EUR 56.58 For Business Accounts Only

Working capital pile-up overlooked; Reiterate UW

Rally unjustified. We raise our TP by 29%, on the net effect of c7% higher USD:EGP estimates over 2018-22, and 17.5% higher non-material cost estimates on sharper fuel subsidy cuts at the new FX rate. Ezz Steel trades on a 2018e EV/EBITDA of 6.8x, and 5.8x in 2019e, in line with global peers for 2018, and only c8% below peers for 2019. We find these multiples elevated, given Egypt’s high capital costs, the company’s weak free cash flow generation, risk profile, and limited growth beyond 2019, given we assume a 100% operating rate (vs. the global average of c71%). Our SoTP-EV puts the stock on a 2019 EV/EBITDA of 5.3x, 16.2% below peers, which we argue fairly captures its profile.

Market ignoring magnitude of leverage and WC pile-up. Ezz Steel has yet to report 4Q17, where we expect it to swing back to profitability, with EBITDA of EGP1.6bn and net income of EGP977mn, driven by EGP850mn in new funding, acquired in Aug-17. While this could trigger positive sentiment, the struggle for WC funding continues to date, due to heavy leverage (9M17 net debt of EGP19bn, 4.3x 2017e EBITDA). Our negative stance on the stock comes despite assuming its ability to acquire financing to optimise operations, but this will come at a cost, undermining valuation. To optimise capacity utilisation, Ezz Steel needs to pay EGP4bn in late dues, putting 2018-19e WC needs at EGP13bn (c22% of 2018e sales) and sustainable WC/sales at 20%.

Low likelihood of gas price reduction, in our view. Our assessment of Egypt’s natural gas market concludes that LNG import price parity of USD8.5-9/mmBtu should dictate Egypt’s gas pricing in the long-run. Due to timing uncertainty, we choose to use the current state-supplied price of USD7/mmBtu over our 5-year forecast horizon, assuming that higher gas prices should be passed onto end-product prices, which we estimate at a marginal 1.8% for every USD1/mmBtu higher gas price.

Remain negative on risks. Failure to acquire WC funding puts shareholders at risk of equity dilution, although it appears that this is a last recourse. We assume a 100% operating rate starting 2019, meaning every 5% of lower-than-expected operating rate would reduce our TP by 50%. Every 5% of higher/lower-than-expected steel margins, due to either steel or input prices, adds/deducts c22% to/from our TP, all else constant.