Fertilizer Sector 2015

Current Prices as of Nov 16th, 2015; FATIMA PA being our group company is not under our coverage.

Fertilizer Sector November 18, 2015

BUY433.5 293.0 47.9

BUY108.7 84.0 29.3

BUY140.7 122.5 14.9

BUY65.0 57.0 14.0

ENGRO PA

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EFERT PATarget Price

AHL Universe Performance

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F:+92 21 3242 0742

E: [email protected]

www.arifhabibltd.com

Target PriceCurrent PriceUpside (% )

Source: Bloomberg

Analyst:Tahir AbbasD:+92 21 3246 2589UAN: +92 21 111 245 111, Ex t: 248

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FFBL PA

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Weak int’l market created downward pressure on fertilizer sector The current year 2015 has so far remained largely unremarkable from global investors’ viewpoints. Most major equity indices have remained in the red, while declining commodity prices amid slowing global demand has adversely affected commodity traders in general. The performance of the global fertilizer market was no exception as lagging demand resulted in 25% decline in international prices during CY15TD. Despite the negative trend so far, we cannot overrule that fertilizer prices might have bottomed out and could take an upturn ahead amid growing consumption in emerging and developing countries, which continue to rely heavily on the agriculture sector to support their economy.

Local industry to perform, despite challenges The local fertilizer sector is expected to remain in the limelight for our forecasted horizon (CY15-20), considering that agriculture contributes roughly one-fifth to the nation’s GDP. One key area of concern is gas shortage, which could lead to underutilization and lower profitability. Secondly, pressure on local prices is also a downside risk to our valuations. At present, the sector is operating at 81% capacity due mainly to gas curtailment. In order to fill the demand-supply void, the government has been importing urea. Further, in order to alleviate the pressure of gas shortage on local fertilizer manufacturers, the government has employed various options, such as gas supply on a rotational basis and temporary need-based allocation for the short term, while also announcing a long term gas plan for the future. Secondly, we expect local manufacturers to maintain their margins going forward, as seen recently, when excess demand helped manufacturers from passing on the additional costs of gas tariff hike to the consumer.

ENGRO – Diversification strategy paying off through deep valuations ENGRO is the top pick in our universe, with our SoTP based target price of PKR 433.5/share implying an upside potential of 48% from current levels. The growth is primarily driven from fertilizer business along with food business amid better volumes and stable margins. Future Thar coal projects amounting to USD 2bn is a potential upside risk to our valuations.

FFC – Attractive yields plus gas advantage makes it a safe bet! Being the market leader in terms of offtake, the safest bet in the fertilizer sector with 11% attractive dividend yield along with diversified investment base into 1) Financial services, 2) Alternate energy, 3) Food business, and 4) Exploring offshore investment options. Our SoTP based Jun-16 target price works out at PKR 140.7/share offering 15% upside potential from current levels.

FFBL – Core business plus new ventures adding to company’s profitability! The company is the sole producer of DAP fertilizer with diverse investment base, including 1) Financial Services, 2) Alternative energy, 3) Meat business, 4) Coal-based power plant, and 5) Food business. With the announcement of ‘KISAN’ package by the government the company is expected to maintain its market share in DAP. Our SoTP based Jun-16 target price is PKR 65.0/share implying an upside potential of 14% from current levels.

Exhibit: Financial Snapshot (CY16F) Current Price Target Price* Upside (%) P/E (x) P/B(x) DY (%) ENGRO 293.0 433.5 47.9 8.8 1.7 5.8 EFERT 84.0 108.7 29.3 8.2 2.5 8.3 FFC 122.5 140.7 14.9 8.7 5.3 10.6 FFBL 57.0 65.0 14.0 11.6 3.6 7.0 Source: Bloomberg, AHL Research, * Jun-2016

Fertilizer Sector

Despite soft global outlook, local industry to remain upbeat!

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Commodity Prices - Boom to Gloom A boom that lasted for over a decade initiating in the year 2000 known as “super cycle” boom was unlike any other and led to swelling commodity prices from sustained demand growth from emerging markets (mainly China and India). Rising incomes and population growth led to higher consumption, consequently spiking prices. In 2014 for instance, China and India accounted for over 12% and 4% of the global oil consumption, respectively, and used 28% of the global energy, whereas their share of world agricultural consumption remained stable at 22% and 10%, respectively from the previous period. Economic activities in both countries intensified by three-fold from 2000 to 2014 to 16% while their contribution to global population stayed steady at 37%.

In 2015, most commodity prices witnessed a downward trajectory, indicating the end of the super cycle, on the back of supply glut and subdued demand. Energy prices too tumbled owing to declining oil prices, whereas natural gas prices are projected to fall below 2014 levels across markets in US, Europe and Asia. Already high levels of agricultural inventories and abundant supplies are also estimated to adversely affect agricultural prices, including raw material prices while fertilizer prices (a cost central to farmers) are projected to decline amid weak demand.

According to the World Bank, a move towards a more services-based growth as opposed to an industrial growth will slow down China’s overall growth below 7% by 2017 and past that, with a gradual decline to 0.3% p.a. growth in population over the next decade. India, on the other hand, will excel with overall growth of greater than 7% up to 2017 and robust population growth of 1% in the coming decade. Both countries will average above the developed countries growth (2-3%), however their diminishing combined growth pace casts a valid expectation of a global shift, with decelerating metals consumption and mild growth in agricultural demand, putting downward price pressure on commodities.

Exhibit: GDP Growth projections - China & India

Source: World Bank Global Economic Prospectus Jun-2015

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November 18, 2015

Fertilizer Sector

Demand & Supply Dynamics of Global Harvests

Wheat- Multi-year new highs of buffer capacity expected In recent years, global wheat inventory levels have stayed in surplus keeping prices in check. Output accretion in countries like Australia, China, Morocco, Turkey, Ukraine and the United States are expected to drive global wheat production expansion in 2015 to 735Mt, (up by 2Mt from 2014). While wheat consumption projections for 2015/16 also show positive growth of 2% to 727Mt. Future utilization comes mainly from wheat usage as feedstock led by robust demand from Asia and North America, estimated to increase to 144Mt (4.2% YoY) in 2015/16. Countries in the EU, the Russian Federation and the United States are expected to expand their buffer inventory capacities, as a cushion against unforeseen production bottlenecks, thus leading global wheat inventories to rise to a 13 year high level of ~206Mt in 2016. Projections of per capita consumption of wheat in 2015/16, is expected to remain constant from last year at 67(kg/year).

Rice- Bleak Supply Expectations Rice prices continue to be unattractive, a trend set in motion since September 2014, discouraging major rice producers to expand production. This coupled with unfavorable weather conditions amid the prevailing El Niño glitch, adversely effected the 2015 paddy crops. Meagre global rice projections estimate production to drop in all states to 493Mt in 2015, barring Latin America, Caribbean and Europe. Forecasts of smaller rice inventories (down by 3.5%) to 164Mt in 2016 amid production (493Mt) falling short of consumption (499.9Mt) puts future food security under pressure. Trade of rice however is projected to pick up in 2016 to 45Mt (after a 3% drop in 2015) subject to demand from Indonesia, the Democratic Republic of Korea and the Philippines.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Global Agricultural Prices Outlook Wheat While initial estimates seemed glum, crop trends continued to surprise pleasantly amid improving weather conditions with expectations of another bumper crop in the current year (2015). With buffer supplies secured from the previous seasons already in place, the adverse pressure on prices continued to dampen international wheat prices, so much so that the benchmark US wheat (No. 2 Hard Red Winter), FOB. US Gulf averaged at a 5 year low to USD 218/ton in August/September (down 60% from September 2014).

Rice International rice prices have witnessed record lows during recent times despite consumption exceeding production going forward. This has mainly been an influence of tumbling prices of other major crops. While import prices remained bearish in Asia (particularly in India and Pakistan) where demand stayed subdued amid greater production achieved (not a norm in other regions of the world). Moreover, strong competition globally, restricted export prices in most key regions. The benchmark Thai 100% B rice, FOB. Bangkok was thus 14.5% below its January 2015 level at USD 367/ton.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Availability of Nutrients Globally Soil and plants require various nutrients aided by fertilization which results in maximum yield per hectare of land. These generally include nitrogen (N), phosphorus (P) and potassium (K) as well as sulphur, calcium and magnesium. Relative presence of each nutrient in soil has a key impact on output. However, soil in less developed countries suffers from nutrients deficit while developed countries have nutrients in surplus for cultivation leading to disparity in the nutrients balance. On average, 60% of the mineral fertilizer is now produced in developing countries, with major production in Eastern Asia (particularly in China which is the largest producer globally), followed by North America and India while countries like Russia, the Middle East and Caribbean produce substantial amounts on the back of significant natural gas and oil reserves. Although consumption of fertilizer is mostly in Southeast Asia, South Asia, Europe and North America. Nitrogen forms 74% of the fertilizer used in the world today and its consumption continues to grow as regimes in Asia and Africa make constant efforts to rely less on imports and expand their internal agricultural capacities. Globally a relentless argument has been raised over the years to weigh in the pros and cons of mineral fertilizer use.

CY15 - Testing Times for Global Fertilizer Demand and Prices According to the World Bank, global consumption in CY15 is anticipated to fall amid weak demand in US, Europe and Asia as well as currency depreciation. This is in line with the 4% decline in fertilizer prices in the first quarter of the year owed to lower crop prices and restricted purchases from buyers who expected further price cuts. Urea prices were down 6% while phosphate prices dipped 3-5%, however potassium prices jumped a tad bit.

Downbeat Global Fertilizer Demand Perspective Short term - FY16 Future fertilizer demand can be seen driven by greater need for feed use in developed and emerging economies and growth in food consumption in less developed countries due to their burgeoning population. However, fertilizer demand seems modest for FY16 following relatively bleak crop prices, projected to grow by a meager 1% YoY to 186.5 Mt. Sufficient growth will be witnessed in phosphorous demand of 1.1% to 41.8 Mt, followed by 1% growth in nitrogen demand of 112.9 Mt and 0.8% rise in demand of potassium to 31.8 Mt with leading changes awaited from South Asia, East Asia and North America.

Exhibit: Global Urea Capacities, Demand & Utilization Rate Exhibit: Global DAP Capacities, Demand & Utilization Rate

Source: IHS, IFA, IFDC, AHL Research

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November 18, 2015

Fertilizer Sector

Exhibit: Short term Forecasts for World Fertilizer Demand (Mt nutrients) N P2O5 K2O Total 2012-13 108.1 41.6 29.1 178.8 2013-14 110.4 40.3 30.2 180.9 2014-15E 111.8 41.3 31.5 184.6 Change 1.30% 2.50% 4.20% 2.00% 2015-16F 112.9 41.8 31.8 186.5 Change 1.00% 1.10% 0.80% 1.00% Source: IFA, AHL Research

Long term - FY15-20 Although it may take a few years to reach more satisfactory levels of inventories-to-consumption (given no major policy changes and reasonable weather conditions), but in the medium term it seems as though global commodity prices and stock levels would remain range-bound. Cumulative fertilizer demand is anticipated to grow to 200 Mt by FY20 (at an annual rate of 1.7% p.a) with highest growth projections in countries of Africa (4.4% p.a), Sub-Saharan Africa (6.3% p.a) and Latin America (3% p.a), encouraged by promising policy and economic climate and wider arable area. Improved efficiency from nitrogen use will restrict growth rates to 1.3% p.a to 119.2 Mt whereas phosphorous demand would reach 45.7 Mt (up 1.8% p.a) and potassium demand will clock in at 35.3% (2.6% p.a growth) in FY20.

Exhibit: Medium-Term Forecasts for World Fertilizer Demand (Mt nutrients) N P2O5 K2O Total Avg. 2012-13 to 2014-15E 110.1 41.1 30.3 181.4 2019/20 (F) 119.2 45.7 35.3 200.2 Avg. Annual Change 1.30% 1.80% 2.60% 1.70% Source: IFA, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Steady progression of the global fertilizer supply In FY14, the global fertilizer supply thrived in order to meet the colossal world demand and restock existing distribution channels while fertilizer manufacturers operated on an 80% average installed capacity. Future projections for individual nutrients are as follows: Nitrogen In FY19 the global nitrogen supply is expected to reach 174 Mt (mounting 19% since FY14) to meet demand of 157 Mt steered mostly by the increased fertilizer consumption in Africa, that is, it would be sufficient to meet the probable demand and arrange for an annual surplus of 18 Mt. Probable urea supply in FY19 will be 211 Mt (FY14: 179 Mt, CAGR: 4%), to meet demand of 198 Mt (up 32 Mt since FY14). Some 60 new units (20 units in China alone) are expected to commence operations between 2014 and 2019 to meet the robust demand of urea in industrial uses from South Asia, East Asia (China) and Europe, while Africa and North America would contribute 18% and 15%, respectively to the capacity growth. Phosphate Supply of global phosphate rock is expected to grow by 16% (35 Mt) to 255 Mt from FY14 to FY19 whereby 80% of this will be contributed by Saudi Arabia, Jordan, Morocco and China. Growth in total global phosphoric acid capacity (62.9 Mt in FY19, up 7.8 Mt over FY14) will enable supply to reach 51.1 Mt in FY19 (increasing 2.5% p.a since FY14) compared to forecasted consumption of 48.3 Mt (annual growth rate of 2.4% since FY14). Around 30 new units are expected to add to the global capacity to mainly support DAP growth. Potash Amid the 25 ongoing expansion plans and 4 other key greenfield projects to come on stream in Canada, Russia and Belarus, capacity of potassium is expected to widen by 16% to 60.8 Mt in FY19 (FY14: 52.2 Mt). 70% of the world production of potash (51.8 Mt in FY19, 9 Mt addition over FY14) will come from North America (Canada), Eastern Europe/Central Asia (Russia & Belarus) and East Asia (China). This will be ample to meet global demand of 39.5 Mt (annual growth rate of 2.5% since FY14), providing bulk of 12 Mt in FY19.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Outlook for Fertilizer Prices Urea Outlook for Urea prices continues to appear gloomy on the back of surplus supply, diminishing production costs (Chinese manufacturer’s achieving optimal production at negligible cost levels amid decelerating coal prices and weaker yuan) and an unappealing demand situation caused by USD appreciating against most currencies along with feeble crop prices. India however can become a key player regulating prices in the upcoming months with news regarding its growing import appetite. In the long-run though India’s reliance on import may decline in the future amid their government’s decision to provide subsidized gas at USD3.82/mmbtu as opposed to the previous USD4.66/mmbtu.

Exhibit: Global Urea Capacity & Demand (Mn tons) 2011 2012 2013 2014E 2015E 2016E 2017E Region North America 9.1 9.0 9.1 9.1 9.8 11.0 11.6 Latin America 7.9 7.9 8.0 9.7 10.6 11.5 11.5 Western Europe 5.7 5.7 5.7 5.7 5.7 5.7 5.7 Central Europe 4.8 4.6 4.6 5.0 5.0 5.0 5.0 Eurasia 15.4 16.2 16.3 16.3 18.3 19.8 19.8 Africa 7.7 7.7 12.7 12.9 15.5 15.5 15.5 Asia 143.3 153.4 157.0 186.2 202.5 204.7 204.7 Oceania 0.5 0.5 0.5 0.5 0.5 0.5 0.5 Global Capacity 194.3 205.0 213.9 245.3 267.8 273.7 274.3 Consumption North America 15.8 17.9 18.2 17.8 17.0 17.7 18.4 Latin America 9.5 9.6 11.5 11.8 11.5 11.8 12.2 Western Europe 7.8 8.1 8.4 8.5 8.1 8.1 8.2 Central Europe 2.8 3.2 3.5 3.5 3.5 3.6 3.7 Eurasia 8.3 8.6 9.5 9.5 9.6 9.9 10.1 Africa 4.0 4.8 5.1 5.3 5.5 5.7 5.9 Asia 103.7 106.8 122.5 123.9 125.5 127.0 128.6 Oceania 2.6 2.5 2.9 2.9 3.0 3.1 3.1 Global Demand 154.4 161.4 181.5 183.3 183.7 186.9 190.2 Source: IHS, IFA, IFDC, AHL Research

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November 18, 2015

Fertilizer Sector

Phosphate On a comparative basis Phosphate prices dipped by a mere 3% (FOB, USA) till the beginning of October this year although counties like India and Brazil continue being stressed and suffer from depreciating currencies, adverse weather conditions, low credit/liquidity and surplus stocks. Uncertainty in global markets will also keep demand in check. On the flipside the VAT imposition in China (to discourage phosphate exports) raised prices a little but it may not have a long term impact as global consumption for phosphate appears depressed. Varying DAP rates circled the markets with USD455/t for Chinese exports to Pakistan and USD355/t cfr to Brazil while Chinese demand in the West is yet to be asserted.

Exhibit: Global DAP Capacities & Demand (Mn tons) 2011 2012 2013 2014E 2015E 2016E 2017E 2018E Region North America 5.9 5.4 5.3 5.1 5.0 4.9 4.7 4.5 Latin America 0.5 0.8 0.7 0.7 0.7 0.7 0.8 0.9 Western Europe 0.1 0.1 0.1 0.4 0.4 0.4 0.4 0.4 Eastern Europe 0.3 0.2 0.2 0.2 0.2 0.2 0.2 0.2 FSU 2.8 2.5 2.4 2.2 2.8 3.0 3.1 3.1 Middle East 0.8 1.3 1.3 1.7 2.0 2.3 2.7 2.8 Africa 2.1 2.3 2.3 2.4 2.6 2.8 2.9 3.1 South West Asia 2.0 1.9 2.0 2.1 2.3 2.3 2.4 2.4 China 12.4 12.4 12.7 12.4 12.3 12.2 12.0 12.0 South East Asia 0.2 0.1 0.1 0.2 0.2 0.2 0.3 0.3 Japan 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0.1 Australia 0.5 0.5 0.5 0.5 0.5 0.4 0.4 0.4 Total Global Production 27.5 27.6 27.7 27.9 29.0 29.5 29.8 30.1 Consumption North America 4.2 3.9 3.8 3.8 3.8 3.8 3.8 3.8 Latin America 3.1 3.4 3.8 3.9 4.0 4.2 4.3 4.4 Western Europe 0.7 0.8 1.2 0.9 1.1 1.0 1.0 1.0 Eastern Europe 0.4 0.4 0.5 0.4 0.4 0.4 0.4 0.4 FSU 0.6 0.6 0.8 0.7 0.7 0.7 0.7 0.7 Middle East 0.4 0.6 0.6 0.6 0.6 0.6 0.6 0.6 Africa 0.9 1.0 0.9 0.8 0.8 0.9 0.9 0.9 South West Asia 5.9 5.1 4.9 5.0 5.5 5.9 6.1 6.2 China 10.1 9.2 9.7 10.2 10.2 10.2 10.6 10.8 South East Asia 0.6 0.8 0.9 0.9 0.9 0.9 1.0 1.0 Japan 0.2 0.3 0.3 0.3 0.3 0.3 0.3 0.3 Australia 0.6 0.6 0.7 0.7 0.7 0.7 0.7 0.7 Total Global Consumption 27.7 26.6 27.9 28.2 29.0 29.5 30.2 30.8 Source: IFDC, IHS, IFA, Bloomberg, ANDA, FAJ, AHL Research

Key Risks to Fertilizer Outlook The global fertilizer outlook is dependent on a number of reservations and peripheral factors among: (i) rebound in oil prices; (ii) prices of other commodities; (iii) exchange rate fluctuations; (iv) regional geopolitical environment; (v) major policy changes; (vi) subsidy schemes; (vii) organic nutrients used as a substitute; (viii) greater efficiency in nutrient consumption; and (ix) retreat in energy prices.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Pakistan Agriculture Sector The Agriculture sector alone is of significant importance to Pakistan’s economy contributing ~21% to country’s GDP while at the same time ensuring food security and providing employment to 45% of Pakistani population. Pakistan is an agrarian country as its prime exports consist of textiles (an output of agricultural activities).

Pakistan Fertilizer sector Fertilizer is one of the few sectors that provides maximum value addition by converting raw gas into urea granules and benefits the country in terms of food availability, balance of payment, poverty reduction, economic growth and the drive towards industrialization. Even though this sector is extremely crucial for sustainable agricultural growth, it remains competitive, faces severe gas curtailment issues and excess demand. The fertilizer sector has a total market capitalization of PKR 656bn (USD 6.2bn) and the market capitalization of our sample companies (FFC, FFBL, ENGRO and EFERT) stands at PKR 472bn (USD 4.5bn). The index weight of the total fertilizer sector is ~15.0% in KSE100 index while our sample companies (FFC, FFBL, ENGRO and EFERT) comprise ~11.1% of the KSE100 index weight. Pakistan fertilizer sector is comprised of seven companies (see table below). The prime product of the sector is urea followed by DAP. The major players of the sectors include Fauji Fertilizer Company Limited (FFC) and Engro Fertilizer Limited (EFERT) having installed capacities of 2.05mn tons and 2.3mn tons per annum respectively, contributing 67% to country’s total capacity. Fauji Fertilizer Bin Qasim Limited (FFBL) is the country’s sole producer of DAP having capacity of 0.65mn tons per annum. In addition to this FFBL urea capacity stands at 0.5mn tons per annum. The snapshot of Pakistan’s fertilizer sector is summarized below in the table:

Exhibit: Pakistan's Fertilizer Sector Snapshot

(Mn Tons) Location Urea Capacity

CY15E Urea Production

Utilization (%)

Gas Supplier Current Status Primary

Products FFC Goth Macchi, Punjab and Ghotki, Sindh 2.05 2.42 118.2 Mari Gas Operational Urea ENGRO Ghotki, Sindh 2.28 1.96 86.0 Mari Gas Operational Urea FFBL Bin Qasim, Sindh 0.50 0.27 53.6 SSGC Operational DAP FATIMA Rahimyar khan, Punjab 0.50 0.42 83.0 Mari Gas Operational NP,CAN PAK Arab Multan, Punjab 0.09 - - SNGP/LNG Rotational Basis NP,CAN Agritech Mianwali, Punjab and Haripur, KPK 0.47 0.07 14.5 SNGP Rotational Basis Urea Dawood Hercules Sheikupura, Punjab 0.45 0.03 7.6 SNGP Rotational Basis Urea Total Urea Capacity 6.34 Operational Urea Capacity 5.17 Total Capacity Utilization 82% Source: AHL Research

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November 18, 2015

Fertilizer Sector

Local Fertilizer Industry Fertilizer use in Pakistan was initiated in early 1950’s and 1960’s by imports of Nitrogen, phosphorous and potassium based fertilizers. Soon the government increased focus on tactical investments to build the local fertilizer industry with help from foreign companies to develop native fertilizer plants. Pakistan’s generous gas supply in the late 1960’s equipped local producers to multiply fertilizer production of gas based fertilizers (nitrogen and phosphate) so that the country relied on fewer imports. DAP and potassium had to be imported nonetheless amid their reliance on non-gas production support. In CY14A about 71% of the total fertilizer production (7.8mn tons) comprised of urea while 21% was DAP and Potash based production. In CY14 and CY15E, the industry operated at utilization levels of 76% and 81% respectively. It is pertinent to note that 100% utilization of urea capacity would have been adequate to meet domestic demand in the said years. In CY14 about 87% of total fertilizer consumed in Pakistan was locally produced, comprising of 71% of Urea, 21% of DAP and 8% others for domestic consumption.

Exhibit: Industry Capacities (000 tons) CY08 CY09 CY10 CY11 CY12 CY13 CY14 CY15 Urea Fauji Fertilizer Company 2,048 2,048 2,048 2,048 2,048 2,048 2,048 2,048 Fauji Fertilizer Bin Qasim 551 551 551 551 551 551 551 551 Engro Fertilizer 975 975 975 2,275 2,275 2,275 2,275 2,275 Dawood Hercules 445 445 445 445 445 445 445 445 Agritech Limited 346 346 467 467 467 467 467 467 Pak Arab Fertilizer 92 92 92 92 92 92 92 92 Fatima Fertilizer - - 397 500 500 500 500 500 Total 4,458 4,457 4,976 6,378 6,378 6,378 6,378 6,378 DAP Fauji Fertilizer Bin Qasim 446 600 650 650 650 650 650 650 Total 446 600 650 650 650 650 650 650 NP Pak Arab Fertilizer 305 305 305 305 305 305 305 305 Fatima Fertilizer - - - 244 360 360 360 360 Total 305 305 305 548 665 665 665 665 CAN Pak Arab Fertilizer 450 450 450 450 450 450 450 450 Fatima Fertilizer - - 297 420 420 420 420 420 Total 450 450 747 870 870 870 870 870 TOTAL Fertilizer 5,658 5,812 6,677 8,447 8,563 8,563 8,563 8,563

Source: NFDC, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Fertilizer policy 2001 overview The fertilizer policy of 2001 was envisioned to enable new fertilizer manufacturers to compete with imports from the Middle East by getting subsidized gas to meet local demand of fertilizer. Subsidy for fertilizer manufacturers comes in the form of natural gas at lower rates, which is a substantial amount as the fertilizer industry uses 17% of the gas reserves in Pakistan. Fuel stock gas on the other hand allocated to fertilizer manufacturers is based on a standardized market price. Fertilizer policy was announced taking effect from 1st July 2001. The policy was initially operational for ten years and aimed for an estimated investment of USD 1.2bn during its tenure. The basic objective of this policy was 1) to attract investment in the sector, 2) support farmers through provision of fertilizer products at an affordable price and 3) to ensure best optimal price and supply of gas to keep the plants’ utilization at max. The policy brought fruitful results in the form of USD 2.0bn investment through green field projects and BMR activities however, the rationalization of gas subsidy as envisioned in the Policy has not yet been materialized.

Investment via policy 2001 EFERTs expansion took place with the capacity addition of 1.3mn tons of urea plants whereas 0.5mn urea, 0.4mn NP and 0.4k CAN were set up by Fatima Fertilizer Company (FATIMA). In line with the fertilizer policy the GoP approved subsidized feed stock for both of the companies at USD 0.7/mmbtu for the tenure of 10 years. Conversely, the gov’t failed to honor its sovereign guarantee resulting in substantial gas curtailment for EFERT and manufacturers operating on the SNGPL network. However, to date the problem has not been catered for as the Economic Coordination Committee (ECC) of the Cabinet has decided to revert 60mn cubic feet per day (mmcfd) previously diverted, back from Guddu Power Plant to EFERT after which the company has been able to operate at 80-85% utilization of its installed capacity. It is interesting to note that the Guddu gas is a temporary arrangement for EFERT and set to expire in Dec-15 while other manufacturers on SNGPL are to operating on rotational basis.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Demand drivers Pakistan is an agricultural country thus need of fertilizers for agricultural growth and its contribution to the GDP is significant. There are several factors affecting demand of fertilizer products in Pakistan. The major demand drivers include 1) greater cultivatable area and guaranteed offtake (last 5 year average urea demand: 5.5mn tons), 2) commodity support prices, 3) water availability, 4) fertilizer prices, and 5) growing population.

Exhibit: Fertilizer usage vs Production of important Crops

Source: PBS, AHL Research

Cultivatable area Cultivatable area is a major aspect in determining fertilizer demand. Higher area would lead to growth in the fertilizer offtake and eventually result in higher crop production. Despite the damage caused by the major floods back in CY10 coupled with less destructive minor floods in subsequent years, cultivable area was able to grow by a modest 10 year CAGR of 0.5%. Likewise, urea offtake increased by 10-year CAGR of 2% for the same period. Resultantly, cumulative wheat and cotton production jumped by a CAGR of 2.9% and 2.4% respectively in the last 10 years.

Exhibit: Area of Important Crops Exhibit: Production of Important Crops ('000’ hectares) FY-12 FY-13 FY-14 CAGR (‘000’ tones) FY-12 FY-13 FY-14 CAGR Wheat 8,650 8,660 9,199 3.1% Wheat 23,473 24,211 25,979 5.2% Maize 1,087 1,060 1,169 3.7% Maize 4,338 4,220 4,944 6.8% Rice 2,571 2,309 2,789 4.2% Rice 6,160 5,536 6,798 5.0% Sugarcane 1,058 1,129 1,173 5.3% Sugarcane 58,397 63,750 67,460 7.5% Cotton 2,835 2,879 2,806 -0.5% Cotton* 13,595 13,031 12,769 -3.1% Source: PBS, AHL Research Source: PBS, AHL Research

*Production is in thousand bales of 375 lbs. each Fertilizer offtake and total cropped area reached its peak in CY09 at 6.2mn tons and 23.8mn hectares, respectively. Given that the country has faced less severe flood-related catastrophes in recent years, the total cultivatable area and fertilizer offtake is expected to grow going forward.

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*Production is in thousand bales of 375 lbs. each

Crops FY-12 FY-13 FY-14Wheat 110 114 119 Maize 140 136 146 Rice 111 100 123 Sugarcane 131 143 149 Cotton 104 100 98

Exhibit: Production Index of Important Crops 2005-06 Base


(mn hectares) FY-10 FY-14Punjab 12.45 12.52 Sindh 4.90 5.18 KPK 1.84 1.88 Balochistan 2.06 2.49 Total 21.25 22.07 Source: PBS, AHL Research

Exhibit: Total Cultivated Area

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Exhibit: Crop-wise usage of Fertilizers & Production Growth

(000 nutrient ton) FY12 FY13 FY14 %age of total Production CAGR over FY12 to FY14

Wheat 1,930 1,811 2,045 50.0 5.2% Cotton 965 905 1,022 25.0 -3.1% Sugarcane 309 290 327 8.0 7.5% Rice 232 217 245 6.0 5.0% Maize 58 54 61 1.5 6.8% Others 367 344 388 9.5 Total 3,861 3,622 4,089 Source: PBS, AHL Research

Definite offtake Urea demand in Pakistan during the last 5-years averaged at 5.5mn tons with the installed urea capacity of 6.4mn tons (operational capacity of 5.1mn tons excl. Pakarab, DH fertilizer and Agritech). This trend shows guaranteed offtake as the local manufacturers managed to offload all of their inventories during CY14. Furthermore the wide demand supply gap is catered through urea import of ~1mn ton by the government to ensure any shortfall of the commodity in the market.

Exhibit: Province-wise Consumption of Fertilizers (000 nutrient ton) FY12 FY13 FY14 CAGR Nitrogen Punjab 2,181 1,988 2,164 -0.4% Sindh 657 523 731 5.5% KPK 222 213 177 -10.7% Balochistan 146 130 112 -12.4% Total 3,207 2,854 3,185 -0.3% Phosphate Punjab 451 537 623 17.5% Sindh 126 123 187 22.1% KPK 35 51 48 16.7% Balochistan 21 36 23 4.9% Total 633 747 881 18.0% Source: PBS, AHL Research

Crop Support prices to play a vital role Traditionally, support prices for commodities have played a vital role in boosting fertilizer offtake. As an agrarian country, the government always tends to support farmers through every possible mode including higher support prices. The gov’t is offering support prices for various crops including Wheat, Cotton and Sugarcane. Support prices are directly proportional to the fertilizer offtake. We have witnessed an upward trend in wheat support price since FY11. At present, wheat support price stands at PKR 1,300/40kg, depicting a 5-year CAGR of 8.2%, while Sugarcane support prices grew at a 5-year CAGR of 9.6%. Additionally, cotton support prices now have of PKR 3,000/40kg in FY15.

Exhibit: Support/Procurement Prices of Agricultural Commodities (PKR/40kg) FY-11 FY-12 FY-13 FY-14 FY-15 CAGR Wheat 950 1,050 1,200 1,200 1,300 8.2% Sugarcane* 125 151 171 171 181 9.6%

Cotton Seed (Phutti)** - - - - 3,000 nm Source: PBS, AHL Research, *Average **B-557, 149-F, NIAB-78

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Supply constraints – depleting gas reserves Pakistan was endowed with rich natural gas reserves but the increasing demand and insufficient exploration activities in the past have resulted in a restriction on the availability. Currently, the country is facing seasonal outages typically during the winter season with annual gas shortfall of ~2,000mmcfd. The situation may aggravate in the future as the country’s energy requirements and industrial growth potential will require a much higher utilization of gas resources. In this case, the fertilizer sector, which already consumes 17% of total gas, has limited potential to induce further investors. Declining gas supply trend Severe gas curtailment has been observed since CY10TD and the gas consumption of fertilizer sector from SSGC and SNGP network has declined by 38% and 63% respectively whereas MARI gas field consumption delivered 5 year average growth of 24%. Cumulatively however, gas consumption by the fertilizer sector dropped 2% YoY on average since CY10.

Exhibit: Gas Supply for Fertilizer Sector Exhibit: Gas Consumption by Sectors

Source: Energy Year Book, AHL Research

-

50,000

100,000

150,000

200,000

250,000

FY-0

7

FY-0

8

FY-0

9

FY-1

0

FY-1

1

FY-1

2

FY-1

3

FY-1

4

Mari Gas Field SSGCL SNGPL(MMCFt)

Domestic22%

Commercial3%

Gen.Industries21%

Pakistan Steel Mills

1%Cement0.04%

Fertilizer (Feedstock)

13%

Fertilizer (Fuelstock)

4%

Power29%

Transport (CNG)

7%

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Gas prices – Upward trajectory continues Feed-stock gas is the basic raw material for making fertilizer particularly urea. Initially with the low consumption of gas in the fertilizer sector amid lower installed capacity, gas prices were lower compared with other sectors, industries and international gas prices. However, with the imposition of Gas Infrastructure Development Cess (GIDC) and incremental capacities coupled with depleting reserve of gas, the feed and fuel stock prices surged at a 5-year CAGR of 49% and 15%, respectively. Fertilizer manufacturers easily managed to pass on this gas prices impact as urea prices increased at a 5-year CAGR of 22%. This showed the ability of the manufactures to easily pass on the impact of gas price increase to end consumers. However, with the current scenario of soft int’l commodity prices along with the imported urea available at only 2% premium, the companies are struggling to maintain their margins.

Exhibit: Gas and Fertilizer Prices Exhibit: Historical Urea and DAP Prices


60 160 260 360 460 560 660 760

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Feed stock Fuel stock

GIDC

PKR/mmbtu

- 500

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500

CY-0

0CY

-01

CY-0

2CY

-03

CY-0

4CY

-05

CY-0

6CY

-07

CY-0

8CY

-09

CY-1

0CY

-11

CY-1

2CY

-13

CY-1

4CY

-15T

D

Urea DAP(PKR/bag)

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Imported urea a major threat? The country is facing the problem of imported urea which ultimately affects the import bill and consequently the government incurs a high cost. However with the downward trajectory of int’l prices of urea which dropped 25% YoY during CY15TD to USD 250/ton, the cost of int’l imports has relatively decreased. The problem of imported urea is posing a minor challenge to the domestic market because the discount to the int’l prices has shrunk to 2%. Manufacturer’s stance on this is quite clear that any cost push inflation would lead them to increase end consumer prices. To make matters worse, there are plants which use gas inefficiently leading to shortages and, hence, an increase in fertilizer prices in peak seasons results in reduced product offtake.

Exhibit: Local and International Urea Comparison Exhibit: Local and International DAP Comparison

Source: Bloomberg, NFDC, AHL Research

0%10%20%30%40%50%60%70%80%

- 500

1,000 1,500 2,000 2,500 3,000 3,500

CY-0

8

CY-0

9

CY-1

0

CY-1

1

CY-1

2

CY-1

3

CY-1

4

CY-1

5TD

InternationalLocalAvg. Discount (RHS)

(PKR/bag)

-80%-60%-40%-20%0%20%40%

1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000

CY-0

8

CY-0

9

CY-1

0

CY-1

1

CY-1

2

CY-1

3

CY-1

4

CY-1

5TD

InternationalLocalAvg. Premium (RHS)

(PKR/bag)

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Outlook of fertilizer sector Macro outlook For the Pakistani economy to flourish, it is vital for agricultural yields to go up which is only possible through the consumption of fertilizers in the right quantity at the right time. Given the current situation, the importance of fertilizers cannot be overlooked since it has a direct impact on the growth, output and economic activity of the agriculture sector. Hence, the gov’t is making continuous efforts to tackle gas shortage issues through new exploration projects. At this point in time, gas shortage and import threat continue to pose a major challenge to the entire sector.

Sector forecasts We expect the sector’s urea offtake to grow by 2% YoY in CY15. Our assumption with respect to growth in urea offtake stems from: 1) increase in Wheat Support Price to PKR 1300/40kg, 2) low interest rates enabling farmers to secure cheap agri-loans, and 3) better demand due to increased cultivatable area with improving yields amid favorable weather conditions compared to the last year. Furthermore, the clarity with respect to local urea prices would help the companies to offload their piled up inventories in the current year.

Exhibit: Urea Production and Offtake Exhibit: DAP Production and Offtake


Exhibit: Fertilizer offtake CY14 Exhibit: Fertilizer offtake 9MCY15


80%90%100%110%120%130%140%

4.0

4.5

5.0

5.5

6.0

6.5

2009

A

2010

A

2011

A

2012

A

2013

A

2014

A

2015

E

(mn tons)ProductionOfftakeOfftake / Production (RHS)

0.50.70.91.11.31.51.71.9

0.2

0.4

0.6

0.8

1.0

1.2

2009

A

2010

A

2011

A

2012

A

2013

A

2014

A

2015

E

(mn tons)Local ProductionImportedTotal Offtake (RHS)

FFC43%

FFBL3%

ENGRO33%

FATIMA7%

DH Fertilizer1%Agritech

1%

Pak Arab0%

NFML12%

FFC41%

FFBL4%

ENGRO33%

FATIMA7%

DH Fertilizer

1%Agritech

1%Pak Arab

0%NFML13%

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Key risks Gas unavailability The key risk remains the unavailability of gas to the fertilizer plants, especially on the SNGPL network. In this regard, the materialization of the long-term plan and its timings are very crucial for the plants operating on this network.

Price reduction Pricing risk prevails, as the gov’t may pressurize the manufacturers to cut urea prices due to lower int’l urea prices. Albeit, we believe the probability of this is low.

Imported urea Imported urea could be a threat to local manufacturers if traded at lower prices compared to local urea.

Political risk / GoP priority Political instability coupled with government’s stance and how it prioritizes gas allocation to the fertilizer sector would bring clarity in the future for the fertilizer sector.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Crop Seasons Pakistan has two crop seasons; Kharif being the first sowing season from April-Jun; harvested during October-December. Main Kharif crops include rice, sugarcane, cotton, and maize. Rabi, the second sowing season begins October-December; harvested in April-May. Major Rabi crops include wheat, gram, lentil, tobacco, rapeseed, barley and mustard. With two crop seasons, the fertilizer offtake with respect to products also registers significant difference due to variations in fertilizer needs by each crop which eventually affects the demand situation. When talking about demand scenario, as stated earlier, Pakistan is an agri-based economy and for a healthy crop yield farmers need optimal amounts of fertilizer to enhance crops’ growth. Resultantly, the overall domestic demand generated is higher than local fertilizer production which stimulates extensive need for importing fertilizer products like urea, and DAP etc.

May June Ju ly Aug S ep Oct Nov Dec Jan Feb Mar Apr

W heat

Cotton

Rice

S ugar Cane

Maize

Patato

Chillies

KHARI F RABI

GrowingS owing Harvesting

Fertilizer Sector

November 18, 2015

Fertilizer Sector

BUY433.5 293.0 47.9

Shares (mn) 524 50.0

1,476

3M 6M 12M-12.7 7.1 49.2

2,225.8 2,929.0 4,487.9 335.8 337.5 337.5288.2 269.4 187.8

Source: Bloomberg

Return %

Market Cap. (PKR mn)

Tahir Abbas

F:+92 21 3242 0742

D:+92 21 3246 2589

ENGRO PA

Free float (% )

Upside (% )Current PriceTarget Price

Analyst:

Recommendation


Market Cap. (USD mn)


UAN: +92 21 111 245 111, Ex t: 248

153,464

Relative Performance

Major Shareholders

Price Performance

Avg. Volume (000)High Price - PKRLow Price - PKR

- MSCI FM, KSE100 Index

- Patek (Pvt) Ltd & Dawood Hercules

Indices

70%

100%

130%

160%

190%

220%

Nov-

14De

c-14

Jan-

15Fe

b-15

Mar

-15

Apr-1

5M

ay-1

5Ju

n-15

Jul-1

5Au

g-15

Sep-

15Oc

t-15

Nov-

15

ENGRO KSE100

We reiterate our strong ‘Buy’ stance on Engro Corporation Limited (ENGRO) with our SoTP based Jun-16 price objective of PKR 433.5/share implying an upside potential of 48% from current levels. On a consolidated basis, we expect the company to post 5-year profitability CAGR of 26%. The expected growth is primarily driven from 1) EFERT where we assume recurring concessionary gas would be available for full year along with synergies from DAP trading business, 2) Foods business (EFOODS) which is expected to be back on track with increasing volumes and stable margins, 3) Power business which is likely to remain stable amid secure gas supply, and 4) Future power projects of ~USD 2bn including Sindh Engro Coal Mining Company (SECMC) mining project amounting USD 800mn and Engro Powergen Thar Power Limited mine-mouth 660MW coal power plant amounting USD 1,200mn. The stock’s recent underperformance of 4.1% (last 30 trading days) was attributable to news regarding diversion of gas from EFERT. We believe that the market has overplayed the news and feel that the stock still offers attractive valuations. The stock is currently trading at CY16F P/E of 8.8x along with the dividend yield of 6%.

Exhibit: Key Financials CY13A CY14A CY15E CY16F CY17F EPS PKR 15.3 13.6 25.9 33.4 42.2 DPS PKR - 6.0 13.0 17.0 21.0 P/E x 19.2 21.6 11.3 8.8 6.9 P/B x 2.8 2.3 2.0 1.7 1.5 Dividend Yield % - 2.0 4.4 5.8 7.2 Source: Company Financials, AHL Research

Engro Fertilizer Limited Ambiguity regarding Guddu gas supply remained a major hindrance while evaluating the investment case for EFERT. However according to our analysis even the worst case scenario portrays a relatively better picture than assumed by most, as we expect the company to post PAT of PKR 13,671 (EPS: PKR 10.27) despite of gas diversion from Guddu. We value the company using FCFF and our target price works out to be PKR 108.65/share.

Engro Foods Limited The company was back on track in the current year since the revival of volumes and margins catered by UHT segment amid lower int’l powder milk prices. Our Jun-16 target price for EFOODS works out to be PKR 150/share using FCFF.

Engro Powergen Qadirpur Limited Being operating on permeated gas, the company is well positioned to secure its supply. We believe stable cash flows ahead, our TP works out to be PKR 35/share.

Engro Eximp Agri Product Pvt Limited ENGRO has purchased the entire share capital of Engro Exim Agri-products Limited (EEAP, subsidiary of EXIMP) making it a direct subsidiary of ENGRO. EEAP is engaged in procurement, processing & sale of Basmati rice & owns the largest integrated rice processing plant in the country. The restructuring of the company is ongoing and it recently booked impairment on its rice processing plant.

Engro Vopak Terminal Limited We expect stable cash flows ahead from storage business due to historical stable operations subject to long term contracts with LOTCHEM, Akzonobel and others. We value the company using DDM model and our target price is PKR 3.0/share based on ENGRO’s stake.

Engro Corporation Limited

Diversification strategy paying off through deep valuations; ‘Strong BUY’

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Elengy Terminal Pakistan Limited Elengy Terminal Pakistan Limited, won the GOP’s tender for Fast Track LNG back in Nov-2013. Accordingly, Engro setup a re-gasification facility and will handle LNG on tolling basis for 15 years. We value the company using FCFF and our target price is PKR 7.4/share on ENGRO’s paid up capital.

Cracking the Value pie The flagship business (EFERT) is expected to provide major value to ENGRO, contributing 50% to our SoTP based target price. We view that even in the case of gas diversion in CY16 the investment case is expected to remain intact amid higher utilization of EnVen and concessionary gas flows. Furthermore, the DAP trading business is also expected to contribute in EFERT’s earnings going forward. EFOODS is the second major contributor in our ENGRO valuation adding 44% to the total value, we believe higher consumer spending in conjunction with revival of volumes and margins would unleash new horizons for the fast growing food business. Engro Powergen (via Engro Powergen Qadirpur Limited) contributes 3% to our valuations.

Future power projects of ~USD 2bn which includes Sindh Engro Coal Mining Company (SECMC) mining project amounting USD 800mn and Engro Powergen Thar Power Limited mine-mouth 330MW x 2 coal power plant amounting USD 1200mn. As per initial estimates we believe Engro Powengen Thar Power Limited will contribute PKR 46.23/share to our target price of ENGRO assuming 65% stake of Engro Powengen, 30.65% RoE and 75:25 debt to equity ratio, while upside from SECMC mining project will be PKR 8.14/share assuming 22% stake of Engro Powergen, 27% RoE and 75:25 debt to equity ratio. However due to lack of information amid pre financial closure phase of the projects, we have not included the impact in our valuations.

Exhibit: Sum of the Parts Valuation (SOTP) Company PV of Cash flows Stake Adjusted TP*

Engro Fertilizer 144,610 79% 113,941 217.5

Engro Foods 114,179 87% 99,415 189.8

Engro Eximp Agri Products 850 100% 850 1.6

Engro Powergen** 10,689 69% 7,376 14.1

Engro Vopak 3,179 50% 1,589 3.0

Engro Elengy Terminal 4,841 80% 3,873 7.4

Total 278,348 227,045 433.47

Source: AHL Research *Target prices on ENGRO's paid up capital, **Engro Powergen own 69% of Engro Powergen Qadirpur

Engro Corporation

Engro Foods (87%)Engro Eximp Agriproducts

Private Limited (100%)

Engro Fertilizers (79%)

Engro Eximp Private Limited

(100%)

Engro Eximp FZE (100%)

Elengy TerminalPakistan Ltd.

(80%)

Engro Powergen (100%)

Engro Powergen Qadirpur

Limited (69%)

Sindh Engro Coal Minig Company

Limited (22%)

Thar Power Comapany

Limited (65%)

Engro Polymer and Chemicals Limited (56%)

Engro VoPak terminal Limited

(50%)

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Focus Charts

Exhibit: Upbeat GMs amid recovering sales Exhibit: Net margins and PAT both tilt upwards

Exhibit: Gross and Net Margins continue Exhibit: Sales and Net Margins

Exhibit: Deleveraging leading to lower risk Exhibit: Lower debt plus falling interest rates leading to lower interest costs

Source: Company Financials, AHL Research

155.4

176.0

150.7

163.8 172.9

15.0

20.0

25.0

30.0

35.0

40.0

130.0

150.0

170.0

190.0

210.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Net Sales Gross Margins (RHS)(PKR bn) (%)

8.2 10.0

19.2 21.5

27.5

5.0

10.0

15.0

20.0

25.0

5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

PAT Net Margins (RHS)(PKR bn) (%)

- 7.5

15.0 22.5 30.0 37.5 45.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Gross Margins Net Margins(%)

155.4

176.0

150.7 163.8

172.9

5.0 7.5 10.0 12.5 15.0 17.5 20.0

130.0

150.0

170.0

190.0

210.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Sales Net Margins (RHS)(PKR bn) (%)

47.4 57.2

62.2 70.6

82.6

-

0.5

1.0

1.5

2.0

2.5

40.0 50.0 60.0 70.0 80.0 90.0

100.0 110.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Equity Debt to Equity (RHS)(PKR bn) (x)

15.6

12.3

8.5 7.3

6.1

-

0.5

1.0

1.5

2.0

2.5

5.0

7.0

9.0

11.0

13.0

15.0

17.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Interest Expense Debt to Equity (RHS)(PKR bn) (x)

Fertilizer Sector

November 18, 2015

Fertilizer Sector

BUY108.7 84.0 29.3

Shares (mn) 1,331 25.0

1,075

3M 6M 12M-11.7 0.5 36.2

1,564.3 2,886.8 4,313.6 97.8 97.8 97.884.0 82.6 58.9

Return %


Tahir Abbas

F:+92 21 3242 0742

D:+92 21 3246 2589

EFERT PA

Free float (% )


Analyst:

Recommendation




UAN: +92 21 111 245 111, Ex t: 248

111,812


Major Shareholders

Price Performance


Source: Bloomberg

- Engro Corporation

Indices- KSE100 Index

70%

100%

130%

160%

190%

Nov-

14De

c-14

Jan-

15Fe

b-15

Mar

-15

Apr-1

5M

ay-1

5Ju

n-15

Jul-1

5Au

g-15

Sep-

15Oc

t-15

Nov-

15

EFERT KSE100

EFERT has two fully integrated fertilizer plants having nameplate capacity of producing 2.275mn tons of urea (base plant: 0.975mn tons and EnVen: 1.3mn tons). Both of the company’s plants are located in Sindh. The company is expected to remain a major contributor to ENGRO’s profitability by contributing 74% in CY15E (ENGRO EPS impact: PKR 21.34) and 71% in CY16F (ENGRO EPS impact: PKR 20.56) respectively.

Exhibit: Key Financials CY13A CY14A CY15E CY16F CY17F EPS PKR 4.1 6.2 10.7 10.3 12.8 DPS PKR - 3.0 6.0 7.0 7.0 P/E x 20.3 13.6 7.9 8.2 6.6 P/B x 4.5 3.2 2.8 2.5 2.1 Dividend Yield % - 3.6 7.1 8.3 8.3 Source: Company Financials, AHL Research

Guddu gas availability to remain a concern Guddu gas is expected to be diverted from EFERT in Dec-15 as stated in the GSA signed between the company and the Gov’t. Bridging the average power shortfall of 6,000MW as gov’t priority, there is a high chance for the diversion. However, further delay of 3-6 months cannot be ruled out amid technical issues in Guddu 747 MW (249 MW x 3) power plant. Our channel checks suggest that it would be delayed for another 3 months. Clarity is yet to emerge on the same as further extension has not been finalized. It is important to mention here that Guddu gas diversion has been delayed twice in the past due to the same issue. Assuming complete diversion of Guddu gas, we expect the EnVen plant to operate at 103% with all the available gas. Resultantly we expect the company to post PAT of PKR 13,671 (EPS: PKR 10.27) in CY16F. Our sensitivity analysis indicates one month’s availability of Guddu gas having a positive earnings impact of PKR 0.23/share. Being on a conservative side we have assumed diversion and that only EnVen is operational in CY16F.

GP margins to hover around 54%, PAT to grow at a 5 year CAGR of 13% Concessionary gas flows would fully be magnified in CY16 amid availability for full year. GM are expected to clock in at a CY15-19 average of 54%. Similarly, company’s profitability is expected to post 5-year CAGR of an impressive 13% going forward.

Product pricing to remain stable As far as product pricing is concerned, the industry is expected to maintain urea prices at current levels. We derive our assumption with the manufacturer’s stance that urea prices reversal is only possible if gov’t will revert gas tariff (both feed and fuel stock) to old level. Furthermore, the demand-supply gap of urea, is expected to remain ~1mn tons as observed from regular imports being made by the gov’t.

Synergies from Engro Eximp Subsequent to the purchase of Engro Eximp the DAP trading arm by EFERT, the company is expected to import 450k tons of DAP annually leading towards improvement in annualized after tax earnings by PKR 1,585 (EPS: PKR 1.20). Important to mention here is that annual demand for DAP in Pakistan is around 1.6mn out of which FFBL is expected to cater 0.7mn while remaining pie is for EFERT and other private importers.

Key Risks 1) Intervention by gov’t in setting up prices for the fertilizer sector, 2) Substantial reduction in Int’l urea prices (highly unlikely), 3) Increased GIDC, and 4) Margin attrition in DAP trading business.

Engro Fertilizer Limited

Stable prices plus subsidized costs cultivating upside potential; ‘BUY’

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Focus Charts

Exhibit: Net Sales & Total Volume Exhibit: Production & Utilization

Exhibit: Higher earnings going forward Exhibit: Higher profitability coupled with better margins

Exhibit: Rising Gross, EBITDA and Net margins Exhibit: Higher gross margins amid new plant

Exhibit: Deleveraging leading to lower risk Exhibit: Lower finance costs amid receding interest rates and lower debt


50.1

61.4 61.1

45.3

57.0

1,200

1,400

1,600

1,800

2,000

37.0 42.0 47.0 52.0 57.0 62.0 67.0 72.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Net Sales Total Volume (RHS)(PKR bn) (K tons)

50%55%60%65%70%75%80%85%

600

1,000

1,400

1,800

2,200

2,600

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Capacity Production Utilization(K tons)

4.1 6.2

10.7 10.3 12.8

2.0

6.0

10.0

14.0

18.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

EPS(PKR)

5.5 8.2

14.2 13.7

17.1

10.0 13.0 16.0 19.0 22.0 25.0 28.0 31.0 34.0

5.0

9.0

13.0

17.0

21.0

25.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


5.0 15.0 25.0 35.0 45.0 55.0 65.0 75.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Gross Margins EBITDA Margins Net Margins(%)

50.1

61.4 61.1

45.3

57.0

30.0 35.0 40.0 45.0 50.0 55.0 60.0 65.0

42.0 47.0 52.0 57.0 62.0 67.0 72.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Sales Gross Margins(PKR bn) (%)

25.1 34.5

40.6 45.0 52.7

-

0.5

1.0

1.5

2.0

2.5

10.0 20.0 30.0 40.0 50.0 60.0 70.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Equity Debt to Equity (RHS)(PKR bn) (x)9.9

6.6 5.4 5.0 4.4

-

0.5

1.0

1.5

2.0

2.5

3.0

5.0

7.0

9.0

11.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


Fertilizer Sector

November 18, 2015

Fertilizer Sector

Financials

Exhibit: Income Statement (PKR mn) CY13A CY14A CY15E CY16F CY17F Net Sales 50,129 61,425 61,089 45,274 56,966 Gross Profit 22,121 22,603 30,516 27,340 31,913 Gross Margins % 44.1 36.8 50.0 60.4 56.0 EBITDA 18,610 18,161 26,510 24,319 28,188 EBITDA Margins % 37.1 29.6 43.4 53.7 49.5 Operating Profit 18,302 18,520 27,179 24,773 28,783 Other Income 1,151 2,449 2,138 1,585 1,994 Financial Charges 9,918 6,625 5,350 4,960 4,413 Profit after Tax 5,497 8,208 14,188 13,671 17,059 Net Margins % 11.0 13.4 23.2 30.2 29.9 EPS PKR 4.1 6.2 10.7 10.3 12.8 DPS PKR - 3.0 6.0 7.0 7.0 Source: Company Financials, AHL Research Exhibit: Balance Sheet (PKR mn) CY13A CY14A CY15E CY16F CY17F Shareholders' Equity 25,069 34,478 40,613 44,968 52,710 Non Current Liabilities Long Term Loan 52,896 36,091 22,591 18,072 13,554 Total Non Current Liabilities 62,186 41,437 27,937 23,419 18,901 Current Liabilities Trade and Other Payables 18,012 24,472 8,735 5,124 7,158 Total Current Liabilities 22,673 35,556 25,407 12,814 14,848 Total Liabilities and Equity 109,929 111,472 93,957 81,200 86,459 Assets Non Current Assets 79,563 75,175 71,172 68,125 65,558 Current Assets 30,366 36,297 22,785 13,075 20,901 Total Assets 109,929 111,472 93,957 81,200 86,459 Source: Company Financials, AHL Research

Exhibit: Ratio Analysis CY13A CY14A CY15E CY16F CY17F ROE % 29.2 27.6 37.8 31.9 34.9 ROA % 7.3 7.4 13.8 15.6 20.3 Coverage Ratio x 1.8 2.8 5.1 5.0 6.5 Debt to Equity x 3.4 2.2 1.3 0.8 0.6 Debt to Assets x 0.8 0.7 0.6 0.4 0.4 Dividend Yield % - 3.6 7.1 8.3 8.3 P/E x 20.3 13.6 7.9 8.2 6.6 P/B x 4.5 3.2 2.8 2.5 2.1 Source: Company Financials, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

HOLD149.6 156.3

(4.3) Shares (mn) 767

15.0

1,152

3M 6M 12M-10.8 15.9 59.7973.5 1615.3 2615.4175.2 175.2 175.2144.6 131.9 96.0

Source: Bloomberg


UAN: +92 21 111 245 111, Ex t: 248

119,834


Major Shareholders

Price Performance


- Engro Corporation Limited

Indices- KSE100 Index

Return %


Tahir Abbas

F:+92 21 3242 0742

D:+92 21 3246 2589

EFOODS PA

Free float (% )


Analyst:

Recommendation



70%

100%

130%

160%

190%

Nov-

14De

c-14

Jan-

15Fe

b-15

Mar

-15

Apr-1

5M

ay-1

5Ju

n-15

Jul-1

5Au

g-15

Sep-

15Oc

t-15

Nov-

15

EFOODS KSE100

The foods business is mainly engaged in manufacturing and selling of dairy and juice products along with penetration in ice cream segment and also owns a dairy farm. After suffering from turbulent year back in CY13 amid supply chain issues, the company is all set to contribute 18% and 25% into earnings of ENGRO in CY15E and CY16F followed by 44% contribution to ENGRO’s target price.

Exhibit: Key Financials CY13A CY14A CY15E CY16F CY17F EPS PKR 0.3 1.2 4.6 6.2 7.7 P/E x 568.0 134.8 33.8 25.4 20.3 P/B x 11.2 10.4 8.1 6.2 4.7 Source: Company Financials, AHL Research

We expect the company to post profit after tax (PAT) of PKR 3,541mn (EPS: PKR 4.62) in CY15 significantly up 3.9x YoY. The major driver behind this growth is revival of volumes in low end UHT milk segment (Tarang and Omung) coupled with expected price increase in dairy products going forward.

Exhibit: 04-year Average


Dairy & beverages segment The dairy products include UHT milk, powder milk, cream and juices. We expect the dairy volume to grow at a 5-year CAGR of 6% and is expected to contribute 91% to the total revenues and profitability.

Ice cream segment The company’s Omore brand is country’s 2nd largest ice cream brand. Furthermore, the ice cream segment posted LAT of PKR 293mn CY14. However, in CY15 the segment posted profitability of PKR 101mn in 9MCY15. Going forward we view that the volumes are expected to grow at a 5-year CAGR of 3% along with revenue to grow at 4%.

Farm segment The segment posted PAT of PKR 15mn in 9MCY15 as compared to LAT of PKR 34mn in the SPLY. The revival is mainly on account of increase in herd size along with some improvement in the yields. We expect the segment to post PAT of PKR 18mn and PKR 30mn in CY15E and CY16F respectively.

Key Risk and Outlook 1) Unexpected increase in int’l powder milk prices, 2) Higher fuel cost, 3) Lower consumer spending, and 4) Volume slowdown in dairy segment. Going forward the company is expected to maintain its focus on leading brands like Olpers, Tarang, Omung and Omore along with aggressive advertising and marketing techniques to maintain its market share.

5.8%8.8%

11.2%

0.0%

5.0%

10.0%

15.0%

Food Inflation Fresh Milk Powder Milk

Engro Foods Limited

Volumetric growth in dairy products to push profitability upwards

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Focus Charts

Exhibit: Rising sales, albeit at a slower pace Exhibit: Expecting higher earnings ahead

Exhibit: Rising PAT and Net Margins Exhibit: Gross and Net Margins

Exhibit: Higher margins amid rising sales Exhibit: Declining interest expense

Exhibit: Sales Contribution CY14 Exhibit: PAT Contribution CY14 (PKR mn)


37.9 43.0

54.4 62.3

65.8

(10.0) (5.0) - 5.0 10.0 15.0 20.0 25.0 30.0

30.0 37.5 45.0 52.5 60.0 67.5 75.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Net Sales Growth (RHS)(PKR bn) (%)

0.3 1.2

4.6

6.2

7.7

-

3.0

6.0

9.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

EPS(PKR)

0.2 0.9

3.5

4.7

5.9

- 2.5 5.0 7.5 10.0 12.5 15.0

-

2.0

4.0

6.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


- 5.0

10.0 15.0 20.0 25.0 30.0 35.0 40.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


37.9 43.0

54.4 62.3 65.8

15.0

19.0

23.0

27.0

31.0

35.0

30.0

40.0

50.0

60.0

70.0

80.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


0.8

1.2

1.0

0.6

0.3

-

0.2

0.4

0.6

0.8

1.0

-

0.3

0.5

0.8

1.0

1.3

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


Dairy & Beverages,

90.6%

Ice Cream, 6.6%

Dairy Farm, 1.7%

Business Development

, 0.2%Others, 0.9%

Dairy & Beverages,

1,710

Ice Cream, (293)

Dairy Farm, (31)

Business Development

, (238)

Others, (280)

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Financials

Exhibit: Income Statement (PKR mn) CY13A CY14A CY15E CY16F CY17F Net Sales 37,891 43,027 54,357 62,273 65,830 Gross Profit 8,143 8,101 13,323 16,484 18,094 Gross Margins % 21.5 18.8 24.5 26.5 27.5 Operating Profit 2,174 2,328 7,073 8,171 9,584 Other Income 324 305 417 423 513 Financial Charges 785 1,237 972 575 320 Profit after Tax 211 889 3,541 4,723 5,910 Net Margins % 0.6 2.1 6.5 7.6 9.0 EPS PKR 0.3 1.2 4.6 6.2 7.7 Source: Company Financials, AHL Research

Exhibit: Balance Sheet (PKR mn) CY13A CY14A CY15E CY16F CY17F Shareholders' Equity 10,715 11,578 14,755 19,478 25,388 Non Current Liabilities Long Term Loan 7,127 5,477 4,786 2,086 500 Total Non Current Liabilities 8,675 6,665 5,975 3,274 1,688 Current Liabilities Trade and Other Payables 3,369 3,223 3,923 4,349 4,549 Total Current Liabilities 4,655 7,457 8,146 8,591 7,748 Total Liabilities and Equity 24,046 25,700 28,876 31,344 34,824 Assets Non Current Assets 16,033 16,214 15,314 13,563 12,553 Current Assets 8,012 9,485 13,562 17,781 22,271 Total Assets 24,046 25,700 28,876 31,344 34,824 Source: Company Financials, AHL Research

Exhibit: Ratio Analysis CY13A CY14A CY15E CY16F CY17F ROE % 1.8 8.0 26.9 27.6 26.3 ROA % 0.7 3.6 13.0 15.7 17.9 Coverage Ratio x 2.8 1.9 7.3 14.2 30.0 Debt to Equity x 0.8 0.8 0.6 0.3 0.1 Debt to Assets x 0.3 0.4 0.3 0.2 0.1 P/E x 568.0 134.8 33.8 25.4 20.3 P/B x 11.2 10.4 8.1 6.2 4.7 Source: Company Financials, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

HOLD35.0 35.9 (2.4)


112

3M 6M 12M-6.9 -6.7 -8.3

156.4 381.0 608.238.6 39.5 42.834.9 34.9 33.6

Source: Bloomberg


UAN: +92 21 111 245 111, Ex t: 248

11,615


Major Shareholders

Price Performance


- Engro Corporation

Indices- KSEALL Index

Return %


Tahir Abbas

F:+92 21 3242 0742

D:+92 21 3246 2589

EPQL PA

Free float (% )


Analyst:

Recommendation



80%

100%

120%

140%

Nov-

14De

c-14

Jan-

15Fe

b-15

Mar

-15

Apr-1

5M

ay-1

5Ju

n-15

Jul-1

5Au

g-15

Sep-

15Oc

t-15

Nov-

15

EPQL KSE100

Engro Powergen Qadirpur Limited (EPQL) is a gas based thermal power project near Qadirpur (Sindh) and has a net capacity of 217.3MW. EPQL constructed a state-of-the-art power plant of Chinese origin on the said land. The cost for the project was estimated to be USD 205mn with a debt to equity ratio of 75:25. It supplies power to NTDC under Power Purchase Agreement (2007) which is valid for 25-yrs from the plant’s COD and its tariff was indexed accordingly. Since operations started the plant has managed to maintain an average Billable Availability Factor of 95%. To be more precise, EPQL is a combined cycle power plant which utilizes low BTU permeate gas to generate electricity. The plant uses High Speed Diesel (HSD) as a start-up and back-up fuel. It runs on combined cycle operations, with one gas turbine, one heat recovery steam generator and one steam turbine. Being a gas run plant, it is one of the lowest cost power producers in the country. ENGRO’s 100% owned subsidiary Engro Powergen owns 69% stake in EPQL.

Exhibit: Steady load factor amid permeate gas advantage

Source: NEPRA, AHL Research

Permeate Gas: Ensuring undeterred gas supply The Company uses low BTU, high sulphur content permeate gas from Qadirpur Gas field as fuel, which safeguards it from gas shortage - supply of permeate gas is entirely separate from the national gas supply. Moreover, due to usage of permeate gas, the company is able produce one of the cheapest forms of power and this has ensured the company’s spot on NEPRA’s dispatch merit order list.

Guaranteed USD base return IRR of ~15% The Company operates under 2007 Power Purchase Agreement (PPA), which guarantees USD based Internal Rate of Return (IRR) of ~15%. In addition, the tariff structure also lets the company to pass on costs to the power purchaser. Furthermore, any changes in inflation, exchange rate, interest rate and additional fuel costs are not borne by the company.

Earnings to grow at 8% 5-year CAGR Earnings of the company are projected to grow at a 5-year CAGR of 8%, leaving decent cash flow availability. We have valued the company using Dividend Discount Model (DDM). We have set our target price for EPQL at PKR 35/share and it is expected to contribute 3% in ENGRO valuations.

0%30%60%90%120%

- 100 200 300 400 500

1QCY

13

2QCY

13

3QCY

13

4QCY

13

1QCY

14

2QCY

14

3QCY

14

4QCY

14

1QCY

15

2QCY

15

3QCY

15

Generation Load Factor (RHS)(GWh)

Engro Powergen Qadirpur Limited

Guaranteed returns plus cost efficiencies powering up earnings

Exhibit: Key Financials CY13A CY14A CY15E CY16F CY17F EPS PKR 4.5 6.2 5.1 5.6 6.0 DPS PKR 6.2 1.5 3.0 3.0 3.0 P/E x 8.0 5.7 7.0 6.4 6.0 P/B x 2.1 1.8 2.2 1.9 1.6 Dividend Yield % 17.2 4.2 8.4 8.4 8.4 Source: Company Financials, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Focus Charts

Exhibit: Steadily growing sales amid rising dispatches Exhibit: Earnings growth beyond CY15E

Exhibit: DPS and Payout ratio Exhibit: PAT and Net Margins

Exhibit: Gross and Net Margins Exhibit: Sales and Gross Margins

Exhibit: Debt to Equity Exhibit: Interest expense & Debt to Equity


8.7

12.0 13.0 14.0 15.3

1,300

1,500

1,700

1,900

5.0

10.0

15.0

20.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Net Sales Dispatches (RHS)(PKR bn) (GWh)

4.5

6.2

5.1 5.6 6.0

1.0 2.0 3.0 4.0 5.0 6.0 7.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

EPS DPS(PKR)

6.2

1.5

3.0 3.0 3.0

10.0

50.0

90.0

130.0

170.0

-

2.0

4.0

6.0

8.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

DPS Payout Ratio (RHS)(PKR) (%)

1.5

2.0

1.7 1.8

1.9

12.0 13.0 14.0 15.0 16.0 17.0 18.0

1.0

1.5

2.0

2.5

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


10.0

14.0

18.0

22.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


8.7

12.0 13.0 14.0 15.3

10.0 14.0

18.0 22.0 26.0 30.0

5.0

10.0

15.0

20.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


5.5 6.5

5.4 6.2

7.1

- 0.5 1.0 1.5 2.0 2.5

5.0

7.0

9.0

11.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


0.5

0.6

0.8 0.8 0.7

- 0.5 1.0 1.5 2.0 2.5

0.3

0.4

0.6

0.7

0.8

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


Fertilizer Sector

November 18, 2015

Fertilizer Sector

Financials Exhibit: Income Statement (PKR mn) CY13A CY14A CY15E CY16F CY17F Net Sales 8,665 12,041 12,990 13,997 15,258 Gross profit 1,652 2,006 2,138 2,249 2,309 Gross Margins % 19.1 16.7 16.5 16.1 15.1 Other Income 410 154 317 324 368 Profit from Operations 1,934 2,600 2,455 2,572 2,678 Financial Charges 476 579 792 760 743 PAT 1,458 2,021 1,663 1,812 1,935 Net Margin % 16.8 16.8 12.8 12.9 12.7 EPS @324 mn Shares PKR 4.5 6.2 5.1 5.6 6.0 DPS @324 mn Shares PKR 6.2 1.5 3.0 3.0 3.0 Source: Company Financials, AHL Research Exhibit: Balance Sheet (PKR mn) CY13A CY14A CY15E CY16F CY17F Total Shareholders' Equity 5,523 6,509 5,365 6,198 7,063 Non Current Liabilities Long Term Loan 9,586 7,714 6,730 5,444 3,956 Total Non Current Liabilities 9,586 7,714 6,730 5,444 3,956 Current Liabilities Short term borrowings 882 1,961 3,248 3,483 3,855 Total Current Liabilities 3,923 4,806 7,313 7,859 8,663 Total Liabilities and Equity 19,033 19,029 19,274 19,368 19,548 Assets Non Current Assets 15,337 14,329 14,166 13,946 13,575 Current Assets 3,696 4,699 5,108 5,422 5,973 Total Assets 19,033 19,029 19,274 19,368 19,548 Exhibit: Ratio Analysis CY13A CY14A CY15E CY16F CY17F ROE % 26.4 33.6 28.0 31.3 29.2 ROA % 7.7 10.6 8.7 9.4 9.9 Coverage Ratio x 4.1 4.5 3.1 3.4 3.6 Debt to Equity x 2.1 1.7 2.1 1.7 1.4 Debt to Assets x 0.6 0.6 0.6 0.5 0.5 Dividend Yield % 17.2 4.2 8.4 8.4 8.4 P/E x 8.0 5.7 7.0 6.4 6.0 P/B x 2.1 1.8 2.2 1.9 1.6 Source: Company Financials, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Engro Eximp Agri Product Pvt Limited EEAP is engaged in procurement, processing & sale of Basmati rice & owns the largest integrated rice processing plant in the country. The restructuring of the company is ongoing and the company subsequently has booked impairment against rice processing plant of PKR 2.138bn in CY15 while the net book value of the rice plant now stands at ~PKR 2.3bn. The company has already explored its B2B side and plans to now redirect its focus to the B2C side in the rice segment. The outlook depends upon several factors most importantly the ability to cater retail segment. The company has launched packaged wheat under the brand name ‘Onaaj’ and expects a good response from the market. Similar strategy would be opted for rice branding going forward.

Engro Vopak Terminal Limited Engro Vopak Terminal Limited (EVTL) is a 50:50 joint venture between Engro and Royal Vopak (Netherlands). Major clients include Lotte Chemicals Pakistan (LOTCHEM), ICI Pakistan (ICI), Akzonobel Pakistan (AKZO) which imports PX, MEG, Ethylene and others. LOTECHEM is one of the biggest clients of VOPAK. We have valued the company using DDM and our target price works out to be PKR 3/share based on ENGRO’s stake in the company and contributes 1% to our SoTP valuation of ENGRO.

Exhibit: Major Customers Akzo Noble Jamshoro Joint Venture Ltd. Lotte Chemicals Pakistan Ltd. Aftab Traders Engro Polymers and Chemicals Ltd. SHV Fauji Fertilizer Bin Qasim Ltd. Source: Company Website, AHL Research

Engro Elengy Terminal Limited Elengy Terminal Pakistan Limited, won the GOP’s tender for Fast Track LNG back in Nov-2013. Accordingly, Engro setup a re-gasification facility and will handle LNG on tolling basis for 15 years. As per the agreement the volume of gas will be 200mmcd for 1st year while for the remaining 14 years it will be 400mmcfd. However, the maximum handling capacity is around 600mmcfd. It is important to mention here that, as per the agreement if gov’t won’t be able to import LNG, the company would receive amount of USD 272k per day. We value the company using FCFF and our target price is PKR 7.4/share on ENGRO’s no. of shares and has 2% contribution in ENGRO’s target price.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

BUY140.7 122.5 14.9


1,100

3M 6M 12M-15.1 -11.7 11.9

1087.2 1247.7 1652.7143.4 156.7 156.7121.7 121.7 107.6

Source: Bloomberg


UAN: +92 21 111 245 111, Ex t: 248

114,428


Major Shareholders

Price Performance


- Fauji Foundation

Indices- MSCI FM, KSE100 Index

Return %


Tahir Abbas

F:+92 21 3242 0742

D:+92 21 3246 2589

FFC PA

Free float (% )


Analyst:

Recommendation



80%

100%

120%

140%

160%

Nov-

14De

c-14

Jan-

15Fe

b-15

Mar

-15

Apr-1

5M

ay-1

5Ju

n-15

Jul-1

5Au

g-15

Sep-

15Oc

t-15

Nov-

15

FFC KSE100

FFC remained the biggest player in urea market in terms of offtake making it the safest bet in the fertilizer sector while peers were challenged with gas curtailment in CY15. This was possible due to secure gas supply from Mari’s gas network, which faced least gas curtailment (~12%-15%). FFC continued to be the market leader in urea sales, as the company catered to 43% and 41% of total urea off-take for CY14 and 9MCY15 respectively. Together with its core business, the company is diversifying its investment base into 1) Alternate energy, 2) Financial services, 3) Food business, and 4) more recently setting up an offshore fertilizer plant in Tanzania which is in the initial stages.


Functioning position Capacity utilization of the company was optimal in CY14 / 9MCY15, and was recorded at 117% / 118%. The operational performance is expected to maintain the same level going forward with the utilization hovering around 118% in CY16. Top-line of the company is expected to grow at 5-year CAGR of 2% amid better production coupled with 2.5% expansion in urea prices subject to 5% gas price hike assumed in our valuations.

Price reduction could be tricky! The company’s earnings are highly sensitive to fluctuations in urea prices due to its full exposure and dependency on urea. Our sensitivity analysis suggests that every PKR 50/bag change in urea price would lead to earnings impact of PKR 1.11/share (7.8% of CY16 earnings). However, we do not expect any price cuts in the local urea prices as the inflated urea prices are on account of gas tariff hike for feed and fuel stock announced in Sept-15 coupled with prevailing demand-supply gap of ~1mn tons. Urea price cut can only be expected if gov’t decides to reverse gas tariff hike.

Diversification at top notch With the successful transaction of 28% stake acquisition in Askari Bank Ltd (AKBL), Fauji Foundation and Fauji Fertilizer Bin Qasim back in Sept-13, the company has started reaping profit with CY14 dividend income of PKR 702mn (EPS impact of PKR 0.55 for FFC). Going forward, we believe that AKBL will maintain its dividend payout ratio and will distribute PKR 2/share in CY15 and PKR 2.5/share in CY16. The dividend income does not stop here as FFC’s venture into wind power business with FFC Energy Limited CoD in May-13 will start to pay dividend in CY15. The business posted profit after tax of PKR 735mn in CY14 with annual electricity production of 142GWh and average plant availability of 99%. Assuming payout ratio of 90%, we believe that the annual contribution in FFC would be PKR 662mn (pre-tax FFC EPS PKR 0.52/share) in CY16F.

Valuation Our SoTP based Jun-16 target price for FFC works out to PKR 140.7/share, translating into an upside potential of 14.9% from the last closing price of PKR 122.5/share. Besides this sizeable upside potential the stock is trading at CY16F PER of 8.7x and PEB of 5.3x, while offering lucrative yield of 10.6% for CY16F against 1-year T-bill yield

Fauji Fertilizer Company

Attractive yields plus gas advantage makes FFC the safest bet!

Fertilizer Sector

November 18, 2015

Fertilizer Sector

of 6.3% thus forming a strong case of yield play alongside with diversified base into fertilizer, foods, alternate energy and financial services sectors.

Key Risks These factors largely based on industry risk include 1) Intervention by gov’t in setting prices for the fertilizer sector 2) Significant reduction in Int’l urea prices 3) Increased GIDC 4) Lower demand stemming from the food business.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Focus Charts

Exhibit: Net Sales and Total Volumes Exhibit: Continues to maintain high payouts

Exhibit: DPS & Payouts Exhibit: Recovering PATs ahead, with stable NMs

Exhibit: Gross, EBITDA and Net Margins to remain strong Exhibit: Sales & Gross Margins

Exhibit: Lower Debt-to-equity ratio Exhibit: Lower interest expenses amid falling debt quantum


74.5

81.2 77.4

79.7 82.1

2,200 2,250 2,300 2,350 2,400 2,450 2,500

70.0

75.0

80.0

85.0

90.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Net Sales Total Volume (RHS)(PKR bn) (K tons) 16.4 15.8

14.3 13.6 14.1

10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

EPS DPS(PKR)

15.5 15.4

13.7

12.0

13.0

85.0 87.0 89.0 91.0 93.0 95.0 97.0 99.0

10.0

11.0

12.0

13.0

14.0

15.0

16.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


20.1

18.2 17.3

17.9 18.5

20.0 21.0 22.0 23.0 24.0 25.0 26.0 27.0 28.0

16.0

18.0

20.0

22.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


20.0 25.0 30.0 35.0 40.0 45.0 50.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Gross Margins EBITDA Margins Net Margins(%)

74.5

81.2

77.4 79.7

82.1

35.0 37.0 39.0 41.0 43.0 45.0 47.0 49.0

70.0

75.0

80.0

85.0

90.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Sales Gross Margins (RHS)(PKR bn) (%)

25.2 26.0 28.0

29.4 31.3

1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0

22.0

26.0

30.0

34.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


0.8 0.8

1.2 1.0

0.5

1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0

-

0.3

0.5

0.8

1.0

1.3

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


Fertilizer Sector

November 18, 2015

Fertilizer Sector

Financials

Exhibit: Income Statement (PKR mn) CY13A CY14A CY15E CY16F CY17F Net Sales 74,481 81,240 77,415 79,737 82,129 Gross Profit 34,532 31,103 30,564 31,376 32,299 Gross Margins % 46.4 38.3 39.5 39.3 39.3 EBITDA Margins % 42.6 35.4 37.0 36.9 36.4 Operating Profit 25,807 22,369 21,377 21,561 21,815 Other Income 28,365 24,672 23,586 23,862 24,159 Financial Charges 756 849 1,209 976 478 Profit after Tax 20,135 18,171 17,317 17,948 18,460 Net Margins % 27.0 22.4 22.4 22.5 22.5 EPS @1,272 mn Shares PKR 15.8 14.3 13.6 14.1 14.5 DPS @1,272 mn Shares PKR 15.4 13.7 12.0 13.0 13.0 Source: Company Financials, AHL Research Exhibit: Balance Sheet (PKR mn) CY13A CY14A CY15E CY16F CY17F Shareholders' Equity 25,151 25,959 28,013 29,425 31,349 Non Current Liabilities Long Term Loan 4,280 2,500 1,150 425 - Total Non Current Liabilities 8,358 6,293 4,677 3,705 3,051 Current Liabilities Trade and Other Payables 21,854 24,916 25,626 26,386 27,014 Total Current Liabilities 34,319 39,564 39,676 40,493 41,535 Total Liabilities and Equity 67,829 71,816 72,366 73,624 75,935 Assets Non Current Assets 41,502 40,915 41,815 42,607 43,290 Current Assets 26,328 30,901 30,550 31,017 32,645 Total Assets 67,829 71,816 72,366 73,624 75,935 Source: Company Financials, AHL Research Exhibit: Ratio Analysis CY13A CY14A CY15E CY16F CY17F ROE % 106.8 71.1 64.2 62.5 60.7 ROA % 37.1 26.0 24.0 24.6 24.7 Coverage Ratio x 34.1 26.3 17.7 22.1 45.6 Debt to Equity x 1.7 1.8 1.6 1.5 1.4 Debt to Assets x 0.6 0.6 0.6 0.6 0.6 Dividend Yield % 12.5 11.1 9.8 10.6 10.6 P/E x 7.7 8.6 9.0 8.7 8.4 P/B x 6.2 6.0 5.6 5.3 5.0 Source: Company Financials, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

BUY65.0 56.8 14.3


511

3M 6M 12MReturn % -7.9 20.8 46.5Avg. Volume (000) 4,112.0 5,219.4 4,430.5 High Price - PKR 65.3 65.3 65.3Low Price - PKR 56.5 47.1 38.8

Source: Bloomberg


Tahir Abbas

F:+92 21 3242 0742

D:+92 21 3246 2589

FFBL PA

Free float (% )


Analyst:

Recommendation




UAN: +92 21 111 245 111, Ex t: 248

53,095


Major Shareholders

Price Performance

Indices

- Fauji Fertilizer Co. Limited

- KSE100 Index

70%

100%

130%

160%

190%

Nov-

14De

c-14

Jan-

15Fe

b-15

Mar

-15

Apr-1

5M

ay-1

5Ju

n-15

Jul-1

5Au

g-15

Sep-

15Oc

t-15

Nov-

15

FFBL KSE100

Fauji Fertilizer Bin Qasim (FFBL) is the sole producer of DAP in the country having annual capacity of 650k tons in addition to installed urea capacity of 500k tons. Operating on the Sui Southern Gas Company (SSGC) network, the company faces an annual gas shortage of ~45-48%. Like its parent company, FFC, FFBL also has a diversified investment base in 1) Alternate energy, 2) Financial services, 3) Meat business, and 4) Coal power plant. We project earnings to grow at 5-year CAGR of 7% going forward backed by 1) Higher DAP offtake, 2) expected recovery in DAP margins due to subsidy announcement, and 3) stable local DAP prices.


Operational overview FFBL is facing 45% annual gas curtailment on SSGC network, due to which the company’s urea production and sales declined significantly by 15% and 6% YoY, respectively, in CY14. In CY15, we expect gas curtailment to remain at the mentioned levels. To address the curtailment problem the company is in process of setting up 118MW coal based power plant which is expected to be operational by the end of CY17, eventually allowing the company to divert its fuel stock gas for usage as feed stock. Upward sticky DAP primary margins! Primary margins of DAP are expected to remain on the dull side, as we have already seen the increasing trend in the int’l phosphoric acid prices since Apr-14. During CY15TD the phos acid prices surged 11% while the local DAP prices were sluggish with average prices dropping by 1% YoY. As a result, DAP primary margins for 9MCY15 clocked in at USD 257/ton, down 9% YoY as compared to USD 283/ton in the SPLY. However, the introduction of subsidy on phosphate fertilizer amounting to PKR 20bn (PKR 500/bag for DAP) will help the company to offload its excess inventory in 4QCY15. Broadening investment base The company’s stake in AKBL stood at 21.57%, contributing around PKR 0.81/share and PKR 0.74/share to earnings in CY15 and CY16 respectively, we estimate. Impact of Fauji Meat Limited is expected to add PKR 7.2/share in our valuations and PKR 0.70/share in CY16 earnings. Going forward, FFBL Power Limited which is setting up 118MW coal power plant, out of which ~52MW would be set aside for Karachi Electric Limited (KEL) for which MoU has already been signed further augments our investment case. The said mechanism is also set to save ~10mmcfd of fuel gas which will be used in producing ~125k tons of urea. Our initial estimate suggests that the project would have an earnings impact of PKR 1.26/share starting from CY18. The company also has a 35% stake in Foundation Wind Energy I-II which will bring in an additional PKR 0.50/share in CY16.

Fauji Fertilizer Bin Qasim Limited

Core business plus new ventures adding to company’s profitability!

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Valuation Our SoTP based Jun-16 target price for FFBL works out to PKR 65.0/share, translating into an upside potential of 14.3% from the last closing price of PKR 56.8/share. The stock is currently trading at CY16F PER of 11.6x and PB of 3.6x while offering dividend yield of 7.0% for CY16F.

Key Risks 1) Further delay in the Meat business, 2) Impediments in setting up 118MW coal power plant, 3) Intervention by gov’t in setting up prices for the fertilizer sector, 4) Unfavorable Dap primary margins, 5) Drastic reduction in Int’l urea prices (highly unlikely), and 6) Increased GIDC.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Focus Charts

Exhibit: Higher net sales amid stable volumes Exhibit: Higher earnings to lead to higher dividends

Exhibit: Rich payouts persist Exhibit: Rising PAT and increased Net Margins

Exhibit: Strong Gross, EBITDA and Net Margins Exhibit: Sales to depict rising trend

Exhibit: Debt to equity ratio on decline Exhibit: Falling interest expenses


54.1 52.1

56.7

60.5

64.6

952

956

960

964

968

972

50.0

55.0

60.0

65.0

70.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Net Sales Total Volume (RHS)(PKR bn) (K tons)6.2

4.3 3.9

4.9

5.7

2.5

3.5

4.5

5.5

6.5

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

EPS DPS(PKR)

5.0

4.0

3.0

4.0

5.0

70.0

75.0

80.0

85.0

90.0

95.0

2.5

3.5

4.5

5.5

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


5.8

4.0 3.6

4.6 5.3

6.0 7.0 8.0 9.0 10.0 11.0

2.0

3.0

4.0

5.0

6.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


- 5.0

10.0 15.0 20.0 25.0 30.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F

Gross Margins EBITDA MarginsNet Margins

(%)

54.5 49.4

56.7 60.5

64.6

16.0 18.0 20.0 22.0 24.0 26.0 28.0 30.0

40.0

50.0

60.0

70.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


12.8 13.1 13.9

14.7 15.4

1.5 1.7 1.9 2.1 2.3 2.5 2.7 2.9

10.0

12.0

14.0

16.0

18.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


1.5

1.3

1.8

1.5 1.4

1.5

1.9

2.3

2.7

1.0

1.3

1.5

1.8

2.0

CY13

A

CY14

A

CY15

E

CY16

F

CY17

F


Fertilizer Sector

November 18, 2015

Fertilizer Sector

Financials

Exhibit: Income Statement (PKR mn) CY13A CY14A CY15E CY16F CY17F Net Sales 54,455 49,445 56,661 60,500 64,629 Gross Profit 14,513 11,092 11,070 12,073 13,270 Gross Margins % 26.7 22.4 19.5 20.0 20.5 EBITDA Margins % 18.5 14.3 12.8 13.3 13.7 Operating Profit 10,012 6,460 6,033 6,713 7,569 Other Income 681 1,063 1,676 1,850 1,907 Financial Charges 1,515 1,313 1,781 1,497 1,377 Profit after Tax 5,798 4,016 3,636 4,576 5,309 Net Margins % 10.6 8.1 6.4 7.6 8.2 EPS PKR 6.2 4.3 3.9 4.9 5.7 DPS PKR 5.0 4.0 3.0 4.0 5.0 Source: Company Financials, AHL Research Exhibit: Balance Sheet (PKR mn) CY13A CY14A CY15E CY16F CY17F Shareholders' Equity 12,843 13,072 13,905 14,745 15,384 Non Current Liabilities Long Term Loan 584 - - - - Total Non Current Liabilities 4,042 13,277 11,181 8,377 5,574 Current Liabilities Trade and Other Payables 8,381 13,860 10,934 12,098 13,344 Total Current Liabilities 19,335 19,900 24,549 27,074 28,994 Total Liabilities and Equity 36,220 46,249 49,636 50,196 49,951 Assets Non Current Assets 22,060 24,412 23,956 24,528 25,274 Current Assets 14,160 21,837 25,680 25,668 24,678 Total Assets 36,220 46,249 49,636 50,196 49,951 Source: Company Financials, AHL Research Exhibit: Ratio Analysis CY13A CY14A CY15E CY16F CY17F ROE % 45.7 31.0 27.0 31.9 35.2 ROA % 15.1 9.7 7.6 9.2 10.6 Coverage Ratio x 6.6 4.9 3.4 4.5 5.5 Debt to Equity x 1.8 2.5 2.6 2.4 2.2 Debt to Assets x 0.6 0.7 0.7 0.7 0.7 Dividend Yield % 8.8 7.0 5.3 7.0 8.8 P/E x 9.2 13.2 14.6 11.6 10.0 P/B x 4.1 4.1 3.8 3.6 3.5 Source: Company Financials, AHL Research

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Analyst Certification: The research analyst(s) is (are) principally responsible for preparation of this report. The views expressed in this research report accurately

reflect the personal views of the analyst(s) about the subject security (ies) or sector (or economy), and no part of the compensation of the research analyst(s) was, is,

or will be directly or indirectly related to the specific recommendations and views expressed by research analyst(s) in this report. In addition, we currently do not

have any interest (financial or otherwise) in the subject security (ies). Furthermore, compensation of the Analyst(s) is not determined nor based on any other

service(s) that AHL is offering. Analyst(s) are not subject to the supervision or control of any employee of AHL’s non-research departments, and no personal engaged

in providing non-research services have any influence or control over the compensatory evaluation of the Analyst(s).

Equity Research Ratings Arif Habib Limited (AHL) uses three rating categories, depending upon return form current market price, with Target period as December 2015 for Target Price. In

addition, return excludes all type of taxes. For more details kindly refer the following table;

Rating Description BUY Total return of subject security(ies) is more than +10% from last closing of market price(s) HOLD Total return of subject security(ies) is between -10% and +10% from last closing of market price(s) SELL Total return of subject security(ies) is less than -10% from last closing of market price(s)

Equity Valuation Methodology Following valuation technique(s) are used to arrive at the target price of subject security (ies);

Free Cash Flow to Equity (FCFE) Free Cash Flow to Firm (FCFF)

Dividend Discount Model (DDM) Sum of the Parts (SoTP)

Risks The following risks may potentially impact our valuations of subject security (ies);

Market risk

Interest Rate Risk Exchange Rate (Currency) Risk

Disclaimer: This document has been prepared by Research analysts at Arif Habib Limited (AHL). This document does not constitute an offer or solicitation for the

purchase or sale of any security. This publication is intended only for distribution to the clients of the Company who are assumed to be reasonably sophisticated

investors that understand the risks involved in investing in equity securities. The information contained herein is based upon publicly available data and sources

believed to be reliable. While every care was taken to ensure accuracy and objectivity, AHL does not represent that it is accurate or complete and it should not be

relied on as such. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors. The information given in

this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is

subject to change without any prior notice. AHL reserves the right to make modifications and alterations to this statement as may be required from time to time.

However, AHL is under no obligation to update or keep the information current. AHL is committed to providing independent and transparent recommendation to its

client and would be happy to provide any information in response to specific client queries. Past performance is not necessarily a guide to future performance. This

document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision. The user assumes the entire

risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation

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person from any inadvertent error in the information contained in this report.

© 2015 Arif Habib Limited: Corporate Member of the Karachi, Lahore and Islamabad Stock Exchanges. No part of this publication may be copied, reproduced, stored or disseminated in any form or by any means without the prior written consent of Arif Habib Limited.

Fertilizer Sector

November 18, 2015

Fertilizer Sector

Contact Information Shahid Ali Habib Chief Executive Officer [email protected] +92 -21-3240-1930

Research Team Shahbaz Ashraf, CFA Head of Research [email protected] +92-21-3246-0742 Tahir Abbas AVP- Senior Investment Analyst [email protected] +92-21-3246-2589 Syed Fawad Basir AVP- Investment Analyst [email protected] +92-21-3246-2589 Ahmed Lakhani Investment Analyst [email protected] +92-21-3246-1106 Rao Aamir Ali Investment Analyst [email protected] +92-21-3246-0742 Syed Shiraz Zaidi Investment Analyst [email protected] +92-21-3246-1106 Waleed Rehmani Investment Analyst [email protected] +92-21-3246-1106 Misha Zahid Investment Analyst [email protected] +92-21-3246-1106 Ovais Shakir Officer- Database [email protected] +92-21-3246-1106

Equities Sales Team Khurram Schehzad EVP- Head of Sales [email protected] +92-21-3246-8285 Azhar Javaid VP- International Sales [email protected] +92-21-3246-8312 Usman Taufiq Ahmed AVP- International Sales [email protected] +92-21-3246-8285 M. Yousuf Ahmed SVP- Equity Sales [email protected] +92-21-3242-7050 Syed Farhan Karim VP- Equity Sales [email protected] +92-21-3244-6255 Farhan Mansoori VP- Equity Sales [email protected] +92-21-3242-9644 Afshan Aamir VP- Equity Sales [email protected] +92-21-3244-6256 Atif Raza VP- Equity Sales [email protected] +92-21-3246-2596 Furqan Aslam AVP- Equity Sales [email protected] +92-21-3240-1932

Fertilizer Sector 2015

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