Earnings Report /
Egypt

Ezz Steel: Top line declines on lower prices; gross profit drives relative recovery

  • Lower steel prices pressure top line, despite volumes improvement

  • Shift to cheaper input costs drive relative margin recovery; debt balance slightly down along with cheaper cost of funds

  • Underweight on ESRS and IRAX; price recovery is key 

Al Ahly Pharos Securities Brokerage
10 August 2020

Lower steel prices pressure top line, despite volumes improvement  

Ezz Steel consolidated top line came in at EGP10,786 million in 1Q20 compared to EGP12,616 million in 1Q19 and EGP10,455 million in 4Q19, declining by 14.5% YoY, but up by 3.2% QoQ. The drop in revenues annually is attributed to a decline in steel prices to the levels of EGP8.5 thousand/tonne dropping by 17% YoY despite the 3% YoY increase in volumes sold, while the relative improvement in QoQ revenue is driven by a marginal uptick in prices and volumes from 4Q19.   

We expect the top line to deteriorate in 2Q20 owing to weaker volumes on the back of 3 main reasons: 1) the pandemic causing a shift in demand priorities and production disruptions for steel producers all over the world leading to a decline in global steel prices by 14% YoY and 5% QoQ in 2Q20, 2) The six months halt of building permits and activities in capital cities and governorates had a detrimental effect on private local consumption, 3) Ramadan season which typically witnesses lower building activities.  

Shift to cheaper input costs drive relative margin recovery  

Gross profit recorded EGP80 million versus gross profit of EGP303 million in 1Q19 implying a drop of 73.4% YoY and versus a gross loss of EGP1,504 million in 4Q19. The gross profit margin was 0.7% vs GPM of 2.4% in 1Q19 and GLM of 14.4% in 4Q19. Despite the huge drop in gross profit on a YoY basis, the quarterly turnaround to gross profit from the severe gross losses in 4Q19 is mainly driven by:  1)the change in inputs composition from the costly iron ore (iron ore prices have been shooting up since the beginning of  FY20 Up by 9% QoQ in 1Q20 mainly due to supply concerns after Brazilian production shrunk on the back of rising COVID-19 cases) to local scrap ( which saw an 18% YoY decline in prices in 1Q20), 2) possible belated reflection of cheaper gas cuts enacted in Oct19 by USD1/MMBtu. We believe that the impact of gas and electricity tariff cuts enacted in late March 20 will be fully felt in 2Q20 and likely to improve GPM by 3-5%.  

LBITDA stood at EGP15 million versus EBITDA of EGP220 million in 1Q19 and LBITDA of EGP1,975 in 4Q19. While LBITDA margin came in at -0.3% versus EBITDA margin of 2.1% in 1Q19 and LBITDA margin of -18.9% in 4Q19, which was driven by weaker gross profit and higher SG&A to Sales which came at EGP476 million in 1Q20 up 14% YoY and down 23% QoQ (SG&A/Sales of 4.4% in 1Q20 versus 3.3% in 1Q19 and 5.9% in 4Q19).   

Attributable net losses recorded EGP860 million compared to EGP1,082 million in 1Q19 and EGP2,605 million in 4Q19. The company continues attaining losses albeit not as severe as 4Q19, saved by gross margin recovery mainly as well as lower cost of debt. 2Q20 should witness further improvement in the bottom line on the back of lower natural gas and electricity cost, as well as an even lower cost of debt.  

Debt balance slightly down, along with cheaper cost of funds   

Net debt slightly decreased despite weak operating performance, as net debt came in at EGP30,352 million in 1Q20 versus EGP26,654 in 1Q19 and EGP30,565 in 4Q19. Net Debt/Market Cap rose to 9.1x.  

On the bright side, the interest rate cuts enacted by mid-March 2020, and CBE low-cost financing initiatives for the industrial sector will act as a breather for the highly leveraged Ezz steel group especially in 2Q20 and should result in significant interest expense savings, north of EGP200 mn per quarter.   

Underweight ESRS and IRAX; price recovery is key 

We continue to advise our clients to offload positions in both companies given current industry dynamics. We do not believe that global industry spreads will significantly improve in FY20 and we also factor in weaker demand in the local market. We reiterate that a game-changer for the company and our recommendation would be a major hike in import tariffs, significant recovery in global steel prices or steel/iron ore spreads, or a major weakness in the EGP/USD exchange rate, which would drive a massive jump in revenues and help the company switch to healthy profitability.