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Pakistan Fertilizer: Sector Earnings up by 47% YoY in 1Q2018

• Pakistan’s fertilizer sector started 2018 with robust profitability growth of 47% YoY due to  increase in urea sales volume by ~43% YoY to 1.2mn tons. DAP sales also recorded significant growth of 14% compared to last year, with volumes clocking in at 517k tons vs. 447k tons.
• Higher urea sales is attributed to 1) continuation of subsidized prices in 1Q2018 at Rs1,400 per bag, 2) improved purchasing power of farmers amid better prices of rice and cotton crop (while, sugarcane payment to farmers was delayed) and 3) early procurement by farmers/dealers to avoid urea shortage (or expensive buying) in upcoming kharif season as production facilities of some urea manufacturers (Agritech, Fatima Fert and Pak Arab) are facing intermittent operations amid unavailability of system based gas and higher LNG cost.
• Gross margins of the manufacturers went up by 5ppts YoY to 31% as urea retention prices posted growth of 2-3% (or Rs25-35 per bag) and touched its ceiling of Rs1400 per bag. Urea prices improved after inventory depletion, where manufacturers successfully exported surplus stock of 635k tons of urea. Later, lower urea production due to short supply of natural gas further strengthened retention prices.
• Lower discounts by manufacturers i.e. Fauji Fertilizer (FFC) recorded discounts of Rs47mn vs. Rs364mn in 1Q2017 also provided respite to GP margins of companies.
• Other income of the manufacturers fell by 37% YoY to Rs3.7bn due to removal of cash subsidy on DAP (Replaced with reduced sales tax of Rs100 per bag) and decline of Rs56/bag on urea cash subsidy to Rs100 per bag.
• Finance cost went down by 25% YoY to Rs1.7bn, due to availability of  GIDC accrual amount, resulting in higher free cash flows.
• Among companies, FFC recorded healthy growth of 84% YoY in its revenues to Rs21bn owing to 52% YoY growth in urea sales volumes coupled with 142% YoY growth in DAP sales volume.
• While, Fauji Fertilizer Bin Qasim (FFBL) turned around from gross loss ratio of 3% in 1Q2017 to gross profit ratio of 7% in 1Q2018 as in corresponding period of last year DAP prices were capped at Rs2500/bag.
• Engro Fertilizer (EFERT) margins improved 5ppts YoY to 40% owing to higher urea prices and better trading segment (DAP) margins. Finance cost of the company went down by 24% YoY to Rs524mn due to re-pricing of various loans and continuous deleveraging of balance sheet.
• Fatima Fertilizer (FATIMA) showed significant improvement in its GP margins to 57%, up by 14ppts YoY, as company has been enjoying concessionary gas like EFERT’s Enven plant.
• Amongst fertilizer scrips, FFBL is our top pick with ‘BUY’ recommendation, while EFERT and FFC are ‘HOLD’.