Equity Analysis /
Pakistan

Pakistan Steel 1QFY20 preview: Prefer MUGHAL over ASTL

    Ahmed Raza
    Ahmed Raza

    Investment Analyst

    Intermarket Securities
    24 October 2019

    We maintain our Buy stance on MUGHAL (Jun’20 TP of PKR35/sh vs PKR33/sh previously) but downgrade ASTL to Neutral (Jun’20 TP of PKR30/sh, unchanged). Positives for the sector include declining scrap prices, limited competition from the ship-breaking industry and stable PKR against US$.

    We prefer MUGHAL over ASTL due to presence in the girder market and lower fixed costs. However, both will benefit greatly from the monetary easing cycle expected to begin by 2HFY20.

    In 1QFY20, we expect weak results due to pre-emptive buying in the previous quarter (to avoid FED regime) and lengthy rain spell during Aug’19 affecting business operations. The weak result, however, will provide attractive entry points, in our view.

    Positive outlook emerging for the sector

    We maintain our Buy stance on Mughal Steels (MUGHAL) but are Neutral on Amreli Steels (ASTL) despite our positive outlook for the sector overall. Firstly, international scrap prices have declined significantly (down 16% FY20TD) due to global economic slowdown and US-China trade war. While rebar prices have already been reduced by 6-8% to PKR110,000/ton, even though steel players carry a 3mth inventory, we think the companies will also enjoy some benefit. This also looks possible given stable PKR against US$. Additionally, the ship-breaking industry, which has historically met c.15% of rebar demand, is struggling. Reasons include low demand, higher PKR (as ships are imported) and higher interest rates. This has provided temporary relief to quality rebar players as ship-breakers may enter the market again only after demand recovers strongly. Finally, we are expecting monetary easing to start by 3QFY20. This will help both the companies to contain finance cost. We estimate FY21 EPS increase of 6% and 13% for MUGHAL and ASTL respectively, if interest rates decline by 1%. 

    MUGHAL: More diversified than ASTL amid lower fixed costs 

    MUGHAL’s presence in the girder market (c. 30% of its sales mix) and lower operating expenses have provided it with a relatively stable margin profile compared to ASTL, which is expected to continue. To highlight, FY19 opex as a percentage of sales was 1.8% for MUGHAL vs 4.3% for ASTL. Mughal has about 20% market share in girder segment, which is used mostly in rural areas Additionally, ASTL will record more depreciation charges due to high asset base and revaluation (FY19 depreciation expense was higher by PKR532mn). ASTL is also expected to stay in losses in the near term.

    1QFY20 profits may be weak; advocate buying on dips

    MUGHAL is expected to post its weakest profit in the last 11 quarters while ASTL will remain in losses, in our view. The reasons for weak profits include muted sales due to pre-emptive buying in Jun’19 (sales were up c.45% qoq in 4QFY19) ahead of change in the sales tax regime for the sectors and fewer working days in Aug’19 due to religious holidays/lengthy monsoon period. On the cost side, we expect gross margins to slightly recover from the previous quarter due to a decline in scrap prices (down 10% in 4QFY19 on qoq basis) and price increases from Jul’19.

    Risks: (i) PKR depreciation against USD, (ii) rise in scrap/electricity prices, and (iii) new capacities in the sector.