AISHA STEEL MILLS LIMITED SET TO LEAD COLD ROLLED COIL (CRC) SALES DOMESTICALLY IN THE STEEL INDUSTRY OF PAKISTAN

AN INTERVIEW WITH MR. KASHIF SHAH, CHIEF EXECUTIVE OFFICER, AISHA STEEL MILLS LIMITED

SAAD ANWAR HASHMI
(feedback@pgeconomist.com)

Oct 15 - 21, 20
12

PAGE: PLEASE TELL US SOMETHING ABOUT YOURSELF AND YOUR CAREER?

KASHIF SHAH: I graduated from LUMS with an MBA in 1994. After graduating, I joined a brokerage house by the name of Trust Securities in Corporate Finance which was started by a consortium of banks. I found working there relatively a smaller platform which induced me to join Prime Bank, the only bank having its headquarters in Lahore. With Trust Securities, I worked in Corporate and Investment Banking and looked after Project Finance transactions for about two years. I again felt it was a smaller platform which is when I came to Karachi in 1997 and joined JP Morgan as an Associate. JP Morgan later exported me to Hong Kong in Mergers and Acquisitions. Upon my return in 2001, I joined UBL at a time when the bank was setting up its Investment Banking division. I worked with UBL as Head of Investment Banking upto 2005. In early 2006 I joined HBL as Head of Investment Banking where I stayed till late 2009 before joining Byco Group as Sponsor's Advisor and Director. In August 2011, I joined Aisha Steel Mills Limited as CEO. I am also on the board on Arif Habib and am part of the team involved in strategic decision making for the entire group.

PAGE: PLEASE TELL US ABOUT THE BUSINESS MODEL OF AISHA STEEL MILLS LIMITED (ASML)?

KASHIF SHAH: ASML is the most state of the art Cold Rolling complex with a nameplate capacity of 220,000 metric tons per year. ASML represents one of the largest private sector investments in the steel industry of Pakistan. It is the only Cold Rolled Coil (CRC) manufacturer in the country which is using brand new Japanese machinery for all of its main processes, ensuring best quality production of CRC in the country. ASML is also the largest CRC producer in Pakistan. We have recently declared COD and are currently operating at 70 percent capacity which shows remarkable success for us. The company is a joint venture between Arif Habib Group, Metal One Corporation, Japan and Universal Metal Corporation, Japan. ASML produces CRC's as per international standards from imported Hot Rolled Coils (HRC). Our Group Chief, Mr. Arif Habib believes in professional management, therefore I have been given a lot of power to make strategic decisions. ASML is therefore run like a qusai multinational in the domestic market. Our management team is professional and bring is wealth of experience from the industry. ASML is the largest investment in the steel sector after Pakistan Steel. I am also pleased to inform that ASML has been awarded an A-/A-2 rating by JCR-VIS which is incredible considering that we have just commenced business.

PAGE: WHAT ARE THE PLANS TO INCREASE THE CAPACITY UTILIZATION FROM CURRENT 70 PERCENT TO 100 PERCENT REACHING THE THRESHOLD OF 220,000 METRIC TONS PER ANNUM. CONSIDERING THAT THE PRODUCTION WILL BE RAMPED UP GRADUALLY, HOW DO YOU SEE THE BOTTOM LINE FOR ASML BY DECEMBER 2012.

KASHIF SHAH: When I joined ASML, there were a lot of learnings. The first learning was how do we communicate and inform the bankers and investors about ASML as a business as generally banks or even investors would know less than what is actually going on in the company internally. The ramp up in a greenfield project like ASML is a challenging task, however, considering that we are operating at 70 percent capacity within the first year is a great achievement for the engineers and the technicians working on the plant. We had already achieved 50 percent capacity within the first month of declaring COD which again is an achievement on its own. There are a number of issues which keep springing up as the production levels increase, however, each issue will be addressed as production and capacity utilization improves. We hope to achieve 100 percent capacity utilization in 2013 and believe we can even exceed the given threshold. An important thing to mention is that when we say the capacity is 220,000 metric tons, this is based on Japanese standards whereas standards within Pakistan are not as stringent. Therefore, our production levels being achieved with the installed machinery are at par with international standards.

PAGE: SBP RECENTLY REDUCED THE DISCOUNT RATE TO 10 PERCENT TO INCREASE PRIVATE SECTOR CREDIT IN LIGHT OF DECREASING INFLATION. SUCH CREDIT TO MANUFACTURING CONCERNS WOULD PRIMARILY BE CHANNELIZED THROUGH CORPORATE AND INVESTMENT BANKING. CONSIDERING THAT BANKING SECTOR NPL'S HAVE SURPASSED PKR 650 BILLION AND THAT BANKS ARE PRIMARILY CAPITALIZING ON THE CURRENT PORTFOLIO MARGINALLY SEEKING NEW RELATIONSHIPS, WOULD YOU EXPECT AN INCREASE IN PRIVATE SECTOR CREDIT.

KASHIF SHAH: The reduction in discount rate is positive sign and a step in the right direction by SBP to encourage lending which eventually will create more jobs and will assist economic welfare. I personally believe that inflation in a country like Pakistan is not liked with interest rates as inflation is liked with commodity prices. We are not a consumer finance driven market where you increase the interest rate to control spending. Hence, I do not agree with the usage of interest rate to control inflation. With respect to the industry, we are already facing a number of challenges e.g. law and order issues, energy shortages, high cost of inputs whereas the industry is further being choked through high interest rates. I believe that the discount rate of 10 percent is still high and would need to be reduced further.

PAGE: WHAT CHALLENGES DOES THE INDUSTRY FACE WITH HIGH INTEREST RATES IN ORDER TO BE COMPETITIVE IN INTERNATIONAL MARKETS AND HOW MUCH SHOULD INTEREST RATES IN PAKISTAN FURTHER REDUCE.

KASHIF SHAH: The reason why I say that interest rates are still high is because we want our industry be it Steel or any other industry to compete in international markets. Interest rate in China is 5.8 percent. In Japan and Korea form where we import our raw materials, the interest rate is less than 3 percent. If my raw materials come from Korea and Japan with low interest rates, they enjoy low cost financing advantage which is lost in Pakistan since KIBOR are high. I believe that the interest rate should come down to 6 percent or even lower for enable the entire industry compete internationally.

PAGE: IT BEEN OBSERVED THAT BANKS WOULD INVEST IN TREASURY SECURITIES TO FINANCE BUDGETARY DEFICIT TO EARN A RISK FREE RATE WHICH HAS RESULTED IN CROWDING OUT. DO YOU THINK IF THE GOVERNMENT KEEPS BORROWING FROM THE BANKING SECTOR, PRIVATE SECTOR CREDIT WILL BE ON A STATUS QUO EVEN IF THE RATES ARE DECREASED?

KASHIF SHAH: The answer to this question doesn't lie on reduction in discount rate, the answer relies on either we have a government which doesn't need to borrow with I do not foresee in the near future or SBP makes a policy targeting this particular aspect. SBP as an example can impose certain levies on lending done by banks to the government which would discourage the banks to lend to the government. Another thing that SBP can do is to partially take treasury securities out of Statutory Liquidity Requirements (SLR) which again would encourage banks to lend to the local industries. Lowering of the discount rate will not assist lending if other factors as I have mentioned as an example are not implement to increase lending. It is currently disappointing that banks can lend to the government to earn a risk free rate considered AAA rated and meet their required annual targets simply through government lending rather than focus on earnings through advances driven through Corporate and Investment Banking, Commercial, SME and Consumer Banking. Industrialization will not be encouraged through reduction in discount rate keeping other factors constant.

PAGE: ASML IS A GREENFIELD PROJECT AND BORROWING AT COMMERCIAL MARK-UP RATES. AS SBP HAS ENCOURAGED EXPORTS THROUGH VARIOUS PRODUCTS E.G. ERF AND LTFF, WHAT POLICIES SHOULD BE BROUGHT IN PLACE TO ENCOURAGE GREENFIELD INVESTMENTS?

KASHIF SHAH: SBP should introduce policies where greenfield investments could be done at subsidized rates to encourage investments. Independent of discount rate or KIBOR, why is it that greenfield projects cannot be provided with financing at 2 percent or 3 percent for the first 3 years or first 5 years. Such a financing option will encourage more investments in such projects. In the past when interest rates were low, people borrowed an invested in real estate within Pakistan and abroad rather than projects. Therefore simply lowering of the interest rate with claims that industrialization will start will not yield results and will be abused unless strategies to increase lending is defined and implements. The discount rate should therefore be lowered further to 6 percent with subsidized financing for greenfield projects. Keeping with an example, SBP could introduce a policy where by a project in excess of PKR 500 Million meeting certain financial and non-financial parameters will be given financing at 2 percent for 5 years as a long term loan or working capital line at 2 percent for the first 3 years.

PAGE: WE KNOW THAT ASML IS THE LARGEST CRC PRODUCER OPERATING IN PAKISTAN USING LATEST JAPANESE TECHNOLOGY. INCLUDING THIS, WHAT ARE THE CORE COMPETENCIES OF THE COMPANY IN COMPARISON TO ITS COMPETITORS IN THE INDUSTRY?

KASHIF SHAH: We pride ourselves having the largest CRC manufacturing facility and the only manufacturing facility using latest Japanese technology. We are the only CRC Mill which can meet the requirement high-end to low-end using specialized machinery which only ASML has. We in Pakistan are targeting and achieving Japanese standards. Our products are sold at a premium as compared to others in the market since our quality is unmatched by other competitors. Today are prices are higher than Pakistan Steel Mills and International Steel Mills and are still able to sell our product since we offer better quality which the buyers have accepted. We are the only CRC mill with an exclusive dealer network in Pakistan. We want to make a name for ourselves in the industry which has been abused through imported CRC having inferior quality which has not helped in developing the vendor industry. Using the exclusive dealer network, our vendor industry will be developed domestically whereas awareness about quality will also be raised. If auto makers have access to quality CRC, they may even export vehicles.

PAGE: PLEASE TELL US ABOUT THE PRICE AT WHICH YOUR PRODUCT IS CURRENTLY BEING SOLD IN COMPARISON TO OTHER PLAYERS IN THE MARKET.

KASHIF SHAH: Different thickness has a different price but the benchmark price is usually 1 mm. For 1mm our price is PKR 73,000 per ton before sales tax. International Steel is selling for around PKR 72,600 per ton before tax whereas Pakistan Steel is selling for around PKR 72,100 per ton before tax. ASML is selling at a premium for the quality being offered.

PAGE: THE AUTOMOTIVE SECTOR PRODUCED 157,000 CARS IN FY12 WHICH IS EXPECTED TO REACH 200,000 BY FY13. A MAJOR CHUNK OF SALES BY ASML WILL BE DIRECTED TOWARDS THE AUTO SECTOR. CONSIDERING THAT CRC SOLD BY ASML IS AT A PREMIUM AND CRC IMPORTS ARE ALSO AVAILABLE AT A LOWER PRICE, WOULD THIS AFFECT THE OVERALL OFF-TAKE OF YOUR PRODUCT IN THE AUTOMOTIVE SECTOR SINCE MANUFACTURING CONCERNS TRY TO CUT CORNERS TO SAVE ON PROCUREMENT AND RAW MATERIAL COST?

KASHIF SHAH: The prices I had mentioned earlier were for commercial sales. For automobile manufacturers, the prices are much higher and they are interested not in lower prices but quality which is extremely important for the end buyer of a vehicle. If any customer would go to purchase a brand new car, they would expect the highest quality standards which ASML produces. The quality of imported CRC is inferior to the product sold by ASML. This is where ASML has a stated goal that we want to be the best CRC manufacturer in the world not just in Pakistan alone. We have the latest technology to produce CRC and are buying raw materials from global giants like Nippon Steel and Kosco. We therefore produce CRC at par with international standards and better than imports and other players in the domestic market. Whatever we produce is immediately sold which shows the success of our product. Auto manufacturers would not mind paying more for CRC otherwise they would end up in claims which they would avoid. In order to be competitive, our prices will always remain at import parity. Therefore, whatever price at which a company in Pakistan can import, ASML will sell at that price.

PAGE: WHAT IS THE TARIFF PROTECTION GIVEN BY THE GOVERNMENT TO THE DOMESTIC CRC INDUSTRY AND HAS IT DISCOURAGED IMPORTS SPECIALLY LOOKING AT CHINA. ADDITIONALLY, WHAT CHALLENGES DOES THE INDUSTRY FACE?

KASHIF SHAH: In an environment where we have to give a mark-up of more than 10 percent on borrowed funds and that the Japanese counterparts pay less than 2 percent or even 1 percent, it is not a level playing field where we have to face higher costs which eats into our margins.

Pakistan has signed Free Trade Agreement (FTA) with China to promote trade of those goods which one country produces and are deficit in the other country. CRC was also put in that list as Pakistan was importing more than 50% of its CRC. However, with commissioning of Aisha Steel and International Steel Limited in last 2 years, the CRC demand can be met locally. Hence, CRC should be excluded from China-Pak FTA so that local manufacturers can enjoy level playing field. With the FTA with China, Chinese companies can sell CRC to Pakistan at only 5 percent duty against protection of 10 percent from other countries. End users had gotten concessional tariff under SRO-565 because more than 50% CRC was being imported. As the local CRC industry can substantially meet all of the local demand, CRC should be taken out of SRO-565. Currently the tariff protection on CRC import is only 10% which is low. In other countries like Malaysia, Bangladesh, etc this is upto 35% so that local industry can be given ample protection to compete against global giants and also create cushion for growth.

In Pakistan, CRC industry's localization is a recent phenomenon and therefore a higher than 10% protection should be provided in line with above mentioned countries. A 25% tariff protection would be appropriate and would encourage further value-addition amongst the local CRC producers. We do not see Pakistan Steel and International Steel as our competitors, we see them more as partners in developing this local industry. The real challenge and competition the industry is facing is through imports, particularly China being the largest exporter of CRC in the world. As an industry we want a better tariff protection. China is facing massive over capacity which is being sold at reduced prices with which industry like Pakistan is finding hard to compete. In China the interest rate is 5.8 percent where we domestically pay more than 10 percent minimum.

Another major challenge is the difference between primary and secondary quality at customs level. Custom gives a 21 percent discount on the secondary quality which is not anywhere in the world where the difference between in discount between primary and secondary is just 3 percent or 4 percent. When CRC is imported, it is appraised on the value Custom authorities have based London Metal Exchange where the last three month average is taken to identify the duty to be charged. The import mafia in this regard gets the benefit. If discount is given at 21 percent, custom duty is given on 79% of the value rather than 97 percent where the import mafia evades taxes.

PAGE: WITH DEVALUATION OF THE RUPEE AGAINST THE DOLLAR, HOW DO YOU HEDGE THE RISK ASSOCIATED WITH IMPORTS?

KASHIF SHAH: We have a natural hedge as the prices offered to the buyer are import parity prices. If devaluation takes place, an increase in import cost is eventually transferred to the end buyer, which once again the buyers have accepted against the quality being sold.

PAGE: THE BUSINESS MODEL OF ASML IS DESIGNED TO RUN FOR 330 DAYS A YEAR WITH A SHUT DOWN PERIOD OF 30 DAYS FOR MAINTENANCE. HAVE YOU ACCOUNTED FOR ANY LOSS IN PRODUCTION IN YOUR ASSUMPTIONS DURING THE MAINTENANCE PERIOD? DO YOU FORESEE ANY ADDITION TO EXISTING MACHINERY?

KASHIF SHAH: We do not foresee any addition in machinery this year since the technology and machinery is new. The 30 day period is divided by 12 which means that the plant will is being allocated 2 to 2.5 days a month for maintenance purposes. The regular maintenance and cost associated with the maintenance is being managed where we for not see any capex.

PAGE: WITH THE CAPEX INVOLVED TO SETUP SUCH A PLANT AS ASML, DO YOU SEE ANY NEW ENTRANTS COMING INTO THE MARKET?

KASHIF SHAH: We hope there are new entrants in the steel sector because the road to development of any country like Pakistan will be through Energy and Steel. There are no current plans of any company planning to launch a project in CRC. At this stage it is probably too late to plan such a project since ASML, Pakistan Steel and International Steel will cater to the entire market demand. Based on future plans, we hope to expand our capacity to 360,000 tons which is when we will export CRC. This is also where we will compete with Japanese, Korean, Chinese and Indian firms. A number of our machines already have the capacity to reach 360,000 tons. With minimum capex, we shall be able to achieve even higher production levels. The first challenge is that since we have just entered the market, we would like to stabilize our cash flows before we focus on expansion.

PAGE: DID YOU CONSIDER THE OPTION WHERE RATHER THAN GOING THROUGH DEALERS, YOU COULD SELL DIRECTLY TO THE END BUYERS SINCE YOU WOULD BE ABLE TO SAVE ON THE DEALER MARGIN AND GIVE BENEFIT TO THE BUYER?

KASHIF SHAH: We have divided the customers into two categories i.e. large customers who do not go to the dealers to whom we sell directly and others who purchase our product through the dealers. The large customers primarily includes OEM's. The challenge was how to sell to other customers through our network of dealers. We have 18 top dealers who were chosen on stringent requirements which they had to meet. We were able to finalize the dealer network through the help of Mitsubishi Corporation in Pakistan who look after sales and marketing of 100 percent of the product for ASML. We sell to the dealers on cash who then sell to other buyers on credit. If we had sold directly on credit, there would have been a possibility that some would have defaulted on the payments, some would not have paid us within the credit period and transaction cost to ensure recovery would be an unattractive option. Using the network of dealers, we do not have to worry about recovery and are able to get cash as soon as sales are made. Dealers personally know the buyers and are more savvy to recover after providing the credit.

PAGE: PLEASE TELL US ABOUT PROCUREMENT OF RAW MATERIALS AND CHALLENGES IF YOU HAVE FACED IN THIS REGARD?

KASHIF SHAH: We are fortunate that we import from Nippon Steel which is the second largest steel mill in the world and also Kosco which is the third largest steel producer in the world. These two are regular suppliers. Saudi Arabia has an export duty since the domestic demand is so much that they want to keep all the CRC produced locally for domestic use. This is the reason why we do not import from Sabic in Saudi Arabia since in terms of cost it will not be viable. We have not faced any challenges with imports since we get our raw materials from the best steel manufacturers as mentioned earlier.

PAGE: BANKS ARE GENERALLY SERVICING THEIR CURRENTLY PORTFOLIO AND ARE VERY CAUTIOUS WITH FRESH LENDING. WITH ASML BEING A NEW PROJECT, HAVE YOU FACED ANY HURDLES FROM BANKS WITH THE FINANCING AND DO YOU FORESEE ANY HURDLES IF YOU APPROACH BANKS GOING FORWARD FOR SHORT AND LONG TERM LINES TO SUPPORT EXPANSION?

KASHIF SHAH: When we approached our lenders, the foremost factor was the credibility of our sponsors which the banks considered as Arif Habib group has a strong footing in the market. The Group has an amazing track record of keeping its word and promise. Mitsubishi Corporation is bigger than Pakistan and have deep pockets who we are associated with. Additionally with the quality of the product and the technology, lenders found their comfort. We have Japanese engineers on ground looking after the production which is also a plus point. Since ASML business is based on import substitution, this also helps in selling our case to the lenders and investors alike. In order to make a name for ourselves in capital markets, we will be issuing our first Sukuk in October 2012 or November 2012 worth a ticket size of PKR 500 Million. These funds will be used for working capital requirements. The tenor of the Sukuk will be six months charged on current assets.

PAGE: WHAT ARE YOUR PLANS FOR INTERNATIONAL EXPANSION AS YOU HAVE MENTIONED THAT ONCE CAPACITY FURTHER INCREASES, EXPORTS WILL BE A POSSIBILITY?

KASHIF SHAH: The question is challenging as we need to decide whether we expand our plant domestically or go into a joint venture internationally and expand internationally. From the stand point of Capex it makes sense to expand domestically as the market already is aware of ASML and the quality of the product on offer, therefore it will be easier to get financing. From the perspective of market protection and tariff perspective, it makes more sense to expand internally as the duty protection and tariff benefit will be there. It is too early to decide which model for expansion we will eventually follow. The first year we will stabilize our cash flows and start paying mark-up on debt borrowed and later will focus on expansion.