Earnings Report /
Pakistan

Engro Fertilizers: Q3 review and analyst briefing takeaways: Decent earnings with surprise payout

    Intermarket Securities
    21 October 2019

    EFERT posted consolidated Q3 19 NPAT of PKR3.33bn (EPS: PKR2.49), down 35% yoy, taking 9M 19 NPAT to PKR10.51bn (EPS: 7.87), down 14% yoy. The result was slightly above our expected EPS of PKR2.34. The decline in profitability was mainly led by (i) hike in gas prices (feed/fuel by 62%/31%), (ii) drop in urea market share, and (iii) one-off deferred tax charge. The result announcement accompanied a surprise cash dividend of PKR6.0/sh against our expectations of PKR2.25/sh, taking total payout during the 9M19 to PKR11.0/sh.

    EFERT booked certain one-offs during Q3 which included: (i) deferred tax reversal of PKR400mn and (ii) provisions which lead to a jump in other income by 5.7xyoy. 

    Q3 19 results key highlights:

    • Net sales posted a decline of 4% yoy to PKR27.11bn in Q3 owing to drop in urea market share post resumption of LNG based plants. To highlight, EFERT’s urea sales declined by 12% yoy, implying a 5ppts drop in urea market share. 
    • Impact of higher gas tariff led to a decline in gross margins by c2.5ppt to 33%. Note that the impact of hike in gas tariff was withheld by manufacturers during Jul-Aug’19 in anticipation of GIDC resolution which remained futile.
    • Other income rose 5.7x yoy to PKR1.2bn on account of provisioning. This helped offset rise in finance cost by 2.3x yoy to PKR1.2bn owing to higher interest rates and PKR devaluation. 
    • EFERT booked effective tax rate of 44% as compared to 25% in same period last year. This is potentially owing to partial reversal of deferred tax gain booked in CY 18 on account of revised corporate tax rates. As yet, EFERT has reversed PKR1.2bn of deferred tax in 9M19 (PKR400mn in 3Q19) while remaining PKR400mn is likely to be realised in Q4. Moreover, capital gains on sale of Engro Eximp FZE led to further increase in effective tax rate.

    Key takeaways from analyst briefing:

    • During 9M 19, EFERT’s production has improved to 1451k ton, up 2% yoy, owing to better gas availability and de-bottlenecking of its base plant. 
    • Few variables that have directly impacted the production cost during 9M 19 include: (i) hike in industry gas rates, (ii) PKR devaluation, and (iii) increase in transportation cost (axle load implementation).
    • With regards to the settlement of sales tax refunds, government has issued ST refund bonds worth PKR2.0bn in order to resolve the working capital issues of the company. Note that the mismatch in input and output sales tax results in total refund of PKR3.7bn on urea and DAP for EFERT. Though a step to resolve liquidity issues, fixed rates on these bonds (lower than the benchmark) leads to financial losses.
    • EFERT is yet to receive the subsidy claims worth PKR6.5bn (industry receivable of PKR20bn) from the government, which was expected to be resolved with GIDC settlement.
    • Management stressed the importance of providing smart subsidy to small farmers (similar to subsidy provided on phosphate products given earlier) in lieu of subsidising expensive imported LNG which results in higher import bill. Looking at the demand supply imbalance created from surplus urea capacity from LNG based production, approval to export urea will help in fetching fx and reduce inventory glut.

    The payout during the quarter remained impressive. However, we expect payouts to trim in Q4. We expect earnings in Q4 to rebound as positive impact of increase in urea price (for concessionary based players) will support bottom-line. EFERT trades at a CY 20f P/E of 5.5x and offers an attractive D/Y of c. 17%. This is however balanced by the impending discontinuation of concessionary gas provision. We thus have a Neutral stance on the scrip with a Dec’20 target price of PKR68/sh.

    Risks: (i) Unfavourable GIDC settlement, (ii) surplus urea inventory and (iii) delay in subsidy collection.