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Pakistan Fertilizer: Companies profit up by 67% YoY in 2Q2018

• Pakistan’s Fertilizer manufacturer’s profitability has surged 67% YoY to Rs8.3bn in 2Q2018, primarily due to higher GP margins of 29% in 2Q2018, up by 7ppts YoY coupled with increase in revenue by 15% YoY to Rs66bn. Our profitability analysis is based on  sample of 4 largest listed companies, namely Fauji Fertilizer (FFC), Engro Fertilizer (EFERT), Fatima Fertilizer (FATIMA) and Fauji Fertilizer Bin Qasim (FFBL). We have taken unconsolidated statements of FFBL and FFC, and consolidated statements of EFERT and FATIMA for true depiction of their fertilizer business. This sample of 4 companies makes above 90% of the fertilizer production in Pakistan.
• Net sales of fertilizer companies depicted improvement due to 1) increase in urea prices by ~8% YoY, and 2) increase in DAP sales and prices by ~14% YoY and ~20% YoY respectively. On the other hand urea sales volume went down by 19% YoY during 2Q2018 which was primarily due to high base effect of 2Q2017, wherein 1.06mn tons were sold alone in Jun 2017 in anticipation of cut down in cash subsidy.
• Gross margins of the industry improved to 29%, up by 7ppts YoY due to higher retention prices coupled with minimal discounts amidst tight supply. To recall, during 2Q2017 fertilizer manufacturers offered heavy discounts to sell their stock in market as NFML was offloading its old stock of urea at discounted rate of ~Rs1300/bag, that forced manufacturers to offer discounts.
• Selling and distribution cost of the industry is down by 3% YoY due to lower handling cost amid normalized inventory level.
• Other operating expense increased by 61% YoY due to exchange losses incurred by companies on foreign exchange payables and foreign loans. While, other income fell 40% YoY as cash subsidy was reduced to Rs100/bag on urea vs. Rs156/bag in 2Q2017 coupled with its recognition till May 07, 2018. Further replacement of cash subsidy on DAP with reduced sales tax is also a reason behind lower other income.
• Finance cost fell substantially by 32% YoY to Rs1.6bn due to improved working capital of the manufacturers amid availability of cash flows from GIDC accruals.
• Effective tax rate during 2Q2018 remained at 37% vs. 40% last year, as EFERT recorded tax reversals of Rs1bn (another Rs1bn would be recorded in 2H2018) on account of lower projected tax rates in forecasted years (from 30% to 25% till FY23).
• Among players, Fatima outperformed its peers in terms of urea sales by witnessing volumetric growth of 22% YoY to 158k tons, while EFERT and FFC saw decline of 10% and 8% respectively. On DAP side, EFERT outperformed peers by posting growth of 106% YoY in its volumes at 120k tons, followed by FFC 81% YoY. Whereas, FFBL’s volume were down by 27% YoY to 66k tons.
• On profitability side, Fatima and FFC showed robust performance with 182% YoY and 51% YoY growth in their  bottom-line due to 31ppts YoY and 5ppts YoY respectively rise in their GP margins. Similarly, EFERT posted growth of 32% YoY in its profit due to decline in finance cost 42% YoY and lower effective tax rate of 33% in 2Q2018 vs. 41% in SPLY.
• Compared to last quarter (1Q2018), profitability of fertilizer companies remained nearly flat as decline in GP margins by 2ppts QoQ were better compensated by increase in revenues by 9.3% YoY and decline in admin & other opex by 16% and 3% respectively.
• Key risks to fertilizer industry’s profitability/valuation includes, 1) decline in international urea prices, 2) slower than expected urea sales, 3) poor crop season and 4) rupee devaluation.