Pak Elektron Limited - Revising Estimates Post Release of Detailed Financials
We revise down our Jun-18 PT for PAEL by 5.4% to PKR 118/share (vs PKR 125/share) after incorporating detailed 2Q financial results and tweaking company’s medium term revenue assumptions. The stock is currently trading at cheap 2017/18 PE of 8.5/7.7x and offers a total return of 65% from its last close.
Historically 2Q remains a major earning driver owing to staggering seasonal demand emanating from white good sales, however this year the company witnessed an earnings attrition of 6%YoY to PKR3.25/share. Segment wise breakup suggests Appliances revenue expanded by 18%YoY to PKR10.4bn while Power segment depicted an accretion of mere 6%YoY to PKR3.5bn.
Despite significant discounts offered, refrigerator sales depicted a stagnation as they dropped by 1%YoY to PKR7.1bn owing to heavy downpour, while low base AC sales grew 2x to PKR2bn. On the other hand, deferred contracts of Power transformers by GoP led to sluggish growth in power division.
Our channel checks suggest that PAEL is planning to enhance its product line by introducing winter consumer products over the next two years. We believe this can uplift company’s gross margins and significantly improve cash cycle. While we have not yet incorporated this into our model, we have provided sensitivities to potential introduction of washing machines.
Revising PT by 5.4% to PKR 118/share: We slightly tweak our overall revenue assumption for Pak Elektron Company Limited (PAEL) by -1.5%/-2% for 2017/2018E from our earlier estimates after incorporating detailed 2Q results which indicated some structural delays and heavy discounts. Consequently, we revise down our 2017 and 2018 earnings estimates by 6.5% and 2.5% to PKR8.6/share and PKR9.5/share, respectively. Our investment case for both Power and Appliances segments remains intact owing to heavy investments in country’s deteriorated T and D structure, coupled with healthy population dynamics to support consumer demand for white good products. We maintain our Buy stance on the stock with our DCF based Jun-18 PT of PKR118/share (â5.4% from earlier PKR125/share) still providing significant capital upside of 60% along with a healthy dividend yield of 5%.
2Q Highlights Structural Problems for the Industry: Historically 2Q remains a major earning driver for the company owing to staggering seasonal demand emanating from white good sales (refrigerators and AC’s). However this year the company witnessed an earnings attrition of 6%YoY to PKR3.25/ share (in-line with our expectations) for 2Q2017. At Gross levels, revenue of the company depicted a healthy accretion of 14%YoY to PKR14.0bn (vs PKR12.2bn) with Appliances: Power mix of 74:26, however net revenue of the company grew by only 2%YoY owing to significant Sales Tax and Discounts of 25% (vs 16% in SPLY).
Segment wise breakup suggests that Appliances revenue expanded by 18%YoY to PKR10.4bn while Power segment depicted an accretion of a mere 6%YoY to PKR3.5bn. It is pertinent to highlight that despite significant discounts of 23%, gross sales of refrigerator division witnessed a stagnation; dropping by 1%YoY to PKR7.1bn (vs PKR7.2bn SPLY) which is primarily on the back of unfavorable pre-monsoon season which affected company’s sales during May-June period. Low base AC division however compensated for most for the sluggishness in other products as it expanded 2x to PKR2bn. On the other hand, delays in government contracts for Power transformers resulted in a decline of 71%YoY in its sales. However owing to healthy performance of Power transformer sales in 1Q, cumulative earnings of the company grew by ~26% to PKR5.45/share. Along with the result the company also announced an interim cash dividend of PKR 1.5/share.
Possible Entry in Winter Consumer Products: PAEL’s strategy to retain its market share in white goods is currently on track while our channel checks suggest that the company is planning to enter winter dominated products in order to i) expand product range, ii) manage cash cycle more effectively and, iii) improve revenue mix high margin Appliances sales. With Washing Machines, Television Sets and Water Heaters being the key products for winters, we expect the company to introduce former two product during the end of 2017 and 2018, respectively. We highlight that additional sales and cash management from winter cycle is yet to uplift our valuations, but for now we provide an earnings sensitivity analysis for each product on sustainable basis:
Steeper than expected discounts of ~19% (annual basis) on appliances products owing to stiffer competition can further erode company’s revenues.
More than expected hike in interest rates (and/or PKR depreciation) can hamper double digit earnings growth in the medium term.
Heavy downpour and/or extended winters remain key risks for revenue growth in appliances segment.
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