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Pak Elektron (PAEL): Recovery in Appliances with upbeat Power sales; Reiterating Buy with new Target Price of Rs40

• We reiterate our ‘Buy’ stance on Pak Electron (PAEL) with a revised Target Price of Rs40 (from Rs32 earlier), offering a potential upside of 30%.
• We are revising up our earnings forecasts for PAEL by 2-29% over 2020E-2022F, where we now expect EPS to clock in at Rs2.4 in 2020E and Rs4.7 in 2021F.
• Our optimism is based on (1) improving sales dynamics in Appliances division, (2) low interest rates, (3) higher-than-expected sales of Power division and (4) bottoming out of margins.
• Improving Sales Dynamics: We are expecting a recovery in Appliances division on the back of (1) pent up demand owing to COVID-19, (2) increasing consumer financing due to decline in interest rates, (3) improved farmer liquidity and (4) construction of new houses.
• The shift towards urbanization and increasing mercury levels will continue to boost sales, in our view.
• We expect Appliances division to post 20% YoY volumetric growth in 2021F after witnessing a decline of 5% YoY in 2020E and 2019A each. Over last four years (2015 to 2018), the company has recorded annual growth of 18% in the appliances division.
• Decline in interest rates: The company has a Debt to Equity ratio of 57%. Amidst the decline in KIBOR by over 650bps, we are estimating annual savings of ~Rs600mn in interest costs.
• This savings alone translates into EPS impact of ~Rs0.85, which is 35% of 2020E EPS.
• Higher than expected sales of Power division: In 1Q2020, the company has recorded exponential growth of 88% YoY, 500% YoY and 54% YoY in Distribution Transformers, Power Transformers and Energy Meters, respectively.
• We believe high sales in the Power business is on the back of government’s focus towards improving the existing T&D infrastructure, under the IMF program.
• Margins likely to have bottomed-out: We expect PAEL’s margins to have largely bottomed out in 2019 (23.6% vs. 5-year average margins of 27.6%), with the company slowly passing on the impact of PKR devaluation.
• The impact of PKR devaluation appears to have largely been passed on to the consumers, with average prices for the Appliances division increasing by about 5% over the last year.
• Valuation raised to Rs40: We have revised up our Target Price for Pak Electron (PAEL) to Rs40 per share (earlier Rs32 per share) based on discounted cash flow methodology, offering a potential upside of 30%.

Key Risks: (1) Increase in raw material costs and the company’s inability to pass on the impact to the consumers, (2) higher-than-expected PKR devaluation, (3) higher financial charges to fund working capital and (4) greater competition due to new entrants.