Equity Analysis /

Pakistan fertilizers: Limited room for upside

  • Lower Urea prices and higher crop prices will maintain demand

  • The risk of oversupply increases if RLNG-based plants come online

  • The government is planning to announce PKR37bn bailout package for farmers in the form of direct subsidy for fertilizers

Intermarket Securities
11 May 2020

Despite a steep decline of 25% yoy in urea offtake in 1QCY20, we believe that urea demand will rebound in the remainder of CY20f. The combination of lower urea prices, better food commodity prices and government focus on the agriculture sector will lift overall demand to 5yr industry average level of 5.7mn tons, in our view.

Significantly lower oil prices will limit gas tariff hikes in future, which will enable RLNG based producers to better negotiate with the government to allow them to produce. If this happens, the market share of the incumbents will be again at risk, in our view.

We have an Marketweight stance on the sector, where its high dividend yield is a key attraction but balanced by moderate certainty on earnings/payouts, in our view. We prefer FFC (Buy, TP PKR120/sh) for a high DY and less peculiar risks than for peers.

Lower Urea prices and higher crop prices will maintain demand 

We have revisited the estimates for our fertilizer coverage, in light of lower urea prices (post GIDC cuts by the government) and our view that present lockdown conditions will have limited impact on urea off-take. The government has allowed fertilizer producers and dealers and to operate business-as-usual amid sowing of Kharif crops (April-June). Moreover, recent increase in support prices of wheat and sugarcane will encourage farmers to consume more urea for better and larger crop yield, in our view. We also think that the government will continue to support farmers by procuring more than the usual amount of crops. These factors will remain in place, if not enhanced, during CY20, in our view. They underlie our expectation of total urea off-take of 5.7mn tons in CY20 – which is the same as its past 5yr average demand.

The risk of oversupply increases with lower oil prices

As international oil prices have dropped significantly (c.60% CYTD), there will likely be limited hikes in gas price (thus no more cost pressures) in CY20, in our view. On the flipside, however, LNG prices have also come down significantly, which means that the government can allow RLNG based producers to resume production. If this happens, then the market share of the incumbents (mainly Fauji group and EFERT) will be diluted. The two RLNG based plants (Agritech and FatimaFert) have a combined capacity to produce 822ktpa of urea; we think they can produce about half of that, if they are allowed to operate from July 2020 onwards. Nevertheless, we think the government will to do so only if it foresees urea demand exceeding 5.8mn tons; in which case, it will either provide gas to RLNG based plants or import urea itself.

We prefer FFC 

A key attraction for the sector will be high dividend yield (c.10% or more) in a low interest-rate environment; but, except for FFC, earnings and payouts certainty remains moderate to low, in our view. We like FFC for a more durable dividend yield, lower input cost and higher gross margins (amid discontinuation of GIDC). FFBL also has the potential to improve core profitability amid better DAP primary margins, lower interest rates and discontinuation of GIDC. However, FFBL’s weakness on a consolidated basis will likely remain (courtesy deep losses of food subsidiaries). EFERT and FATIMA are set for margins/earnings attrition post GIDC cuts and eventual cessation of concessionary gas arrangement.