The economic planners of the country must cherish Pakistan's moth-eaten manufacturing base in secret. At least that's the lesson from the first quarter accounts announcement of International Steels Limited (PSX:ISL).

It appears that the star of domestic steel sector,  whose top-line had grown at a CAGR of 24 percent between FY12-FY18, is no longer able to hold fort. As top-line growth comes to a standstill, bottom-line is already down by half.

International Steels Limited
Rs (mn)1QFY201QFY19YoY % chg
 Sales     11,545     11,628-1%
 Cost of Sales    (10,311)    (10,009)3%
 Gross profit       1,234       1,619-24%
 Selling & distribution expenses         (244)         (110)123%
 Administrative expenses           (62)           (66)-6%
 Profit/(Loss) from core operations          928       1,444-36%
 Other income            65            78-18%
 Other expenses           (24)           (95)-74%
 Earnings before interest & taxes          968       1,427-32%
 Finance cost         (667)         (285)134%
 Profit before tax          301       1,142-74%
 Taxation            47         (300)-116%
 Net profit for the period          348          841-59%
Earnings per share (Rs)0.801.93bps
GP margin10.69%13.92%ê 323
Operating margin8.04%12.41%ê 437
EBIT margin8.39%12.27%ê 388
PBT margin2.61%9.82%ê 721
Interest coverage1.455.00ê 355
 Source: based on company notice on PSX 

If ISL's contracting performance is any guide, the economy would have been screaming full-blown recession had the dependence on the industrial sector been any higher. Already in FY19, overall domestic ‘steel products' production volume (aggregate) contracted by 12.5 percent as tracked by Large Scale Manufacturing index.

Fortunately, ISL had remained insulated from volumetric contraction till that time. Back in June, cold rolled steel strip production was still marching ahead after doubling its capacity, even as galvanized steel production had begun to show signs of slowdown.

This was because unlike other poorly diversified steel products manufacturers, ISL's off take is not wholly dependent on construction, with high-value sales also made to automotive and electronics manufacturers. While customer diversification and lower dependence on construction allowed the company to grow top-line by 16 percent for full year FY19, it appears that the decline in automotive is now taking its toll too.

On the cost side, high borrowing cost is restricting blood flow to bottom-line. Finance cost eroded PBT margin by six percentage points,  as interest coverage is also down by 355bps. Note that in addition to higher mark-up rate, interest expense has also grown  on account of ST borrowings which grew by close Rs2billion (between FY18 and FY19). This is a sign of concern as it may indicate that the operating cycle is under stress.

It is lamentable that the company which managed to reduce its long term leverage despite substantive capacity additions over past five years is bleeding cash just to finance its working capital requirements.

Nevertheless, it appears that the investors had caught on to signs of steel down very early on. Between Feb-17 to date, ISL lost over two-thirds of its market value, as the price has fallen from peak of Rs165 to levels last seen in FY16.

Having said that, if the policy rate finally reverses gear in latter part of FY20, the bleeding is bound to slowdown if not stop altogether. Stable capital structure – debt to equity is still less than 0.6 times – coupled with strong sponsor support and profile means ISL is very much capable of weathering the storm. And with past capacity expansions already geared, the engines are just waiting to be fired up. How soon? Answer to that, however, remains elusive.