Strong rally justified by rising margins. EREGL staged a strong rally over the last 6M on improving margins as slow capacity restarts and quicker recovery in demand translated into significantly higher global steel prices. Supply conditions became tight especially in Europe as inventories depleted and import barriers backfired. Logistic bottlenecks further added to the problems of the region. As a result, European HRC price has approached USD1200/ton (vs. USD550/ton in 2020) while the price in Turkey also jumped above USD1000/ton (up from 2020 avg. of c. USD500/ton). We estimate this would result in significant margin expansion for EREGL with EBITDA increasing to USD270/ton in 2021E, up from USD112/ton last year, translating into USD2.3bn in EBITDA vs. USD1.0bn in 2020.
Still has room to go in a historical context, yet remaining upside is less attractive. Looking at previous cycles, EREGL had two similar runs in the past; one between 2006-2008 (ended by global financial crisis) and the other between 2016-2018 (ended by Trump-era trade wars). In both cases, EREGL’s market cap had peaked around USD10bn level. We can thus say, in a historical context, current price is still around 20% below previous cycle peaks, but it should also be noted that a large part of the rally is already behind with 117% total return in USD terms since Oct’2020.
What to watch? Global stimulus race… As fiscal stimulus measures gain importance in global response to Covid-19 pandemic, initiatives like infrastructure plan in the US and recovery plan in the EU could create additional steel demand for an extended period. If these plans turn into action quickly, expected moderation in steel prices could be slow and the length of current cycle could be longer.
and China’s policies… China’s recent policy actions has been supportive of other steel producers like Turkey as (1) it signaled removal of export rebates, which would divert production from exports to domestic market (2) implemented informal ban on Australian coking coal, leading to lower price for other buyers (3) announced new production curbs and preference for importing semi-finished steel, lending support to global pricing outlook and preventing iron ore price from excessive spikes.
Updated DCF yields TP of TL22.0/share (from TL18.20/share). We shortened forecast period in our DCF, where we project a gradual decline in EBITDA from USD270/ton in 2021 to USD175/ton in 2024 and calculate terminal value based on normalized EBITDA estimate of USD150/ton and EV/EBITDA multiple of 5.5x. With a USD-based CoE of 12.5%, we reach a target price of TL22.0/share up from TL18.2/share. We also note attractive dividends, yielding 15% p.a. on average for the next 3-years, which could limit downside for EREGL.
1Q Preview: In 1Q’21, we estimate TL3.57bn EBITDA (+33% q/q and >250% y/y) and TL2.46bn net income (vs. TL0.3bn a year ago), indicating EBITDA of USD240/ton vs. USD144/ton in 4Q and USD95/ton a year earlier. We revised up our EBITDA and Net Income estimates by 49% and 43% for 2021E, respectively, implying 5.6x PE and 3.5x EV/EBITDA multiples.
Source: Y.F. Securities Research