Agha Steel Industries Limited (ASIL) is a prominent steel re-rolling manufacturing company in the country with a rated capacity of 250,000 tons for graded rebars and 450,000 tons of billets. Through its recent IPO in October last year, the company raised Rs 3.8 billion at a strike price of Rs32 (floor price: Rs30) and was oversubscribed by 1.63 times. The IPO proceedings have gone toward acquiring new Italian technology for re-rolling called Mi.Da. Agha is the only long-steel manufacturer to have an installed electric-arc furnace for melting at a capacity of 45 tons (read our detailed pre-IPO analysis—IPO Files: Agha Steel’s ‘Midas’ touch, Oct 6, 2020).
The company has been in expansion mode since 2018. In the first phase, it raised melting capacity (process by which scrap is melted to remove impurities and casted into standard-sized billets) from 250,000 to 450,000 tons and re-rolling capacity (process by which billets are rolled into graded rebars) from 150,000 to 250,000 tons. In the current second phase, the rolling capacity would be raised to 600,000 tons.
Operational and financial performance Though Agha has a lower capacity of production compared to peers—at the moment—but it is a winner in terms of cost and production efficiencies. The electric-arc furnace reduces wastage in the melting process and consumes lower energy. The automation also leads to lower labor costs. This has led to historically lower costs incurring for the company that has led to superior gross margins over the years compared to peers. In FY20, the company’s gross margins stood at 24 percent compared to Amreli’s 7 percent and Mughal’s 10 percent.
The six-year revenue CAGR between FY14 and FY20 was 25 percent which translated to a 33 percent compounded annual growth rate in net profits. Meanwhile, net margins have also remained promising compared to industry averages—in FY20, net margin was 9 percent compared to 2 percent and -4 percent for Mughal and Amreli respectively. The company sells 75 percent of its products to institutions and projects while the rest goes to the retail market. This sales mix helps the company in saving on distributions costs, retailer margins and discounts.
The graded steel industry faces heavy competition from the ungraded steel sector which constitutes of small rolling mills that churn half the total production of rebars in the country. However, over the past year at least, graded steel has become hot in the market owing to the quality of the rebars in terms of safety as well as variety while appropriate marketing and branding activities by steel makers in differentiating their products from ungraded rebars has also popularized use.
Another positive development that has allowed for a lot more expansions to come in has been the government’s hand in industry protection. Through a multi-player tariff structure, domestic steel is protected from imports with custom duties as well as regulatory duties. Meanwhile, there are anti-dumping duties also in place which help keep demand for domestic steel intact.
Agha’s capacity utilization remained strong between FY15 and FY18—holding 70-85 percent production amid the capability to roll out 150,000 tons of rebars. However, this began to fall once the new expansion came in and capacity grew to 250,000 tons. Production kept growing though—last year amid the pandemic dropping into the world’s lap, the company still managed to increase production by 22 percent and also raise utilization back up—now levelling at 61 percent. This will continue to grow because of the optimistic outlook on demand.
The government has been taking a lot of steps in boosting the construction industry. There is an amnesty scheme in operation which allows builders, developers and investors to pour in their undocumented money into real estate through registration with the FBR. The promise here is that there will not be any questions asked on source of funds. This in conjunction with the Naya Pakistan Housing Plan will generate substantial demand for steel and other construction materials manufacturers. Moreover, as many as 10 hydro power projects have been approved, a few of which have even begun construction work which would also supplement current demand.
Various estimates put projected steel demand growth between 10-12 years annually which could take steel consumption to 9-10 million tons over the next decade from its current 3-4 million tons.
Agha’s investment in the new rolling mill would allow it to further double down on costs as the steel making process becomes more efficient with the new technology—the new mill will reduce power consumption and will have a continuous rolling process which would result in a higher billet to rebar yield and will potentially also allow the company to provide tailored rebar sizes based on customer demand in the future.
The company had a leveraged balance sheet with a reasonably high debt to equity ratio. However, by raising money through an IPO, this was improved—by Dec 2020, the debt to equity was lowered to 1.15x while interest coverage ratio also substantially improved from 1.8 in Dec-19 to 3.68, according to company officials (read about company’s risks here).
Outlook Though unfortunately, Agha’s quarterly reports leave much to be desired in terms of communicating the company’s operational performance, in the nine-months of the fiscal year, Agha’s income statement shows the company is in the right direction. Revenues have improved by 43 percent in 9MFY21, while after-tax profits grew 57 percent. This has been likely made possible through a continued growth in sales but also an increase in rebar prices. Margins have squeezed down to 20 percent versus 25 percent during 9MFY20 because of the massive rally in international scrap prices. During the period, average scrap prices grew 29 percent compared to the corresponding period last year.
Much like the rest of the industry, the company is totally at the mercy of international scrap, that being its primary raw material. Given that the company mainly makes money off of institutional sales, it can make very precise estimations of its demand, and more prudently, manage scrap inventory better to offset some of the price effects.
Though gross margins decline is a shame, the company managed to improve its net margins as finance costs significantly declined to 6 percent as interest rates reduced. Earlier, finance costs were 13 percent of revenue, considerably higher than the overheads that were being expensed (3% of revenue). This reduced cost burden helped shore up the bottom-line.
Given demand prospects, Agha has a strong foothold in the industry. When the new capacity comes online, Agha will be the largest rebar manufacturer with advanced technology backing it to boot. Its current revenues are behind the other rebar players but if the company manages to tap the retail market as effectively as it does the institutional market, it can raise revenues in tandem with its rising capacity. In fact, together with inventory management, if Agha manages to keep a tight lid on its cost of production—as it should given that its technology is meant to be more energy and cost efficient—Agha will remain head and shoulders ahead of the industry.