EUR 140.00 For Business Accounts Only

Egypt steel producers | Industry dynamics deteriorate; Proposed share swap deal no game changer; Maintain UW

Negative domestic, global industry dynamics continue to unfold. Domestic steel demand has been falling since Nov-16 (2019e demand is 16.5% below pre-float levels). Globally, iron ore prices started to normalise as anticipated, but there are strong signals that steel prices could follow (Aug-19 steel price composite down to USD575/t, the lowest in nearly two years), amid global trade tensions and potential slowdown. We assume full protectionism of the domestic market, but there is a risk of an adverse ruling on 8 Sep, threatening the domestic trade policy.

Cut TP by 65% for Ezz Steel, 41.5% for EZDK. This is mainly to reflect 1.5% lower volumes over our 5-year forecast horizon and c15% lower EBITDA/t. We look for a 2019e loss of EGP3.8bn for Ezz Steel and EGP2.5bn for EZDK, mainly on 25% y-o-y higher iron ore prices, but assume better commodity price and operating rates should turn both companies profitable in 2021e. We expect 2019e interest coverage to fall to 15.2% for Ezz Steel and no coverage for EZDK vs. 129% and 232% in 2018, respectively. We expect Ezz Steel and EZDK’s 2019e net debt/equity to stand at 26.7x and 4x, with limited scope for improvement beyond 2019. We expect Egypt’s falling interest rates to be offset by rising net debt balance, limiting the impact on interest expenses beyond 2019e.

Proposed deal, if materialises, leaves 46.8% downside for Ezz Steel, c75% for EZDK. EZDK’s BoD approved plans to acquire 56% stake in EFS and 100% stake in ERM, through a share swap deal with Ezz Steel, slated for voting on 22 Sep. We do not incorporate the deal in our valuation. The deal is positive for Ezz Steel and negative for EZDK, in our view, entailing Ezz Steel swapping shares in the low-value EFS and ERM for shares in the higher value EZDK. If it goes through, the deal would raise our TP for Ezz Steel to EGP6.00/share and reduce our TP for EZDK to EGP173/share.

Government support remains the main upside risk. Government support to the sector, through higher steel import tariffs and/or cheaper natural gas, is the main upside risk. Otherwise, Ezz Steel’s valuation is highly sensitive to commodity prices and FX forecasts. Every 5% higher-than-expected steel margins over 2020-21e (leaving margins beyond 2021 constant) raise our TP by c12% and 5% for Ezz Steel and EZDK, respectively, all else constant. Every 5% higher USD:EGP over 2020-21e raises our TP on Ezz Steel and EZDK by 40.5% and 17.9%, respectively.