Elixir Securities Limited – Elixir Insight

Karachi, August 09, 2017 (PPI-OT): Pakistan Flat Steel Sector – Booming on Spending Revolution

We initiate coverage on Pakistan Flat Steels with an Overweight stance. Flat steel manufacturers are expected to do particularly well with expansions planned to cater booming domestic demand arising from robust growth outlook for downstream sectors including autos, electronics and construction.

Anti-dumping duties levied on Chinese flat steel imports have turned the tables in favour of domestic manufacturers, providing a sigh of relief against the threat of cheaper dumped imports.

We expect Flat Steel Stocks to offer an average upside of ~38% backed by robust earnings growth (3-year / 5-year forward CAGR of 34% / 24%).

With our Jun-18 PT’s of PKR178/share for ISL and PKR30/share for ASL, the stocks offer total return of 38% and 36%, respectively.

Demand Boom Likely to Sustain Momentum: Domestic demand for flat steel products has been growing at a robust pace (greater than 10% p.a.) led by strong growth witnessed in downstream sectors including autos, electronics and construction. These sectors have seen particular surge in demand led by rising real income, increase in consumerism and ever-growing government spending to address infrastructure shortfall. As such, Pakistan’s crude steel consumption per capita remains relatively low at 37.5kg compared with global average of 224.4kg, with impressive growth rate (3-year historical CAGR of 21%) in recent years expected to sustain at least in the medium term. As such, we expect future flat steel demand to grow at a rate of 10% p.a.

Local Expansions to Replace Imports’ Market Share: In the backdrop of booming domestic demand and significant gap present in domestic demand/production, flat steel manufacturers have announced expansions in both CRC (450k tpa / 480k tpa by ISL / ASL) and GC (250k tpa by ASL) to expand their market share. In this regard, we expect CRC / GC market share to increase from 51% / 48% in FY16 to 73% / 79% by FY20 when the planned expansions start commercial operations.

Anti-Dumping Duties to Provide Meaningful Protection: The flat steel manufacturers are expected to significantly benefit from recently imposed anti- dumping duties levied on Chinese flat steel products. In this regard, Competition Commission of Pakistan (CCP) has imposed anti-dumping duties of 13.17%- 19.04% and 6.09%-40.47% on imports of CRC and GC from China/Ukraine, respectively. As a result, realized spreads of CRC-HRC / GC- HRC jumped from USD92 / USD176 per ton in FY16 to estimated USD163 / USD211 per ton in FY17.

Going forward, we expect realized CRC-HRC / GC-HRC spreads to stay firm at USD150 / USD230 per ton owing to increased cost of CRC and GC imports post the levy of anti-dumping duties. In this backdrop, flat steel manufacturers would be relatively resilient to falling international prices of CRC and GC whereas any decline in global HRC prices will help local manufacturers realize higher primary margins.

Valuation: Driven by a strong pickup in private consumption, flat steel stocks have rallied 223% since Jun-16, however they still remain undervalued in our view. We opine that relatively premium PE multiples of 12.9x / 9.1x for FY18F / FY19F are justified on the back of 1) expectation of 3-year / 5-year forward earnings CAGR of 34% / 24%, and 2) anticipated stability of spreads owing to protection provided by anti-dumping duties. Our Jun-18 PT’s of PKR178/share for ISL and PKR30/share for ASL imply a total return of 38% and 36%, respectively.

   

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