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Fertilizer Sector - Rabi’23 commences with healthy numbers!, (AKD Monthly Report, Nov 20' 2023)

After much discussions, OGRA issued the long awaited gas price revision notification (effective: Nov’23), increasing prices for all categories. For the fertilizer sector, companies on the SUI network’s (FFBL and EFERT) prices changed from PkR510/mmbtu to PkR580/mmbtu (feed) and PkR1,580/mmbtu from PkR1,500/mmbtu (fuel). However, the notification has again remained silent on the MARI network’s prices, reducing transparency on the same.

Overall, the price change effect to fertilizer companies has remained small in comparison to other sectors, which saw an upsurge in between 60% - 200%. Understandably, the fertilizer sector remains an integral part of the agricultural ecosystem, attracting sufficient protection from the government in order to maintain low urea prices to maintain farmers’ affordability (domestic urea price is at a 40%-50% discount over international urea).

Previously, the country’s annual urea demand stood at  ~6.0—6.5mn tonnes, but given the hike in demand (CY22 total offtakes closed at ~6.7mn tonnes) we can safely assume the year to close in line with CY22. We expect the said demand to only grow with the onset of an agri revolution and corporate farming activities, etc. through increased focus in the SIFC.

Oct’23 offtakes remained strong owing to Rabi cultivation: Total urea offtakes increased 7%YoY, but saw a sharp decline of 19% over the previous month. We believe this to be the result of higher than average sales achieved during the 3QCY23 over market expectations of price hikes, setting a high base. Hence with the exception of FATIMA’s Sheikupura plant (DH), all other producers saw declining numbers. In absolute terms, Oct’23 urea offtakes were ~459k tonnes vs. ~430k tonnes remaining largely in line with prior years.

On the other hand, DAP volumes continued their YoY growth spree, staying higher by 122% vs. SPLY and 50%MoM in preparation of the Rabi’23 season’s requirement and anticipation of further increase in global prices, in our view; domestic prices have reached almost PkR13k/bag, standing at ~PkR12.8k/bag presently. This is due to the increasing pressure from high raw material prices where global phosacid prices have seen a surge from US$850 in the last quarter to US$985/tonne currently. Overall, DAP volumes for Oct’23 stood at 159k tonnes vs. 106k tonnes in the previous month, and we believe DAP offtakes can close the year at ~1.5mn tonnes (~↑25% compared to CY22). Albeit, this is lower than the long term average of ~2.0mn tonnes.

Fertilizer prices are at an all time high: Current Urea MRP stands at ~PkR3,400/bag, rationalized across the sector, being at their all time highs. Whereas DAP MRPs have exceeded PkR12,000/bag (currently at ~PkR12,800/bag) challenging the highs set post COVID-19 commodity boom (Prices exceeded PkR14,000/bag). Market prices are a different story, which crossed PkR4,000/bag during the year for urea and remained elevated for DAP, attracting significant government attention to curb the illicit profiteering. However, as per PBS urea retail prices currently remain in the ~PkR3,700/bag range, in line with Sep’23. Furthermore, global DAP and phosacid prices are strengthening creating the possibility of further price increases locally.

Owing to our analysis as set out below and the relative strength of the sector, with urea trading at a 40%-50% discount, we remain bullish on the AKD fertilizer universe with its regular dividend paying capacity and subsidized feed gas costs, alongside inelastic demand being an integral component ensuring food security keeps the sector safe in the medium to long term.

Gas price revised, effective from Nov, 2023: There remained significant discussions on gas price revision across the board to curb the ever growing circular debt. Owing to its significance in landing a successful IMF review,  the ECC met on Oct 23, 2023 and increased prices, following which OGRA issued the revision notification. As per understanding, prices were to be rationalized across industry, with feed gas increasing to PkR580/mmbtu from PkR302/510 per mmbtu, and fuel gas from PkR1,023/1,500 per mmbtu to PkR1,580/mmbtu. However, the OGRA issued notification remains silent on price increase for MARI network companies, namely FFC, FATIMA and EFERT (though the latter is billed as per SNGPL tariff but receives feed gas at the FP-01 rate of US$0.7/mmbtu owing to a stay order) presenting difficulties in ascertaining whether the above mentioned companies will continue to receive gas at prior rates or new rates. This was the case in Feb’23 notification as well, and FFC and FATIMA received a price advantage in urea over their competitors.

However, we have accounted for price rationalization in our estimates, prudently.

FFC: During the current month, FFC registered a ~28%/12% MoM/YoY decline in urea offtakes, although DAP offtakes witnessed a 59x/3x MoM/YoY hike in volumes. We attribute higher than usual sales of urea in the prior quarter to expectations of price increases, as the main reason for this decline. However, on a cumulative basis a ~5%/61% YoY/YoY was seen in urea/DAP offtakes, respectively for the 10MCY23. Capacity utilization during the period remained at 125% in line with historic trends. FFC previously enjoyed the lowest price in the sector, however, the current price is in line with the sector at ~3,400/bag, incorporating a portion of the gas change effect. The company’s market share stands at 38% for CY23 to date, leading the sector in urea offtakes.

EFERT: The company registered a 12%MoM decline in urea offtakes for the month against a 77.1%YoY increase. The MoM fall is due to the high base effect, however the YoY hike is because of lower urea availability with the company in SPLY owing to base plant turnaround. However, DAP volumes registered a 16%/36% MoM/YoY increase owing to better demand prospects ahead of the Rabi’23 season. 10MCY23 figures saw an increase of 17%YoY for urea and a modest 4%YoY increase in DAP offtakes, where company’s urea MRP remained in the range of PkR2.4k – 3.4k/bag, and DAP prices crossed PkR12.8k/bag in the month in review. EFERT’s market share clocked in at 35% for CY23 to date, just behind FFC, making it the second largest urea seller in the country.

FFBL: Oct’23 numbers suggest a 9%MoM drop in DAP offtakes, staying lower than prior 5yr October average of 87k tonnes. We do not consider any significant mitigating factor to this effect. However, a sizeable 1xYoY hike in offtakes was witnessed owing to demand destruction last year due to floods and high commodity prices globally. FFBL has secured a 59% market share YTD vs. 51% in SPLY. Furthermore, urea offtakes declined by 24%/66% MoM/YoY continuing with the downward trend posted by major players and possibly due to the company’s comparatively more expensive granular urea (~PkR3,800/bag). Cumulatively, FFBL posted a 66%YoY hike in DAP offtakes, with urea volumes down by a sizeable 35%. In addition, the company has received a firm commitment from the govt. for ensuring gas supply throughout the Rabi season (upto Mar’24), therefore, the plant will not enter a turnaround during the start of next year, as is seen from past practice.

FATIMA: The company’s performance remained impressive during Oct’23 with an aggregate 6%/20% MoM/YoY increase in urea offtakes from all three plants. The Sheikhupura plant (DH) performed well with a 28%MoM increase in urea offtakes. Sadiqabad plant’s urea offtakes declined by 5%/19% MoM/YoY, with a 43%/45% MoM decline in NP and CAN offtakes. Overall, we believe the company to remain strong since the government would allow urea manufacturers to remain operational in order to reduce reliance on imports of urea (expected shortfall through news flows is 200k tons).  Furthermore, the Sheikhupura plant will continue to receive uninterrupted subsidized RLNG till Mar’24 to ensure urea production.

Outlook: We expect the sector to remain under pressure due to rebasing of gas tariffs, reducing subsidies thereby increasing costs and prices. However, being the sector ensuring food security, it is unlikely for the government to remove/reduce subsidies significantly so as to ensure positive farmers’ economics. Talks on WACOG, if implemented, will mean gas price unification which would be negative for the sector especially in the face of possible regulation of fertilizer prices, urea specifically. We prefer all companies within the AKD universe owing to stable demand and govt. support within the agriculture industry, and cash rich balance sheets cushioning against adverse developments.