Ezz Al Dekhela (EZDK) [IRAX.CA], a 55%-owned subsidiary of Ezz Steel [ESRS.CA], has reported its consolidated 2Q16 financial results, showing net loss of EGP238mn (nearly flat Q-o-Q and vs. EGP156mn net loss in 2Q15), which was significantly weaker than our EGP144mn net loss estimate. Revenue fell to EGP2.7bn (-23% Q-o-Q ,-15% Y-o-Y), mainly as market demand softened (-33% Q-o-Q) on: i) seasonal impact from lower sales during the month of Ramadan; as well as ii) sudden price changes (+18% Q-o-Q) that followed the EGP devaluation and the movement in international steel markets. While standalone gross margin improved to 8.9% (vs. 8.3% in 1Q16) on: i) nearly flat DRI integration level of c70-75%; and ii) access to cheap iron ore from inventories bought at the commodity's bottom during 1Q16, consolidated margin fell and was affected significantly by weak operations at EFS. We think that the operational weakness at EZDK's subsidiary (EFS) is mainly due to the fact that the company is still adjusting to transforming into a DRI-integrated facility, as the new DRI plant has been ramping up production in 2Q, with gas cuts likely being prevalent at the new DRI plant (more so than EZDK's existing DRI facilities).   Surprising FX losses as the company reduces FX debt exposure: The main surprise we see in EZDK's results comes from the appearance of a EGP180mn FX loss, which we had not accounted for in 2Q16, as there was no move in the official FX rates. However, based on our discussion with management, the company decided to reduce its balance sheet’s FX exposure by paying down some revolving FX-denominated debt facilities, resulting in the loss. These debt facilities have been utilised mainly for the purchase of imported raw materials, and posed a balance sheet risk. We think that the company's preemptive decision to reduce FX exposure is a prudent move, especially as the market prepares for a possibly substantial move in official FX rates, which should have possibly a larger impact on the company's results. The decision to cut FX debt exposure also frees up EGP-denominated cash balances, which have been restricted at the banks as collateral for the FX debt facilities.   Impact on Ezz Steel's 2Q16: Overall, the poor results shed light on the still-weak operational environment that steel producers face. We are already expecting Ezz Steel to be loss-making in 2Q16, but now believe 2Q16 results will likely be much weaker than anticipated initially. This is driven primarily by: i) cost of reducing FX debt exposure; and ii) seasonally weak sales figures on the back of Ramadan and sudden price movements. Accounting for the EZDK results and the FX loss that emerged, we think EZZ Steel's 2Q16 consolidated net loss could reach up to EGP300mn.   Remain Buyers as LT dynamics are still attractive: We still believe losses will continue to hit Ezz Steel throughout 2016, while a recovery in earnings requires a number of factors to play out; namely: i) improvement in global steel pricing; ii) recovery in Egyptian gas supplies; and iii) stable and available FX scene in Egypt. On gas pricing in Egypt, the debate between government entities is still ongoing to either cut gas prices to USD4.5/mmbtu or keep it the same at USD7/mmbtu. We believe the decision to cut gas prices could offer an attractive cost saving of USD25/tonne, if applied, but it remains unclear if it would take place. Looking ahead of 2016, we think that the stock is offered today at a cheap 2017e P/E multiple of c6x; hence, we remain Buyers. (Earnings release, Ahmed Hazem Maher)   Ezz Steel: EGP7.25 as of 25 September 2016, Rating: Buy, FV: EGP12.00 per share, MCap: USD444mn, ESRS EY / ESRS.CA