margins over our five-year forecast horizon, settling at 15.4% in the terminal year.

    Bottom line buoyed by specialty products

    Pachin had just barely been able to keep its bottom line in the green thanks to the increased contribution of its specialty products. Despite Pachin’s loss of market share in the decorative paints segment, the company’s sales of high-margin products, namely inks, industrial paints, and resin, have been ramping up. Now, given the halt to its resin exports, Pachin will have to rely more on its sales of inks and industrial paints to support profitability. We expect the heightened pressure on profitability will significantly bring down Pachin’s historically high payout ratio.

    Land to unlock potential upside

    Despite the fact that land development progress has been sluggish, Pachin’s 52,000 sqm plot still represents major upside potential for the stock. From our talks with management, it seems the company has completed building demolition and levelling activities for the residential portion of its land plot amounting to 22,000 sqm, and are currently working on land surveying. Pachin is also still working on changing the license for the remaining 30,000 sqm of land from recreational to residential as well. We reiterate that Pachin’s land, if valued at a conservative EGP10,000/sqm, could add EGP21.67/share to our FV.