Ezz Al Dekhela (EZDK) [IRAX.CA], a 55%-owned subsidiary of Ezz Steel [ESRS.CA], has reported its 2Q16 standalone key financial highlights, with net loss coming in at EGP187mn vs. a net loss of EGP297mn in 1Q16 and our net loss estimate of EGP133mn. Operationally, gross profit came in at EGP207mn, ahead of our EGP127mn estimate, as gross margins expanded during the quarter to 8.9% (+29 Y-o-Y, +63% vs. estimate). The gross margin expansion was likely driven by a mix of: i) higher-than-expected DRI integration level; and ii) draw-down on low-cost inventories from 1Q16, as iron ore price was at its lowest point of cUSD40/tonne.   Despite the beat on the operational level, net loss was worse than expected, likely on: i) higher interest expenses, given the company's exposure to variable interest rate debt; and ii) non-operational expenses. While the full set of results have not yet been released, the lower net loss figure Q-o-Q was likely driven by a substantial FX loss of EGP415mn that was booked in 1Q (following the devaluation in the EGP during March). We think that EZDK did not book any material FX loss during 2Q as the official USD-EGP rate remained flat.   How would this translate to Ezz Steel consolidated results? With net loss continuing to plague Ezz Steel's main subsidiary (EZDK) in 2Q, it is likely that the group would continue to face a tough time during 2016, and we estimate that Ezz Steel results would still be in the red for 2Q16 and come in at a net loss of EGP153mn. Overall, the worse is yet to come for Ezz Steel in 2016, in our view, as: i) gas supply cuts during the summer will add pressure on DRI integration levels; and ii) risks of further EGP devaluation could result in the booking of more FX losses.   Despite the negative factors surrounding Ezz Steel's operations today, we think that some positive factors are not yet priced in, mainly anticipated improvement in gas utilisation rates in the coming years, which should drive a substantial recovery in margins and earnings. On gas prices, it remains unclear if the government would move ahead, with the cut to USD4.5/mmbtu (from USD7/mmbtu currently), given several hesitant moves in applying the price reduction in the past months. Nevertheless, if this decision were to be applied, we think that earnings could see considerable levels of upside on cost savings of USD25/tonne. Looking at 2017, Ezz Steel trades at an attractive P/E of 7.4x; hence, we reiterate our Buy rating on the stock. (Earnings release, Ahmed Hazem Maher)   Ezz Steel: EGP8.67 as of 16 August 2016, Rating: Buy, FV: EGP12.00 per share, MCap: USD530mn, ESRS EY / ESRS.CA