Egypt steel producers | Downgrade to Underweight on rising materials costs, waning margins, heavy leverage
A bear steel cycle is becoming more evident. Vale’s (the largest global iron ore producer) Brazil mine crisis on 25 Jan led global iron ore prices to soar by 20% over Jan-Mar 2019. However, global steel prices did not follow suit amid unsupportive demand. The World Steel Association sees global steel demand growth weakening to 1.4% in 2019 vs. 4.3% in 2018 and 2% in 2017. The IMF forecasts China (c50% of global consumption)’s real GDP growth to drop to 6.2% in 2019 vs. 6.6% in 2018. Protectionism and global trade tensions are likely to keep pressuring steel margins, at least in 2019, we believe.
Margin erosion and hefty leverage to take their toll on Egypt steel producers in 2019. Ezz Group cut ex-mill long steel prices by EGP325/t (2.6%) in Aug-18 and EGP600/t (5%) in Dec-18. We expect the mix of price weakness, rising material and energy costs (30% electricity price increase in 2019e), and substantial leverage (2019e net debt to EBITDA of 11.6x for Ezz Steel, 10.5x for Al Ezz Dekheila) to weigh on profitability. We cut our average EBITDA forecasts by c23% for Ezz Steel and Al Ezz Dekheila over our horizon. We expect Ezz Steel’s losses to widen by 53% to EGP2.6bn and Al Ezz Dekheila to swing to losses in 2019. This is despite assuming a rising operating rate at EFS (90% operating for integrated capacity vs. c40% in 2018), and robust pace of monetary easing, such that the CBE cuts interest rates by 3PPT in 2019 and 5% in 2020. We assume improving commodity prices beyond 2019, leaving a worse/longer-than-expected bear steel cycle as major downside.
Key upsides: Government support, better-than-forecast commodity prices. We downgrade both Ezz Steel and Al Ezz Dekheila to Underweight from Neutral. The main upside risks, we see, are: i) government supporting the sector via cheaper natural gas and/or higher import tariffs, and ii) better-than-expected steel margins, with every 5% higher EBITDA than our estimates, raising our TP by 25% for Ezz and 18.6% Al Ezz Dekheila, all else constant.
Al Ezz Dekheila Steel Company Alexandria SAE. Al Ezz Dekheila Steel Company Alexandria SAE (EZDK) is an Egypt-based engaged in the manufacture and production of steel in different types and forms. The Company's direct subsidiaries include Al Ezz Steel Sheet Manufacturing Company SAE, which focuses on the production of coil and rolled flat steel strips, and Steel Company for Industry, Trade and Contracting Company (Contrasteel) SAE, which is focused on the manufacture and trade in all types of metal and metal products. The Company also holds shares indirectly in Egypt Company for the Manufacture of Pipes Supplies and Casting SAE, which is engaged in manufacturing pipe supplies and construction supplies, as well as mechanical equipments. The Company is 55%-owned by Al Ezz Steel Rebars.
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