MMK - 2Q20 Trading Update Weak, as Expected; Earnings Preview

As expected, MMK has reported a weak trading update, with sales volumes falling 19% Q-o-Q and the average realized price declining 12% Q-o-Q. We expect EBITDA in 2Q20 to contract 50% Q-o-Q to $225 mln and FCF to be close to zero. As previously guided, a decision on dividends has been moved to autumn, hence we do not expect any 2Q20 dividend announcement with the IFRS results, scheduled to be reported on July 29.> Crude steel output dropped 22% Q-o-Q in 2Q20 to 2.36 mln tonnes due to the scheduled revamp of the hot rolling mill 2500 (and thus lower production of rolled steel products) and lower market demand. > Sales of steel products were down 19% Q-o-Q to 2.2 mln tonnes. The product mix slightly improved, with the HVA share in the consolidated mix rising 4 pp Q-o-Q to 52%. At the Russian steel division, sales of flat rolled products were circa 1.5 mln tonnes in 2Q20, 600 kt below normal quarterly levels. Around 500 kt of this is attributable to the mill 2500 revamp and 100 kt to weaker domestic demand. Long product sales in 2Q20 were 270 kt, 100 kt below normal levels due to weak demand from the construction industry. > The geographical sales mix worsened because of weak domestic demand during the lockdown, with export sales reaching 40% in the total mix in May and 23% in June versus the normal 10-15%. As a result, the average realized price dropped 12% Q-o-Q on an EXW basis to $522/tonne, depressed by the relatively low export netback. The price performance was far weaker than that of Severstal, which yesterday reported a decline of just 4% Q-o-Q in its average realized price.> We expect MMK's EBITDA to drop around 50% Q-o-Q to $225 mln for just an 18% margin. Despite the lower sales and prices, we expect a working capital buildup because of the higher share of exports, as payment deferrals are longer. Therefore, we expect FCF at close to zero in 2Q20. As previously guided, a decision on dividends for 1Q20 and 2Q20 has been moved to autumn; hence we do not expect any 2Q20 dividend announcement when the IFRS results are reported on July 29. Overall, 2Q20 has vividly demonstrated the dependence of MMK's earnings on the health of the domestic market.> The market outlook is generally positive. MMK expects the recovery in the domestic market in June to continue in 3Q20. Mill 2500 will be launched this week following the revamp with effective capacity increased 700 ktpa to 4.2 mtpa. Thanks to higher demand and more available capacity, MMK expects consolidated steel sales volumes this year to contract just 4% y-o-y to around 10.9 mln tonnes. This means that sales volumes in 2H20 are guided to increase 19% H-o-H and 4% y-o-y to 5.9 mln tonnes. At the current USD/RUB rate and iron ore price we estimate MMK's HRC cash cost on an EXW basis at around $280/tonne. The export HRC price recently recovered to $410/tonne FOB Black Sea. Assuming a transportation cost to FOB of around $60-70/tonne, all of MMK's exports appear to have now turned profitable. Hence, profitability in 2H20 should increase relative to 2Q20, even if the company has to maintain a relatively high share of exports.