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Pakistan Steel Sector: Beneficiary of falling interest rates and construction package

• The Pakistan listed steel sector (engineering) has registered an impressive 19% rise in the last one month, where optimism has been driven by (1) falling interest rates, (2) announcement of construction package and (3) progress on Naya Pakistan Housing Program.
• We believe the recent run-up in share prices of steel companies is justified as sector is set to reap the benefits of the above mentioned developments. The sector is still down 62% from its peak seen on May 27, 2017, while benchmark KSE-100 index is down 30%.
• Our sample of four companies, which includes International Steel (ISL), Mughal Steel (MUGHAL), Aisha Steel (ASL) and Amreli Steel (ASTL), have a debt to equity ratio of 1.5x with total debt and equity of Rs62bn and Rs41bn, respectively. With nearly 650bps fall in KIBOR, after-tax profits of the sector are likely to improve by Rs3bn, which is 65% of the Rs4.3bn profits of these four companies in FY19. Lower oil prices along with a stable currency outlook is also likely to provide some respite to margins, as former will help through lower transportation costs while the latter will ensure price stability in the local market.
• Our sample of these four companies is currently trading at FY22E PE of 7.3x vis-à-vis last five year’s average PE of 16.4x. On EV/Ton, the sector is trading at a discount of 35% at Rs53k compared to last five year’s average of Rs82k.
• We prefer long steel producers over flat steel owing to likely initiation of construction related activities in the country after the announcement of construction package and allocation of Rs30bn subsidy by the government for low cost housing.

The State Bank of Pakistan (SBP) has also made it mandatory for commercial banks to allocate 5% of their private sector advances for construction related activities, which can potentially bring additional liquidity of Rs200-300bn over the course of 1-2 years in the construction sector.