Equity Analysis /
Pakistan

Pakistan Fertilizers Q3 CY 19 Preview: A weak quarter

    Intermarket Securities
    16 October 2019
    • We expect earnings of IMS Fertilizer cluster to decline by 24% to PKR9.7bn in Q3 CY 19. The decline in profitability is mainly led by (i) hike in gas prices (feed/fuel by 62%/31%), impact of which was withheld by manufacturers (Jul-Aug'19) in anticipation of resolution of GIDC, and (ii) 14ppts drop in urea market share of incumbents.
    • GIDC noise was a central event during Q3. This was evident from uncertainty in urea prices post hike in gas tariffs in Jul'19. However, all efforts to maintain prices went in vain after the revocation of GIDC ordinance amid a political backlash, which in turn led to an increase in urea price by PKR200/bag in Sep'19.
    • Though Q3 will be a bad quarter, earnings are likely to rebound in Q4, in our view, especially for concessionary gas based producers owing to improved primary margins. That said, the verdict of the SC on GIDC remains a major trigger ahead, which may dictate sector’s performance. Hence, we maintain our Market-weight stance on the sector.

    FFC’s GMs to fall amid gas price hike 

    We expect Fauji Fertilizer (FFC) to post Q3 CY 19 NPAT of PKR3.26bn (EPS: PKR2.57), down 14%yoy, on (i) 7% yoy decline in Urea offtake (market share down to 40% vs 45% in Q3 18), and (ii) drop in Urea’s primary margins amid hike in gas prices. Note that FFC remains highly sensitive to impact of industry gas prices. This will take 9M 19 EPS to PKR9.57, up 43% yoy. We expect FFC’s gross margins to drop by c7ppts yoy to 25%. Other income is expected to remain elevated (up by 2.8x yoy) mainly owing to hefty cash balance, courtesy the pile up of GIDC accruals. This will more than offset the impact of increase in borrowing cost amid higher interest rates. We expect FFC to pay an interim cash dividend of PKR2.25/sh, taking total payout during 9M 19 to PKR7.6/sh. 

    EFERT’s tax reversal may further dent profitability 

    Engro Fertilizer (EFERT) is expected to post Q3 19 profitability of PKR3.12bn (EPS: PKR2.34), down 39% yoy. Net sales are expected to decline by 14% yoy owing to potential decline in urea/DAP offtake by 11/38% yoy. Impact of higher gas price is expected to trim gross margins by 4ppts yoy. Also, higher finance cost will keep a check on profitability growth, in our view. Moreover, reversal of deferred tax can further trim our earnings estimate by PKR0.6/sh. Recall that EFERT has partially realised the deferred tax reversal in 2Q19 (PKR800mn of total cPKR1.6bn). We expect EFERT to announce an interim cash dividend of PKR2.25/sh.

    FFBL’s core earnings to remain depressed

    Fauji Fertilizer Bin Qasim (FFBL) is expected to post unconsolidated NLAT of PKR770mn (LPS: PKR0.82) in Q3 19 as compared to NPAT of PKR790mn (EPS: PKR0.85) in the same period last year. The core earnings of FFBL are likely to deteriorate in Q3 due to (i) weak Urea sales (down 27% yoy) and (ii) higher gas prices. This is likely to offset the 19% yoy growth estimated in DAP sales. Higher finance cost (up by 2.7x yoy) is another impediment keeping a check on profitability. However, some respite may come in terms of dividend from its power subsidiary which will result in earnings accretion of PKR1.03/sh (assuming a similar payout as in CY 18).

    FATIMA likely to outperform 

    We expect Fatima Fertilizer (FATIMA) to post unconsolidated earnings of PKR4.11bn (EPS: PKR1.96) in Q3, up 32% yoy. The growth in earnings is likely to be led by better retention prices on product mix. Note that impact of increase in industry gas rates is limited on concessionary gas based producers. 

    Risks: (i) Unfavourable verdict on the GIDC case, (ii) inventory buildup, and (iii) low pricing power.