Equity Analysis /
Pakistan

Pakistan Steel Q2 FY 20 Preview: Profits likely to stabilise on sequential basis

    Intermarket Securities
    10 January 2020
    • We expect the IMS Steel Universe to record NPAT of PKR570mn, improving by a moderate 6%qoq (although down by 59%yoy). ASTL is expected to post its fourth consecutive loss (it will be the lowest though) while ISL may announce its first interim dividend.
    • On a sequential basis, we expect improved volumes and lower raw material prices to offset rising finance cost. In Q2 FY 20, rising cement dispatches and higher PSDP disbursements suggest pickup in construction activity while 2/3 wheeler sales have also improved since Oct’19.
    • IMS Steel Universe has rallied by 55% since FY 20td low (compared to 25% increase for KSE-100) amid improved economic outlook and sharp decline in raw material prices. Going forward, we advocate buying on dips given cost pressures, potential delay in monetary easing and premium valuations (FY 21f P/Ex of 8.6x vs 7.1x for KSE-100 Index).

    Expect better volumes in Q2 FY 20

    In Q2 FY 20 results, we expect profits to inch up on a sequential basis (although down significantly on a yoy basis). During the period, construction activity picked up with local cement sales up 23%qoq and 7%yoy to 11.2 tons while PSDP dispatches rose 34%yoy to PKR301bn in H1 FY 20. Similarly, PAMA registered 2/3 wheelers showed a positive yoy change in Nov’19 (up 2%), a first since Sep’18. Additionally, raw material prices were also on a declining trend. On average, scrap and HRC prices were down by 8% and 6% qoq, respectively during Q1 FY 20 (assuming a 3mth lag). This should help in margin accretion, although some benefit was passed on via reduced prices and discounts, in our view. However, we expect finance cost to continue rising, as short-term borrowings have increased from Jun’19 levels. 

    ASTL still in losses, but others should hold up

    We expect ASTL to post its fourth quarterly loss in a row during Q2 FY 20 of PKR18mn (LPS: PKR0.06). This, however, will be lower than Q1 FY 20 loss of PKR74mn (LPS: PKR0.25). The improvement should come from increased gross margins (12.9% expected, up 1.9ppt qoq). Profits of Mughal Steels (MUGHAL) on the other hand, may decline by 5%qoq to PKR250mn (EPS: PKR0.99) as we assume effective tax of 22%, compared to 14% in Q1. We also expect a slight sequential decline in NPAT of International Steels (ISL) to PKR339mn (EPS: PKR0.78). However, pre-tax profits are expected to be up 53%qoq (ISL recorded a tax credit of PKR47mn in Q1). We also foresee first interim dividend of PKR1.0/sh for ISL (compared to PKR1.5/sh last year).

    Thematic backdrop is favourable, but few negatives can play out

    IMS Steel Universe is up 55% during FY 20td, outperforming the KSE-100 due to improved economic outlook. However, we think the recent uptick in raw material prices, impending increase in gas/electricity prices and potential delay in interest rate cut can keep price performance in check. Hence, better entry points can arise, in our view. Our long-term thesis remains intact, where we expect 3-year forward earnings CAGR of 15% in our steel coverage as accelerating GDP growth will support volumetric growth. We advocate building positions in MUGHAL and ISL at dips.