-We initiate our coverage on Pakistan long steel sector with an Outperform rating and Buy recommendation on Amreli Steel Limited (ASTL) (PT: PkR58, 41% upside) and Mughal Steel Limited (MUGHAL)(PT: PkR64, 25% upside). In a bid to stimulate the economy, Government of Pakistan announced construction package, providing incentives for investments into the industry, including an amnesty for new construction undertakings. Moreover, subsides for “Naya Pakistan Housing Scheme” are also introduced. All these factors, coupled with material incentives proposed in the Federal Budget 2020-21, are expected to rejuvenate construction activity in the coming months.
–Construction Package and subsidies under Naya Pakistan Housing Scheme. It has been estimated that Pakistan’s undocumented economy amounts to ~50% of its GDP. To direct funds from the undocumented sector, the government waived provision of showing the source of funds, under income tax ordinance section 111, in case of the purchase or construction of residential or commercial buildings. Moreover, the government plans to build low-cost housing units under the “Naya Pakistan Housing Scheme” for which subsidies, tax incentives, and loans at lower interest rates will be provided. In addition, SBP has also mandated commercial banks to allocated 5% (PkR330bn) of their private sector loan portfolio to the construction sector. All the initiatives will generate activity in the construction sector that will spur demand for long steel.
–Budget 2020 provided additional material incentives. The government has classified construction as industry and has increased federal PSDP allocation by 15% from FY20’s disbursements to PkR650bn. Moreover, to provide relief in the cost of production, the government has removed 2% additional customs duty on import of scrap and tax of PkR1/unit on electricity consumed for the production of billets.
–Lower scrap prices to support margins. Scrap prices constitute ~70% of the total manufacturing cost. Due to lacklustre demand amid COVID19 outbreak, international scrap prices are on a declining trend. LME scrap futures currently hovers in the range of USD250-270/ton compared to USD350-380/ton in 2018. We believe, scrap prices will remain below USD300/ton for the next 12months amid dull global demand, providing relief to steel players.
–Sharp monetary easing to lower finance cost. In a bid to offer relief to businesses and counter economic slowdown due to COVID19, SBP has cut the policy rate by 625bps in the last four months from 13.25% to 7%. Moreover, banks are being asked by the central bank to defer principal payments for one year. Sharp monetary easing would provide relief to long steel players in the form of lower finance cost as they are highly leveraged.
–Duty protection improves pricing power. Currently, duties amounting to 50%-60% are imposed on the import of different long steel products providing pricing power to local players against imported products. Moreover, under the recent FBR valuation ruling 1455/2019, reduction in the valuation of imported scrap (from USD360/ton to 301/tons) for determination of customs tariff will support margins by reducing overall import cost of raw material
–Key risks: Key risk to our thesis includes the resumption of lockdowns to prevent the spread of coronavirus hindering demand growth, a sharp increase in international scrap prices, and upwards revision of electricity tariffs.