Karachi, September 23, 2022 (PPI-OT): Scrap prices declined but rebar prices are likely to hold ground

International scrap prices have declined 8%MoM in Sep’22 and are currently hover around US$360/ton compared to FYTD/CYTD avg. of US$383/480/ton. However, the decline in scrap prices has been largely offset by rising energy costs for Electric Arc Furnace producers across the globe.

Furthermore, the European energy crisis is unlikely to resolve anytime soon, as energy prices are unlikely to see any mean reversion, and scrap prices still maintain long-term averages. Hence, the mills across Europe are likely to keep rebar prices high to sustain the rebar-scrap margin which is currently trading at US$260-270/ton.

Local rebar prices have remained flat at PkR227-229K/ton in Sep’22. Henceforth, current rebar prices incorporate scrap prices of US$470-480/ton at PkR/US$240, as per our calculation, if margins are at FY22 levels. Moreover, even with lower scrap prices, we expect rebar prices to hold ground at least in short term, due to continuous depreciation of PkR against US$ and rising fuel and finance cost.

Furthermore, we believe, local players are still shielded from dumping of imported rebar as the landed price of is also expected to remain high and currently estimated at PkR245K-255K/ton, still at a premium of 10-12%.

Local long steel manufacturers have underperformed, declining by ~4.8% against 4.3% of KSE-100, as the broader market took the pressure of constant currency depreciation. However, in the case of MUGHAL (TP: PkR87/sh, upside 37%), the risk profile is somewhat reduced due to its diversified product portfolio and dollar-denominated income from the non-ferrous segment where currency depreciation is likely to further bolster non-ferrous contribution to the bottom line.

International scrap prices declined 8%MoM in Sep’22:

International scrap prices have declined 8%MoM in Sep’22 and currently hover around US$360/ton compared to FYTD/CYTD avg. of US$383/480/ton. Scrap prices continue to remain in backwardation due to a slower demand outlook from the EU and China.

For Eurozone, industrial production struggles are largely driven by a slowdown in economic activity due to soaring energy prices (a sharp increase of 50% in gas prices) and rising interest rates (1.25% increase in the key rate since Jul’22).

Over to China, multiple Covid-19 lockdowns and a slowdown in construction activities have played their part in hampering steel consumption where a 6%YoY decline in 7MCY22 was witnessed. Furthermore, high input prices (coke, coal, and iron ore) forced producers to intentional production cuts where crude steel production plummeted 10%MoM in Jul’22.

Going forward, the European energy crisis is unlikely to resolve anytime soon, hence energy prices may not mean revert in the near term, and hence, scrap prices are expected to maintain long-term averages. Hence, the mills across Europe are likely to keep rebar prices high to sustain the rebar-scrap margin which is currently trading at US$260-270/ton.

Local rebar prices likely to hold ground:

Local rebar prices have remained flat at PkR227-229K/ ton before declining by PkR10K/ton in Aug’22, in response to a decline in scrap prices and diminishing construction demand where cement dispatches declined by 35% YoY in 2MFY23.

Hence- forth, current rebar prices incorporate scrap prices of US$470-480/ton at PkR/US$ 240, as per our calculation, if margins are at FY22 levels. Moreover, even with lower scrap prices, we expect rebar prices to maintain their ground at least in short term, due to continuous depreciation of PkR against US$ and rising fuel and finance cost. Furthermore, we believe, local players are still shielded from dumping of imported rebar as the landed price is also expected to remain high (mentioned above) and currently estimated at PkR245K-255K/ton, still at a premium of 10-12%.

Therefore, the only threat for the local players would be if the pricing power declines due to depressed demand where recently we have witnessed local cement sales decline by 35%YoY in 2MFY23. However, in the medium term, rehabilitation programs in the flood-affected areas (~1.9mn houses affected as per NDMA) are likely to bring construction demand back on track, especially in rural areas where we expect the demand for Girder and T-iron to lift off in particular which bodes well for MUGHAL and ITTEFAQ.

Investment Perspective:

Local long steel manufacturers have underperformed, declining by ~4.8% against 4.3% of KSE-100 as the broader market took the pressure of political and macroeconomic uncertainties, resulting in constant currency depreciation. Apart from this, declining construction demand, rising finance/fuel costs, and the super tax further added to the pressure on the sector.

However, in the case of MUGHAL (TP: PkR87/sh, upside 37%), the risk profile is somewhat reduced due to its diversified product portfolio and dollar-denominated income from the non-ferrous segment where currency depreciation is likely to further bolster non-ferrous contribution to the bottom line. In this backdrop, we expect MUGHAL’s non-ferrous segment to register a 4yr earning/sales CAGR of 8.7/11% with an earnings contribution of 57%, along with avg. GMs of 22% between FY22-26F.