Disclaimer: The article below is the work of a participant of Fundamentals of Capital Market training. Sarmaaya.pk holds no liability for the recommendation mentioned.

Ittefaq Iron Industries falls under the broader category of Engineering Sector in the Pakistan Stock Exchange. However, it can be categorised as the Steel industry segment as well. Being a cyclical sector, its performance is dependent on the economic conditions.
This report includes a detailed analysis of Ittefaq Iron Industries - one of the prominent players in the sector. The report also includes Pakistan's country profile, Ittefaq's business overview, and a detailed financial, business, and management analysis. Through a thorough examination of these factors, the aim of this report is to provide investors with a holistic understanding of the company's market position and investment worthiness.

In a Nutshell

• Analyst Background

• Macroeconomic Profile

• Company Profile

• Financial Analysis

• Business and Management Analysis

• Strength and Weakness

• Summary

Analyst Background:

The following analysis is carried out by Mirza Salman Asif. He is a participant of Fundamentals of Capital Market training (Batch 6), offered by Ammar Yaseen. Mr. Asif is the CEO of Mehboob Sons, a renowned name in rice milling and exporting since 1935! With an educational background in Marketing and a career is rice exporting, Mr. Asif had no prior experience in investing in stock market, or even analyzing a company. Now, however, after 12 weeks of training, he is well equipped to handle any financial analysis task.

Macroeconomic Profile:

Pakistan is a nation that depends heavily on oil imports, with petroleum products making up one-third of all imports. Pakistan is greatly impacted by the price of oil. The price of Arab Light Oil (which is mainly used by Pakistan) began to rise steadily in April 2020 and peaked in October 2022 at about $125 per barrel.
Arab Light Oil began a declining trend after reaching its peak, and it is currently trading at about $82 per barrel as on 2nd January 2024. The price of Arab Light oil is currently declining, which can help Pakistan's economy.

Inflation has declined. During the 1st quarter of FY24, the headline inflation remained at 29% as compared to 35% during the previous quarter on the back of high base-effect and moderating food inflation. PKR depreciation and floods in FY23 led to higher food inflation. As a result, the SBP kept the policy rate unchanged at 22% during the quarter.


Overall, the decision of whether or not to decrease interest rates in the near future is a delicate balancing act for the SBP. They need to weigh the potential benefits of stimulating economic growth against the risks of reigniting inflation or jeopardizing financial stability. The SBP will likely take a data-driven approach and closely monitor economic indicators before making any decisions. Recent statements suggest a possible gradual decrease in the policy rate in 2024 if inflation falls sustainably.

The rupee has recovered. The REER Chart demonstrates that the PKR depreciated excessively in April 2023, when it was valued at approximately 85.5(REER value). This was brought on by currency dealers and speculators, as well as Pakistan's diminishing foreign exchange reserves and a delay in the International Monetary Fund's (IMF) Extended Fund Facility (EFF) program. After that, the army began to crack down on currency dealers, and negotiations with the IMF were started. As a result, PKR gained confidence and began to appreciate in value. The rupee is currently trading close to its fair value. The REER as of January 2, 2024, is 98.2. For Pakistan's import/export businesses, the value of the rupee at 98.2 REER, or Rs. 282 per dollar, is neutral.

The fiscal deficit has improved, in FY23, it was 7.75% as opposed to 7.86% in FY22. Primary deficit improved from 3.1% to 0.8%. In July, fiscal deficit was at 0.2% of GDP (flat compared to last year). However, primary balance in July has improved from PKR 142B last year to PKR 311B in 2023. The improvement in primary balance is driven from increase in FBR collections which were provisionally at PKR 2B in 1QFY24 vs PKR 1.6B in 1QFY23, up 24% YoY. Non-tax revenues have also increased driven by higher PDL collection. Non interest spending went down by 48% YoY.

As of 22nd December 2023, Pakistan's total foreign exchange reserves stand at $12.86 billion. This includes:

• $7.76 billion held by the State Bank of Pakistan (SBP) Good

• $5.10 billion held by commercial banks Good

Growth since January 2023, when they fell to a low of $8.12 billion, reserves have significantly improved. The primary reasons for this increase are that Pakistan's current account deficit has decreased and it received the sixth installment of the $6 billion Extended Fund Facility (EFF) from the IMF in November 2023.

Company Profile:

Ittefaq Iron Industries Limitedis the leading steel rolling mill in Pakistan with the capability to manufacture international quality products with various standards, such as DIN, ASTM etc. The company has created a name for itself and is known as the pioneer in steel products. Ittefaq Iron Industries has been shaping steel for the nation for more than 50 Years.

The company mainly produces three types of products:

Deformed steel bars of Grade 40 and Grade 60 are produced in all American and British Standards Sizes from 10mm to 50mm.

Ittefaq Steel is manufacturing I & H-Beam, Girder, T-Iron, Channel and Angle that has no match in strength and durability.

Steel Billets. Throughout our melt shop from steel scrap to billets the company maintain strict control over the composition of our steel.

Since the company imports scrap from overseas markets, it is heavily reliant on the USDPKR exchange rate.

The government's expansionary policies, particularly the mega projects started by the federal or provincial governments under PSDP (Public Sector Development Program), are another factor that it depends too much on.

Price increases for energy, particularly for electricity, have a negative effect on profitability.

Financial Analysis:

Growth Factors:

The company's yearly sales, which were 6.81 billion in 2019 and will reach 8.28 billion by the end of the fiscal year 2023, represent an annual growth rate of 3.99%. The rate of increase in sales in recent five years is far too low.

The business's operating profits, which came to Rs. -69.95 million, are negative. Because gross margins are being squeezed, operating earnings have been declining continuously, and this year they even went negative.

Similarly, because the business lost Rs. 94.46 million, its net income is likewise negative. This year there was a loss.



Both last year and this year saw a decline in the Earnings Per Share. The company's growth performance over the past few years has been unacceptable.

Stability Factors:

Over the past seven years, the company's performance has been consistently subpar. The net margin percentage over the last three years has averaged just 1.75%, which is quite low and unacceptable.

The corporation is subject to a 29% corporate tax rate, however, because of losses, it has only received income tax refunds and has not paid income tax out of pocket. This might indicate that the business will need to pay more taxes in the upcoming years or that its tax refund account will be depleted.

Even compared to EBITDA, which is 69.83 million, the Financial Cost is larger at 75.47 million for the year 2023. An inadequate Interest Coverage ratio for the fiscal year 2023 is indicated by this. Even the profit margin that would allow the business to pay for its financial cost is insufficient.

A significant improvement, the total and current liabilities are both cut by 53% in FY23 compared to FY22. The debt-to-equity ratio is now 0.48, down from 0.98 in FY22, which is good.

Even though total debt in FY23 has dropped dramatically, the company has increased its borrowing in the last three years, which means total debt has accumulated. The primary cause of this decline is the significant 65% reduction in Trade Payables, which is a result of the company doing less business than it did the previous year.

The company's current ratio is 2.39, indicating that it is able to easily meet its short-term obligations.
The company has lost money this year, so its cash flow from operations is negative. the company has recently increased its cashflow from operations which is encouraging.
A bad sign is the company's net reduction in cash and cash equivalents by 795 million.

The graph also shows that net fixed asset turnover is increasing annually.

The company's return on equity is -2.07% which is not a good sign.

Valuation Factors:

The traditional Price-to-Earnings (P/E) ratio cannot be calculated for a company that has incurred a loss because the denominator, earnings per share (EPS), is negative. Dividing the stock price by a negative EPS would result in a nonsensical negative P/E value. Therefore, we have to look upon other valuation factors for this company.
The book value of a share is Rs. 31.68, and as of the first week of January 2024, the share price is Rs. 8. Consequently, the price to book value is 0.25, indicating that the company is available for a cheaper rate.
With 57.37 sales per share and a current share price of Rs. 8, the price to sales ratio is 0.14, which is good and positive.
From 2019 to 2023, throughout this five-year span, the company has regrettably not given any form of dividends to its investors.

Business and Management Analysis:

Business Factors:

In the financial year ending on June 30, 2023 there was no smooth sailing due to the over-all political and economic turmoil in the country in addition to the rapidly increasing cost of doing business.

During the year the sales volume has decreased to the level of Rs 2.94 billion showing a decrease of almost 26% as compared to the previous year's figure of Rs 5.024 billion. Due to significant rise in cost of doing business, the gross profit has decreased to Rs 142.38 million as compared to the last year's figure of Rs 509.02 million. The company this year has to bear net loss of Rs 94.456 million.

The main factors responsible for such negative results are excessive devaluation of Pakistani Rupee in relation to US dollar leading to a very steep hike in the raw material cost. Furthermore, due to foreign exchange constraints, the extended ban on import of scrap being labelled as non-essential item this year has been another reason of the loss as it negatively affected company’s production cycle in addition to being the cause of extreme rates fluctuation in the steel sector market. The steel sector in the country has also been negatively affected due to non-initiation of any new major projects by the federal and provincial governments under the Public Sector Development Program (PSDP).

Furthermore, throughout the year, the government has also been significantly increasing electricity/fuel rates in addition to hefty increase in taxes to pave the way for entering into a standby arrangement with The International Monetary Fund (IMF). Resultantly, this year the cost of production has exorbitantly increased as compared to that of the last year.

In FY22, the production utilized was around 50% of the installed capacity, however, in FY23, production utilization dropped even further to only about 25% of the capacity. This indicates a lack of demand and a management team that is unable to identify potential sales channels. This is a very concerning indication for investors.

Management Factors:

The general public, which includes local investors, currently owns 86.62% of the company's shares, while top management, directors, and their families own 8.2%. Neither mutual funds nor insurance companies have any investments in the company.

Strength and Weakness

Strengths:

• Quality Products

• Good Current Ratio

• Declining liabilities

• Net Fixed Asset turnover ratio is good

• Available at lower price to book value

Weaknesses:

• Declining operating profit percentage

• Bad interest coverage

• Negative free cashflow

• Poor percentage of return on equity

• Declining Sales

• Declining production volumes

Summary

• FY 2023 proved turbulent for the company, grappling with a 26% sales plummet to Rs 2.94 billion amid soaring business costs. Devaluation-fueled raw material hikes, a scrap import ban, and government austerity measures like tax hikes and energy price increases all conspired to drive down gross profit by 72% and plunge the company into a net loss of Rs 94.46 million. The lack of new government projects further stifled the steel sector, exacerbating these woes.

• In the medium to long run the things are expected to improve only if the political and economic stability returns to the country and a new IMF program is secured by the incoming government after the elections.

• It is obvious that the company will only be profitable when the government implements "expansionary" policies, grants preference to the construction industry, launches new, massive projects, and implements public sector development initiatives. The company has been severely impacted by this slowdown in the economy.

• The company's management is entirely reliant on the massive PSDP projects, and it has no strategy in place to mitigate the likelihood of an economic downturn. In the absence of mega government-led projects, the company should have a way to generate revenue on its own.