EUR 34.80 For Business Accounts Only

Pakistan Fertilizer: Pricing Momentum Looks Supportive Market weight ‘Maintained’

• Investment thesis: We revisit our stance on Pakistan Urea manufactures; Fauji Fertilizer (FFC) and Engro Fertilizer Limited (EFERT) and revise up our earnings estimates by 3-20% for 2018-2020. This is after 1) incorporating 2017 financial results, 2) ease off in urea inventory pileup, resulting in higher retention prices and lower discounts, 3) production curtailment by relatively high cost LNG based manufacturers, and 4) rising domestic/international Urea prices, enhancing GP margins.
• 2017 Results – Earnings increased by 6.3% YoY: During 2017, profitability of the urea manufactures witnessed rise of 6.3% YoY, to Rs23bn as net sales of  manufacturers  increased by 18% YoY owing to increase in urea offtakes by 14.1% YoY to 4.7mn tons (including exports of 445k tons). Excluding exports, urea sales of the companies grew by 3.2% YoY owing to 1) continuation of subsidy, 2) higher discounts offerings by manufacturers to alleviate surplus inventory and 3) improved farmers economics. To note, 2017 financial results remained better than our expectations.
• Inventory glut over: The concern of inventory glut prevailing since Aug 2015 has normalized to 264k tons as per Jan 2018 data released by National Fertilizer Development Centre (NFDC). This is almost equivalent to ten years average inventory of 274k tons and substantially lower than average inventory stock 1.1mn tons in last 29 months. Lower inventory could be attributed to 1) Govt. allowed exports of 600k tons, and 2) lower production after disruption in production of few manufacturers.
• Urea price to accede inflationary pressure: Urea prices, post inventory depletion period improved to average Rs1,389 per bag in 4Q2017 against 9M2017 average of Rs1348 per bag, while current urea price is hovering at Rs1400-1420 per bag. This has helped manufacturers to pass on budgetary impact of subsidy reduction by Rs56 per bag (subsidy on urea was reduced from Rs156 to Rs100 per bag), we believe. Given tight supply situation amid disrupted production by Agritech and FatimaFert, we opine manufacturers would be able pass on cost inflationary pressure, going forward.
• Urea production curtailment: Urea production during 2017 declined by 6% to 5.6mn tons due to intermittent operations of LNG based manufactures (DH Fertilizer, Agritech, and Pak Arab) as Govt. diverted their allocated gas supply to retail consumers in winter season. Fertilizer production using LNG as a feed is not a feasible option for manufacturers as cost of LNG (indexed to crude oil) is ~2x higher than the natural gas based urea manufacturers and is further expected to increase on the back of rising crude oil prices, we believe.
• Outlook: Going forward, urea production is likely to post meager growth of 1.5% YoY to 5.7mn tons in 2018 as production of LNG based manufactures is expected to restore in second half of March 2018, as per our channel checks. Post  2018, we expect urea production to remain stable at 5.7mn tons, keeping in view the rising crude prices (resulting in higher LNG prices) and episodic supply of gas to selected manufacturers.
• We expect urea demand to grow at 3% YoY to 5.9mn tons in 2018 due to 1) continuation of lower fertilizer prices and 2) improved farmers economics on the back of better pricing of Rice/Cotton crop. Post 2018, demand is likely to remain at around 5.9mn tons.
• Further, we expect urea prices to increase with cost inflationary pressure as manufacturers has sufficient pricing power owing to alleviation of inventory glut and frequent disruption of gas supply to few manufacturers. We expect urea inventory to hover around 250-300k tons by Dec-2018.
• Risks: We flag 1) inventory buildup, 2) increase in GIDC/gas cost, 3) poor crop season and 4) Government’s intervention by keeping urea price stable as key risks to our industry estimates and company’s valuations.