Equity Analysis /

Pakistan Fertilisers: GIDC holds the key to sector outlook

    Intermarket Securities
    19 August 2019

    We revisit our estimates for the IMS fertiliser universe following revised macroeconomic and sector assumptions. Our major assumptions now include (i) c31%-62% increase in gas prices adjusted against a proposed cut in Gas Infrastructure Development Cess (GIDC) rates, (ii) lower market share of our fertiliser cluster, and (iii) higher risk-free rate. After the recent fall in stock prices, the sector now offers a dividend yield of 12.8% (ex-FFBL). 

    The pending decision on GIDC settlement remains the key checkpoint for the sector, in our view. As per the last round of negotiations, the potential reduction in prospective GIDC (by 50%) has led producers to maintain Urea prices. We believe that any retrospective GIDC settlement would likely happen against payables outstanding from CY 16. However, we have not incorporated it as yet.

    For CY 19f, we expect urea offtake to remain stable at 5.8mn tons. With LNG-based production (AGL and FatimaFert) expected to continue until Oct’19, urea availability is likely to reach 6.3mn tons, taking closing urea inventory to c500,000 tons which is unlikely to disrupt the demand-supply equilibrium.

    Market share dilution offset by improved pricing 

    With LNG-based producers currently operational, the urea offtake of our fertiliser universe is likely to decline by 5% yoy in CY 19f. However, improved pricing is expected to offset the decline in volumes. Urea prices have increased by PKR300/bag to PKR1,840/bag in the last year following (i) removal of subsidy & pricing cap, (ii) lower inventory levels, and (iii) significant PKR depreciation (opening the gap between imported and local urea). Incorporating the adjustment of recent gas price hikes (62%/31% hike in feed/fuel) against an assumed 50% prospective GIDC cut and improved retention prices, we expect earnings for our universe (ex-FFBL) to grow by 1.3%/5.1% in CY 19/CY 20f. The sector now offers a dividend yield of 12.8% in CY 19f.

    GIDC settlement and maintaining urea prices

    The pending decision on GIDC settlement remains a key checkpoint for the sector, in our view. Following negotiations between urea producers and the government, the net adjustment of reduction in prospective GIDC against gas tariff hikes has enabled producers to uphold urea prices at present levels (at PKR1,840/bag). Specifically, the government has reportedly offered a 50% cut in prospective GIDC rates against the recent gas tariff hikes (62/31% increase in feed/fuel). On a recurring basis, this will be negative for concessionary-gas based producers, namely EFERT and FATIMA; their earnings will be lower by PKR0.50/sh and PK0.15/sh, respectively. It will be marginally positive for FFC, however. In our estimates, we have reduced GIDC rates by 50% going forward and adjusted this against the gas price hikes.

    The settlement of retrospective GIDC remains uncertain. In our view, retrospective GIDC (50% only) will likely be settled against outstanding payables from CY 16. This would partially be offset by subsidy and GST refunds, resulting in net payables by the producers amounting to cPKR10bn. To recap, the outstanding GIDC amount from the sector stands at PKR90bn (as of June'19), with accruals of FFC peaking at PKR51bn. The subsidy and GST refund of the sector cumulatively stands at cPKR35bn, respectively. We believe a settlement of 50% of outstanding amount in the above manner may lead to one-off gains for FFC/EFERT/FATIMA by PKR12.9/3.7/0.6 per share. However, producers are demanding settlement of the entire accrued amount since CY 12. If this happens, this will lead to hefty receivables (PKR40bn) from the government; hence we do not consider this as a probable scenario. Such a cash-flow settlement will lead to material changes in the working capitals of our covered companies (impact on payouts, valuations etc.) In case the GIDC settlement is not reached soon, fertiliser manufacturers are likely to raise urea prices to offset the impact of higher gas prices. We await a final decision on the retrospective GIDC settlement to incorporate it in our estimates.