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Valuation looks attractive despite weak outlook for near term margins

As Covid-19 brought a sudden stop for global economy, outlook for steel prices quickly worsened since March. However, with the early recovery in Asia (12% rebound in China HRC price not mirrored yet in EU and Turkish markets) and gradual reopening of EU economies (potentially reinforced by a stimulus plan), we expect demand and steel pricing to normalize in 2H’20. We estimate 2020 margins of EREGL to be near cyclical lows (USD86/ton vs. long term average of USD130/ton), but our forecast of gradual recovery in 2021E margins (USD110/ton) yields an attractive 3.9x EV/EBITDA multiple for the stock, which implies 29% discount to 5-year historical average multiple.

Well positioned to keep high CUR as the main domestic supplier

Turkey’s flat steel market remains in deficit as domestic consumption is c.10% higher than domestic production. Flat steel demand in Turkey was more resilient in the aftermath of 2018 currency shock compared to long steel market as export-oriented end-users maintained their consumption levels. With Covid-19, flat steel demand is also likely to take a hit, but we expect EREGL to better protect its volumes and see softer volume contraction as the biggest and lowest cost producer. Our estimate for Q2, for instance, implies 14% lower volumes q/q which looks better than Arcelor’s guidance of 25-30% lower shipments. For FY20, we estimate CUR of 80% for EREGL, down from 91% in 2019.

More protectionist steps could be taken by both Turkey and EU

Local steel makers in both EU and Turkey filed complaints about imports and we could see trade protectionism keep increasing. We find it important for EREGL that Turkish government looks ready to roll out retaliatory steps to protect Turkish producers. We also note that direct export share in EREGL’s turnover already fell to 13% in 1Q’20 (21% in FY19) and rapid increase in trade barriers would push more end-users to seek local suppliers, which would help EREGL to more easily penetrate into higher added-value segments of steel supply chain in the long run.

Outperform maintained with higher TP of TL10.7/share

We revise our target price from TL8.60 to TL10.70 as we reflect recently announced investment program (USD1.3bn) and raise longer term margin forecast (from USD125/ton to USD140/ton) as a result of expected improvement in efficiency and increase in added-value. Our TP is also lifted by a lower dividend payout estimate from 2019 earnings (TL0.24 DPS expected now vs. TL1.20 initial proposal). Following the removal of dividend cap, we estimate dividend yield of 12.1% in 2021E. Key downside risks for the investment case are (I) more prolonged impact of Covid-19 on global demand (II) supply shocks related to key raw materials.



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Published By: Atilla Yeşilada

GlobalSource Partners’ Turkey Country Analyst Atilla Yesilada is the country’s leading political analyst and commentator. He is known throughout the finance and political science world for his thorough and outspoken coverage of Turkey’s political and financial developments. In addition to his extensive writing schedule, he is often called upon to provide his political expertise on major radio and television channels. Based in Istanbul, Atilla is co-founder of the information platform Istanbul Analytics and is one of GlobalSource’s local partners in Turkey. In addition to his consulting work and speaking engagements throughout the US, Europe and the Middle East, he writes regular columns for Turkey’s leading financial websites VATAN and and has contributed to the financial daily Referans and the liberal daily Radikal.