fertilizer_sector_financial_analysis.pdf

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Corporate Finance

Financial Analysis of Fertilizer

Industry

Fatima Fertilizer

Fauji Fertilizer

Fauji Fertilizer Bin Qasim

Group # 5 - Members

Anwar Ul Hassan Syed Muzzamil Imam

Muhammad Arsalan Ahmed


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TABLE OF CONTENTS

Executive Summary ........................................................................................................................... 3

Risk Profile .......................................................................................................................................... 5

Investment Analysis ............................................................................................................................ 5

Capital structure ................................................................................................................................. 5

D iv i de n d p ol ic y ................................................................................................................................. 7

V al u a t i o n ........................................................................................................................................... 7

Introduction .................................................................................................................................... 7

Brief description of the companies ..................................................................................................... 8

Fatima Fertilizer ............................................................................................................................. 8

About the company .................................................................................................................... 8

Final Products.............................................................................................................................. 9

Intermediary Products ................................................................................................................ 9

Cost estimates & Plant Performance .......................................................................................... 9

Fauji Fertilizer Company Limited ................................................................................................ 11

About the Company ................................................................................................................. 11

Largest Urea producer ............................................................................................................. 11

Production Efficiency .............................................................................................................. 12

MIRPUR MATHELO-Urea Production (met Tons/Year) .......................................................... 14

Vast distribution networks an important plus point ............................................................... 14

Low leverage levels .................................................................................................................. 14


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Cost of equity ................................................................................................................................ 22

Cost of debt ..................................................................................................................................... 24

Cost of capital .................................................................................................................................. 26

M a rk e t v al u e o f e q u i t y ............................................................................................................ 26

De b t a n d E q u i t y r a t i o s ............................................................................................................ 26

Measuring Returns ..................................................................................................................... 27

ROE and ROC ........................................................................................................................... 27

Future outlook ......................................................................................................................... 28

C o nc l us i o n s .................................................................................................................................... 30

Current financing mix ...................................................................................................................... 31

FFBL .............................................................................................................................................. 31

FATIMA ......................................................................................................................................... 31

FFBL .............................................................................................................................................. 31

Current Cost of Capital / Financing Mix .......................................................................................... 48

Cost of Capital at Different Financing Mixes .............................................................................. 49

Quantitative Analysis ...................................................................................................................... 50

Current Dividend Policy .............................................................................................................. 50

Fatima Fertilizer .......................................................................................................................... 58

FFC BIN QASIM ............................................................................................................................. 58

Valuation models ............................................................................................................................ 58

Valuation model and inputs. ....................................................................................................... 59


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EXECUTIVE SUMMARY

21% of Pakistan’s GDP is backed by the agriculture sector and a hefty 62% of country’s population is

directly or indirectly dependent on agriculture. The Agriculture sector’s strong linkages with the rest of

the economy are not fully captured in the statistics. While on the one hand, the sector is a primary

supplier of raw materials to downstream industry, contributing substantially to Pakistan’s exports, on

the other, it is a large market for industrial products such as fertilizer, pesticides, tractors and

agricultural implements. A thriving agriculture sector is also essential to the prosperity of

manufacturing sector of the economy which mainly consists of agro based industries such as textiles,

sugar, food etc.

Fertilizers are substances added to soil to improve the growth of plants, as well as their yield. Fertilizer

industry in Pakistan is dominated by two main products; urea (nitrogen based product, accounting for

66% market share) and DAP (phosphorus based product, having 19% market share). Country’s annual

urea demand is approximately 6.5mn tons with local manufacturing capacity being 5.0mn tons. Delta

demand is met through imports. While Fauji Fertilizer Bin Qasim is the sole producer of DAP in

Pakistan, accounting for 42% of local DAP market share, whereas the remaining 58% demand is met

through imports.

Due to this high dependence ratio on agriculture sector, Government has always maintained a

transparent and consistent policy for fertilizer industry regarding, a) fresh investments, b) input prices,

c) supply of inputs. After domestic consumers, fertilizer industry is placed at priority list when it comes

to rationing of gas. The largest domestic urea producing companies receive their gas supply from Mari

Gas field. Mari field gas is not pipeline quality due to which there is limited risk of gas diversion, even ifthere is shortage of gas in other segments.

The government sets minimum purchase prices of major crops (wheat, paddy, sugarcane). In the


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in FY92). Likewise, the year following 1992 floods, nitrogen application growth slowed down to +1%

while phosphate demand slipped to -5%. A potential positive for the longer term is that the present

increase in dams’ water level may actually bode well for agricultural growth and fertilizer demand oneyear out where lower than mean water availability has stunted growth in major crops in the last couple

of years.


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RISK PROFILE

FIGURE 1: RISK PROFILE

We used beta to estimate the exposure of each company to market risk. The results reflect the

fundamental characteristics of each company and in particular variance of earnings and leverage.

The riskiest company as measured by historical regression beta is Fauji Fertilizer Bin Qasim and the

least risky is Fauji Fertilizer Limited (FFC). Because of the historical character of the regressions beta

and high standard errors of the estimates we used bottom-up betas in our further analysis.

In addition, returns on capital of each company with relation to its risk have been calculated. The top

performing companies were Fauji Fertilizer Limited and Fatima Fertilizer Limited (FFL).

INVESTMENT ANALYSIS

W d ti f t t l th t t i l i t t j t


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we computed optimal capital structures for each firm and assessed the impact on the WACC from

moving from the current capital structure to the optimal. The result was an average of 3-5%change

in the WACC value of the firms, most of this decrease comes from FFC.


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D I V I D E N D P O L I C Y

All three companies are dividend paying companies, although for very different reason,

FFC and FFC Bin Qasim pays out all almost profit in its dividend .This exhibits a great potential to

invest in both of these companies for short term gains. On the other hand Fatima Fertilizer

Limited (FFL) pays half of its profits as dividends.

V A L U A T I O N

The results from our valuations are presented in the table below:

FIGURE 2: VALUATION


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FIGURE 3: COMPANY INFORMATION

Throughout the report analysis has been presented based on information gathered from

various public sources, including statutory filings with regulatory authorities in the respective

jurisdiction, company annual reports, management presentation and other publicly available

information. We have tried to acknowledge each source of information where possible. Figures

and data that are not referenced to any source has been result of our own analysis.

For computational ease the analysis for each company has been undertaken in the reporting

currency under which the company reports annual results.

BRIEF DESCRIPTION OF THE COMPANIES


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FIGURE 4

CAN and Urea have already started production. NP plant is projected to start commercial production fromDecember this year. The project is located on 947 Acres of land acquired at Plant site Mukhtar Garh

Sadiqabad, Rahim Yar Khan in the Punjab Province.


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at 69.4k tons and 23.9k tons. As per the mgmt., current utilization of both urea and CAN plants stands at

107% and 94% respectively.


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FAUJI FERTILIZER COMPANY LIMITED

ABOUT THE COMPANY

Fauji Fertilizer Company (FFC) was incorporated in 1978 as a private limited company, in a joint

venture between Fauji Foundation (a leading charitable trust in Pakistan) and Haldor Topsoe A/S of

Denmark. Present share capital of the company stands at PKR6.8bn. FFC has 51%, 12.5% and 13.5%

stake in Fauji Fertilizer Bin Qasim Limited (formerly FFC-Jordan Fertilizer Company Limited), Pak

Maroc Phosphor (PMP) and Fauji Cement Company Limited (FCCL) respectively. FFC commenced

commercial production of urea in 1982 with designed annual capacity of 570k tons, which has beensubsequently augmented to 1.9mn tons at present. FFC currently has 678.5mn shares outstanding

out of which 44% shares are held by Fauji Foundation, being the largest shareholder of the

company.

FFC is involved in manufacturing & sale of urea, and also imports and sells phosphate fertilizers.

Fauji holds 50.88% share in Fauji Fertilizer Bin Qasim (FFBL), a listed company involved in

manufacturing and sale of urea and DAP. FFBL is the only DAP manufacturer in the country. FC alsohas joint-venture investment with OCP of Morocco in phosphoric acid manufacturing operations

(Pak Maroc Phosphore). PMP is a USD 240mn project with FFC holding 12.5% of the equity.

SONE UREA

Most widely used fertilizer in the country. Fertilizer is white in color, free flowing, readily soluble in

water and both contain 46% Nitrogen. Because of its high solubility, it is suitable for solution

fertilizers.


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The company has a production capacity of approximately 1.9mn tons. Being the largest urea

manufacturer, FFC benefits from economies of scale, and as a result has the best gross, operating

and net margins in the industry.

FIGURE 5: FIVE YEAR AVERAGE MARGIN

PRODUCTION EFFICIENCY


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1986 594,901 104.36 - - 594,901 104.36

1987 632,079 110.89 - - 632,079 110.89

1988 637,737 111.88 - - 637,737 111.88

1989 632,972 111.04 - - 632,972 111.04

1990 652,665 114.50 - - 652,665 114.50

1991 629,266 110.39 - - 629,266 110.39

1992 648,178 102.55 - - 648,178 102.55

1993 657,376 94.58 477,339** 95.85 1,134,715 100.41

1994 678,114 97.57 659,526 103.86 1,337,640 100.57

1995 680,062 97.85 700,031 110.24 1,380,093 103.76

1996 710,862 102.28 695,749 109.56 1,406,611 105.76

1997 773,048 111.22 734,275 115.63 1,507,323 113.33

1998 742,599 106.84 682,969 107.55 1,425,568 107.18

1999 726,723 104.56 734,689 115.69 1,461,412 109.88

2000 729 864 105 01 695 938 109 59 1 42 5802 107 20


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MIRPUR MATHELO-UREA PRODUCTION (MET TONS/YEAR)

Base Unit Expansion Unit Total

Years Production

Capacity

Factor (%

Design)

Production

Capacity

Factor (%

Design)

Production Capacity Factor

(% Design)

2002 59,886* 102.91 - - 590,886 102.91

* FFC acquired 100% management control of PSFL-Mirpur Mathelo

effective from July 1,2002

Source: http://www.ffc.com.pk/contents/manfacturing.htm

VAST DISTRIBUTION NETWORKS AN IMPORTANT PLUS POINT

FFC being the current market leader in urea, has the most stretched out distribution network. The

company has its outreach in all four provinces with market leadership in Punjab, Baluchistan and

NWFP provinces, whereas the company’s prime competitor Engro only has a strong hold in Sindh

region. FFC also markets FFBL’s products through its distribution setup. The company charges

commission for marketing these products. This ensures that FFBL is able to cost efficiently and


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GAS CURTAILMENT MORE THAN OFFSET BY PRICE HIKE

FFC and Engro have more than offset the negative impact of lost production by raising urea pricesby PKR 75/50kg bag. The price increase was calculated on the assumption of 12% gas curtailment

on Mari field based plants whereas the actual curtailment during 1h2010 has been only 4-5%. Mari

field based fertilizers plants have witnessed margin increased during 2q2010 due to lesser than

expected gas curtailment.

MULLING PURCHASE OF AGRITECH LTD

FFC is reportedly contemplating bidding for Agritech Ltd (AGL) and its 100% owned subsidiary

Hazara Phosphate Fertilizers (HPFL), as Azgard Nine Ltd, the majority shareholder of Agritech, has

decided to completely divest its 80% equity stake in the company. Agritech currently has the

capacity to produce 0.38mn tons of urea and 0.1mn tons of single super phosphate (SSP) per

annum. The company plans to increase urea capacity to approx 0.46mn tons / annum through BMR

in Cy10.

While the details on the proposed transaction are not yet available, simplistic calculation indicates

that FFC can easily fund its acquisition through leverage due to company’s low current leverage.

Assuming acquisition price is equal to prevailing market price of approximately PKR 23/share, FFC

would require approx PKR 9bn to purchase 100% equity of the target company. Given that cash and

liquid investments amounted to PKR 3.8bn as at Mar 31, 2010, out of which payment of ~PKR 2.7bn

would have been made for the 1qCy10 dividend, FFC would be left with PKR 1.1bn in

cash/investments. Assuming this as minimum cash balance required for working capital needs, it is

likely that the company takes on PKR 9bn (100%) worth of debt to fund the acquisition.


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FIGURE 6: FREE CASH FLOW TO EQUITY

BENEFITS FROM ENGRO’S COST INCREASE AND MARGIN PUSH

To mitigate its rising expansion costs, stemming from depreciating Rupee and higher financialcharges, Engro has been pushing for increase in urea selling prices. This as a result has directly

benefited FFC, as the company has followed Engro’s price hikes. The above has resulted in margin


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FIGURE 7: FAUJI FERTILIZER MANAGEMENT COMPENSATION


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FIGURE 9: FAUJI FERTILIZER BIN QASIM MANAGEMENT COMPENSATION

SOCIAL RESPONSIBILITY

FFC CSR

For Fauji Fertilizer Company Limited, social responsibility means facilitating communities andempowering its people. Sustainability shall always remain quintessential for the performance of

CSR. Historically, FFC has always been socially a responsible corporate entity. The Company

t t d it CSR l i 1982 b i t d i A i S i th h l i i t


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In districts Rahim Yar Khan and Ghotki, flood had crippled the lives of people of the area.

FFC thus took the task of shouldering its share of responsibility initially in flood relief effort

for the affected natives of District Rahim Yar Khan and Ghotki. Some of these relief effortswere:

Distribution of cooked food

Dry ration for families

Transport for Evacuation

Mineral & FFC filtered Drinking Water

Tents/ shelters

Cloths, Blankets & Shoes for the affected families

Soap & Washing Powder

Crockery

FFC employees voluntarily made remarkable contribution in their respective plant sites

which amounts to millions. Food, drinking water, beddings, shelters and clothing was

provided to the flood affectees in the relief phase of the operation. Medical teams from

FFC medical units performed day night service for the flood affectees in Rahim Yar Khan

and Ghotki, saving many precious lives.

REHABILITATION

FFC h t k th h ll f t ti 3 ill f di t i t R hi Y Kh d


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FATIMA FERTILIZER WELFARE HOSPITAL (FFWH)

Fatima Fertilizer Welfare Hospital (FFWH) is a key project of Company's vision towards community welfare.

The Company, under the guidance of Government of Punjab has undertaken to establish a modern welfare

hospital in the vicinity of Plant site, to cater for the needs of underprivileged of the area.

This is the first ever initiative of its kind and magnitude in private sector.

CLEAN DEVELOPMENT MECHANISM

Global warming has become the most important challenge the world is facing in the 21st century. A lot of

research and development is being done for curtailing greenhouse gas emissions. Following its accession to

the Kyoto Protocol of the United Nations Framework Convention on Climate Change (UNFCCC) in January

2005 Pakistan made the Ministry of Environment the Designated National Authority (DNA) for CDM under

the protocol. A CDM cell was created in the Ministry in August 2005.

In order to care for the environment and greenhouse effect, the Management has installed a Clean

Development Mechanism (CDM) Project on its Nitric Acid plant.

It is expected that about 1.3 million CER's per annum will accrue from the start of the project up to 2020.

Mitsubishi Corporation has assisted in implementation of the project and is now in the process of

registration of Fatima Fertilizer's CDM Project with the United Nations.

UHDE has provided the technology and equipment and also helping with the implementation of CDM for

Fatima Fertilizer.

MARKET RISK AND RETURN


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FIGURE 10

In general, none of the three firms did better than the market. These results w e r e expected for all

three as due to severe economic crises fertilizer sector facing as a whole.

To analyze the market risk of the three firms we regressed their returns against broad based

market index and used the coefficient of the regression as a measure of market risk. We us ed t w o

year daily returns for t h e r e g r e s s i o n . The choice of index reflected the marginal investor in each

company, assuming that each investor is exposed to the same market risks in their respective

-60.00%

-40.00%

-20.00%

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

3 - J a n - 1 2

3 - F e b - 1 2

3 - M a r - 1 2

3 - A p r - 1 2

3 - M a y - 1 2

3 - J u n - 1 2

3 - J u l - 1 2

3 - A u g - 1 2

3 - S e p - 1 2

3 - O c t - 1 2

3 - N o v - 1 2

3 - D e c - 1 2

3 - J a n - 1 3

3 - F e b - 1 3

3 - M a r - 1 3

3 - A p r - 1 3

3 - M a y - 1 3

3 - J u n - 1 3

3 - J u l - 1 3

3 - A u g - 1 3

3 - S e p - 1 3

3 - O c t - 1 3

3 - N o v - 1 3

3 - D e c - 1 3

Fatima

FFC

FFBL

KSE


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SLOPE OF THE REGRESSION – BETA

The coefficients of the individual regressions are the companies’ betas and are used as a

measure of the company exposure to market risk. The analysis indicates that FFBL is the company

with highest exposure to market risk (regression beta of 0.83). This is a reflection of high

indebtedness and negative and volatile earnings. FFC on the other hand have regression beta

much lower than the other two companies in the industry. The reasons behind the different risk

profiles of each firm will be examined in greater details further in the report.

R - SQUARED

R-squared of the regression provides information as to what proportion of the variability inreturns could be explained by the regression. The market non-diversifiable risk represents 17.54%,

4.044 % and 19.37% for Fatima, FFC, and FFBL respectively. The remainder is company specific,

non-diversifiable risk. While the relatively high R-squared for Fatima and FFBL could be explained

by the fact that they were small, fast growing companies during the observed period and were

facing numerous company specific challenges in establishing their business models.


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• Market risk premium (Rp)- this measure reflects the excess return to which an investor is

entitled as a compensation for the higher risk he / she undertakes by investing in risky security rather

than a riskless one

Beta – as computed above.

The cost of equity, for all companies, is defined as:

Ke = Rf + β x Rp


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The cost of equity computation is summarized in Figure below

FIGURE 12: CALCULATION OF COST OF EQUITY

Cost of Equity Fatima Fertilizer Fauji Fertilizer FFBL

Risk Free Rate 12.8% 12.8% 12.8%

Beta 0.72 0.55 0.83

Risk Premium 7% 7% 7%

Country Risk - - -

Cost of Equity 17.86 % 16.63% 18.63%

COST OF DEBT

The other important component of the cost of capital is the cost of debt. It reflects the

perceived risk of the companies by lenders and debt investors, or its credit risk. The two

components of credit risk are default risk (or the probability that a company will cease making

payments as agreed in the credit agreement) and non-recovery risk (or the probability of

recovery of the capital provided, once the company goes in default).

The cost of debt for each company has two components – a risk free rate of return and

compensation for the credit risk associated with the company. In estimating the credit risk for

h t k h


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After computing the cost of debt for each firm we computed the after tax cost of debt. The after tax cost of

debt reflects the fact that interest payable on debt is deductible from the operating income for tax purposes

and results in tax savings for the firms.


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COST OF CAPITAL

M A RK E T V A L U E O F E Q U I T Y

The market value of equity for each firm has been estimated by multiplying the

number of shares outstanding for each company by the current share price. The market values of

equity are presented in Figure below

Figure 20 Market values of equity place from excel file

Value of Equity (million) American Airlines BAA

Fatima FFC FFBL

Market Value of Equity (million) 67,200 143,762 37,364

D E B T A N D E Q U I T Y R A T I O S


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FIGURE 15: CALCULATION OF COST OF CAPITAL

The company with highest cost of capital is Fauji Fertilizer. The lowest cost of capital,

is that of F a u j i F e r t i l i z e r B i n Q a s i m .

The ability of each firm to grow and create value for its stockholders ultimately

depends on its management capability to identify and undertake projects that generate

returns exceeding the cost of capital employed. In this section we will analyze the quality of

the projects that the three companies undertake ad review the past performance of the

companies as measured by indicators such as Return on Capital (ROC) and Return on Equity(ROE).


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FIGURE 16: ROC & ROE

FUTURE OUTLOOK

The ability of any of the companies to generate positive excess returns depends on itscompetitive advantages and their sustainability in the medium and long term. In this section welook at some key indicators for the Fertilizer sector, which could help us to understand how thecompanies are positioned for the future.


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FAUJI FERTILIZER FATIMA FERTILIZER FFC BIN QASIM


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C O N C L U S I O N S

In conclusion, we believe that in the medium term FFC and FFBL can sustain competitive

advantages which will allow the company to earn return on capital in excess of its cost of capital.

Fatima Fertilizer in the other hand has been keen to invest in expansion programs aimed to

increase its capacity.


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CURRENT FINANCING MIX

Summary of the current debt structure of all three companies has been given below. As can be

observed, the three companies employ very different kinds of debt:

FFBL

FFC has outstanding a variety of debt notes, from bank debt. On one hand this is driven by the

necessity to tailor the debt to match the company’s cash flow profile and risk, which is very

specific. On the other hand this is a symptom of the financial difficulties the company has been

going through and the need to raise capital in any form it was available.

FATIMA

fatima also has debt outstanding and this is a reflection of both the early stage of the life cycle is in and

its ability to generate cash flows, thus funding growth largely with internal funds. we expect the financing

mix to change as the company continues to expand.

FFBL


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Fatima Fauji Fertilizer Fauji Fertilizer Bin Qasim

FIGURE 17

Based on the above analysis, we draw the following conclusions:

FFC and FFBL have the ability to carry higher debt ratios given the relative stability of their cash

flow profile compared to Fatima. Whereas Fatima’s debt ratio is at the correct level. FFBL’s debt


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FIGURE 18

COST OF CAPITAL AT D IFFERENT FINANCING MIXES

As the next step in our analysis to estimate the optimal capital structure we used the

cost of capital approach to compute a different WACC at each debt ratio for our companies. The

table below summarizes the result.


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QUANTITATIVE ANALYSIS

CURRENT DIVIDEND POLICY

All three companies that we are analyzing, all of them pay dividends:

FFC has kept a stable dividend policy over the past several years, with an average

dividend payout ratio of 90%.

FIGURE 20


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FATIMA FERTILIZER

The company generates and still have a dividend payout ratio of 65%. the company‘s

ROC is higher than its cost of capital and it is rapidly accumulating excess cash.

FIGURE 21

FFC BIN QASIM

The company pays out almost all of its profit in dividends.

VALUATION MODELS


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The choice of growth period reflects the sustainability of competitive advantages of each

firm as outlined in above – Investment Returns and Future prospects.

VALUATION MODEL AND INPUTS.

The valuation assumptions are.

Sales growth is only due to increase in prices due to inflation. Terminal Growth is minimal for all three

firms. Firm will refinance its existing loan at the same cost of financing.

FATIMA FERTILIZER:

FIGURE 23


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FIGURE 25

FAUJI FERTILIZER LIMITED

FIGURE 26


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FAUJI FERTILIZER BIN QASIM

FIGURE 28

FIGURE 29


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APPENDIX

FATIMA FERTILIZER BALANCE SHEET

FIGURE 30


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FIGURE 31


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FATIMA FERTILIZER INCOME STATEMENT

FIGURE 32


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FAUJI FERTILIZER BIN QASIM LIMITED BALANCE SHEET

FIGURE 33


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FIGURE 34


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FAUJI FERTILIZER BIN QASIM PROFIT & LOSS ACCOUNT

FIGURE 35


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FAUJI FERTILIZER COMPANY BALANCE SHEET

FIGURE 36


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FIGURE 37


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FAUJI FERTILIZER PROFIT & LOSS ACCOUNT

FIGURE 38

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