Fertilizer Sector Study May 2011

7/29/2019 Fertilizer Sector Study May 2011

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SECTORSTUDYThe Pakistan Credit Rating Agency Limited

RIS K MAT RI X

HIG HL IG HT S

FY10 P KR

Total Credit ~150bln

NPL Ratio n.a.

Investment (last 3 yrs) 127bln

Subsidy (3yr average) 18bln

Listed Companies 5

SECT OR TRE ND S

Major expansions onlineAround 1.8mln ton urea capacityadded to the system

GST implemented on FertilizersPrices gone up third time in oneyear

Improved MarginsPrice hikes have contributedpositively to the sector withmargins going up

Supply deficit to continueDespite expansion, shortages to be

met by imports NPLs emerging from single

entity

2007 2008 2009 2010

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

0%

5%

10%

15%

20%

25%

30%

35%40%

45%

Fertilizer-Turnover & Margins

Turnover Gros s Margin NP Margin

FERTILIZER SECTOR - 2011

Agriculture (excluding livestock) accounts for approximately10% of the GDP. The foremost mean to increase agricultural

productivity is by the use of balanced fertilization (Nitrogenous,

Phosphatic & Potasssic). Pakistan produces ~4% of world urea

(Nitrogenous) output, all consumed locally (FY10: 5.1mln; FY09:

4.9mln) while larger portion of Phosphatic fertilizer (DAP) is

imported. In recent times, industry has experienced around USD 2bln

of investment, taking total number of players to nine. Fertilizer

sector's association with larger agrarian economy places it in a strong

strategic position. The sector enjoys preferential treatment from GoP,

primarily in the form of subsidized natural gas - the key raw material

in urea production and price subsidy for phosphatic fertilizers.

KEY RISKS

Natural Gas Availability: Natural gas production has remainedflat () in the last__ years in Pakistan, while demand is high. Despite

having high priority access to supply of natural gas (Natural Gas &

Management Policy 2005), fertilizer sector is facing upto 20% gas

curtailment resulting in lower capacity utilization. This has neutralized

the impact of enhanced capacities which came online during the year

and the supply deficit is likely to continue.

Total demand of all fertilizers stood at 8.9MT against the supplyof 6.7MT during FY10. The price of urea went up by ~48% in one years'

time on back of gas curtailment and GST implementation (currently at

a discount of ~40% to the international prices). However, the demand

for urea is highly inelastic and price change is expected to have limited

impact on demand. However, phosphatic fertilizer DAP being price

sensitive, would experience decline in its offtake. In the past, GoP has

provided subsidies for phosphatic fertilizers whenever prices have

escalated beyond farmer community's reach. Hence, fertilizer demand

would be dependent upon GoPs action in the current situation.

CREDIT EXPECTATIONS

Owing to the capital intensive nature of the sector, the recentexpansions by large players has pushed the average financial leverage

for the sector to a significant level (~7% of total private sector lending).

The short term borrowings are a function of imported fertilizer

quantum, which varies within entities. The leveraging levels for

growing entities are as high as 70:30 (debt to equity).

The quality of credit is good based on the ability of business togenerate strong and stable margins(~42%). The cash nature of the

business requires lesser working capital credit. The sector serviced

~PKR 22bln interest during the year.

PACRA has used due care in preparation of this document. Our information has been obtained from sources we consider to be reliable but its accuracy or completeness is not guaranteed. PACRA shall owe noliability whatsoever to any loss or damage caused by or resulting from any error in such information. None of the information in this document may be copied or otherwise reproduced, stored or disseminatedin whole or in part in any form or by any means whatsoever by any person without PACRAs written consent. Our reports and ratings constitute opinions, not recommendations to buy or to sell.

Tel: 92 (42) 35869504 Fax: 92 (042) 35830425 www.pacra.com


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The Pakistan Credit Rating Agency Limited SECTORSTUDY1. PROFILE

Strategicallyimportant association withagrarian economy

Largely based onnatural gas as araw material

Enjoyspreferentialtreatment fromGoP subsidizedgas rates

1.1 The agriculture sector is thebackbone of Pakistanseconomy. It accounts forapproximately 10%1 of the GDP(excluding livestock) andprovides employment to almost

45%2 of the countrys total workforce. Moreover, agriculture andagro-based products are thelargest source of foreignexchange earnings for thecountry. Agriculture sectorregistered a sharp recovery in FY09 and grew by 4% as against the preceding yearsgrowth of 1%. However, continuing with the high volatility trend, the sector postedonly 2% growth in FY10. Supply of cultivable land in Pakistan is relatively inelasticand the land is highly deficient in nutrients resulting in low yields. Therefore, theforemost means to increase agricultural productivity is by the use of fertilizers.Subsidy on imported phosphatic and potassic fertilizers, good wheat production and

attractive agricultural support prices, were the key factors behind significant 15%growth seen in fertilizer offtake in FY10. The focus of the government on agricultureas an engine of growth and the rapidly increasing demand for agricultural produceplace the fertilizer industry in a strategic position.

1.2 Product Classification: Fertilizer products are divided into the followingclassifications (1) Nitrogenous fertilizers, (2) Phosphatic Fertilizers, (3) PottasicFertilizers and (4) Complex Fertilizers. However, in terms of final products, urea anddi-ammonium phosphate (DAP) are the most standardized products tradedworldwide.

Category Products Composition

Nitrogenous Urea 46.65%N 26.64%O 20%C 6.71%HCAN 27%N 6%CaO 4%MgOAS* 21%N 24%S

Phosphatic DAP 18%N 46%PMAP* 11%N 52%P (most common)

TSP* 46%P (rock phosphate)SSP* 16%P 19-25%Ca Free Acid 3.5-4.5%

Pottasic SOP* 50%K 18%SMOP* 60%K 3.5% Sodium

Complex NP* 12%N 52%PNPK* Various combinations of N P & K

* Unlike Urea and DAP, these are not standardized products and are available in various combinations of chemicalcompounds.

Urea comprises over 70% of the fertilizer demand in Pakistan followed by DAP(~17%). The availability of natural gas a major raw material allows local

production of Urea and DAP. However the demand outspaces the production and theshortfall is met by imports. Wheat being the largest crop of Pakistan takes up almost

1 Economic Survey 2009-20102 Federal Bureau of Statistics

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2005

-06

2006

-07

2007

-08

2008

-09

2009

-10

The Pakistan Credit Rating Agency Limited SECTORSTUDY

47% of the total cultivated land, while it accounts for 50% of the fertilizerconsumption. The use of fertilizers among different crops in Pakistan is depicted inthe graph.1.3 Historical Review:Organized research intofertilizer technology began in

the early seventeenth century.As scientific chemical theoriesdeveloped, the chemical needsof plants were discovered,which led to improved fertilizercompositions. The chemicalfertilizer industry could be saidto have its beginnings with apatent issued to Sir John Lawes

British agricultural chemist(18141900) which outlined amethod for producing a form of phosphate that was an effective fertilizer. The

synthetic fertilizer industry experienced significant growth after the First World War,when facilities that had produced ammonia and synthetic nitrates for explosives wereconverted into nitrogen-based fertilizers plants. The global fertilizer industryproduces some 170 million tonnes of fertilizer nutrients annually. These are used inevery corner of the globe to support agricultural production. There is no substitute forthe nutrients absorbed by crops. As a major source of these, fertilizers thereforerepresent an essential ingredient in the drive towards world food security3.

1.3.1 A sharp shift in actual consumers of fertilizer has also occurred over theperiod in view. From 12:88 ratio (developing : developed nationsconsumption) in early 1960's the mix has now become 65:35. Almost aparallel shift has also occurred in fertilizer production in which close to 70%

of the world's fertilizer is produced in developing countries as against about40% in the early 1960s. Interestingly, over a third of the world's totalproduction is in just two countries namely China and India. Hence, production

Urea

(M

T)

6,000,000

5,000,000

4,000,000

3,000,000

2,000,000

1,000,000

0

Urea Production (Pakistan)

of fertilizers has become concentrated in countries, who are also the majorusers. Pakistan produces some 4% of the world urea.

1.4 Global Context: After the worst recession since World War II, the globaleconomy is recovering. According to the International Monetary Fund (IMF), world

3 International Fertilizer Industry Association (IFA)

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output is seen as firmly rebounding in 2010 (+4.8%), driven by robust growth inemerging and developing economies. However, the recovery remains fragile, mostlybecause of high unemployment, low consumer confidence, reduced householdincomes, and high public debt in many of the advanced economies. As aconsequence, economic growth is expected to be +3.5% in 2011. These forecastsface certain downside risks, at least until the required reforms are completed.

However, IMF estimates that these risks are appreciably lower than a year ago. Withthe economic recovery, prices of most commodities, including oil, minerals andagricultural commodities, have remained firm or have strengthened in 2010 and2011. After a sharp contraction in 2009, international trade recovered in 2010 andcould further increase in 2011. The weak US dollar strongly affects the profitabilityof farming in countries with strong currencies while providing opportunities to thefarmers in countries with weaker currencies. Resultantly, Farmers in strong currencycountries are more reluctant to invest in fertilizers.1.4.1 Global Fertilizer Demand: After a sharp drop in 2008/09 due to the financialand economic downturn, world fertilizer consumption started to recover in 2009/10.Aggregate consumption in 2009/10 is estimated to be up by 5.2% to 163.7 Mtnutrients. This is still 4.2 Mt below the record in 2007/08 of 167.9 Mt. Nitrogenous

(N) fertilizer demand is estimated to have fully recovered (+4.1%) to 102.6 Mt N,which is 2.1 Mt above the previous record. Phosphatic (P) fertilizer demand stronglyrebounded (+11.5%) to 37.5 Mt (P2O5), but remained 0.9 Mt below its record of twoyears earlier. Pottassic (K) fertilizer demand remained stable and depressed at 23.5Mt (K2O), which is 5.4 Mt below its previous record. Demand is estimated to haveincreased in all the regions but Latin America and Oceania. The largest changes involumes occurred in North America (+2.8 Mt), South Asia (+2.5 Mt), East Asia(+1.2 Mt), and Western and Central Europe (+1.1 Mt).

Supported by attractive agricultural commodity prices in the second half of 2010,total world fertilizer demand is forecast to rise firmly in 2010/11 by 4.7% to 171.4Mt. N demand would increase by 1.6% and is projected to reach a new record at104.2 Mt. P demand is expected to fully recover (+6.0%) to a new high at 39.8 Mt. K

demand should strongly rebound (+16.3%) at 27.4 Mt, but would remain 1.6 Mtbelow the record of three years earlier. Total fertilizer demand is forecasted to rise inall the regions but Eastern Europe, Central Asia and West Asia. The largest increasesin volume are seen in East Asia (+3.1 Mt), North America (+1.5 Mt), Latin America(+1.3 Mt) and South Asia (+1.2 Mt).

Forecasts of 2011/12 are still very speculative. They will be greatly influenced by theevolution of agricultural commodity prices, which are likely to be highly volatile in2011. Aggregate demand is forecasted to be up by 3.8% to 177.9 Mt.1.4.2 Global Fertilizer Supply: Global fertilizer demand in 2010 has been robust andwidespread, driven by a strong rebound in traditional markets where nutrientapplication was depressed in 2009 (Latin America, North America, Oceania and

West Europe) and a sustained level of consumption in emerging markets. Therecovery in demand has been stronger than anticipated and has provided support foran increase in domestic sales and global trade.



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Global total nutrient production in 2010 has converged with world consumption,marking a significant 11% rebound over 2009. Production has increased in allnutrient segments, but potash has registered the largest gain. Ammonia productionhas increased by 4%, while urea output has expanded marginally. Phosphate rockproduction and that of phosphoric acid have grown in parallel, at the same rate of

10% over 2009. Potash production has increased by 57% over 2009, fully recoveringfrom the depressed conditions existing since mid-2008.

Globally, the fertilizer industry has operated at 82% of installed capacity in 2010,compared with 74% in 2009. While this indicates a rebound, it does not yet signal theemergence of a potential shortfall in supply compared with 2007.

1.4.3 Global Demand/Supply - Urea: Global urea production in 2010 is estimated at149 Mt product, representing a marginal 1% increase over 2009. The internationalurea trade is estimated at 38.5 Mt, a 6% increase over 2009. Imports have increasedin most regions, notably Latin America, North America and Oceania. Worldwide,close to 25 urea projects will provide new capacity in 2010 and 2011. IFA estimates

that global urea capacity will be close to 181 Mt in 2010 and 190 Mt in 2011. Chinaalone would contribute 46% of the annual capacity increases. Taking into account amaximum operating rate of 87% of installed nameplate capacity, it is estimated thatworld urea supply will increase from 157 Mt in 2010 to 164.2 Mt in 2011. The globalurea supply/demand balance shows an increase in the potential surplus by the secondhalf of 2011, reaching 8.8 Mt product by the end of the year. Overall, the potentialsurplus would represent less than 5% of supply when idled plants are taken intoaccount. Additional capacity in 2011 would add substantial tonnage of exports, withat least 3 Mt of urea by the end of 2011, equating to 9% of current global trade. Thesupply deficit nature of industry would not allow any negative impact on the prices.

1.5 Pakistan's Fertilizer Industry: Pakistans first Nitrogenous fertilizer plant, PakAmerican Fertilizers Limited (now Agritech Limited), was commissioned in 1958 toproduce 50,000 metric tons per annum of ammonium sulphate based on indigenouscoal and gypsum as raw materials. This was a public entity. Although, Mari GasField was discovered in 1956 by the Esso Eastern Pakistan Ltd. with the appraisal of3 wells, the field was left undeveloped for lack of a suitable market till 1965-1966.Esso proposed the establishment of a urea plant in Dharki, a small remote area nearMari gas fields, due to the suitability of this gas for urea fertilizer production. EssoPakistan Fertilizer Company Limited (now Engro Corporation Limited) started

commercial urea production in 1968.1.5.1 Production Process: The production process of fertilizers is depicted in thefollowing figure.



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The most recent offtakes of all fertilizers in Pakistan are depicted in thegraph below:

80.00%

70.00%

60.00%

50.00%

40.00%

30.00%

20.00%

10.00%

0.00%

1HFY11

Urea CAN AS DAP MAP TSP SSP SOP MOP NP NPK

FY10 FY09

All Fertilizer Offtake in Pakistan

Nitrogenous Phosphatic Pottasic Complex

Urea CAN AS DAP MAP TSP SSP SOP MOP NP NPKOfftake FY09 4 4

Offtake FY10 72% 4% 0% 17% 1% 0% 0% 0% 0% 0% 0%

Offtake 1HFY11 4 4 4ource :

1.5.2 Major players: Currently there are 9 players in the fertilizer industry in Pakistanout of which 3 major players contribute ~80% to the industry (based on FY10 ureaproduction capacity). Six players are in the production and marketing of urea andother fertilizers while two players specialize in the production of Single SuperPhosphate (SSP) fertilizer only. Fauji Fertilizer Bin Qasim is the sole producer ofDAP in Pakistan. Out of 18 plants in Pakistan, 11 are in Punjab, 6 in Sindh and 1 inKhyber Pakhtunkhwa (KP).



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The Pakistan Credit Rating Agency Limited SECTORSTUDYProduct

Location Province Manufactured

1 Fauji Fertilizer Company Limited (FFC)

Plant -I

Plant -II

Plant -III2 Fauji Fertilizer Bin Qasim Limited (FFBL)

Plant-I

Plant-II

3 Engro Fertilizers Limited (EFL)

Plant-I

Plant-II

Plant-III

4 Dawood Hercules Chemicals Limited (DAWH)

5 Pak Arab Fertilizers Limited (PFL)

Plant-I

Plant-II

Plant-III

6 Fatima Fertilizers Company LimitedPlant-I

Plant-II

Plant-III

Agritech Limited (formerly Pak American7 Fertilizers Limited)

8 Hazara Phosphate Fertilizers Limited (HPFL)

Goth Machhi, RYK

Goth Machhi, RYK

Mirpur Mathelo, Ghotki

Bin Qasim, Karachi

Bin Qasim, Karachi

Daharki

Bin Qasim, Karachi

Daharki

Sheikhupura

MultanMultanMultan

Iskanderabad, Mianwali

Haripur

9 Lyallpur Chemicals & Fertilizers Limited (LCFL) Jaranwala

Punjab Urea

Punjab Urea

Sindh Urea

Sindh UreaSindh DAPSindh Urea

Sindh NPK

Sindh Urea

Punjab Urea

Punjab Urea

Punjab NP

Punjab CAN

Punjab Urea

Punjab CAN

Punjab NPK

Punjab Urea

KP SSP

Punjab SSP

FFC is currently the leader in the fertilizer industry with approximately 46% marketshare (urea). In the past, the fertilizer industry has not been able to meet the localdemand. This has encouraged firms to increase their capacities. In this regard, thelargest expansion plan carried out by Engro Fertilizers Limited which is expected toannounce COD in 2Q10; increasing its capacity by 1,300 Mt per annum. FatimaFertilizer has undertaken a major fertilizer project with urea capacity of 500,000 tonsper annum began production in 1HFY11. Meanwhile, a minor urea revamp is alsounderway in Agritech Limited. The fertilizer industry may experience excess supply,albeit limited, once the expansion projects are complete and gas is fully restored toall fertilizer plants.

UreaProduction

2,500,000

46% 32%35%

22%

12% 10%8%9% 8% 7%

2% 1%8%

50%

45%

2,000,000 40%

35%

1,500,000 30%

25%

1,000,000 20%

15%

500,000 10%

5%

- 0%

FFC FFBL EFL DAWH PakArab Fatima Agritech

CurrentCapacity ExpandedCapacity

1.1 1.6 Strategic Importance: Urea, being the most desired fertilizer, formed 71% of thetotal use of fertilizers in Pakistan in FY10. Urea is produced from Ammonia,production of which is entirely dependent upon the use of natural gas as a raw

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material. Pakistan, being blessed with indigenous natural gas reserve, has asignificant portion allocated to fertilizer sector. The fertilizer industry is highlydependent upon the policy decisions by the government on the supply of gas. Lately,constrained supply of gas and its diversion to power plants has brought curtailment ingas supply for fertilizer sector.1.7 Gas Availability: Pakistans available gas reserves are around 28 Trillion Cubic

Feet (TCF) and the current annual consumption is 1.3 TCF4. Although these gasreserves, if tapped, could last for another 20 years at the current consumption rate,lately supply has lagged behind consumption because extraction from current fieldsis stagnant and no new fields have been discovered. In this regard, natural gasproduction increased nominally from 4,002mcfpd (million cubic feet per day) inFY09 to 4,063mcfpd (1.5% increase) to FY10. Meanwhile, the massive oil importbill and volatile international oil prices have forced the government to place greateremphasis on promoting the development of indigenous energy resources.Consequently, the government has been encouraging the industrial sector and powerplants to shift from oil to gas, and the bulk of increased gas production has beendiverted to this sector in recent years. As a result, Pakistans final energyconsumption by source has witnessed a rise in gass share from 36% in FY05 to 44%

in FY10. The fertilizer sector is the second largest consumer of gas (~670mmcfd)after the power sector (~2000mmcfd). Gas is used as fuel (fuelstock) and as theprincipal raw material (feedstock) in the production of fertilizers. Feedstock accountsfor three-fourth of the total gas consumption of the industry. However, the recentenergy crises have forced the sector to face upto 20% gas curtailment despite havinghigh priority access to supply of natural gas according to the Natural Gas & ManagementPolicy 2005.

1.8 Regulatory Structure: Fertilizer sector has always held its strategic importance inPakistan. The early industrial players were public limited companies and governmentwas able to exercise its pricing policy directly with the objective to keep it affordablefor the farmers, helping the agricultural sector.

The fertilizer sector falls under the purview of Ministry of Food, Agriculture, andLivestock (MINFAL). MINFAL is mainly responsible for policy formulation,economic coordination and planning in respect of food grain, agricultural &livestock. It also includes procurement of food grains, fertilizer, import pricestabilization of agriculture produce, international liaison, economic studies forframing agricultural policies, fishing and fisheries beyond territorial waters andanimal quarantine5.

1.9 Sector Development: In the last decade, all the public sector fertilizer plants havebeen privatized by GoP while the private sector companies are also addingmanufacturing facilities. This has been possible due to incentives provided by theMinistry of Commerce & Industry through its Fertilizer Policy 2001. The highlight

of the policy was the grant of extra gas subsidy upto 10 years. This was lower thanthe subsidized rates for the feedstock provided to the sector, available for setting upa new fertilizer manufacturing facility by the private sector. The subsidized rates areavailable to the manufacturers who sign the General Sales Agreement (GSA) withgas providers. The purpose was to keep up with the growing need of fertilizers in thecountry. GoP provided average ~PKR 18bln in subsidy to the sector in the past threeyears.

4 Pakistan Energy Yearbook 20105 http://www.minfal.gov.pk/

http://www.minfal.gov.pk/http://www.minfal.gov.pk/


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2. GOVERNANCE

Governed by twoMinistries

Special incentivesfor the sectorthrough FertilizerPolicy 2001

NFDC FertilizerResearch &Development

2.1 It is useful to examine the nature of governance system prevailing in the industryin order to assess the feasibility and efficacy of an industry towards achievingsustainable development. Fertilizer sector contributes directly to the agriculture ofPakistan and the first ministry to look after the welfare of agriculture was formedright after the partition in 1947 Ministry of Food, Agriculture and Health. Raja

Ghazanfar Ali Khan Khokhar , a leading member of the All India Muslim Leagueand a trusted lieutenant of Muhammad Ali Jinnah, was appointed as its first minister.Today, fertilizer sector comes under the scope of two ministries, i) Ministry of Food,Agriculture & Livestock (MINFAL) and Ministry of Industries & Production(MOIP). The Federal Minister, appointed by the Prime Minister, is the functionalhead and is assisted by the Parliamentary Secretary. The position remains subject topolitical shifts. The sitting minister for MINFAL is Mir Israrullah Khan Zehri(graduate in agricultural studies UK) while Mr. Shafqat Hussain Naghmi is theSecretary of MINFAL. The current minister for MOIP is Chaudhary Pervaiz Elahi(Diploma in Industrial Management UK) and Mr. Aziz Ahmed Bilour is theSecretary to the Ministry.

2.1.1 MINFAL: The Ministry is mainly responsible for policy formulation, economic

coordination and planning in respect of food grain, Agricultural & Livestock. Majorfunctions include procurement of food grains, fertilizer, import price stabilization ofagriculture produce, international liaison, economic studies for framing agriculturalpolicies, fishing and fisheries beyond territorial waters, animal quarantine. It haseight attached departments, five autonomous bodies and one corporation (PASSCO Pakistan Agriculture Storage and Services Corporation).



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Functions: Functions of MINFAL are summarized in the table below:Ministry Functions

Ministry of 1.Economic Co-ordination and planning in respect of food.Food, 2. Keeping a watch over the food supplies (including storage) position in the

Agriculture country.& Livestock 3. Procurement of food grains, including sugar:-a) from abroad;b) for Federal requirement;c) for Inter-provincial supplies;d) for export and storage at ports. 4. Import and export control on food grains and foodstuffs. 5. Inspection, grading analyses of food grains and foodstuffs and maintenanceof standards of quality for import and export.Note:- Inspection, handling, storage and shipment of rice for export is theconcern of Commerce Division 6. Preparation of basic plan for bulk allocation of food grains and foodstuffs7. Price stabilization by fixing procurement and issue prices includingkeeping a watch over the price of food grains and foodstuffs imported from abroad or required for export and those required for inter-Provincial supplies. 8. Collection of statistics regarding production, consumption , prices, imports and exports of food grains. 9. Food and Agricultural Organization of the United Nations in respect offood.10. Co-ordination of work relating to aid/assistance being received from aid- giving agencies in respect of food sector.11. Economic, Planning and policy-making in respect of agriculture.12. Agricultural Research Council; Agricultural commodities research.13. Food and agriculture organization of the United Nations in respect ofagriculture.14. Co-ordination of work relating to aid/assistance being received from aid- giving agencies in respect of agriculture sector. 15. Plant protection:-a) standardization and import of pesticides;b) aerial spray;c) plant quarantine; and d) locust control in its international aspect and maintenance of locust warningorganization.16. Economic studies for framing agriculture policy.17. Farm management research for planning, project formulating andevaluation.18. Seed testing and seed certification ; crops forecast and estimation; cropinsurance.19. Collection and complication of agriculture statistics. 20. Marketing intelligence.21. Grading of agricultural commodities other than food grains, for exports.22. Agricultural commodity research (marketing research and laboratoryresearch for laying down national grades).23. Soil survey, comprehensive inventory of the soil resource of the countryand their proper utilization. 24. Standardization and import of fertilizers for meeting Provincialrequirements25. Introduction of special crops like jute, tea, olive etc. 26. Standardization of agricultural machinery.27. Under-developed Areas :-a) Identification of Under-developed Areas.b) Identification of the fields in which an area is under developed.c) Measures necessary to remove the causes of under-development in different areas.28. Administrative control of the PASSCO. 29. Sugar Board.31. Socio-economic studies for framing agricultural research policies.



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32. Agricultural commodities research; Federal Agricultural ResearchOrganizations (expecting Pakistan Central Cotton Committee and Soil SurveyDepartment).33. Coordination of aid/assistance from international aid-giving agencies and FAO in respect of agricultural research, including manpower training forresearch.34. Research for the introduction of improved germ plasm, both of plant and animal origin 35. Research coordination in respect of livestock production , livestock diseases and marine fisheries.36. Collection of statistics on agriculture research.37. High level manpower training for agricultural research..38. Inter-provincial coordination and coordination between the center and the provinces in respect of agricultural research, including training of high levelagriculture scientist. 39. National policies, planning and economic co-ordination in respect of -i) Live stock including dairy, poultry and fisheries;ii) Animal disease control. 40. i) Co-ordination of foreign aid and technical assistance in the livestocksector and related fields;ii) Liaison with international agencies especially Food and AgricultureOrganization of the United Nations in the field of livestock.41. Development and co-ordination of livestock and poultry complexes withbilateral assistance.42. Statistics regarding livestock, poultry and fisheries.43. Price stabilization measures.44. Animal protection:i) Vigilance and measures for prevention of extension from one Province toanother of infectious or contagious diseases affecting animals;ii) Animal quarantine and inspection.45. Veterinary drugs, vaccines and animal feed additives. i) Import and Export. ii) Procurement from abroad for Federal requirements and for inter-provincial supplies. 46. Livestock, poultry and livestock products;i) Market intelligence.ii) Import and export. iii) Laying down national grades;iv) Project formulation and evaluation.47. Standardization of dairy, poultry and meat processing machinery.48. Livestock insurance.

2.1.2 MOIP: Ministry of Industries (MOI) was established in early 1950s to act as apolicy formulating agency and a focal point for promotion and expansion ofindustrial sector of the country. It was also entrusted to supervise the activities of

Pakistan Industrial Development Corporation, which had the charter to develop thesectors where the private investor was not willing to invest. The concept of PublicSector emerged under Economic Reform Order (ERO) of January 1972, when majornationalization of industrial sector took place. Accordingly, the Government set up anew ministry namely Ministry of Production to supervise the affairs of newlynationalized Public Industrial Sector. In October 1993, both the Ministries weremerged into one, as Ministry of Industries & Production (MOI&P).

Ministry Functions

Ministry of AS PER RULES OF BUSINESS 1973 AND AMENDED IN 1999 ,Industries THE FUNCTIONS OF INDUSTRIES & PRODUCTION DIVISION

& ARE AS UNDER:Production

National industrial planning and coordination.FERTILIZER Page 11 of 26May 2011 www.pacra.com


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The Pakistan Credit Rating Agency Limited SECTORSTUDYMinistry Functions

Industrial Policy. Employment of foreign personnel in commercial and industrial enterprises. Federal agencies and institutions for:

a. Promoting industrial productivity;b. Promotion of special studies in the industrial fields; andc. Testing industrial products.

Keeping a watch, from the national angle, over general price trends andsupply position of essential commodities; price and distribution controlover items to be distributed by statutory orders between the Provinces.

Administration of the Essential Commodities Control Order, 1971, andrelated laws including price and distribution controls.

Explosives (excluding the administration of Explosive Substances Act) andsafety measures under the Petroleum Act and Rules made there-under.

Designs and inventions including patenting thereof. Prescription and review of criteria for assessment of spare parts and raw

materials for industries.

Administration of Boilers Act. Development of Industries (Federal control) (Repeal) Ordinance, 1979. Economic Reforms (Protection of Industries) Regulation, 1972. Transfer of Managed Establishment Order, 1978. All matters relating to State Industrial Enterprises, especially, in basic and

heavy industries, namely:-

State Engineering Corporation, Islamabad Pakistan Automobile Corporation, Karachi National Fertilizers Corporation, Lahore Pakistan Steel Mills Corporation, Karachi Pakistan Industrial Development Corporation, Karachi

Any other industrial enterprises assigned to the Division.

2.2 Pakistan Fertilizer Policy 2001 :Fertilizer Policy was announced with effect from1st July 2001. The Policy was fixed for ten years with an estimated investment ofUSD 1.2bln in this sector for ten years. The policy has already entered its tenth yearand a new policy is awaited. Basic objective of this Policy was a) to bring in new

investment in this sector; b) provision of fertilizers to farmers at reasonable prices; c)to ensure optimal price and supply of gas; d) and to keep fertilizer prices 20% belowthe import prices.

It was estimated that Pakistan will need additional 2 million tons of fertilizers forlocal consumption in 10 years when the production stood at 4.2 million tons whileconsumption was 4.4 million tons in 2001.

As a result of this policy, the fertilizer industry experienced significant growth duringthe 10 year tenor. The green field projects as well as BMR activities in the sectorattracted over USD 2bln investment in the sector with additional nameplate capacityof over 2 million tons. However, the rarionalisation of gas subsidy to the sector asenvisioned in the Policy has not materilized.



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The Pakistan Credit Rating Agency Limited SECTORSTUDYPolicy Highlights

The Policy had three parts : 1) Existing Fertilizer Plants, 2) NewFertilizer Plants and 3) Existing Plants Planning for expansion andBMR. The Highlights of the policy were as follows:

Gas subsidy on Fertilizer will end in next five years. Pakistan offers gas to the new Plants at USD 0.70 as compared with

USD 0.77 in many countries.

Window for obtaining permission for new plants will be open for 4Years only.

For expansion in the existing Plants the gas prices will be the same forfeed stock for five years.

Second hand Plants will be allowed for import for the manufacture offertilizer.

Privatization of Gas Companies will have no effect on gas price tonew plants as these will be catered from Mari Gas Field.

Duty free import of rock Phosphate to Phosphatic Fertilizermanufacture and duty-free import of raw material to NPK fertilizerproducers.

FertilizerPolicy 2001 Guaranteed minimum price of DAP at USD 250 per tone.

New investors would enjoy 10% discount on determined prices of Gasfor a period of 13 years from the date of Gas Supply Agreement(GSA), in dollar terms.

The Import of Plant, machinery and equipment not manufacturedlocally is allowed against customs duty of 10%.

The charge of catalyst, chemicals lubricants and spares for the firsttwo year operations would also be exempted from all taxes and levies.

All the fertilizer producers, domestic and foreign, public and privatewould be treated equally in commercial, fiscal, corporate andcontractual matters.

To encourage local production, 10 percent duty on NPK importswould apply for a period of 5 years only, from the date ofcommencement of production.

Selling price of fertilizer shall remain deregulated. Tax relief : Initial Depreciation Allowance (IDA) @50% of machinery

& equipment cost

2.3 NFDC: The National Fertilizer Development Centre (NFDC) was set up by theGovernment of Pakistan (Planning and Development Division) in December 1977.After a brief period of aid from the United Nations Development Programme(UNDP) it has been assisted by the Food and Agriculture Organization (FAO) of theUnited Nations with Trust Funds from Norway (NORAD) upto May 1981, and fromthe Netherlands upto December 1997.

NFDC is a multidisciplinary research and development organization at the federallevel that integrates disciplines such as economic planning, pricing and subsidies,privatization and deregulation, production and imports, marketing and credit,agronomy and soil science, research, extension and training.

In co-operation with the various federal and provincial institutions, NFDC studies allfertilizer-related problems from the supply source to the farmers' fields, with a viewto helping in the formulation of Government policies and their implementation and togive support to other institutions.



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The current broad objectives of NFDC are:

To provide objective and comprehensive advice to all levels ofGovernment, to the fertilizer industry and to other parties as may berelevant, on all matters related in any way to the fertilizer sector ofPakistan and its relations with the international fertilizer community.

To conduct research studies on physical and economic returns onfertilizer use to farmers, impact of input prices on crop output,deregulation/privatization of fertilizer in order to facilitate policydecisions.

To conduct fertilizer use surveys at farm level to monitor fertilizer useby crops, impact on crop productivity, crop responses to fertilizers andproblems faced by farmers.Natonal

Fertilizer To monitor the status of all aspects of fertilizer use development:

Development production, imports, consumption, prices and evaluate situation

Centre (NFDC) critically for the information and action by the concernedorganizations, so that timely actions can be taken to effectimprovement.

To promote efficient, balanced and environmental friendly integrateduse of plant nutrients for sustainable agricultural growth.

To help upgrade the capability of fertilizer research, extension andmarketing personnel in the transfer of fertilizer technology.

To provide a neutral common platform to resolve contentious issues infertilizer sector.

To launch new initiatives in soil fertility and plant nutritionmanagement.

Organization Objectives

2.4 Entity governance structures: The ownership structures in the sector isdominated by prominent corporate groups of the country. This is translated into thebetter governance practices followed throughout. The sector is continuing to improveits governance with entities having foreign members on their boards. The entities arealso active in imparting adequate information, fulfilling corporate socialresponsibilities and maintaining suffcient health and safety standards.

2.5 MINFAL safeguards the interests of the farmer community while MOIP isresponsible for the well being of the industries. Hence, a slight conflict of interestexists for fertilizer sector. However, this has not caused any significant problem todate. The gas allocation related issues are moved in by the ministries to the EconomicCoordination Committee (ECC), which takes the final decision considering the

energy requisites of the country.3.1 Fertilizer Industry is a capital intensive industry which requires huge initial

3. OWNERSHIP capital outflow. Plant setup costs are high and the process takes 3-5 years to Capital Intensive complete. To develop current idea about the costs involved, Engro is at an advanced

Industry stage of setting up a 1.3mln MT urea plant at a cost of USD 1,050mln. Considering

Instituitional the huge costs, approximately USD 850mln has been arranged through local andHolding Structure foreign debt while USD 300mln was injected as equity from the sponsors.

3.2 The industry experienced significant growth during the past 10 years. The fresh Owned by largeallocation of gas for fertilizer plants in this period attracted over USD 2blngroupsinvestment in the sector. After the completion of privatization process in 2006, thereare currently 9 fertilizer companies of which 5 are listed on stock exchange. Thefollowing graphs provide YoY status of the paid up capital, market capitalization of

listed fertilizer companies and their respective share in Karachi Stock Exchange.



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2006 2007 2008 2009 2010

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

0.0%

1.5%

3.0%

4.5%

6.0%

7.5%

9.0%

10.5%

12.0%

Market Capitalization

Fertilizer Industry Capitalization % of total KSE Capitalization

PKR(

mln)

2006 2007 2008 2009 2010

0

5,000

10,000

15,000

20,000

25,000

30,00035,000

40,000

45,000

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Paidup Capital

Paidup Capital % of total paidup capital on KSE

PKR

(mln)

3.3 The presence of private investors in Pakistani corporates normally implies thatthe majority of companies would be owned by individuals or family ownedinstitutions. However, in the fertilizer sector, the ownership structure has evolvedfrom individual holdings and there is concentration towards institutional/group

holding structures. The fertilizer industry is owned by large financial groups ofPakistan including Dawoods, Fauji Foundation, and recently Fatima Group and ArifHabib Group. Hence the level of commitment from the sponsors have been fairlyhigh. The sponsoring groups financial strength has enabled them to inject as well asattract capital to fertilizer industry. The move from individual to group holdingstructure has largely mitigated the succesion risk in ownereship. A brief profile andownership structure of the major fertilizer players of Pakistan is discussed below.

3.3.1 A) Fauji Fertilizer Company Limited (FFC), incorporated in 1978, commencedfull commercial production in 1982 as a urea manufacturing, purchasing andmarketing company in Pakistan. Listed on all three bourses of the country, FFC hastwo production facilities: one located at Goth Machi, District Rahim Yar Khan and

the other in Mirpur Mathelo, District Ghotki. FFC is currently the largest ureamanufacturing facility of Pakistan comprising three ammonia/urea plants with acombined design capacity of ~2mln MT per annum.

B) Fauji Foundation (FF) holds the majority shareholding in FFC. FF, established asa charitable trust in 1954 and operating on a completely self-sustaining basis,channels approximately 80% of the dividends from commercial ventures into socialprotection programs. The Foundation provides services in the areas of healthcare,education, technical and vocational training. The commercial ventures includeentities operating in fertilizer, cement, power generation, oil and gas, food, financialand security services. Established entities like FFC, Fauji Fertilizer Bin QasimLimited, Fauji Cement Company Limited, Mari Gas Company Limited and Fauji

Cereals are part of the group. FF holds combined assets of over USD 2bln.

3.3.2 A) Fauji Fertilizer Bin Qasim Limited (FFBL), incorporated in 1994,



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commenced full commercial production in 2000 as a granular urea and Di-Ammonium Phosphate (DAP) fertilizers manufacturing, purchasing and marketingcompany in Pakistan. It is listed on all three bourses of the country with themanufacturing complex located in Eastern Zone of Bin Qasim, Karachi. The currentdesign capacity is 551,000 MT per annum for urea and 670,000 MT per annum forDAP.

B) Fauji Fertilizer Company Limited (FFC) and Fauji Foundation (FF) hold themajority shareholding in FFBL. Both FFC and FFBL market their products underone umbrella brand, Sona, which has wide recognition among the farmerscommunity.

3.3.3 A) Dawood Hercules Chemicals Limited (DHCL) was incorporated in 1968as a joint venture between Dawood Group and Hercules Incorporation, USA. Thecompany, listed on Karachi and Lahore Stock Exchanges, is engaged in the businessof manufacturing Urea. DHCL was the first private sector venture in Pakistan (infertilizer industry). DHCLs urea production capacity is 445,500 MT per annum.

B) Dawood group (DG) has majority shareholding in DHCL (through groupcompanies and individuals). DG is primarily engaged in the business of fertilizer,textiles, insurance, IT, and power. The journey of the group started in 1949 with thefoundation of first group company - Lawrencepur Woollen & Textile Mills. With thepassage of time, apart from DHCL, some other group concerns Dawood Cotton MillsLimited, Burewala Textile Mills Limited, Central Insurance Company, DawoodFoundation, and Dilon Limited were also founded. In 2004, all the textile companiesof the DG were merged in a single entity Dawood Lawrencepur Limited. During thesame year, the group acquired majority stake in Inbox Business Technologies (Pvt.)Ltd, an information technology firm. The group also runs a small brokerage house bythe name of Elixir Securities Pakistan (Pvt.) Limited. Meanwhile, the DG, throughDHCL, also has a strategic investment in Sui Northern Gas Pipelines Limited.

3.3.4 A) Following demerger of fertilizer operations as on January 1, 2010 from EngroCorporation Limited (formerly Engro Chemical Pakistan Limited) to Engro FertilizerLimited (EFL), EFL began its fertilizer manufacturing operations as a new entity. EFL,currently the second largest producer of urea in the country, is in the business ofmanufacturing and marketing of fertilizers. EFL markets urea under the brand name of

Engro Urea, MAP under the brand name of Zorawar, NPK under Zarkhez and DAP asEngro DAP. EFLs urea plant, with a capacity of 975,000tons per annum, is located atDharki, whereas NPK plant is situated at Port Qasim.

B) EFL is a wholly owned subsidiary of Engro Corporation Limited ECL whileDawood Group holds a majority stake in ECL through direct and indirect shareholding.

As a part of demerger, Engro Corporation is now the holding company for all strategicinvestments including fertilizer operations. Other business interests include EngroEximp Limited, Engro Foods Limited, Engro PowerGen Limited and Engro VopakTerminal Limited.

3.3.5 A) Fatima Fertilizer Company Limited, incorporated in December 2003 as a non-listed public company, is at significantly advanced stage of setting up a fertilizercomplex at Mukhtar Garh, Sadiqabad, Rahim Yar Khan to produce Urea, CalciumAmmonium Nitrate (CAN), Nitro Phosphate (NP) and Nitro Phosphate Potash (NPK).The company was listed on all three bourses of the country in Mar10. The nameplateproduction capacity of the fertilizer complex would be 1.58mln tons per annum.

Fatima Group (FG) and Arif Habib Group (AHG) acquired Pakarab Fertilizers Limited(PFL), the associate company of Fatima Fertilizer, in 2005 from the government ofPakistan at a total cost of USD 250mln. PFL, with its plant located in Multan,



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The Pakistan Credit Rating Agency Limited SECTORSTUDYmanufactures nitrogenous (Urea and CAN) and complex (NP) fertilizers with anameplate capacity of 846,900 tons per annum. It is currently the only producer ofCAN (450,000 tons per annum) in Pakistan.

B) FG and AHG own Fatima Fertilizer through PFL and their direct shareholding inthe company. FG includes Fazal Group (FaG) as well. Late Mr. Sheikh Fazal-ur-

Rehman, the predecessor of the Fatima Group, started his journey in 1936 by setting upa vegetable oil and ghee unit. His son, Mr. Sheikh Ahmad Mukhtar, played a leadingrole in establishing Fatima Group. FG is now one of the leading corporate groups inPakistan with interests in sugar, textiles, fertilizer and foreign trade. Two of groupsentities, Fazal Cloth Mills Limited and Reliance Weaving Mills Limited, are listed onKarachi and Lahore Stock Exchanges. The group has close to seven decades ofexperience in textile business with over 50 years of experience of dealing in exportmarkets such as the USA, Japan, Hong Kong and various European countries. Othergroup entities include Fatima Sugar Mills Limited, Reliance Cotton (Pvt.) Limited,Reliance Commodities (Pvt.) Limited and Pakarab Fertilizers Limited.

Ownership Summary

Company Majority Stake Listing statusDawood Hercules Chemicals Limited Dawood Group Listed

Engro Fertilizers Limited Dawood Group Not Listed

Fauji Fertilizer company Limited Fauji Foundation Listed

Fauji Fertilizer Bin Qasim Limited Fauji Foundation Listed

Fatima Fertilizer Company LimitedFatima Group/ArifHabib Group Listed

Pakarab Fertilizers LimitedFatima Group/ArifHabib Group Not Listed

Agritech Limited (formerly PakAmerican Fertilizers Limited) Azgard9/JS Listed

Hazara Phosphate Fertilizers Limited Azgard9/JS Not listed

Lyallpur Chemicals & Fertilizers Limited Al Hamd Chemicals Not listed

4. MANAGEMENT,SYSTEMS &CONTROL

Experiencedprofessionals

Renownedconsultants forprojectmanagement

Integrated MISimplemented inlarge companies

4.1 Management & Control: Fertilizer industry in Pakistan is mostly populated withchemical engineers with degrees from local universities. Nevertheless, the topmanagement of fertilizer companies constitutes people holding foreign degrees andhaving working experience abroad. The individuals working in a fertilizer companyare classified as management and non-management staff members. The termmanagement staff refers to individuals who are actively involved in managerialactivities, mostly based in head offices situated in major cities and a few on the plantsite. All others are termed as non-management staff members. Being a veryspecialized sector, the turnover is very low in the industry. For instance, people in thetop management of fertilizer companies have been associated with their firm for 20or more years in majority cases.

The industry is dominated by few players, the top 3 firms comprise ~80% of thesystem share. These top firms maintain an effective control environment with clearreporting lines and well defined policies and procedures. The review andaccountability function runs through the entire organizational structure. To maintainproper monitoring and thorough oversight of strategic investments, these firms haveestablished effective MIS. These characteristics have set precedents in the industryand the new entrants are in process of matching these standards.

Fertilizer companies have a very simplistic organogram with departments dividedinto functional areas such as 1) Manufacturing, 2) Finance & Admin , 3) HumanResource, 4) Marketing & 5) IT. Apart from manufacturing based on plant-site, all

departments are usually located at the head offices in large cities.4.2 Production: The business model of fertilizer companies is not a complicated one.It is a sellers' market and the core management function is to ensure the smooth flow



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of production and distribution. Hence an efficient logistic system in place ensuresready delivery of the product. On the other hand, the only raw material critical forproduction is supply of gas. Hence the other requisite strength in fertilizer industry'shuman resource is their political connections, which ensure stability on theproduction side.

Owing to the capital intensive nature of plants, some fertilizer plants in Pakistan aresecond-hand relocated from Europe. Even during the relocation process, the de-assembling and assembling require a lot of new parts to be used until the plant iscommissioned. Hence, a lot of international consultants, constructors, and technicaladvisers are involved in the setup process. The production process is a simple one,hence once the plant is commissioned and has no apparent technical problems, it isable to produce a salable product even during the trial run.

4.3 Maintenance & BMR: The plants are periodically maintained under annualturnarounds being carried out by local engineers. Regular maintenance and timelyBMRs improve efficiency levels enabling them to consume lesser energy whilemaintaining optimal output. The plants require replacement of parts over time which

are imported.

4.4 New Plants: Pakistan experienced major expansions in fertilizer sector during thelast decade due to the favorable government policies. During this period there wasone new plant erected (Engro), there were plants relocated to Pakistan (FatimaFertilizers) and Balancing, Modernizing and Revamping (BMR) activities carried out(FFC, FFBL, Dawood and Agritech). Hence, different set of skilled labour wasrequired during this period.

In the recent expansionary phase of fertilizer industry, project management is one ofthe key areas developed at the top management level. The people chosen for thisresponsibility are in the industry for over 15 years and have ample experience ofsuccessfully conducting BMR activities. The industry was able to attract workforcefrom specialized chemical industry into fertilizers specially in the area of project

management. Pay-levels in the industry are at par with other major industries buthuman resource retention becomes difficult in competition with fertilizer & chemical

industry in the middle east.

Unlike some industries, such as textile, fertilizer sector is not directly managed bySelf Regulatory Organizations (SRO). The industry falls directly under the purviewof Ministry of Food, Agriculture and Livestock (Minfal). The decisions on theallocation of gas to the firms is decided by the Economic Coordination Committee(ECC).

4.4 Technology: The industry has been engaging leading international contractorsand suppliers, which have significant experience in their respective fields. Theseinclude Sojitz Corporation a leading chemical fertilizer producer in Southeast Asiaand reputed suppliers and technology licensors such as Kellog, Kawasaki andStamicarbon repute in setting up new or refurbished plants. Kellog is a technology-based engineering service provider specializing in ammonia plants, Kawasakispecializes in project management services, whereas Stamicarbon specializing inlicensing of urea has provided license to 220 projects and has a global share ofapproximately 70%. China National Chemical Engineering Corporation, a largecorporation directly administered by the State Council of China, has been responsiblefor establishing the plants and have expertise for civil and mechanical completions.General Electric, a renowned name, is a provider of power plants and known for theoverhauling of the used fertilizer plants. Descon Engineering a multi-dimensionalengineering, construction and manufacturing company operating in Pakistan and theMiddle East has also been involved in projects for fertilizer industry.

Independent consultants such as Shaw Consultants (for technical reviews andmonitoring), Miller Consulting Services (for risk assessment and insurance cover),and Haidermota & Company (for legal advisory and counseling services) have alsobeen the feature of the industry for upcoming plants.



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4.5 MIS: The industry realizes the importance of efficient use of informationsystems in entity resource planning. An ERP integrates all the modules inmanufacturing (including purchasing, inventory and order management) , financialmanagement, human resource planning under one umbrella. For this purpose, twoERP systems are being used in the industry, 1) SAP ERP and 2) Oracle 12. Both

systems are very efficient and capable of generating real time reports to facilitate dayto day operations and also aid in long term strategy formulation.

5. BUSINESS RISK 5.1 Pakistan is an agrarian economy where more than 70% of its population is Stable demand directly or indirectly employed

Gro

wth(%)

Growth Trend Strong Margins by this segment. Similarly, the

performance of this 50%segment

2004 2005 2006 2007 2008 2009 2010

Gas supply riskalso translates into a spiraling 40%and prominent impact on thecountrys overall economicperformance. However,productivity of the farmingsector continues to remain lowdue to the prevalence ofinefficient farming practices,lack of technical know-how anddepletion of nutrients in thesoil. Nevertheless, the strategicimportance of the sectortowards ensuring ruralemployment and food securityof the country forces the

30%

20%

10%

0%

-10%

-20%

-30%

-40%

Year

Agriculture Urea DAP

government to support the sector. Thus, the domestic governments help farmers inthe form of increasing crop support prices, raising market accessibility, improvingwater reservoirs and distribution system, developing infrastructure and emphasizing

the need for credit to the agriculture sector by encouraging banks and DFIs to comeforward. Since efficiency in balancing soil nutrients is always considered as theinitial and the most vital factor for the output of any crop, fertilizer consumption inPakistan is witnessing a persistent growth during last few decades. Currently,Pakistan is amongst the top fertilizer consumers of the world with offtake of approx8mn tons for 2008/09 (almost 5% of the total world consumption as reported in theIFA Annual Conference 2009).

5.2 Strategic Importance: The importance of Agriculture in Pakistan raises thesignificance of fertilizer as the major farm input. The Government has taken severalsignificant steps to boost agricultural production over the last five years. In thisregard, GoP has kept the prices of phosphatic fertilizers affordable for the farmers notallowing them to go beyond certain limit by providing subsidies.

5.3 Market Structure:Fertilizer industry falls under Urea Market Share (Current)an oligopolistic market 8%structure with two players

12%

2%

10%Fauji and Engro Fertilizers combined holding over 75%of the market share. This 46%allows the major players in themarket to have power to

22%

determine urea prices. Themarket share of all players atpresent and after the

expansionary activities areFFC FFBL Engro Dawood Pakarab Agritech

depicted in the pie charts.



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5.4 Competition: Engro andFauji Fertilizers, being thelargest players in the industry,set the urea market prices whileothers players follow. Since the

fertilizer companies have gasavailable to them at subsidizedrates, the final price of theproduct is reviewed by GoP.Pakistan still suffers fromproduction deficit in fertilizers,therefore the element ofcompetition does not dominatepricing. All the players are able

Urea Market Share (post expansion)7%

8%

32% 1%

8%

9%

35%

FFC FFBL Engro Dawood Pakarab Fatima Agritech

to sell everything they produce. The final price of urea in Pakistan works out to be~40% cheaper than the international urea price, thus ruling out any possibility ofinternational competition.

5.5 Barriers to entry: The biggest barrier to the entry in fertilizer sector is the limitedavailability of gas. In early 2000s, GoP initiated the drive to rely more on indigenousenergy resource and distributed additional gas contracts to the existing firms forexpansion and to the new entrants, interested in setting up fertilizer plants. Additionalgas subsidies were also provided under Fertilizer Policy 2001 to encourage fertilizerproduction. Players like Engro opted for an additional plant setup and other playersalso took up minor expansionary projects. Meanwhile, Fatima Fertilizer was the newentrant in the market. However, by late 2000s, the gas demand had increasedsignificantly on the back of increased uses of gas in commercial and industrialactivities. The major contributors were transportation and power segments, whichmoved to gas from oil. In the current scenario, there has to be gas load shedding tomanage the gas supply to all the sectors. Fertilizer, though having the priority

allocation of gas (Natural Gas & Management Policy 2005), faced gas curtailment(upto 20%) for the first time in 2010 as gas was diverted to the power plants. Thislimited gas supply has become another barrier to entry for the fertilizer sector. GoP ismaking efforts to improve the situation through imports from Iran and Turkmenistanto bridge the demand-supply gap. Secondly, the other vital barrier in enteringfertilizer industry is the capital intensive nature of the business. According to thelatest estimates, a million ton urea producing plant requires a billion dollarinvestment. Therefore, this sector provides investment opportunities to only the largegroups with financial muscle.

5.6 Urea Demand-Supply Gap:Urea consumption comprisesmore than 70% of the totalfertilizer use in Pakistan andhence using the term fertilizer,most commonly, refers to urea.The demand for urea has grown~160% over the past twodecades. The local productionhas not been able to meet thedemand and the difference hasbeen bridged through imports.During last two decades, Therehave been only a few years

Tons

Urea Analyses7,000,000

6,000,000

5,000,000

4,000,000

3,000,000

2,000,000

1,000,000

0

(1994-1995 & between 2001- 2005-06 2006-07 2007-08 2008-09 2009-102004) where the domestic

Yearssupply has exceeded the local Production Offtake Imports

demand. On average, ~10%



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demand per year is met through imports. The average production and offtake growthoccurred at almost the same rate (~5%) which meant the demand-supply gap neverdeclined. In fact, in last two years, urea imports have increased (FY09: 878k tons;FY10: 1,523k tons).With new capacities coming online (Engro & Fatima), Pakistancould have urea surplus (~300k tons) for at least a couple of years (2011-2013).

However, the continuing gas curtailment, resulting in lower capacity utilization, haveneutralized the impact of additional capacity. This implies that demand (6300k tons)would out pace supply unless there is significant expansion in the sector. The othercritical factor is sufficient supply of natural gas.

Demand Supply Position for past two decades

Period Production Offtake Surplus/(Deficit) Imports Surplus/(Deficit)

1989-90 2,108,865 2,524,000 (415,135) 371,000 (44,135)

1990-91 2,050,278 2,553,000 (502,722) 541,000 38,278

1991-92 1,902,296 2,553,000 (650,704) 570,000 (80,704)

1992-93 2,306,110 2,849,000 (542,890) 525,000 (17,890)

1993-94 3,103,854 2,978,000 125,854 206,000 331,854

1994-95 3,000,313 3,152,000 (151,687) 0 (151,687)

1995-96 3,258,046 3,648,000 (389,954) 389,000 (954)

1996-97 3,258,135 3,643,000 (384,865) 704,000 319,1351997-98 3,284,168 3,802,000 (517,832) 264,000 (253,832)

1998-99 3,550,457 3,887,000 (336,543) 574,000 237,457

1999-00 3,968,151 3,999,000 (30,849) 114,000 83,151

2000-01 3,983,257 4,047,000 (63,743) 86,000 22,257

2001-02 4,259,829 4,185,000 74,829 0 74,829

2002-03 4,407,462 4,262,000 145,462 0 145,462

2003-04 4,434,834 4,637,000 (202,166) 0 (202,166)

2004-05 4,610,672 5,120,000 (509,328) 307,000 (202,328)

2005-06 4,803,870 5,405,000 (601,130) 825,000 223,870

2006-07 4,731,732 4,678,000 53,732 281,000 334,732

2007-08 4,925,132 5,579,000 (653,868) 181,000 (472,868)

2008-09 4,920,730 5,766,000 (845,270) 878,000 32,730

2009-10 5,152,610 6,545,000 (1,392,390) 1,523,000 130,610

5.7 Derived Demand: The demand for fertilizer is often linked to the agriculturalgrowth in the country. In the past 50 years the growth of agriculture sector has rangedbetween 3%-5% for each decade. However, during the past 7 years the trend has beenvery mixed. The agricultural growth went as high as 6.5% in 2004-2005 and as lowas 1% in 2007-2008. This variation is not reflected in urea offtake, which shows agrowth of 10% in 2004-2005 and 19% in 2007-2008. As a general perception, anincrease in fertilizer offtake should reflect directly in agricultural growth, whereas,the statistics suggest that the the application of fertilizers has been growing at asteady pace. This is peculiar but a justifiable answer is that at the time of theapplication of fertilizer, farmers are not aware of the outcome of the final crop. Hencefertilizer consumption may show growth but attributes like bad weather can wipe out

the crops. A more clearer relation of agriculture and fertilizer use is evident in thepreceding years. The application of fertilizer per hectare of arable land in Pakistan isat 184kg/ha, which is 28 percent higher than the global average. Other variables suchas farmer awareness, farmer income and depletion of nutrients in the soil also playvital role in computing fertilizer demand.

5.8 Farmer Awareness: Fertilizer companies have become very active in recent yearswith the objective to educate farmer on the most effective and efficient usage offertilizer. These efforts materialize through the setting up of camps by the fertilizercompanies in the rural areas to conduct soil testing. This enables the companies torecommend correct proportion of fertilizer use for the farmland. Fertilizerrecommendations are based on two factors: i) nutrient requirement of a crop and ii)fertility level of the soil. Hence, increased awareness contributes to the demand for

fertilizers.5.9 Farmer Income: Income generated in a given year determines the purchasingpower of the farmer effectively in the following year. Though some effect is captured



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in the same year since the farmers raise credit to finance their seed procurement withthe hope of generating higher income. This was evident in the year 2008 when thesupport price for wheat, a major crop, was raised to PKR 950/50kg. The results werevisible in the 2009-2010 fertilizer offtake, which grew by 13.5%.

5.10 Nutrients Depletion: Crop need 16 different nutrient elements for their growth.

With the introduction of high yielding crops (BT cotton) and increased croppingintensity, soils are becoming deficient in these nutrient elements. So to make thedeficiency of nutrients, farmers have to apply more chemical fertilizers. A geneticallymodified crop consume 50%-100% more fertilizer. Therefore, to maintain thenutrients in the soil, fertilizer application has to increase every year.

5.11 Nature of Product: Fertilizer, in nature, is equivalent to a consumer item usedeveryday (food). The way food is important for the humans when they are hungry,fertilizer application is required for the crops whenever they need nutrition intake.The fertilizer application varies like humans where some crops require more intakewhereas others consume less.

5.12 Demand Elasticity: The demand for fertilizer is highly inelastic where a smallchange in price does not corresponds to a very large fall in demand. Its a basicnecessity for the crops and has to be consumed on periodic basis. There may be aswitching effect within the fertilizer products in response to the price of variousproducts but overall fertilizer demand is not affected.

5.13 Diversification: Fertilizer sector has only one avenue to sell its product, whichis agriculture. However, the strategic importance of agriculture is very high and itensures a very stable demand for fertilizer in the country. The product is available indifferent combinations of Nitrogen, Phosphate and Potash.

5.14 Demand & Supply: In 2010, the urea demand, which witnessed a mixed growthtrend during the last few years, increased sharply by 13.7% to 6.5mln tons. Thiscoincided with short revival in the agriculture sector. Not only did the major crops ofthe country (wheat, rice, cotton, sugarcane) perform well in terms of yield, they also

fetched better pricing in the domestic and international market.

In the past, the fertilizer industry has not been able to meet the local demand. Thissupply-demand gap has encouraged firms to increase their capacities. In this regard,the largest expansion plan is being carried out by Engro Fertilizers Limited, which isexpected to come online by end of 2010. This will increase its capacity by 1,300,000MT per annum. Fatima Fertilizer Company Limited is undertaking a major fertilizerproject with urea capacity of 500,000 tons per annum expected to achievecommercial production of urea soon. Meanwhile, FFC has BMR plans to expand itscapacity by 158,000 tons per annum and a minor urea revamp is also underway inAgritech Limited. The fertilizer industry will have excess supply, though limited,once the expansion projects are complete and may have to export the surplusproduction. Nevertheless, since the GoP has decided to curtail the gas supply to

fertilizer industry in order to support the power sector, the industry may continue tohave a deficit position, met through imports. The local production registered a growthof 4.7% in 2010 on YoY basis.

(000 tons)

All Fertilizer

1Q11 FY10 FY09 FY08

Products

Offtake 1,703,033 8,966,253 7,873,882 7,641,000

Production 1,804,224 6,735,387 6,376,716 6,050,300

Urea

Offtake 1,154,000 6,545,365 5,756,963 5,579,000

Production 1,312,000 5,152,610 4,920,730 4,925,000

DAP

Offtake 355,000 1,535,519 1,090,247 1,088,000

Production 164,000 625,889 533,734 356,000

Source: National Fertilizer Development Centre (NFDC)FERTILIZER Page 22 of 26May 2011 www.pacra.com


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July0

9

Aug0

9

Sep0

9Oct0

9

Nov0

9

Dec09

Jan10

Feb1

0

Mar10

April10

May1

0

June1

0

Jul-10

Aug-10

Sep-10

00/

9991

10/

0002

20/

1002

40-

3002

50-

4002

60-

5002

70-

6002

90-

8002

01-

9002

)M

9(11-

01

02


During FY10, DAP sales picked up after having couple of dry years on the back ofhigher phosphate prices. Increased awareness among farmers about the benefits ofbalanced fertilization and the low base effect contributed to ~41% growth in DAPofftake in FY10 returning close to peak FY07 offtake levels (1.6mln tons). DAPofftake in 1HFY10 contributed 79% to the total offtake for the year. The demand

went southwards during the later period owing to the rising trend in DAP prices. Thecountry produced 17% more DAP in FY10 on YoY basis, attributed to no turnaroundthis year.

During July10, Pakistan faced worst floods affecting almost all provinces of thecountry. The flood impacted several agricultural fields and along with capital lossesto the standing crops, eroded distribution channels for the manufacturing industries.Among other sectors, fertilizer production also suffered including one instance wherethe gas pipeline from Mari Gas fields was chocked because of rain water causingsupply disruption lasting ~5 consecutive days. Fertilizer offtake remained slow in thebeginning of FY11 owing to a) submerged agricultural lands and b) the weakenedfinancial strength of the farmers. The World Bank and Asian Development Bank intheir joint Damage and Needs Assessment have assessed ~USD 5bln losses to the

agriculture and livestock of the country during the devastating floods in the country.However, fertilizer offtakeis expected to experience Fertilizer Offtake

recovery, going forward, 1,000,000

in the wake of upcoming 900,000

Rabi season. 800,000

Demand for phosphatic 700,000

and potassic fertilizers, 600,000

required for balanced 500,000

fertilization, has been met 400,000

mainly through imports. 300,000

The high cost of imported 200,000

raw material for non- 100,000nitrogenous fertilizers and 0vulnerability tointernational scenario

Urea DAP

provides limited attractionfor domestic producers to venture into the production of these fertilizers. Fatimasnew fertilizer complex will produce CAN (410k tons), NP (363k tons) and NPK(330k tons) along with Urea. FFBL remains the only DAP producing facility inPakistan which met ~40% of local demand of DAP during FY10. Engro Fertilizeralso has a small facility for manufacturing NPK.

5.15 Prices Urea prices have almost doubled in the last couple of years afterfollowing arelatively stabletrend in thepreceding years. Theprices rose mainlyon the back ofincrease in gasprices and otheroperating expensesin the wake ofpersistent inflation.However, the ureaprices in Pakistan

still remain at ~40%discount to the

P

R

0

b

)

a

g

g

5(

K

K

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0

Fertilizer Price Trend

international market Urea DAPFERTILIZER Page 23 of 26May 2011 www.pacra.com


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0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

due to the subsidy provided in form of feedstock to the local producers. Since most ofthe local consumption of DAP is fed by imports, its prices have been changing in linewith the international market dynamics. Given the past history, GoP comes forwardto provide subsidy on DAP when the prices of DAP go beyond a certain level alevel at which demand of DAP is normally strangled.

With rising imports, the government has to bear the major cost of the importedproduct, which is procured at international market prices and sold to the finalconsumer at subsidized rates. The current import urea price is ~USD 380/ton (fob),whereas current domestic urea price is ~USD 270/Ton. The prices of local urea are,therefore, expected to remain firm and margins are likely to remain stable. Theinternational DAP price is around USD 600/ton (fob) whereas it is sold in thedomestic market at ~USD 850/ton6. GoP provided averaging around PKR 18bln assubsidy to the sector in last three years. The trend in prices of urea and DAP isillustrated in the chart.

5.16 Performance: The year 2010 has been a mixed year for the fertilizer sector interms of its performance. The fertilizer industry, having very stable demand drivers,had a good start to the year.The urea prices were raisedupto PKR 100 per 50kg bag Fertilizer-Turnover & Marginson the back of the gascurtailment announcement 160,000

from GoP in the first quarter, 140,000which contributed positively 120,000to the margins in the industry. 100,000The actual gas curtailment 80,000came in the second quarter but 60,000since the industry had already 40,000incorporated the effect in their 20,000prices, the large players were 0

able to maintain their margins. 2007 2008 2009 2010Unfortunately the smallplayers had to suffer because

Turnover Gross Margin NP Marginof a) their inability to chargehigher prices b) coupled with their geographical location which receivedcomparatively more gas load shedding due to the proximity with most of the powerplants in the country. The gas curtailment was lesser than expected for large playersand they reduced their prices upto PKR 25 per 50 kg urea bag in Aug10. Recently,the prices have crossed PKR 1100/50kg urea bag after further gas curtailment to thesector and implementation of 17% GST on fertilizers.

5.17 Profitability: Major players in the industry reported healthy growth in theirtoplines during the year 2010 on the back of increased fertilizer prices. The gross

margins in the industry remained ~42% on average which converted into an averagebottom line of ~21% of sales in the same period. With the stability of demand, themargins are expected to remain unchanged. The performance of major players in theindustry pertaining to 2010 are depicted in the following table.

Debt servicing for the period ending Dec 30,2010

Fauji Fertilizers FFBL Engro Fertilizers Dawood Hercules Pak Arab Fertilizers

Sales (mlns) 44,874 43,257 19,018 8,715 18,248

Gross Profit (mlns) 19,563 13,463 8,910 3,501 9,197

Finance Cost (mlns) 1,086 934 1,292 909 3,590

Other Income (mlns) 3,153 1,153 120 1,189 1,408

Net Profit (mlns) 11,028 6,514 3,729 2,148 3,232

EPS 16.3 7.0 3.5 17.9 7.2

Gross Margin 44% 31% 47% 40% 50%

Net Margin 25% 15% 20% 25% 18%

6 freight and distribution charges are estimated to range between USD 80-100 per ton. The prices are after incorporating 17% GST



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The Pakistan Credit Rating Agency Limited SECTORSTUDY5.18 Supply Risk: The industry is facing high supply risk in the recent times. Sincethe demand for gas has increased and its utilization is spread to new avenues such aspower sector, the fertilizer industry faced gas load shedding upto 20% for the firsttime in 2010. The industry, having the top priority on the right to utilize gas, lost tothe power sector facing the worst crises in Pakistan. The situation is unlikely to

improve in the short run based on the rising demand for gas until GoP find newsupply line for the gas. In this regard, project is underway to purchase gas from Iranand Turkmenistan but by the time it is available, the gas demand in the countrywould have already exhausted the new addition to the supply line. An alternativesolution may exist in the form of importing LNG and using it as a raw material ratherthan natural gas. However, the issues of allocation of LNG/natural gas between themajor sectors (Power, Fertilizer & domestic segment) has no easy solution as the costdifferential between the two is high and the margins of the sector switched to LNGwill be greatly impacted. A further concern may arise on account of limited foreignexchange available for import of LNG most of which is tied up in the procurementof oil for energy, transport and large scale industries.

Gas curtailment impact on Urea demand deficit(000) tons CY11 CY12 CY13 CY14

a) Urea Demand 6,338 6,559 6,789 7,027

CY15

7,273

Without Gas Curtailment

b) Production 6,822 6,822 6,822 6,822

Surplus/(Deficit ) (c-a) 484 263 33 (205)

6,822

(451)

With Gas Curtailment

c) Production 5,782 5,933 5,933 5,933

Surplus/(Deficit ) (c-a) (556) (626) (856) (1,094)

5,933

(1,340)

6. FINANCIAL RISK

High debt-to-equity driven fromexpansions incapacities

Moderate toStrong debtcoverages

Sufficient access tocapital

5.19 Investment Risk: The returns on the investments in the industry are quite stablefrom the point where the costs have been incurred and the fertilizer plants are up andrunning. However, the delays and cost overruns during the construction of the plants

pose significant risk. Among the listed securities, fertilizer industry is currently oneof the top picks and it is attracting a lot of foreign investment.

6.1 Capital Structure: Fertilizer industry has experienced expansion activities in thelast decade post the incentives given under Fertilizer Policy 2001. These activitiesrequired significant capital investments and along with equity injections by thesponsors, major mode of financing was debt. This brought changes to the capitalstructures in the industry which moved from moderately high to highly leveragedindustry. The high capital intensity of the industry also contributed to a quantum ofhigh debt.

The largest investment activity was carried out in Engro Fertilizers Limited to build anew urea producing capacity of 1.3mln tons per year. The initial project cost was

estimated at USD 1bln with the debt to equity ratio of 60:40. At Jun10, Engro standsat debt to equity ratio of 71:29. Likewise FFBL also went under BMR. This coupledwith the low DAP demand in 2008, pushed the debt-to-equity levels of 71%. FFC iscurrently moderately leveraged but will have to raise more debt if its proposal toacquire Agritech goes forward. The financial leverages in the major players in theindustry are shown in the table.

Financial Leverage

2008 2009 2010Fauji Fertilizers

2008FFBL

2009 2010 2008 2009 2010Engro Fertilizers

2008 2009 2010Dawood Hercules

Debt 9,235 12,446 11,218 25,229 13,599 10,398 29,563 59,592 73,781 6,372 7,499 5,749

Equity 12,285

Debt to Equity 43%

13,082

49%

15,448

42%

10,486

71%

10,660

56%

12,210

46%

21,053

58%

26,888

69%

13,639

84%

17,383

27%

17,855

30%

19,544

23%



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6.2 Debt servicing: With the interest rates rising and large companies in growth stage,the finance cost has been increasing. The finance costs of the major players accountsfor 8% of their turnover, on average. The net interest coverage varies between 1 to 28times with firms experiencing expansion averaging around 3 times due to highfinance cost associated with debt funded capex. The statistics advocate the strong

business dynamics sufficiently meet the costs associated with high leveragingprevalent in the sector.Debt servicing for the period ending Dec 30,2010

Fauji Fertilizers FFBL Engro Fertilizers Dawood Hercules Pak Arab Fertilizers

Sales (mlns) 44,874 43,257 19,018 8,715 18,248

Finance Cost (mlns) 1,086 934 1,292 909 3,590

Finance Cost % of Sales 2% 2% 7% 10% 20%

Net Interest Cover 28.3 21.1 4.4 3.5 1.4

6.3 Cash Flows & Working Capital Requirements: Owing to the demand supply

dynamics, the industry sells fertilizer mostly on cash basis resulting in healthycashflows. This is reflected in form of low receivable amounts on the books of theentities in the industry. However, short term borrowings are a direct function ofworking capital requirements in the industry. In most cases, the entity's reliance onimported fertilizer determines the magnitude of working capital requirements for anentity. The cash nature of the business ensures adequate liquidity in hand at all timesfor the manufacturers. Further the cost of maintaining finished goods inventory,which may vary based on seasonal demand trends, is also borne by the distributionchannel. The liability of the manufacturer is thus limited to financing raw materialinventories, sufficiently reducing working capital requirements.

6.4 Access to Capital: The low business risk of fertilizer sector places it in a verycomfortable position to raise capital as and when required. Fertilizer industry has a

total debt of ~PKR 150bln (~4% of total lending) and pays ~PKR 22bln as a cost toservice this debt. With the gross margins between 40%-45% in the industry, theentities have a sound record of servicing their debts. The debt has been majorly inform of bank loans and TFCs issues.

The other avenue has been the access through capital markets. All the major playersare listed on stock exchange and access capital, often through IPOs. The players havereceived good response from local and international investors based on their goodtrack record of paying out dividends as well as providing capital gain to the investors.During the year 2010, Agritech Limited and Fatima Fertilizer completed their IPOswhile Engro Fertilizers Limited is expected to carry out its IPO in 2H11.

In Jan11, Engro successfully raised medium term debt (PKR 4,000mln @ fixed rate

of 14.5%) from the retail segment of investors through first of its kind TFCs (EngroRupiah). This is the first time that a corporate is tapping the retail sector directly.This helped Engro to raise capital at lower cost while increasing its investor base.The brand name of Engro coupled with low business risk associated with thefertilizer sector aided the uptake of the instrument by the general public. The strongmarketing campaign made a significant contribution towards raising awareness of thedebt-market and its oppurtunities amongst the general public. Engro, based onposituve response, is in process of launching another instrument with similarcharacteristics during 2011.

Fertilizer Sector Study May 2011

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