EUR 24.40 For Business Accounts Only

Fauji Fertilizer Bin Qasim (FFBL): Upgraded to BUY

• Investment thesis: We upgrade our stance on Fauji Fertilizer Bin Qasim (FFBL) to “BUY” from “HOLD” primarily on the back of 1) improved GP margins in DAP segment underpinned by removal of cap on DAP prices, 2) depletion of urea inventory and improved urea prices to further augment GP margins, and 3) higher expected profit from associates and subsidiaries FFBL Power Company (FPCL), Foundation Wind Power (FWEL) and Askari Bank (AKBL). FFBL is currently trading at attractive discount of 41% to its sum of the parts value (SOTP).
• Turnaround in DAP segment: Post removal of pricing cap on DAP by the Govt. amid increase in international DAP prices provided some respite to FFBL, the only producer of DAP in Pakistan. Currently company is securing contribution margin of ~US$160 per ton vs. average of ~US$140 in 2017. We expect these margins to further improve to ~US$170-180 in 3Q and 4Q 2018 on back of peak demand in the start of winter crop (rabi season). Thereafter, implied contribution margins are estimated at ~US$170.
• Urea inventory depletion, augmenting GP margins: Urea inventory in Pakistan as per Mar 2018 is hovering around ~0.3mn tons, down by ~80% YoY owing to 1) allowance of exports upto 600k tons by Govt. 2) higher local dispatches, and 3) lower production by SNGPL based fertilizer manufactures (Agritech and Fatima Fert) amid disrupted natural gas supply and higher LNG prices. As a result, local urea prices touched maximum cap of Rs1400 per bag during Nov-Dec 2017 vs. average Rs1,357 per bag in 2017, leading to higher GP margins.
• Portfolio companies, breaking the ice: Energy sector portfolio of the company (FPCL and FWEL) is expected to start paying dividends to FFBL from 2018, resulting in improved unconsolidated earnings. Similarly, their profitability is likely to gain momentum owing to recent devaluation of PKR/USD (USD indexed ROE), resulting in higher profit from associates in consolidated earnings. Moreover, Fauji Meats Limited (FML, 75% owned by FFBL) is looking to expand its foot prints in China and Saudi Arabia, both of these markets are among world’s largest import markets. Fauji Foods Limited (FFL, ~51% owned by FFBL) is expected to turn into a profit post 2020 mainly on back of the rationalization of various fixed costs due to the gradual increase in volumetric sales.
• Earnings to grow at 3-years CAGR 36% (2018-2020) : From its core operations (Urea and DAP) we expect earnings contribution of ~Rs1.3-1.6 per share during 2018-2020 (~30% of total) vs. ~Rs0.2 per share in 2017 primarily due to improved margins in both segments. While, FPCL is expected to add Rs1.3 per share to the bottom-line of the FFBL (indexed to USD ROE) during 2018 (30% YoY higher than last year), as company started its commercial operations in May 2017. Moreover, profit from associate companies is expected to post 3-years CAGR (2018-2020) of 8%, as we expect higher earnings from AKBL and FWEL. Post 2020, we expect FML and FFL to contribute ~Rs0.5-1.0 and Rs1.5-2.5 per share to the bottom-line of the FFBL, respectively.
• Attractive valuation: FFBL is currently offering attractive discount of 36% to its SOTP with decent dividend yield of 7-10% in 2018-2020.
• Risks: Key risks to our valuation/earnings includes, 1) poor crop season, 2) regulatory changes in packaged milk products, 3) barrier to entry in exports markets for meat segment, and 4) increase in coal prices beyond our expectations.