EAV PROJECT :INDIVIDUAL

ASSIGNMENT PRODUCER
DURABLES: STEEL INDUSTRY
Syeda Habiba Pasha BSAF2K16(A)
Introduction to the company
Mughal Iron and steel Industries ltd was incorporated in 2010 as a public ltd company. The company
principally operates in-long rolled steel industry and is involved in multi-dimensional activities from
making billets to steel re-bars, girders and t-iron. Its main markets are the domestic housing sector and
Large infrastructure project. MW (Mughal Steel’s Annual Report 2018, extract from Company Profile,
page# 08)

Market and Demand Analysis

Domestic demand for steel in Pakistan is estimated around 4 million tons, and has seen a rising trend
over the last few years due to strong growth in construction activity. According to the annual State Bank
of Pakistan report in 2015, the domestic steel production grew by 35.4% from in the last five years, with
significant demand contributions from the auto sector, housing and infrastructure development project

(JCR-VIS Credit Rating Company Limited, 2016)

Between fiscal years 2012 and 2016 Pakistan’s steel consumption has shown a staggering 5-yr CAGR of
25.9% per annum. Pakistan’s steel use in 2016 was almost 39.5kg per capita, which is expected to
increase due to enhanced private and public spending on housing and infrastructure sectors. According
to the World Steel Association Pakistan’s steel requirement is expected to swell over 12 million tonnes
taking the country’s per capita requirement to 62kg/capita in 2019. (Hussain, 2018)

Adnan Sami Sheik, an analyst at Topline Securities, affirms the increase in demand, which is driven by
investment and developments in infrastructure projects such as power plants, dams, airports and road
networks along with public and private housing schemes. (Hussain, 2018)

CPEC

Majority of the aforementioned infrastructure projects and rising steel demand can be attributed to
CPEC. CPEC, is one of the most significant projects in Pakistan’s history, with total investment volume of
about $46 billion out of which almost $9.79 billion have been allocated to infrastructural
projects(Mujaddad and Chaudhry, 2017), such as Orange Line, Karachi-Lahore Motor Way, Neelum -
Jehlum Hydrpower project to name a few. (Hussain, 2018)

As per Pakistan Steel Re-Rolling Mills Association(PSRMA), the start of mega development schemes and
power projects under CPEC will boost annual demand for steel product by more than 30%.
Successful implementation of CPEC requires fulfillment of construction and infrastructural needs that
depend greatly on three major sectors: steel, cement and stone crushing. It was noted that the steel
industry was only operating at 35% capacity utilization, which means that the industry has the potential
to cater to any demand increase, or that it can produce 65% more with the same level of inputs.
(Mujaddad and Chaudhry, 2017)

Housing Sector

The world Bank in its Pakistan Housing Finance Project Report has highlighted the shortfall in housing
units to be around 10 million units(Mughal Steel 2018, Annual Report,Director’s Report, Housing Sector
Review page# 28)In the backdrop of increasing population and emergence of nuclear families, the
demand for housing is on the rise. Notable construction projects such as DHA City, DHA Oasis, Bahria
Town and Luxury projects by Emaar Pakistan will boost the demand for steel in Pakistan. (JCR-VIS
Credit Rating Company Limited, 2016)

Company Analysis

Operational Performance Review

Capacity and Production

The furnaces generated an overall production of 211,934 MT, recording an increase of 82.38% from
previous year. The overall production of rolling mills was recorded at 251,950 MT showing an increase of
4.21% over the previous year. During the year, Company obtained approval from SNGPL for
enhancement in gas load capacity from 2.80 MMCFD to 6.30 MMCFD and from LESCO for enhancement
of grid station load capacity from 19.99 MW to 79.99 MW ( Mughal Steel’s Annual Report 2018, extract
from Director’s Report to Shareholders, Operational Performance Review, page# 30)

Capital Expenditure
The company obtained long term finance to finance, balancing modernization and replacement (BMR) of
bar re-rolling mill. Furthermore, the company recorded an increase in Total assets, of about Rs.
1,451.030 million, which was primarily due to an increase in capital expenditure, with additions in asset
such as power engines, grid enhancement related expenditure and other routine additions. ( Mughal
Steel’s Annual Report 2018, extract from Director’s Report to Shareholders, Operational Performance
Review, page# 30)

Expansion and Efficiency

One main operational advantage that Mughal Steels has is its efforts to overcome energy constraints in
the form of enhancement of their sanctioned grid station load from 19.99 MW to 79.99 MW,
enhancement of gas load from 2.80 MMCFD to 6.30 MMCFD and commissioning of six (6) further gas
engines for generation of in-house electricity. These achievements will not only overcome energy
constraints but also help to eliminate raw material constraints.
Phase II of earlier expansion plan was also approved by the Board which amongst other things included
procurement and installation of further induction furnaces as mentioned above. The addition of
furnaces will help to reduce reliance on expensive outsourced billet and ensure competitiveness and
sustainability of operations. ( Mughal Steel’s Annual Report 2018, extract from Director’s Report to
Shareholders, Operational Performance Review, page# 30)

The overall operational scenario of Mughal Steels reflects a growth and expansionary attitude focused
on maximizing efficiency and growth through expansion of capital assets and being able to cater to the
growing demand of the industry.

Financial Review
2018 has been a good year for Mughal Steels, who reported an 18.2% increase in sales in 2018 as
compared to 2017. The increase was primarily due to increase in sales volume and price. Furthermore,
the company saw significant increase Before and after tax profits. Their gross profit and net profit ratios
were 12.57% and 5.81% respectively, the highest ratio achieved since 2016. ( Mughal Steel’s Annual
Report 2018, extracts from Analysis of Financial Ratios, page # 72and73)

Increased profitability resulted in an increase in EPS to 5.13 from 4.21 last year. Break-up value
increased during the year to 29.67 due to increased profitability. The market value of the share however
closed at 62.57 which was lower than last year’s 19.18 mainly due to overall political environment
prevailing in the country. Dividend payout ratio decreased due to reinvestment purposes, which means
future growth for the company. ( Mughal Steel’s Annual Report 2018, extracts from Analysis of Financial
Ratios, page # 72and73)

( Mughal Steel’s Annual Report 2018, extracts from Analysis of Financial Ratios, page # 72and73)
Choosing Appropriate Model for Forecasting
For valuing Mughal Steel Stock we had two valuation approaches, Free Cash flow approach and Dividend
Discount. The free cash flow approach was not applicable to Mughal Steel as due to increased capital
expenditure they had negative free cash flows.

FCFF Rs.

Net Income Available to Shareholders 1290214932

Investment in Fixed Capital (218874195+14433110) (Note 7.1pg#106) ( 2203175065)

Interest (Income statement page #91)

(tax rate deducted@ 9.5%) 441968185

Investment in working Capital ( 469082102)

Depreciation and Ammortization (Note 7.1 page# 106) 137 024 372

Free Cash flows (803049678)

Working Capital Investment (SOFP page# 90 ) 2018 2017

Current Liabilities 8408467266 8743575879

Less: Short term notes (7840375822) (8014084525)

Less: Current portion of Long Term Loan (31712,571)

568091444 697778783

Current Assets 11130324119 11748962540

Less: Cash (1251,171,471) (2338891995)

9879152647 9410070545

The DDM approach particularly the Gordon Growth Model was a much more easier approach to value
stock as the company had a history of paying dividends.
Valuation Using Gordon Growth Model

Step 1: ROE Calculation

(Net income/Sales)* (Sales/Total Avg Assets)*(Avg Total Assets/avg Shareholder Equity)

(1603727936/22225842588)*(22225842588/16749241612)*( 16749241612/7051715521)

=7.21%*1.32*2.38

=22.65%

Step 2: Growth Rate Calculation:

(1-Payout Ratio)*ROE

(1-43%)*22.65% = 12.9105%

Step 3: Calculate R using CAPM

R= Risk free rate+ beta of company( Market return-Risk free return)

10.9%+0.86(15.90%-10.9%)= 15.2%

Risk Free Rate: (JSBL, 2018)

Beta: As at 6th December 2018, Investing.com Mughal Steel profile

Step 4: Gordon Growth Model: 3 year forecast and Stock Price Valuation

V0= Dividend(1+g)/r-g

=2.22(1+12.910%)/(15.2%-12.910%)

Intrinsic Value=Rs. 109.45

Sensitivity Analysis and Conclusion
The stock is undervalued, trading at a price of RS.43.1 as on 6th December 2018 ((MUGH), M.
(2018). Mughal Iron & Steel Industries Ltd (MUGH) Historical Prices ) . There are various reasons why the
stock has been undervalued in the market.

The company in its annual report has highlighted key factors that impact shares in its share price
sensitivity analysis. (Mughal Steel’s Annual Report 2018, extracts from Share Price Sensitivity Analysis,
page # 81)

 Increase in Fixed costs such as Finance costs, marketing expenses and overheads.
 Increase in Variable costs such as Furnace oil, raw material etc.
 Change in Government Policies
 Changes in Demand.

Interest Rates
The company in its annual report has mentioned that any hike by State Bank of Pakistan on interest
rates of the company, shall have a negative impact on its EPS, and thereby its stock price, as the
company has incurred a long term debt for financing purposes . Since State Bank of Pakistan has raised
interest rates by 150 basis points to 10%, the company’s finance costs will rise significantly and lower
EPS and thereby stock price will be negatively affected.

Rupee Devaluation
The 3.8% depreciation of the Rupee against US Dollar falling to Rs.139.05 /$1, coupled with the hike in
interest rates has had a negative impact on Pakistan’s Stock Market resulting in a wide sell-off at the
Pakistan Stock Exchange (PSX) on 3rd December 7, 2018 with KSE-100 Index losing 1,335 points to close
at 39,160, down 3.30 per cent (Zubairi, 2018). Since investor confidence is at an all-time low with many
investors unsure of the government’s economic road map, the overall stock prices in Pakistan have
fallen, including Mughal Steel’s.

Government
The sudden depreciation of the rupee and hike in interest rates, have had negative implications for
Pakistan’s economic instability. With the Government failing to communicate with investors about their
potential policies and initiatives to cope with these sudden changes, investor confidence and stock
market performance will remain low.

Furthermore, Pakistan is expected to go to the IMF for a bailout package in 2019, who prescribe to, let
the overvalued rupee find its real market worth, minimise energy subsidies, reduce development and
non-development expenses, hike interest rates — and choose economic stability over growth in the
process. (Zubairi, 2018)
Any reduction in Government Expenditure in developmental expenses such as Imran Khan’s Panahgaz
Housing Scheme, or any other infrastructure development would cause a decrease in Demand for steel
products and therefore cause an adverse impact on Mughal Steel’s stock Price.

Conclusion
CPEC and private housing schemes, in Pakistan are a significant source of demand for the steel industry
and are expected to grow. Furthermore, government initiatives to stabilize the economy should improve
investor confidence in the future and therefore improve stock market performance. These external
factors coupled with Mughal steels effort to reduce energy costs, their generation capacity
improvement efforts etc. prove that the company has growth potential and therefore is undervalued.
 Bibliography

References
Hussain, D. (2018). Steel mills prepare to meet CPEC demand. DAWN. [online]
Available at: https://www.dawn.com/news/1342913 [Accessed 28 Nov. 2018].
JCR-VIS Credit Rating Company Limited (2016). Steel Industry. [online] Available
at: http://jcrvis.com.pk/docs/Steel201612.pdf [Accessed 28 Nov. 2018].
JSBL. (2018). Daily Government Security Rates. [online] Available at:
https://www.jsbl.com/treasury/daily-gov-security-rates/ [Accessed 6 Dec. 2018].
Mughal Steel (2018). Annual Report. [online] Available at:
https://www.mughalsteel.com/wp-content/uploads/2018/10/MS-AR-2018.pdf
[Accessed 28 Nov. 2018].
Mujaddad, H. and Chaudhry, M. (2017). Sufficiency Analysis of Local Production
Capacity in Punjab for the Requirement of CPEC. [online] Go.galegroup.com.
Available at:
https://go.galegroup.com/ps/i.do?p=AONE&sw=w&u=googlescholar&v=2.1&it=
r&id=GALE%7CA538247445&sid=classroomWidget&asid=72514102
[Accessed 30 Nov. 2018].
Siddiqui, S. (2018). Market watch: Stocks battered as index plummets over 1,300
points. The Express Tribune. [online] Available at:
https://tribune.com.pk/story/1859113/2-stocks-bleed-kse-100-dives-1200-points-
intra-day-trading/ [Accessed 6 Dec. 2018].
Zubairi, T. (2018). Bloodbath at PSX as benchmark index loses 1,335 points. DAWN.
[online] Available at: https://www.dawn.com/news/1449162 [Accessed 6 Dec.
2018].
Data Sources for excel file
MUGH), M.
Mughal Iron & Steel Industries Ltd (MUGH) Historical Prices - Investing.com
In-text: (MUGH), 2018)
Your Bibliography: (MUGH), M. (2018). Mughal Iron & Steel Industries Ltd (MUGH) Historical Prices -
Investing.com. [online] Investing.com. Available at: https://www.investing.com/equities/mughal-iron---
steel-industries-historical-data [Accessed 7 Dec. 2018
 (MUGH), M.
Mughal Iron & Steel Industries Ltd (MUGH) Historical Prices - Investing.com
In-text: (MUGH), 2018)
Your Bibliography: (MUGH), M. (2018). Mughal Iron & Steel Industries Ltd (MUGH) Historical Prices -
Investing.com. [online] Investing.com. Available at: https://www.investing.com/equities/mughal-iron---
steel-industries-historical-data [Accessed 7 Dec. 2018].
*Beta taken from Mugha industries profile