Changes to earnings

We update our model factoring in higher realized TRY steel prices driven by a combination of a weaker assumed TRY and marking steel prices to market near term given that spot steel prices are higher than our estimates.

 Valuation & price objective derivation

Price objective derivation

We update our price objective setting a price objective at TRY47 based on 5.1x EV/EBITDA, Erdemir's average through cycle EV/EBITDA multiple.

Why the higher target multiple?

Previously we used 4x as a target EV/EBITDA multiple, more towards the low-end of the historic trading range reflecting 1) Pressure on the business as a result of the 2023 earthquake and 2) Broader risks on some unconventional economic policies in Türkiye.  Now, as the business appears to have normalized post the earthquake, an "average" multiple (since 2015) feels appropriate to us. We also see early signs of normalization of economic policy.

Assuming monetization of VAT receivables

Erdemir has outstanding VAT receivables of c. TRY16 bn. Based on discussions with the company, Erdemir expects this to be largely repaid in 2024 (c. TRY15 bn out of TRY 16 bn). The company expects c. TRY 10 bn to be repaid in H1, TRY 5 bn in H2. For reference, at spot, TRY15 bn is about $480 mn. We include this in our financial model.

That said, recognizing the materiality but also being a little conservative, our new price objective explicitly assumes that TRY 12 bn out of the TRY 16 bn is turned into cash (about $380 mn at today's exchange rates). For our EV/EBITDA multiple calculations we make a similar adjustment. This US$ equivalent could also vary with moves in the TRY.

 Steel company valuations

 FY2023 results key figures

 Key takeaways and thoughts on results

(Source: Discussion with company)

Current outlook

As it stands today, the company sees a "normal" order book with c. 2.5 months of orders booked. Local Turkish demand for steel is strong. Utilization has been trending above 90% and EBITDA/t is at "normal" levels i.e. around / above minimum level of US$100/t.

Reflecting on the earthquake impact

2023 was a difficult year for Türkiye and for Erdemir. On February 20^th, 2023, southern Türkiye was hit by a 6.4 magnitude earthquake with another 5.6 magnitude on February 27^th. Aside from the human tragedy, this created problems for Erdemir's business: Erdemir's operations at Iskenderun in Southern Türkiye lost almost three months of production including 600 kt of steel production & sales. This impact came through in the Q1 and Q2 results. By Q3, the production was largely back to normal levels. According to the company, Q3 and Q4 results were more "normal" or typical i.e. utilizations rates around 90% and producing > 2 Mt of steel with EBITDA/t of steel > US$100/t.

In terms of the earthquake impact on the steel plants, the company notes there were no large-scale damages to the facilities, no buildings collapsed. As such the shutdown / reduced production was a result of controlling the situation, checking that all the plant systems were safe and operational. The company did experience some damages in the port but these were not material. Some other facilities also lost production so local Turkish production wasn't enough to satisfy demand. As such, net exports from Türkiye actually dropped in 2023.

Bonus share issue announced

The company has announced a bonus share issue (effectively a share split) which will see the number of shares outstanding double. The timing of this is still to be confirmed but the company expects approval sometime in H1. Inasmuch as a share split is value neutral, we continue model the company based on current shares outstanding i.e. 3.5 bn.

 Key charts from results

FY2023 liquid steel production down c. 8% mainly driven by the impact of the February 2023 earthquake. By Q4, however, the business had recovered to its typical quarterly steel production of around 2.1 Mt / quarter implying FY production at our assumed production level of 8.4 Mt.

Capacity utilization for the FY dropped to 75% but recent quarterly data suggests that this is now back to a normal of c. 90%.

Production of key products down c. -5.5% YoY to around 7.4 Mt. But taking Q4 production annualized we see the business has now recovered to above 2022A production levels. Note: Erdemir defines "Hot" as Hot rolled coil (HRC) + plate and "Cold" as Cold-rolled coil (CRC), tin plate and galvanized steel. Long products are billets and wire-rod. No rebar. So both Hot and Cold are flat products.

Inline with lower production, sales of key production down c. 5.6% to 7.3Mt. Again, as with production, taking Q4 sales levels annualized suggests that the business has recovered to above 2022A levels.

With steel needed for the reconstruction effort in Türkiye and lower steel production, exports dropped c. 29% YoY to 800 kt YoY. That said, again, taking Q4 export numbers annualized, we see that exports have recovered to the 2022 level of c. 1.1 Mt.

 Looking at margins, EBITDA margin decreased YoY to 10.3% from 21.1% in 2022 Key drivers here: Earthquake impacts (lower volumes, lower fixed cost absorption), lower steel prices (Key regional benchmark price -16% to c US$700/t) Raw materials didn't have much impact, iron ore prices flat for the year at about $114/t CFR China reference price and benchmark seaborne coking coal price actually down YoY at just under US$300/t.

 Key end markets

Flat steel is the key product for Erdemir. Within this product, Pipe and Rolling is the largest consumer at 43% of sales in 2023 followed by General Manufacturing and steel distribution. General manufacturing includes white goods. According to the company, c. 80% of sales goes to the domestic market. But interestingly, afterwards, almost half of its customers products are exported. Most of Türkiye's pipe producers are exporters.

Long products are a much smaller business for Erdemir. Key end-market / product is High carbon & special qualities.

 Deleveraging a focus

With the 2023 earthquake impacting cash flow and (fairly) high capex in 2023, net debt increased to just under $1.5 bn implying 2.3x net debt/EBITDA. The company believes that it is at an inflection point in terms of its balance sheet and sees deleveraging from there. In particular, the company sees an expected net inflow from a partial repayment of VAT receivables of c. TRY 15 bn (out of TRY 16 bn on balance sheet) with the expectation that much of this will be refunded in 2023. TRY15 bn is about $480 mn at current spot rates, so this would mean a material decrease in net debt.

Financial debt is held both in TRY and US$. The share of each can vary slightly year to year. As of the end-2023, the debt is largely US$ (c. 87%) at the end of 2022, this was c. 65%. Again because the group's functional currency is US$ and its products and costs are largely priced in US$, this seems appropriate. The company has no financial covenants on its debt. From here, we forecast deleveraging with ND/EBITDA dropping to below 1x by 2027. Reduction in ND/EBITDA is driven mainly by improved EBITDA but also a tapering of capex spend from current peak levels driving more deleveraging.

 According to the company, the group is in a period of "peak" capex with group capex about US$1 bn last year (2023) and this year (2024). As we get out to 2026/2027, this period of growth capex should be largely behind the group and free cash flow will pick up.

Another key input into this deleveraging process is the assumptions on dividends. We assume 25% dividend payout on increasing profitability while the group is deleveraging the balance sheet. In theory, the group could pay lower dividends and deleverage more quickly but given Erdemir's history as a solid dividend player, we believe management will seek to balance dividend payment vs. deleveraging. As such, dividend payout could surprise up and be higher than our assumed 25%.

 Investments for resilience

Erdemir is investing both in its steel facilities and its mining facilities. While these investments won't necessarily drive a big increase to finished steel production, the company believes that the investments will drive a better cost position and environmental performance.  Erdemir expects 2024E capex of c. US$1 bn and is expected stay elevated for the next 1-2 years before normalizing to a "non-growth" level.

New pelletizing plant = increased iron ore self-sufficiency

The company is investing in a new pelletizing facility with capex of US$550 mn which will provide c. 3 Mtpa of pellet feed. Implied capital intensity of c. $183/t appears attractive vs. global benchmarks for incremental iron capacity + pelletizing (can be $200/t for mining only). The company anticipates incremental gross profitability anticipated at $200-250 mn/year as a result of making the investment. Post the pellet plant, self-sufficiency in iron ore should increase from 15-20% to around 40%.

Investments = better cost & environmental performance

In October 2023 the company announced that it had completed the rebuilding of its Number 2 blast furnace, replacing a unit which had been in operations since the 1970s. The new furnace has marginally more capacity than the unit it replaced (1.775 Mt vs. 1.625 Mt). The company is upgrading several of its blast furnaces and coke batteries which should lead to better cost and environmental performance.

Longer term: US$3.2 bn to cut emissions

Longer term, the company plans to invest around US$3.2 bn to drive a 25% cut in its emissions by 2030.  The improvement in performance is expected to come through reduced consumption of coal by substituting with Biomass and Natural Gas. According to group CFO Serdar Başoğlu 70-80% of the $3.2 billion investment will be sourced externally accessing dedicated funds that are available for the green transition.

Decarbonization goals

Longer term, the group has plans to achieve net zero emissions by 2050 and as such is a key contributor to the Türkiye 2053 net zero emission target. Intermediate targets are lowering CO2/t of steel produced by 25% by 2030, 40% by 2040 and achieving net zero emissions by 2050. All these are compared to a base year emissions level of 2022.

Some elements of the plan include

• a 1,710,000 MWh /year solar plant.
• Investing in enhanced energy efficiency and maximizing utilization of by-product gases and waste heat.
• Establishment of a new scrap collection / processing centre.
• New pellet plant investment reduces emissions/t.
• Ongoing efforts to replace coal with Biomass which has a zero-emission factor.
• Investments in Electric Arc Furnace (EAF) technology to take advantage of steel's 100% recyclability.
• Erdemir and Isdemir also envisage production with gas-based DRI (Direct Reduced Iron) to deliver iron units with lower CO2 emissions in the medium term.

 Turkish steel outlook

Spot Turkish HRC steel prices peaked at over $1200/t in early 2022 before correcting down to around US$600/t in late-2022. Prices then rallied to over $800/t in early 2023 before again correcting to around US$600/t. Today, domestic HRC prices are around $670-680/t.

Erdemir is mainly a FLAT steel producer

HRC (Hot rolled coil) is the key product for Erdemir. It benefits from Türkiye being a market which is net short flat steel. It is the only integrated flat steel producer in Türkiye and as such enjoys a privileged market position. It is worth noting that Erdemir is NOT a rebar producer. The Turkish market is oversupplied with rebar and as such local pricing for this product is much less attractive. Similarly scrap is a key input for Rebar producers, not as much for flat steel producers. We provide rebar prices as a reference to show how HRC trades at a consistent and material premium to Rebar in Türkiye.

For Erdemir we model to a reference Turkish HRC price of c. $717/t in H1 2024, up c. 8% from H2 2023. Of course, because of its product mix and market position, Erdemir usually achieves a premium vs. benchmark price indices. For example, Erdemir's disclosed realized price for flat products in 2023A was $811/t vs. the average for this Turkish HRC spot index at $707/t during the same period.

Anti-dumping investigation could be a benefit

According to the company it generally benefits from various existing import tariffs applied by Türkiye (typically in 10-20% range), but it notes that there is an ongoing anti-dumping investigation which could be beneficial to Erdemir in the event of a positive outcome. According to the company: As a result of the application made to the Ministry of Trade by TÇÜD (Steel Producers Association) on behalf of the steel producers, an anti-dumping investigation has been started against the import of "hot rolled flat steel" originating from China, India, Japan and Russia on October 31, 2023. According to the relevant legislation, the ongoing investigation will be completed within 12 months.

Steelmaking raw materials

For reference we include price charts for key steelmaking raw materials, iron ore and coking coal based on typical global benchmark prices. It is worth noting that these tend to be reference delivery to China. Inasmuch as Erdemir is located in Türkiye, the company's realized prices and sourcing are likely to differ from other global peers.

Selected market data

(Source: Company)

Local steel production was fairly flat YoY at c. 37 Mt, impressive considering the interruption to production caused by the February 2023 earthquake. Consumption increased c. 17% YoY with demand being helped by reconstruction efforts in our view.

Exports dropped 31% YoY as more steel stayed in Türkiye again driven by reconstruction related demand. Imports increased c. 16% YoY with tonnes flowing in to balance a fairly tight local market.

 Asset description: Erdemir in brief

Erdemir (EREGL) is a Turkish listed steel producer. It has two key assets - Eregli plant (in Northern Türkiye) and Iskenderun plant (Southern Türkiye, near the Syrian border). It (normally) produces c. 9Mtpa of liquid steel, (mostly) converting this into hot and cold rolled coils and selling to third parties. The Erdemir plants are two of only three integrated steel facilities operating in Türkiye.

In 2023, Eregli plant produced 3.9Mt of steel (2.2Mt Hot and 1.6Mt Cold), while Iskenderun 3.5Mt (0.6Mt long and 2.8Mt hot). Erdemir defines "Hot" as HRC + plate and "Cold" as Cold-rolled coil (CRC), tin plate and galvanized steel. We note that production in 2023 was impacted by the February earthquake, with Iskenderun plant being in affected area, leading to a loss of approximately 3 months of production (c0.6Mt). Iskenderun produces HRC and some long-products (billets and wire-rod. No rebar). For 2024, group targets a return to c8.3-8.4Mt of normalised sales volumes for the group.

Near term investments

In the near-term both plants should see a benefit from previously announced investments in operational improvements. Key ones include:

• 2nd blast furnace in Eregli.
• 4th and 5th Coke Battery in Eregli.
• New Sinter Factory project in Eregli.
• New 3rd blast furnace construction to replace the current one in Iskenderun
• 3rd Coke Battery modernisation, New Sinter Factory and Vacuum degassing plant in Iskenderun

Key steel production assets

At the Eregli site in Northern Türkiye, the group has two blast furnaces having capacity of c. 4 Mtpa of crude steel and 5 Mtpa of finished product capacity.

At the Iskenderun site in Southern Türkiye, the group has four furnaces with a capacity of c. 5.6 Mtpa of hot metal. This site can produce flat products and some long products and also ships some slab to Eregli for further processing.

Iron ore: Increasing production

 In addition, a previously announced development of a new pelletising plant ($550m total cost, with a capacity of 3Mt per annum) should allow the company to improve its supply of ore from 15-20% to 40-45% according to the company.

Total capex for 2024 is expected by Erdemir to be around $1bn (similar to levels of 2023 - $977m), marking a peak capex year. Investment expenditures should decrease from this level as most of the presently planned programs would be complete. The company does not provide any estimate for expected cost savings or EBITDA from these investment programmes.

Erdemir is (mainly) a flat steel producer

Erdemir is an integrated producer of flat steel, the only one in Türkiye. While Türkiye is "long" long products (rebar) it is slightly short flat steel meaning that Erdemir has a privileged position in terms of a naturally tight home market. Erdemir's typical mix is about 90% flat steel vs. c. 10% long. A normal capacity utilization is c. 90%. 2023 was an exceptional year and this utilization figure dipped to c. 75% but has now recovered.

US$ functional currency = Weak TRY is beneficial

Globally, steel production costs are largely US$ denominated (iron ore, coal, other energy). Typically the main local cost is labour. While Erdemir reports in TRY for its statutory accounts it uses the US$ as its functional currency and reports both currencies in its accounts. Revenues that are US$ denominated translate into higher TRY revenues when converted at a weaker exchange rate. The main local cost which could be exposed to high cost inflation is labour but there is a degree of natural offset here i.e. TRY costs against US$ priced (natural) revenues.

Energy: c. 50% self-generated

The company generates c. 50% of its electricity requirements from off-gas from the blast furnaces. Beyond this it purchases natural gas from the local utility and purchases electricity on the local spot market.

Brief company history

In the 1950s, Türkiye's industrial production capacity underwent a paradigm shift. The number of dam constructions increased and the rate of urbanisation accelerated. This led to an increase in demand for flat steel, which foreign currency reserves struggled to meet. In 1960, Erdemir was founded, with first production achieved in 1965.

In 1996, the company underwent modernisation, expanding the capacity of plants and completing Erdemir port (one of the largest in Türkiye). Erdemir has made several acquisitions, including flagship Isdemir. The company is owned by Oyak, the Turkish military's pension fund.  The company typically pays a sizeable dividend.