Experts maintain our Neutral rating on MUGHAL, with a new TP of PKR90/sh (rights adjusted; PKR105/sh pre-rights), led by the (i) diversification into non-ferrous metals business, while (ii) the rebound in construction activity continues.
The change in sales mix (higher copper ingot exports) and inventory gains (amid surging global copper prices) helped raise gross margins by c.4ppt qoq to a new high c.16% in 2QFY21. However, we expect margins to normalize towards mean levels of c.12% in FY22f as inventory gains are unlikely to recur.
The stock has rallied 34% CY21td partly led by a stupendous 2QFY21 result, outperforming other Steel stocks. On the basis of recurring earnings, the stock is trading at forward P/E of 12x. We think the positives are largely priced in, hence we are Neutral.
Remain Neutral with a new TP of PKR90/sh
We maintain our Neutral stance on Mughal Iron & Steel Industries (MUGHAL), with a new June 2022 TP of PKR90/sh (rights adjusted; PKR105/sh pre-rights). Our new FY21/22f EPS estimates are PKR10.8/8.1. The significant jump in our estimates and valuation emanates from (i) an increase in exports of copper ingot (from c.6,500 tons in FY21f to c.8,000 tons in FY22f), in the backdrop of strong demand for long steel in Pakistan, and (ii) a valuation roll-over. We are Neutral because we believe these factors are already reflected in the stock price (up 34% CY21td, outperforming other Steel stocks). In 2QFY21, MUGHAL more than quadrupled its earnings yoy, with gross margins of c.15% (highest in the past 12 quarters). This was majorly driven by inventory gains amid surge in global prices of scrap (19% qoq) and copper (10% qoq). However, we expect gross margins to normalize around c.12% in FY22f, because the business will probably lack significant inventory gains in future, in our view. Recurring quarterly earnings are therefore estimated to be c.40% lower than that in 2QFY21.
Diversification in copper lifts margins but exposes to volatility
MUGHAL generated c.PKR2.0bn revenue from copper ingot exports in 2QFY21 (17% of total), up 4x qoq. The company has the capacity to export 12,000tons pa of copper ingots, where we see a 3yr Sales CAGR of c.15%. Such diversification mitigates the risk of cyclicality in construction activity in Pakistan, for MUGHAL; while lifting overall gross margins, as ingots have margins of c.12-14%, compared with c.9-11% in case of its long steel business. Global copper demand is likely to be supported by (i) the rising consumer preference for electric cars (which requires 5x more copper than an internal combustion engine), (ii) substantial infrastructure spending in the US and China, stemming from fiscal stimulus measures against the Covid-19 pandemic, and (iii) complete reopening of European and North American economies. Copper ingot sales also lower the effective tax rate for MUGHAL, as nearly all ingots are exported. Having said that, the business also stands exposed to volatility in global commodity prices.
Expansion coincides with a surge in long steel demand
Local demand for long steel is on a roll, because of both public and private construction projects, including the Naya Pakistan housing project for low-income units (likely to commence by 4QFY21). MUGHAL’s expansion of re-rolling plant – to a total active capacity of 630,000tpa – thus comes at an opportune time. To add to that advantage, the company produces a variety of products (girders, T-bar, deformed bars, and reinforcement bars), which can be used in various kinds of construction projects. We expect volume sales CAGR of 13% over FY21-24f based on the aforementioned demand outlook and capacity expansion.
Courtesy – Intermarket Securities Limited