Aisha Steel Mills Limited

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1 Target Price: PKR Current Price: PKR Price (PKR/Share) Reuters Bloomberg Website AISH.KA ASL PA 52-weeks High/Low (PKR) 25.1 /15.4 Dividend Yield Market Cap (PKR bn) 17 Market Cap (USD mn) 148 Avg Daily Turnover (PKR mn) 160 Avg Daily Turnover (USD mn) 1.5 Shares Outstanding (mn) 832 KSE-100 Index Weightage (%) 0.2 Free Float 4 ASL-Valuation snapshot (PKRmn) FY17A FY18E FY19E Revenue 14,076 19,646 20,825 % change 31% 4 6% PAT 1,020 1,359 1,484 % change 41% 33% 9% EPS-Diluted EPS-Basic P/E (x) DPS D/Y (%) P/B (x) ROE (%) 19% 19% Aisha Steel Mills Limited Company Report Expansion to provide multi-pronged growth! We initiate coverage on Aisha Steel Mills Limited (ASL), a flat steel producer, with a Buy rating and a DCF-based TP of PKR27.05/sh (32% total return). ASL commands 36% market share in Pakistan s flat steel industry which operates under a duopoly. ASL s two-pronged expansion target include; (i) Pakistan s growing consumer theme and infrastructure investment, and (ii) product enhancement via entry into high-margin segment. Combination of volume growth and margin accretion will likely deliver ASL an impressive earnings growth of 46% p.a. over FY18-FY20E. Our thesis is premised on: #1 Expansion with twofold benefits: With PKR5.4bn expansion slated to come online by 2QCY19, ASL is likely to benefit from; (i) entry in high-margin, high growth segment of Hot Dipped Galvanized Steel (HDGC), and (ii) capturing the flat steel demand via 2.2x capacity expansion in Cold rolled Coil (CRC) while diversifying its market base in terms of geography and segments. Post expansion, we project ASL to command Market Share (MS) in HDGC and 31% in CRC segment. The company is set to finance its PKR5.4bn expansion project with a mix of debt/equity of 6/4 while its long-term D/E is expected to settle at 85% in FY20 from 141% in FY17. #2 Margins accretion on the way: Post expansion we project ASL to foray into higher margin HDGC segment grabbing initial MS of which may likely increase to 22% by FY22E. Consequently, we expect ASL s margin to step up from average of 15% over FY17- FY19E to 16% in FY20E considering a conservative primary margin scenario of CRC-HRC during our projected horizon. #3 Favorable demand dynamics to augment earnings growth: With a boom in electrical appliances sales and strong growth in auto sector, demand for flat steel looks robust. We see demand of flat steel to grow at an annual average of 9% to 1.46mn tons by FY20E. Low per capita steel consumption of 33kg against regional average of 254kg (indicating room for improvement), low interest regime (though on an increase but still low on relative basis) coupled with increasing per capita income provide a supportive platform for demand to take-off. ASL, with timely expansion, is best positioned in our view to cater growing demand. #4 Duty Structure- to provide meaningful support: We opine recent favorable duty changes on CRC/HDGC (increased RD, imposition of anti-dumping duty on Chinese and Ukraine imports) provides much needed room to play for local flat steel players. Prices of local flat steel products now hovers at 8-1 discount to imported substitute, which indicates that flat producers enjoys ample room to sustain margin and pass on volatility in HRC prices. #5 Valuations are undemanding: ASL trades at an attractive PEG of 0.30x over FY18-20E which is at a steep discount to International Steel Ltd s (ISL) valuation of 0.4x for similar period. ASL s P/E of 12.5/11.5x in FY18/19E only partially reflects the growth premium, in our view. In terms of EV/ton (post expansion), ASL trades at USD332 vs USD510 for ISL. Our DCF-based TP of PKR27/share offers an upside of 32%. Faiz ul Sultan faiz.sultan@bmacapital.com Ext: 2006 REP-005 Key risks to our investment thesis: (i) Delays in commissioning of new CRC/HDGC facility from current timeline of 2QCY19, (ii) adverse changes in import duty or anti-dumping duty (we highlight latest decision by high courts will not have any bearing on CRC-HRC prices or margin), (iii) volatility in primary HRC-CRC margins, and (iv) risk of higher financial cost due to above-expected policy rate hike. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN:

2 Aisha Steel Mills Limited - Unlocking growth! Valuation Snapshot FY18E P/E (x) EV/EBITDA (x) D/Y (%) P/B (x) ASL Flat Steel Demand 000 Tons FY17 FY18E FY19E Cold Roll Steel Galvanized Sheets Total 1,113 1,228 1,344 Initiate with a Buy! We initiate coverage on Aisha Steel Mills Limited (ASL), Pakistan s second largest flat steel producer with 0.22mn ton Cold Roll Coil (CRC) capacity (expected to increase to 0.45mn ton along with 0.25mn ton of Galvanised), with a Buy stance and a DCF-based TP of PKR27/sh (32% total return). ASL offers direct exposure to Pakistan s growing consumer segment and infrastructure investment. With expansion coming-in by end of FY19, we foresee ASL to deliver robust earnings growth (3-Yr CAGR over FY18-20E: 46%) amid favorable domestic flat steel dynamics. Furthermore, earnings growth is likely to be augmented by the commencement of CRC expansion along with venturing into superior margin HDGC segment. ASL trades at FY20E attractive PE and EV/EBITDA of 5.51x and 8.3x, respectively. Host of factors to augment earnings growth ASL is set to benefit from a host of factors which are expected to augment earnings growth in medium-term. We opine, (i) strong demand of flat steel emanating from heightened demand in construction/auto sector and electrical appliances, and (ii) expansion by the end of FY19 resulting in top line growth through better CRC offtake and a new galvanized segment will likely help in delivering strong earnings growth (3-Yr CAGR: 46% during FY18-20E) going forward, in our view. Flat Steel demand to grow on favorable dynamics Flat Steel demand has remained robust in recent years (FY15-17 CAGR of 14%) as reflected from strong domestic automotive, electrical appliances growth and upbeat construction demand owing to (i) rising income levels (PKR and USD income per capita), (ii) multi-year low interest rate and subdued inflation, and (iii) increase in construction related private sector credit (at an all-time high of PKR425bn in Dec 17 and record growth of YoY). To note, real construction activity has further picked up pace (5-year CAGR of 112%) due to private sector development taking off in recent years. The boom in the downstream space is expected to normalize in coming years, however we expect demand of flat steel to grow 9% in next five years due to demand emanating from above mentioned factors. Furthermore, Pakistan's steel demand per capita remains relatively low at 34kg compared to regional and global average of 68kg and 240kg, respectively. We estimate materialization of some big ticket projects (like free trade zones and shopping malls) to significantly augment the demand of flat steel products in the medium-term. Moreover, the major potential exists in the form of foreign investment expected to flow in to the automobile sector where companies including Kia, Hyundai and Renault are in plans to start assembling units in Pakistan. Thus, demand for long steel is expected to remain robust where tapping potential of new entrants can result in a super-cycle, in our view. Strong auto sales Local auto assemblers posted volumetric growth of 23% YoY in 8MFY18 due to rising income levels. Following suite, demand for two and three wheelers also grew at significant pace with an annual average of 26% during last two years. Atlas Honda (ATLH); also the largest producer of motorcycles in Pakistan which sold 801k units in 8MFY18 (+16%YoY). 2

3 millions Thousands Pakistan Equities Auto sales on positive trend Passenger Cars LCVs Total Auto Sales Growth Linear (Growth) M2018, PAMA Sales of Two-wheelers following strong trend % 3 25% 15% 1 5% -5% , PAMA.. along with impressive growth in electrical appliances: The demand growth in electrical appliances sector has been robust in the recent years backed by strong consumer demand emanating from growing urbanization and increasing income in rural areas followed by reversal in commodity cycle. In this regard, sales of electronic appliances such as refrigerators, deep-freezers and air conditioners have seen significant demand growth of 23%, 24% and 15% respectively during FY17. Moreover, takeover of leading appliances brand Dawlance by Arcelik, a Turkish company, in FY17 points toward the potential of future demand growth. Going forward, due to persisting factors we see demand of electric appliances to stay strong translating into robust expansion in flat steel consumption. 3

4 Thousands Millions Thousands Millions Pakistan Equities Refrigerator sales made a strong comeback Deep freezers sales picking up % % 1 5% % 4 35% 3 25% 15% 1 5% Source: PBS, BMA Research Source: PBS, BMA Research AirConditioner sales following upward trend Electric fans sales experienced a sharp pick-up % 15% 1 5% % 15% 1 5% -5% Source: PBS, BMA Research Source: PBS, BMA Research 4

5 '000 ' E 2019E 2020E '000 Pakistan Equities Expansion project with two-fold benefits ASL s forthcoming expansion (increasing flat steel capacity to 700ktons) by the end of FY19 put the company in a sweet spot to capture the growing demand (expected annualized growth 7% over next 3-yr). In addition to capture growing demand, the expansion would also help ASL to venture into high growth and superior margin Galvanized segment which may help improve gross margins going forward. Volumes to grow post FY19 Sales CU #1 Volumetric growth to continue ASL announced its plan to expand its existing capacity in view of strong flat steel demand which has grown at FY15-FY17 average of 14%. The PKR 5.4bn expansion facility, which is expected to come online by end of FY19, should allow the company to capture high flat steel demand which is currently operating at optimum utilization of 95%. Post expansion we foresee total volumes to grow by 16%. Flat industry being a duopoly in nature, we foresee ASL and ISL to operate in harmony, given protection measure in place. We also see no threat from new entrants coming into the market due to lack of expertise and manpower constraint which stand as major barriers to entry. We project galvanize steel to contribute around 52% of total revenue. #2...with new galvanizing line to augment margins We expect ASL to unlock its potential in new Galvanizing segment. Just to recall, ASL has planned to venture into HDGC segment with a capex of PKR1.2bn bearing a capacity of 250k tons. Post FY20, scenario looks sanguine for the company based on our projection of improving margins on the back of change in sales mix (CRC 66%; GI:34%). Being a superior margin project, we anticipate margins to improve from FY18-19 average of 14.56% to FY20-22 average of 15.5%. We see utilization for galvanized plant to improve gradually from 6 in FY20 to 8 in FY22. Gross margins to augment as HDGC facility comes online Net sales GP CRC HDGC E 2019E 2020E E 2019E 2020E Capital structure to improve ASL has held a complex capital structure with heavy tilt towards debt financing. With passage of time, significant portion of preferred capital has been converted into ordinary shares with 51mn share left out of the 244mn total issue. In this regard, ASL s D/E ratio has significantly come down to 141% in FY17 from 392% in FY16. Having said that, it is still higher compared to its peer of 105%. However, despite expansion plans we project D/E to settle at comfortable level of 85% by FY20. We see this improvement coinciding 5

6 with increasing interest rate scenario as a positive, however above expected volatility in interest rates may pose a risk. Tax benefit As per our discussions with the management, ASL has classified CRC and galvanized expansions as independent projects to avail the tax credit under 65(E) of the Income Tax Ordinance ASL s galvanized line entails a capex of PKR1.2bn which company plans to finance from equity to avail the tax credit. We estimate PKR0.50/sh of tax saving for ASL from FY20 onwards. Antidumping duties on CRC Antidumping China Ukraine Cold Roll Coils 19.04% 18.92% For 5-Yr since 3 rd -Jan'16 23rd Oct'17 Source: NTC, BMA Research Local spread to remain firm on the back of favorable duties In recent past, the realized average spreads of CRC-HRC remained relatively low compared with international spreads owing to dumped imports. In this regard, ASL remained in losses due to compressed margins resulting from cheaper imports from China till the end of FY16. In this backdrop, case was filed by local manufacturers with Competition Commission of Pakistan (CCP) against the dumped imports from China and Ukraine. After investigating, CCP rightly handed anti-dumping duties of 19.02/18.92% and 46.89% on Chinese and Ukrainain imports of CRC and HRC, respectively effective from 3rd of Jan'16/23rd of Oct'17 for 5 years. This, in our view, has provided much needed protection to the young flat steel industry which remained a victim of cheap imports. Antidumping duty on Galvanized Steel Coils Exporter Name Antidumping duty (%) Angang Steel Company Ltd., Anshan City, China 40.47% Bengang Steel Plates Co. Ltd., Benxi City, China 9.13% Hebei Iron & Steel Co. Ltd., Handan City, China 13.31% Maanshan Iron & Steel Co., Ltd., Maanshan City, China 60.09% All other producers/exporters from China 40.47% Source: NTC, BMA Research Duty Structure HRC CRC HDGC CD 5% 5% RD 5% 1 Lately, ASL has experienced turnaround in earnings led by jump in the realized margins, which increased from USD90/ton in FY16 to USD125/ton in FY17. We continue to see the sanguine margins outlook to carry forward (forecasted margins to average around USD130/ton). We highlight that after imposition of anti-dumping duties, local manufacturers did not fully incorporated duties in prices, which we believe will help them to weather any slide in international CRC-HRC spreads, going forward, which declined from USD104/ton in FY15 to an average of USD80/ton in FY16 in the global markets. We estimate USD10/ton accretion in the margins to have a negative impact of 11%/12% on FY18E and FY19E earnings, respectively. 6

7 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Pakistan Equities ASL vs. KSE100 Relative Chart ASL KSE100 Index Investment thesis ASL trades at an attractive PEG of 0.30x over FY18-20E which is at a steep discount to ISL s valuation of 0.4x for similar period. ASL s P/E of 12.5/11.5x in FY18/19E only partially reflects the growth premium, in our view. In terms of EV/ton (post expansion), ASL trades at USD340 vs USD547 for ISL. Our DCF-based TP of PKR27/share offers an upside of 32% from current levels. Snapshot of Peer's Valuation FY18E Segment PE DY EV/EBIDTA ROE International Steels Flat % % Aisha Steel Flat International Industries Tubular % % Amreli Steels Long steel % % Mughal Steel Long steel % % Source: Bloomberg, BMA Research Key risks to our thesis #1 Delays in expansion: ASL s significant expansion of CRC and HDGC is expected to come online by Apr 19. Though, we assign very low probability on delays, however, any hiccups will likely delay the earnings growth and margin accretion. #2 Volatile Primary Margins: We highlight that due to the nature of the business earnings are sensitive to primary margins. With every USD10 decline in the CRC and HDGC primary margins, the earnings for FY18E and FY19E are estimated to decline by 11/12%, respectively. #3 Increase in duty structure i.e. 'CD' or 'RD' on HRC: Any increase in duty structure i.e. CD or RD on HRC will put pressure on margins. On the other hand, government recently imposed antidumping duty of 19% on imports from China and Ukraine. In case, the duty is removed on Chinese flat steel, cheap imports poses a major threat. #4 Interest rate risk: With reversal in interest rate in sight we highlight the risk of higher financial cost. We estimate every 100bps above our base case to dilute company s earnings by 2%. 7

8 Aisha Steel Mills Limited (ASL): Company Profile Aisha Steel Mills Limited (ASL) was incorporated in 2005 as a public limited company. ASL s shares are listed on Pakistan Stock Exchange since Aug 12. Arif Habib Group is the main sponsor which holds 52.22% stake in the company through individual and associated companies. ASL started its trial runs from Jul 12 and achieved commercial operations on Oct 12. ASL also enjoys a strategic relationship with Metal One Corporation and Universal Metal Corporation Japan, which owns 13.33% in the company. The company main product is Cold Roll Coils (CRC). Post expansion, ASL is also venturing in Hot Dip Galvanized sheets/coils segment. Presently, the company has a total CRC capacity of 220k tons per annum. Going forward, ASL is expected to increase its CRC and Galvanized capacity to 700k tons by end of FY19. Apart from ordinary shares ASL also have two classes of Preference shares, ASLPS and ASLCPS of 44.3mn and 2.9mn outstanding, respectively. Conversion ratios for ASLPS and ASLCPS stands at 1 and per ordinary shares. Further, matter regarding cancellation of 66mn (8% of current shares outstanding) shares bought by sponsors from Metal One Corporation is subjudiced in the Sindh High Court. Though we lack clarity on the matter, we highlight this as positive for existing shareholders provided SHC decides the matter in the company's favor. Shareholding Pattern International Steels Limited Shareholding Pattern (%) Associate Companies/Related Parties 45.29% Director & Spouses 20.67% Companies/Insurance Co. 6.33% Mutual Funds 3.59% Others 5.24% General Public-Local 18.87% General Public-Foreign 0.02% Total 10, Company Accounts 8

9 ASL Financial Highlights (PKRmn) Income Statement FY16A FY17A FY18F FY19F FY20F Cashflow Statement FY16A FY17A FY18F FY19F FY20F Net Sales 9,634 14,076 19,646 20,825 32,114 PAT ,020 1,359 1,484 3,309 Cost of Sales 8,654 11,988 16,825 17,807 27,040 Non Cash charges Gross Profit 980 2,087 2,821 3,017 5,074 Change in NWC SGA Oper. Cash flows ,591 2,386 3,284 Operating Profit 829 1,831 2,593 2,774 4,812 CAPEX -53-1,246-2,534-3, Other Income Investing Cash flows ,534-3, EBIT ,942 2,119 4,117 Debt Payment ,394-1,075 Finance Cost 1, Financing Cash flows , ,800-2,399 PBT ,942 2,119 4,117 Opening Cash Tax Expense Net Change in Cash PAT ,020 1,359 1,484 3,309 Closing Cash Balance Sheet FY16A FY17A FY18F FY19F FY20F Key Ratios FY16A FY17A FY18F FY19F FY20F PPE 9,689 10,543 12,390 15,433 15,249 EPS (PKR)* LT Assets 10,884 11,959 13,556 16,349 15,915 DPS (PKR) Current Assets 4,468 6,225 7,262 8,052 11,508 BVPS (PKR) Total Assets 15,352 18,184 20,819 24,401 27,423 EBITDA 829 1,831 3,030 3,227 5,458 Equity 2,274 5,476 6,836 7,726 9,712 Gross Margins 1 15% 14% 14% 16% ST Borrowing 3,870 2,435 2,735 2,535 1,535 Net Profit Margin -2% 7% 7% 7% 1 Current Portion ,075 P/E ratio Current Liabilities 7,342 6,406 8,393 8,691 10,802 P/B Ratio LT Loans 5,320 5,031 4,320 6,714 5,639 EV/EBITDA LT Liabilities 5,355 5,077 4,365 6,759 5,684 ROE -7% 19% 19% 34% Equity & Liabilities 15,352 18,184 20,819 24,401 27,423 ROA -1% 6% 7% 6% 12% *Diluted EPS 9

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11 Buy Neutral > expected total return - expected total return Underperform < expected total return *Total stock return = capital gain + dividend yield Old rating system Overweight Total stock return > expected market return + 2% Marketweight Expected market return ± 2% Underweight Total stock return < expected market return - 2% Valuation Methodology To arrive at our period end target prices, BMA Capital uses different valuation methodologies including Discounted cash flow (DCF, DDM) Relative Valuation (P/E, P/B, P/S etc.) Equity & Asset return based methodologies (EVA, Residual Income etc.) 11