The government of Pakistan is reportedly discontinuing GIDC (equivalent to about PKR400/bag) in the future. This is aimed at containing the increase in Urea prices, which will likely follow the impending gas tariff hikes. Based on the new rates proposed by OGRA, a full pass-on of the gas price increase will lead to PKR600/bag higher Urea prices.
Following the discontinuation of GIDC, the government will require fertilizer producers to reduce the price of Urea in a way that the gas tariff hike is partially or fully absorbed, in our view. Note that by discontinuing GIDC, the government is foregoing its own revenues (from potential GIDC collection) for lower Urea prices.
Lower Urea prices will be negative for concessionary gas based producers (EFERT, FATIMA) who were less or not affected by GIDC on their feed gas, thus enjoyed higher margins than producers such as FFC and FFBL, which bore the charge. It is a Neutral event for FFC, insofar as Urea price reduction matches the increase in gas tariff hike (on a per bag basis). Positive for FFBL, however, as DAP prices follow international import parity, and the company could not fully pass on input costs to the farmers. Both FFC and FFBL would have lower income on cash (large amount of GIDC held back as payables to government).
The risk is that the government will make the Urea producers reduce prices more than needed by the GIDC reduction (net of gas tariff hike) and involve subsidies to farmers that lead to cash-flow problems for the producers (late payments from govt).
We have built in possible scenarios, the potential earnings impact of which are presented below in Table 1. We believe that the government will most likely put pressure on fertilizer producers to decrease Urea prices, in the event that GIDC is reduced and gas tariff hikes (136% and 32% for feed and fuel respectively) are also approved. Scenario 3 below is a Best-case scenario, wherein producers will be allowed to increase to the extent of net increase in gas prices.
Table 1: Possible scenarios
| Scenarios | 1 | 2 | 3 |
|---|---|---|---|
| GIDC reduced only | Gas tariff also increased | Urea prices increase in tandem with (1) and (2) |
Gas Prices |
|
|
|
Feed (PKR/mmbtu) | 300 | 759 | 759 |
Fuel (PKR/mmbtu) | 1,021 | 1,343 | 1,343 |
GIDC |
|
|
|
Feed (PKR/mmbtu) | - | - | - |
Fuel (PKR/mmbtu) | - | - | - |
Urea Price (PKR/bag) | 1,600 | 2,000 | 2,200 |
EPS Impact (PKR) |
|
|
|
FFC | 0 | -4.86 | 0 |
EFERT | -4.7 | -1.41 | 2.18 |
FFBL | 1.36 | -1.94 | -1.12 |
FATIMA | -2.06 | -0.34 | 0.60 |
Source: IMS Research
All in all, we think it is highly probable that these two events culminate in lower Urea prices and thus lead to lower profitability of the Fertilizer producers. We therefore maintain our Underweight stance on the sector.