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Pakistan Fertilizer: Lowering to Market-Weight on GIDC; FFBL downgraded to Sell, FFC & ENGRO Buy maintained, EFERT Hold maintained

• We are lowering our stance on Pak Fertilizers to ‘Market-Weight’ from ‘Over-Weight’ earlier following the judgment of the Supreme Court regarding Gas Infrastructure Development Cess (GIDC).
• We downgrade our rating on Fauji Fertilizer Bin Qasim (FFBL) to Sell from Buy, while we maintain our Buy ratings on Fauji Fertilizer (FFC) and Engro Corporation (ENGRO) and Hold on Engro Fertilizer (EFERT).
• The decision was largely in favor of the government, where the court has ordered companies including fertilizer companies to pay outstanding amount. The total outstanding amount due is around Rs457bn, out of which Rs164bn pertains to the fertilizer companies.

The detailed judgment states:

• As all industrial and commercial entities which consume gas for their business activities pass on the burden to their customers / clients therefore all arrears of ‘Cess’ that have become due upto 31.07.2020 and have not been recovered so far shall be recovered by the Companies responsible under the GIDC Act, 2015 to recover from their consumers. However, as a concession, the same be recovered in twenty-four equal monthly installments starting from 01.08.2020 without the component of late payment surcharge. The late payment surcharge shall only become payable for the delays that may occur in the payment of any of the twenty-four installments.
• The Federal government shall take all steps to commence work on the laying of the North-South pipeline within six months and on TAPI pipeline as soon as its laying in Civil Appeals No.1113 to 1155 of 2017 etc. -: 47 :- Afghanistan reaches the stage where the work of laying pipeline on Pakistan soil can conveniently start and on IP pipeline as soon as the sanctions on Iran are no more an impediment in its laying. In case no work is carried out on North-South pipeline within the prescribed time and for laying any of the two other major pipelines (IP and TAPI) though the political conditions become conducive, the purpose of levying Cess shall be deemed to have been frustrated and the GIDC Act, 2015 would become permanently in-operational and considered dead for all intents and purposes.
• In short, prospectively the Cess will not be applicable until government shows progress on gas projects and it will permanently become in-operational if government does not complete the projects in the given timeframe. The companies can pay the outstanding dues in 24 monthly equal installments.
• However, as per our channel checks, companies can opt for a review petition after deliberating on legal language of the verdict.
• For more details on the judgment, please refer to our note released on Aug 13, 2020 titled ‘GIDC Verdict Announced; Corporate asked to pay outstanding amount; Details awaited’.
• We can not rule out a special dividend from companies like KAPCO, LPL, NPL, NCPL and PKGP going forward as working capital requirement of these companies will remain on lower side.
• We are revising down our EPS forecasts of our Fertilizer universe by 1-84% for 2020E-2022F, incorporating impact of GIDC judgment and 2Q2020 financial results.
• Within our Fertilizer universe, all companies have already provided for GIDC in their accounts (except for EFERT on Enven Plant), hence they are not expected to take a direct hit on their reported earnings.
• The decision will be cash flow negative for companies as Fauji Fertilizer (FFC) will be required to pay Rs63bn (43% of market cap) followed by Fauji Fertilizer Bin Qasim (FFBL) - Rs22bn (109% of market cap), Engro Fertilizer (EFERT) - Rs19bn excluding Enven (new plant of EFERT) (21% of market cap) and Fatima Fertilizer (FATIMA) - Rs6bn (10% of market cap).
• All fertilizer companies were sitting on huge cash amounts (excluding FFBL) and were earning substantial amount of interest income on their amount invested in T-bills and other government papers. After recent court decision, companies will have to submit their due amount to the government, which will also hurt their recurring Other Income.
• Going forward, the court has restrained the Federal Government from charging Cess until, the Cess-revenue collected and that which is accrued so far but not yet collected, is expanded on the projects. We believe the work on said project will not start soon, thus companies may not remain liable to pay GIDC amount until government start working on the projects. To highlight, currently government charges GIDC of Rs5/mmbtu on both feed and fuel. 

Decision on Enven (new plant of EFERT) is unclear/pending which is a key downside risk to our investment thesis. The company is still fighting against GIDC on it ENVEN plant, as it believes it is against their contractual agreement. If decision on EFERT’s Enven plant comes against the company it may witness additional cash outflow of  Rs35-38bn which so far has not been provided for and will have affect on reported earnings.