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Pakistan Steel_Grooving to the construction beat, (AKD Detailed Report, Sep 13, 2021) - Coverage Initiation

Mughal Iron & Steel Industries Limited

 

Grooving to the construction beat

We initiate coverage on Mughal Iron and Steel Industries Limited (MUGHAL) with a target price of PKR179/sh, offering upside of 56% from last close. Our bullish stance on the stock is based upon rebar capacity expansion to 430k tons from 150k tons (expected to come online in 1QFY22) where MUGHAL is perfectly positioned to play robust construction demand cycle triggered by recently concluded amnesty scheme and Govt.’s flagship project of Naya Pakistan Housing Scheme (total industry rebar volume is expected to register a 3y CAGR of 7.25%). Moreover, MUGHAL will capitalize on increased copper demand and prices, taking earnings contribution from non-ferrous segment to 43% on avg. for next 3 years. Further, capacity expansion of billet (current capacity meets 77% of total re-rolling requirement) amid sufficient  power available (40MW in excess even after assuming 100% utilization of expanded rebar capacity) will also drive earnings growth. MUGHAL is currently trading at PEG of 0.2x vs. ASTL’s PEG of 0.45x with earnings of the company expected to register a 3yr CAGR of 28% between FY21-24.

MUGHAL in a perfect spot to capitalize on construction demand: Local long steel manufacturers are direct beneficiaries of improving economic activity after the Govt. placed the onus of economic growth on the construction sector. Impact is already visible with derived steel demand increasing by 19%YoY for FY21—highest in a decade. Additional uplift is expected to arrive from initiation of work on government’s flagship project of Naya Pakistan Housing Scheme while progress on hydropower projects/dams will further bolster the demand. Based on the aforementioned factors, we expect local long steel demand to stage a CAGR of 7.25% for FY21-24F. MUGHAL, situated in demand hub i.e. Northern region, is expected to be a prime beneficiary of the construction boom as already indicated by 40%YoY increase in topline for 9MFY21 while moving forward, we except company’s sales volumes to grow with a CAGR of 14.1% for FY21-24F as upcoming rebar expansion is expected to take MUGHAL’s rebar market share to 3.5% by FY24 against 2.5% currently. Strong impetus to growth is provided by the rebar capacity expansion which is due to come online in 1QFY22 which would take company’s total capacity to 430K tons from ~150k tons previously.

Surging Copper prices - amplifying Mughal earnings: China, one of the biggest importers of copper products, is ramping up its copper inventories amid expectation of strong infrastructure demand in the medium run. While ongoing trade issues with Australia, political uncertainty in Peru & Chile and supply crunch globally has caused copper prices to ascend to over US$10k/ton (+46% since Jul’20) in international markets, providing Pakistani exporters opportunity to increase their share in Chinese imports after revised FTA categorized it as a zero-rated product. Escalating copper prices provide impetus to Mughal’s earnings after it ventured into exports of copper ingots by establishing a non-ferrous segment, to not only diversify its product portfolio but also to amplify its margins (gross margin for non-ferrous segment stood at 26.8% for 9MFY21 against 12.6% for ferrous segment). Moving forward, company is expected to record 42.8% avg. earnings contribution from non-ferrous segment over FY21-24F.

Investment perspective: MUGHAL’s earnings are expected to register a 3y CAGR of 28% with rebar/girder sales expected to grow by 3yr CAGR of 20%/6% for FY21-FY24F, taking capacity utilization to 75.3% by FY25. The stock is currently trading at FY22 P/E of 5.15x and a PEG of 0.2x vs. 0.45x of ASTL. We have a buy stance on the stock with FY22 TP of PkR179/sh. Upside trigger to stock performance comes from production woes finally settle-in with Mughal being granted grid load of 79.9MW from LESCO, taking company’s electricity load capacity to ~102.68MW against expected requirement of ~63MW, even after assuming 100% re-rolling capacity utilization. Currently, company carries a rerolling nameplate capacity of 630k tons against billet capacity of ~400k tons, resulting in a shortfall of 230k tons. However, recently company has announced a plan to add 3 melting furnaces where we believe, i) excess energy availability, ii) healthy cash flow profile with cash flow from operation averaging at PkR5.3bn for FY21-24, and iii)  D/E of 70% for next 3 years provides us comfort that company can easily finance the recently announced additions. Clarity on the exact capacity of new furnaces and CAPEX is awaited, however we have incorporated addition of three melting furnaces, having capacity of 50k tons each, in each of next three years.

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