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Pak Elektron (PAEL): Earnings revised downward ‘Maintain Buy’

 

• We tweak our earnings assumptions for Pak Elektron (PAEL) post 2018 result and incorporate the current macro economic outlook which may further hamper the short to medium term performance of the company.
• We were previously anticipating the company to post EPS of Rs3.3/3.8 for 2019E/2020F. We now revise this down by average 25% to Rs2.3/3.0 for 2019E/2020F.
• We anticipate PAEL’s net sales at avg. Rs29bn in 2019 & 2020, down avg. 14% from our earlier estimates mainly on the back of 15% lower refrigerator & air conditioner unit sales from our earlier expectations.
• However, we maintain our ‘Buy’ call on PAEL given the recent correction as the stock is down 14% in 2019YTD, underperforming the benchmark index by 14%.
• We remain wary of the company’s ability to fully pass on the rising input costs in a period where consumers’ appetite to spend on discretionary products has fallen and their confidence has deteriorated owing to unfavorable economic conditions.
• To note, consumer financing (house financing, car financing, credit care, consumer durables, personal loans) growth has slowed down to 17% as of Feb 2019 vs. 26% same period last year.
• To highlight, in 2008, when there was an economic crisis and GDP growth fell less than 3%, consumer financing fell by 12% vs. 13% growth in 2007. For FY19, we expect GDP growth to settle at 3%.
• Moreover, production growth of electronic goods, as per Large Scale Manufacturing (LSM) data on Pakistan Bureau of Statistics (PBS), has slowed down to 19% in 7MFY19 vs. 61% same period last year.
• Due to aforementioned reasons, we expect PAEL to post revenues of Rs28bn in 2019 (-1.2% YoY). However, lower gross margins (-723bps to 24%) on the back of significant PKR devaluation against the greenback of ~20% in 2018 will keep pressure on the bottom-line. Resultantly, net earnings are expected to fall by 13% YoY (EPS Rs2.3) in 2019.
• As per management’s estimates, every 1% PKR devaluation results in Rs100mn foreign currency exchange loss to PAEL.
• In 2019, in appliances division, we expect PAEL to sell around 370k refrigerators, 70k deep freezers and 69k air conditioners, cumulatively down 8% YoY. These products cumulatively constitute around 62% of PAEL’s total sales.
• Though power division performance remained sluggish in 2018—where many projects came to a standstill owing to change in Govt. (2018 General Elections)—we expect this division to perform better than appliances this year mainly on the back of resumption of those projects/new projects in pipeline. Consequently, unit sales of distribution transformers, power transformers and energy meters are anticipated to increase by 5% YoY in 2019.
• The company has also announced to launch washing machines (semi‐automatic and fully automatic) by mid 2019 with an estimated target of 5-10k units. Moreover, sale of LED TVs (launched in later half of last year) will be around 40-50k in 2019. Both these products will cumulatively add around 15% to PAEL’s 2019 earnings.
• The year 2018 had been a challenging year for the company in terms of economic headwinds. Intense competition, weak buying power of consumers and lower aggregate demand led to lower volumes where appliances segment witnessed over 7% decline in 2018. Most notable decline was in microwave and refrigerators which fell ~21% YoY to 57k units and ~12% YoY to 410k units, respectively, as per channel checks.
• Power division which constitutes 25-30% of PAEL’s total sales also had a dull year where energy meters sales fell ~22% to 781k units while EPC contracting and switch gears in rupee terms fell ~16% and ~9% to Rs2bn and Rs3bn, respectively.
• Gross margins during the outgoing year remained under pressure owing to significant PKR devaluation of 20% in 2018 which increased the cost of doing business for the company. This led to lower gross margins, down 4.8ppts to 24.6%.
• We flag, 1) increase in raw material costs and the company’s inability to pass it on, 2) greater than expected PKR devaluation against US$, 3) higher financial charges to fund working capital and 4) greater competition due to new entrants as key risks for PAEL.