Initiation Report Role reversal in the sector; EFERT our ... reversal in...America project, so it...
Transcript of Initiation Report Role reversal in the sector; EFERT our ... reversal in...America project, so it...
Pakistan Fertilizers
Initiation Report Sep 4th, 2015
Recommendation Engro Fertilizer (EFERT PA) BUY
Fauji Fertilizer (FFC PA) NEUTRAL
Fatima Fertilizer (FATIMA PA) NEUTRAL
Fauji Fertilizer Bin Qasim (FFBL PA) U/P
Companies Featured EFERT BUY
2014A 2015E 2016E
Net sales 61 96 81 GP 27 38 34 GP margin 44% 40% 41% EBITDA 23 33 30 EBITDA margin 38% 34% 37% PBT 12 25 23 PAT 8 17 16 Net margin 13% 18% 19% EPS 6.23 13.18 11.89 DPS 3.00 9.00 8.00 P/E 15.93 7.53 8.34 Div yield 3.0% 9.1% 8.1%
FFC NEUTRAL
2014A 2015E 2016E
Net sales 81 90 94 GP 33 35 35 GP margin 40% 39% 37% EBITDA 29 31 30 EBITDA margin 36% 35% 32% PBT 26 29 28 PAT 18 19 20 Net margin 22% 21% 21% EPS 14.28 15.15 15.70 DPS 13.65 15.00 15.00 P/E 9.49 8.94 8.63 Div yield 10.1% 11.1% 11.1%
FATIMA NEUTRAL
2014A 2015E 2016E
Net sales 36 40 46 GP 23 25 29 GP margin 63% 61% 62% EBITDA 20 21 25 EBITDA margin 54% 52% 54% PBT 14 17 21 PAT 9 12 14 Net margin 26% 30% 31% EPS 4.41 5.68 6.72 DPS 2.75 3.00 3.25 P/E 11.50 8.92 7.54 Div yield 5.4% 5.9% 6.4%
FFBL UNDERPERFORM
2014A 2015E 2016E
Net sales 49 54 57 GP 12 13 14 GP margin 25% 25% 24% EBITDA 8 9 9 EBITDA margin 17% 16% 16% PBT 6 6 7 PAT 4 4 5 Net margin 8% 8% 8% EPS 4.30 4.55 5.00 DPS 4.25 4.25 4.75 P/E 14.99 14.17 12.88 Div yield 6.6% 6.6% 7.4%
Ameet Doulat +92-21-111-639-825 Ext: 109 [email protected]
Role reversal in the sector; EFERT our top pick
Initiation- In light of the long anticipated gas tariff hike and the subsequent urea price increase, we initiate our
coverage on the Pakistani Fertilizer sector. We are selectively positive on the sector, with a Buy rating on EFERT (TP
of PKR127) as our top pick. We have a Neutral rating on both FFC (TP of PKR 136) and FATIMA (TP of PKR57).
Although FFC offers limited potential for capital gains, it still remains attractive as a yield play. FATIMA does offer
strong earnings growth, but positives are largely priced in, given the 51% CYTD rally. On FFBL (TP of PKR55), we
have an Underperform stance, with concerns over DAP margins and optimism over the consumer division being
overplayed, in our opinion.
Investment Case- The recent urea price hike on the back of a 23%/62% increase in the feedstock/fuel stock gas
prices highlights the changing dynamics of the Pakistan Fertilizer sector. We see a role reversal as compared to
2010; FFC defending its margins is now benefiting EFERT and FATIMA due to the concessionary gas pricing both
companies enjoy.
We like EFERT due to (1) margin accretion post urea price hike; (2) sharp deleveraging; and (3) concessionary gas
rate shielding the company from sector headwinds; we highlight EFERT as our top pick in the sector, with a 3-yr
earnings CAGR of 26%. Moreover, given plans of its holding company (Engro Corp) to increase its footprint in
Pakistan’s energy sector and lack of significant re-investment opportunities in the fertilizer space, we expect EFERT
to post strong payouts, going forward, thus providing an attractive dividend yield. CY17 dividend yield is 11%, at
par with FFC, whereas the company’s margins remains relatively shielded from further gas prices increases.
Importantly, our valuation on EFERT is fairly conservative; we have assumed single plant operations from CY16
onwards. Availability of Guddu or any other source of gas can provide considerable upside to our valuations.
FFC surprised the market by completely passing on the gas price hike, as most expected a complete pass through
would be difficult. Although earnings growth still remains a challenge for the company, FFC’s 11% dividend yield
looks attractive in the current interest rate scenario. We believe investors will keep FFC in their portfolios for the
dividend yield alone, despite limited potential for capital gains. We believe that market’s assessment of FFC’s
prospects will improve with this urea price hike, as most had not expected a complete pass though of gas price
hike. Thus, expectations will shift from a declining earnings trajectory to a stable one.
FATIMA is expected to post strong earnings growth (3- year CAGR of 17%) due to (1) concessionary gas pricing in a
rising urea price scenario; and (2) first debottlenecking project. With the stock price up by 51% in CY15TD, much of
the positives have already been priced in. Payout ratio is expected to remain lower than peers, due to the North
America project, so it would remain less of a yield play than EFERT and FFC. The stock offers a 13% upside to our
target price, and a CY16 dividend yield of 6.5%.
We have an underperform stance on FFBL, with DAP margins under pressure due to the recent gas price hike and
overplayed optimism on the consumer businesses, in our opinion. The stock has rallied considerably (+51% in
CYTD), and should correct.
Catalysts- The concessionary plants of EFERT and FATIMA put them in a sweet spot post the higher than expected
urea price increase of PKR155-160/bag. Margin accretion along with sharp deleveraging by the company is
expected to boost profitability.
Risks- Reversal of urea price increases due to increased government pressure, imposition of GIDC on new fertilizer
plants and delay in the ammonia debottlenecking for FATIMA are key risks to our valuation.
Upside risks to Valuation- While we are selectively bullish on Pakistan Fertilizers, upside risks to our valuations
include:
(1) Continuation of Guddu gas or approval of any other source for EFERT to ensure second plant operation;
(2) Int’l operations, reduction in gas curtailment and CAN/NP capacity expansions to complement debottlenecking
for FATIMA; and
(3) Consumer business contribution to bottom-line coming in earlier than expected for FFBL.
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Industry Outlook –
Margin accretion for EFERT…
Post the gas price hike of 23-62%, FFC has surprised the market by increasing urea prices by PKR155-160/bag to
PKR1994/bag, effective immediately. Based on this hike, it seems both the current gas price increase and partial
increase in GIDC imposed in 2014, which was not completely passed on, has been passed on this time around.
EFERT has also followed suit, and raised prices. Interestingly, the current scenario is similar to 2010-11 price
increase scenario playing in reverse; EFERT, given their huge debt levels and lack of gas supplies had initiated a
massive price increase; and FFC and FATIMA enjoyed significant margin accretion; FFC gross margin increased by
18% YoY in 2011. This time around, with FFC increasing urea prices by PKR155-160/bag, EFERT along with
FATIMA’s margins and profitability are expected to improve.
Figure 1–During 2011, EFERT initiated a massive price increase due to gas shortages…
Figure 2 – …resulting in significant margin accretion for FFC
Figure 3 – EFERT will now enjoy the same benefit in 2016 from FFC’s price hike
Source: Next Research Source: Next Research
Urea price hike results in earnings upgrade for EFERT, FATIMA, and FFC
FFC: Post this increase, FFC’s earnings are expected to clock in at PKR15.7/sh for 2016, 2.6% higher than old
estimates. FFC required a PKR137/bag increase in the urea prices to completely pass on the impact of the recent
gas price hike.
FFBL’s reliance on DAP makes it highly vulnerable to the gas price hike and despite a PKR155-160/bag increase
in urea prices, our revised earnings estimates for FFBL suggest a 9% dip in its 2016 earnings. FFBL will face
difficulty in passing on the DAP cost hike amid shrinking discount between international and domestic DAP.
EFERT is expected to witness a 9.7% increase in 2016 earnings estimates as a result of PKR155-160/bag
increase in urea prices. However, if the Guddu gas continues to flow in during 2016, EFERT’s earnings are expected
to witness a 13% increase due to this urea price hike, with EPS to clock in at PKR15.18/sh.
Likewise, FATIMA’s concessionary gas rate agreements provide it protection from the feedstock price increase.
This, this PKR155-160/bag increase in urea prices will result in a 6.2% increase from our old estimates for FATIMA
for 2016. Recall, with CAN prices also linked to urea prices, CAN prices are also expected to increase by
PKR135/bag and with FATIMA only facing a cost increase of PKR35/bag, margins of the company are expected to
rise. With the first phase of debottlenecking expected to come online by 4Q15 provides further impetus to
earnings.
Source: Next Research
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EFERT initated a price increase during the period, others followed
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FFC FFBL EFERT
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FFBL
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Figure 4- Revised earnings estimates incorporating gas and urea price hike
Source: Next Research
Old EPS
Revised
EPS %
FFC 15.3 15.7 2.6%
FFBL 5.50 5.00 -9.1%
EFERT-ex Guddu 10.84 11.89 9.7%
EFERT-Guddu 13.44 15.18 12.9%
FATIMA 6.33 6.72 6.2%
CY16E EPS
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Figure 5- EFERT’s gas mix
Source: Next Research
Figure 7- EFERT to match FFC’s D/Y by CY17
Source: Next Research
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Gas Mix[MMCFD]
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SNGPL-Novated
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2015 2016 2017 2018
EFERT FFC FATIMA FFBL
EFERT: In pole position to capitalize
Top pick in the sector; Initiate with TP of PKR 127
We initiate coverage on Engro Fertilizer Ltd (EFERT) with a Dec-16 TP of PKR127/sh, offering an upside of
28% from current levels. We expect EFERT to witness a 3yr earnings CAGR of 26% through 2014-17E owing to
(1) concessionary gas rate making up for the decline in production post 2015; (2) price increases of
PKR155/bag magnifying margin accretion during 2016; and (3) strong EBITDA generation resulting in sharp
deleveraging;. EFERT currently trades at a 2016E P/E of 8.34x v its immediate competitor FFC’s 8.62x.
Urea price hike in concessionary gas rate to boost margins
In the latest development, FFC’s initiative to increase urea prices to PKR1994/bag will result in EFERT’s urea
gross margins (cash basis) to clock in at 66.3% during CY16, from 57% previously. Thus, EFERT is best placed
to benefit from this price increase. EFERT’s concessionary gas rate agreement for the Enven plant shields it
from feedstock gas price increases to a large extent. This margin accretion is despite our conservative
assumption that EFERT will operate only a single plant at concessionary rates post Dec-15. Availability of
Gudu gas post Dec-15 will be an upside risk to margins and earnings.
Figure 6 –Urea price hike is expected to result in strong gross margin growth for EFERT
Source: Next Research
Strong EBITDA to enable deleveraging; payout ratio to increase to 90% by CY17
We expect EFEERT to post an average annual EBITDA of PKR31bn through CY15-18E which is expected to
trigger the company’s sharp deleveraging plans. As of 30th June 2015, the company’s debt level was PKR
40bn, which we expect will fall to PKR 11.5bn by end of CY17. As of 1HCY15, the company stands at a D/A
level of 37%, we project it to reduce further to 27% by 2015E. As a result of this sharp deleveraging, the
company’s financial charges are expected to drop by 23% annually through 2015-18E, boosting the bottom-
line.
Furthermore, reduction in debt levels is being achieved with substantial dividend payments, and once debt
levels reduce by CY17, we expect EFERT to comfortably be able to increase its payout ratio to 90%. Moreover,
we expect payouts to continue increasing as the company pays off its debt, as 1) dividends would help its
holding company’s (Engro Corp) plans to expand in the power business, and 2) there is very limited
opportunity for meaningful expansion in the fertilizer business in Pakistan. By CY17, we expect the payout
ratio to rise to 90%, resulting in a dividend yield of 11%, at par with what FFC offers.
Figure 8–EFERT’s financial position has dramatically improved.
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2014 2015E 2016E 2017E 2018E
2014 2015 2016 2017
EBITDA (PKR bn) 23.2 33.0 30.0 30.2
Principal repayment (PKR bn) 16.3 13.1 14.5 4.8
Financial charges (PKR bn) 6.6 4.4 3.3 2.5
Depreciation (after tax) /share 2.34 1.66 1.70 1.74
Capex per share 0.28 0.05 0.56 0.52
Dividends (PKR bn) 4.0 11.9 10.5 14.5
Payout ratio 48% 68% 67% 87% Source: Next Research
Given that Dep/sh is in excess of capex/sh, the firm can even increase its payout ratio above 100%, if required.
4
Figure 11- EPS sensitivity to Guddu gas
2016 EPS
EFERT-ex Guddu 11.89
EFERT- Guddu 15.18
28% Source: Next Research
Figure 9 –Strong EBITDA levels to support deleveraging theme…
Extension of Guddu gas; an upside risk
Our sensitivity analysis suggests that CY16 earnings of EFERT are expected to witness a hefty 28% jump (EPS
of PKR 15.18/sh) from current estimates if Guddu gas continues for CY16. Consequently, EFERT trades at a
P/E of 6.52x, a massive 25% discount to its immediate peer, FFC. Moreover, it would also offer a highly
attractive D/Y of 11% in such a case.
Valuations
Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR127/sh for EFERT. Key assumptions in
our valuation method include (1) cost of equity of 15%; (2) debt free status attained by 2019 which increases
our WACC of 14.8% to 15%; and (3) risk free rate of 9%.
Figure 12 –DCF Valuation summary
1HCY15 review: Impact of one-offs nullified
EFERT posted PAT of PKR3.8bn (EPS: 2.85) in 2Q15, up 96% YoY, taking 1H15 earnings to PKR6.9bn (EPS:
PKR5.15). Despite the concessionary gas rate clocking in for the entire 2Q, lower-than-expected gross
margins (cash basis) clocked in at 41%. This was largely due to (1) one-off expense of PKR925mn (pre-tax)
against asset classification of compressors installed with Guddu; and (2) low-margin DAP sales. Had the one-
off asset reclassification not happened, cash margins would have been 44%. Sharp deleveraging and lower
interest rates resulted in 31% YoY dip in the financial charges, thus boosting the bottom-line. On the taxation
front, one-offs came in the form of (1) reduction in tax rates in Finance Bill 2015 which resulted in Deferred
tax liability revaluation or PKR1.17bn; (2) super tax worth PKR357mn; (3) tax charge related to IFC stock
options worth PKR548mn; and (4) minimum tax due to better profitability worth PKR341mn. Consequently,
effective tax rate clocked in at 20%. EFERT is still to book PKR1bn of tax losses from the EXIMP division, this
can be a upside risk to earnings in the coming periods. The company also declared its first ever interim
dividend of PKR1.5/sh. Incorporating the one-offs during 2QCY15, we expect the company to post net
earnings of PKR17.4bn (EPS: PKR13.18) during 2015. Increased urea prices of PKR1994/bag effective Sep-
15 along with strong production levels are expected to boost profitability levels.
Figure 10 – …ensuring debt free status by 2019
Source: Next Research
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Source: Next Research
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PKR Mn Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Dec-23 Dec-24
FCFF
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WACC
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Discounted Cash flows
20,744 18,859 15,822 13,917 12,017 10,653 8,629 7,574 5,180
NPV of cash flows till 2024 113,395 NPV of Terminal Value 44,466
Enterprise Value 157,861 Less: Net Debt (10,807) Equity Value 168,669 No. Shares (millions) 1,331 Per Share Equity Value 127.00
5
Figure 13- EFERT Financial statements (PKR mn)
Profit and Loss statement 2014 2015E 2016E 2017E
Net Revenue 61,425 95,630 81,413 84,745
Cost of sales 34,140 57,387 47,793 50,909
Gross prof it 27,285 38,243 33,619 33,836
Admin & Selling Exp. 5,171 5,705 4,416 4,743
EBITDA 23,246 32,960 30,009 30,153
Dep & Amortization 4,725 3,299 3,331 3,354
EBIT 18,520 29,661 26,678 26,799
Financial Charges 6,625 4,363 3,344 2,469
Other income 2,449 2,045 2,375 2,636
Other charges 1,318 1,622 1,570 1,576
Profit before Tax 11,895 25,298 23,334 24,331
Taxation 3,687 7,927 7,663 7,744
Net Prof it after Tax. 8,208 17,371 15,671 16,587
EPS 6.17 13.05 11.77 12.46
DPS 3.00 9.00 8.00 11.00
Balance Sheet 2014 2015E 2016E 2017E
Long term Assets
Non-Current Assets 74,099 71,231 68,640 65,976
Total Non-Current Assets 75,175 71,944 69,352 66,688
Current Assets
Total inventory 1,101 1,851 1,541 1,642
Trade Debt 757 1,179 1,003 1,044
Other current asset 30,250 20,537 18,226 23,423
Cash and bank bal & Short term Investments 4,189 20,039 14,676 14,629
Total Current Assets 36,297 43,605 35,447 40,738
Total Assets 111,472 115,548 104,799 107,426
SHARE CAPITAL AND RESERVES
Share capital 13,183 13,183 13,183 13,183
Reserves 21,295 34,711 38,517 44,557
Total Equity 34,478 47,894 51,700 57,740
NON-CURRENT LIABILITIES
Long Term Debt 0 0 0 0
Other non current liabilities 5,347 5,839 5,840 5,841
Total Non current Liabilities 41,437 21,708 16,935 12,819
CURRENT LIABILITIES
Short term Debt 7,913 14,539 4,774 4,116
Trade Payables 24,472 28,693 28,676 30,036
Other Current Liabilities 3,171 2,713 2,713 2,714
Total Current Liabilities 35,556 45,945 36,164 36,866
Total Liabilities 76,994 67,654 53,098 49,686
Cash Flow Statement 2014 2015E 2016E 2017E
PAT 8,208 17,371 15,671 16,587
Working Capital 2,688 278 1,022 663
Cashflow from Operating Actitivities 19,063 22,906 19,280 20,962
Cashflow from investing Actitivities (22,604) 10,001 1,762 (5,688)
Fixed Capital Expenditures (373) (68) (739) (689)
Cashflow from Financing Activities (13,692) (17,057) (26,404) (15,321)
Dividend Paid 0 (3,955) (11,865) (10,547)
Debt repayments (16,342) (13,102) (14,539) (4,774)
Net decrease/increase in cash &equivalents (17,233) 15,850 (5,362) (47)
cash and cash equivalents at beginning 22,516 4,189 20,039 14,676
Cash & Cash equivalents at end of year 5,283 20,039 14,676 14,629
6
Figure 14- FFC SoTP valuation
EV
Holding (%)
FFC share
FFC-core 157,286 100.0% 123.7
FFBL 60,184 49.9% 23.6
AKBL 29,824 43% 10.1
FCCL 47,863 7% 2.6
FFC energy 4,937 50% 1.9
Total
162
Less: standalone debt
(0.87)
SoTP value (pre-discount) 161.0
SoTP value (post 30% discount) 149.5 Source: Next Research
FFC: Earnings outlook stable after urea price hike
Earnings outlook improves from negative to stable
We initiate coverage on Fauji Fertilizer Ltd (FFC) with a Neutral rating and a Dec-16 TP of PKR136/sh.
Previously FFC’s earnings were expected to dip as complete pass of higher gas prices was deemed unlikely.
However, having recently completely passed on the gas price to maintain margins, the earnings outlook is
now expected to be more stable, even though growth remains a challenge. The stock is expected to witness a
relief rally with the company managing to initiate a price hike of PKR155-160/bag, substantially above
consensus estimates. Our TP of PKR136/sh is derived through DCF valuation. Moreover, our SOTP valuation
analysis suggests a target price of PKR149.5/sh, post 30% conglomerate discount on the portfolio holdings.
FFC currently trades at CY16E P/E of 8.62x and offers a dividend yield of 11%.
Growth remains challenging…
In our view, FFC’s profitability shall remain largely subdued, with a 3 year EPS CAGR of 3.4%. Dividend
income from FFBL is likely to fall, resulting in other income decline of 5% annually through 2015-21E. We
expect FFC to post an EPS of PKR 15.2 in CY15, and PKR 15.7 in CY16.
…but dividend yield attractive in the current interest rate scenario
FFC currently offers a dividend yield of 11%, the highest in the fertilizer universe, and amongst the highest at
the KSE. Given that T-bill rates are hovering around 7%, we believe that some investors would find the yield
attractive, despite the limited potential for capital gains. The spread between FFC’s dividend yield and bond
yields currently stands at a healthy 3.7% vs 3-yr average of 3.5% and is expected to remain in this level in the
near future.
Figure 15 –Spread between FFC’s D/Y and bond yield is at a comfortable level of 3.7% vs 3 year average of 3.5%
Source: Bloomberg, Next Research
Valuations
Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR136/sh for FFC. Key assumptions in
our valuation method include (1) cost of equity of 15%; and (2) risk free rate of 9%.
Figure 16 –DCF Valuation Summary
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FCFF
19,332 19,251 17,452 17,537 18,082 17,194
WACC 14.5% 14.6% 14.6% 14.6% 14.6% 14.6%
Discounted Cash flows
19,332 16,801 13,291 11,655 10,483 8,699
NPV of cash flows upto 2021 80,261 NPV of Terminal Value 81,175 Enterprise Value 161,435 Less: Net Debt (11,608) Equity Value 173,043 No. Shares (millions) 1,272 Per Share Equity Value 136.00
7
Figure 17- FFC- Financial Statements (PKR mn)
Profit and loss 2014 2015E 2016E 2017E
Net Revenue 81,240 89,842 94,467 95,782
Cost of sales 48,420 55,196 59,733 61,439
Gross prof it 32,821 34,646 34,734 34,343
Admin & Selling Exp. 6,346 7,018 7,379 7,482
EBITDA 28,892 31,433 30,392 30,071
Dep & Amortization 1,803 1,811 1,906 2,004
EBIT 27,090 29,622 28,486 28,068
Financial Charges 849 734 169 51
Other income 4,721 6,154 5,363 5,494
Other charges 2,303 2,348 2,325 2,283
Profit before Tax 26,241 28,888 28,317 28,017
Taxation 8,070 9,608 8,349 7,960
Net Prof it after Tax. 18,171 19,280 19,968 20,058
EPS 14.28 15.15 15.70 15.77
DPS 13.65 15.00 15.00 15.00
Balance Sheet 2014 2015E 2016E 2017E
Non-Current Assets 20,094 22,216 22,716 23,165
Total Non-Current Assets 50,678 52,976 53,566 54,115
Current Assets
Total inventory 4,297 4,311 4,289 4,380
Trade Debt 822 738 776 787
Other current asset 29,590 13,886 12,509 10,044
Cash and bank bal & Short term Investments 1,174 2,609 2,698 4,115
Total Current Assets 35,883 21,544 20,272 19,326
Total Assets 86,562 74,520 73,839 73,441
SHARE CAPITAL AND RESERVES
Share capital 12,722 12,722 12,722 12,722
Reserves 12,947 14,415 15,300 16,274
Surplus 0 0 0 0
Total Equity 25,670 27,138 28,023 28,997
NON-CURRENT LIABILITIES
Long Term Debt 2,500 1,150 375 0
Other non current liabilities 4,574 4,574 4,574 4,574
Total Non current Liabilities 7,074 5,724 4,949 4,574
CURRENT LIABILITIES
Short term Debt 13,382 1,351 726 1
Trade Payables 37,935 37,806 37,640 37,369
Other Current Liabilities 2,501 2,501 2,501 2,501
Total Current Liabilities 53,818 41,658 40,867 39,871
Total Liabilities 60,892 47,382 45,816 44,445
Cash Flow Statement 2014 2015E 2016E 2017E
PAT 20,135 18,171 19,280 19,968
Working Capital 14,318 (755) (508) (515)
Cashflow from Operating Actitivities 33,774 20,804 21,569 21,653
Cashflow from investing Actitivities (19,452) 11,824 (996) (52)
Fixed Capital Expenditures (3,452) (3,933) (2,406) (2,453)
Cashflow from Financing Activities (14,860) (31,193) (20,484) (20,184)
Dividend Paid (18,002) (17,811) (19,084) (19,084)
Debt repayments 3,142 (13,381) (1,400) (1,100)
Net decrease/increase in cash & equivalents (538) 1,435 89 1,417
cash and cash equivalents at beginning 1,362 1,174 2,609 2,698
Cash & Cash equivalents at end of year 1,174 2,609 2,698 4,115
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Figure 18- CAN trades at a discount to Urea
Source: NFDC Figure 19- NP trades at a discount to DAP
Source:NFDC
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Se
p-1
4
Ap
r-1
5
NP DAP
FATIMA: Positives largely priced-in Strong earnings growth from de-bottlenecking and urea price hike
We initiate coverage on FATIMA Fertilizer Ltd (FATIMA) with a Dec-16 TP of PKR57/sh and a Neutral rating.
Positives in the form of (1) debottlenecking (DBN) of its ammonia plant; (2) concessionary gas rate resulting
in margin accretion; and (3) aggressive deleveraging; have already been priced in our view. The stock has
witnessed a rally of 51% in CY15TD and currently trades at CY16E P/E of 7.5x. Upside risk to our estimates
include (1) contribution of Int’l operations in the profitability of the company; and (2) increase in capacity
expansions of CAN and NP to complement the second phase of ammonia debottlenecking.
DBN to drive 5 year earnings CAGR of 15%...
The two phases of ammonia debottlenecking (please refer to figure 20) are expected to result in the company
improving its utilization levels. The company has focused on CAN and NP as its prime products; thus their
utilization levels are already very high, however, it has room for production increase in urea. Thus, we expect
urea utilization levels to jump to 80% post Phase I of DBN from 73% currently, and can further increase as
high as 106% post Phase II. Thus, DBN is expected to result in a 5-yr earnings CAGR of 15% through 2014-
18E for the company.
Figure 20- Ammonia Debottlenecking project S
ource: Company accounts
Figure 21 –Expansion in ammonia to be diverted towards Urea production
Source: Next Research
…however, second phase reliant on gas supplies and capacity expansions
FATIMA currently has a gas supply arrangement with MARI to supply 110mmcfd of gas. While the current
curtailment ranges between 9-10%, we expect the company to successfully lower this curtailment to
successfully execute the second phase of debottlenecking. Moreover, while CAN and NP utilization levels are
expected to slightly improve post Phase I, capacity expansions in the two products which are believed to be in
the pipeline will enable FATIMA to divert excess ammonia (post Phase II) to these product lines, ensuring
optimal sales mix and profitability.
Mid-West project to constrain payout
As of Jun-15, FATIMA’s Debt-to-Asset ratio clocked in at 24% vs 29% by CY14. With the company generating
average annual EBITDA of PKR25bn through 2015-21E, we expect de-levering to continue. We have not
incorporated the debt pertaining to the company’s int’l operations which is expected to put some pressure on
the company’s balance sheet. Moreover, payout ratio is likely to remain below peers like FFC and EFERT, as
the project requires equity injection worth US$300-400mn. We have assumed a 50% payout ratio for FATIMA
in CY17.
Debottlenecking Cost Timeline expected
Ammonia capacity gain
New Ammonia capacity (tpd)
First phase US$58mn 2016 7% 1600
Second phase US$80mn 2018 13% 1800
Figure 22- DBN, deleveraging and concessionary rate to result in 15% EPS CAGR
60%
70%
80%
90%
100%
110%
Urea CAN NP
2014E 2015E 2016E
Source: Next Research
8
10
12
14
16
18
20
2015E 2016E 2017 2018 2019
9
Figure 23 –Deleveraging theme to continue; however, intl operations may raise debt levels again
Source: Next Research
Key upside risks
Upside risks to our valuations include:
(1) International operations: FATIMA’s plans of setting up a greenfield fertilizer complex in collaboration
with Midwest Fertilizer in Indiana, United States are in full swing with the plant expected to achieve
financial close this year. With a total cost of US$2.4bn, funding the projects equity participation would
constrain dividend payouts, although the project looks promising from a long-term perspective. The
project completion is expected around 4QCY18.
(2) Capacity expansions in CAN and NP: We expect CAN and NP capacity utilizations to go as high as 106%
through 2015-21E. In order to make the most out of its high-margin product CAN, the management’s
plans of increasing capacities of CAN and NP shall result in significant margin accretion.
Valuations
Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR57/sh for FATIMA. Key assumptions in
our valuation method include (1) cost of equity of 15%; and (2) risk free rate of 9%.
Figure 24 –DCF Valuation Summary
1HCY15 review; earnings increase due to lower tax rate
FATIMA posted PAT of PKR4.4bn (EPS: PKR2.10), up by a hefty 150% YoY in 1HCY15. The result came in
largely above ours and consensus expectations owing to a tax reversal worth PKR1.2bn booked by the
company (EPS impact: PKR0.57). Gross margins came in-line with our expectation at 63%, with one-off GIDC
impact stabilizing in 2Q. Sharp deleveraging by FATIMA reduced financial costs by 42% YoY during the period.
Tax reversal worth PKR1.2bn dragged down the effective tax rate of the company to 4% during the period,
overshadowing the one-off super tax expense. Incorporating the one-offs, we expect FATIMA to post net
earnings of PKR11.9bn (EPS: PKR5.68) during 2015. However, an upside risk to our estimate includes the
successful execution of the first phase of DBN in 4QCY15.
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
2013
2014E
2015E
2016E
2017E
2018E
2019E
Gross debt Interest expense
PKR Mn Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21
FCFF 14,783 14,306 16,688 19,480 19,886 12,970
WACC
13.2% 13.8% 14.3% 14.6% 14.6% 14.6%
Discounted Cash flows
14,783 12,567 12,770 12,960 11,545 6,573
NPV of cash flows upto 2021 71,199 NPV of Terminal Value 68,831
Enterprise Value 140,030 Less: Net Debt 20,797 Equity Value 119,233 No. Shares (millions) 2,100
Per Share Equity Value 57.0
10
Figure 25- FATTIMA- Financial statements (PKR mn)
Profit and loss 2014 2015E 2016E 2017E
Net Revenue 36,169 40,368 46,073 45,910
Cost of sales 13,220 15,654 17,432 18,092
Gross prof it 22,949 24,714 28,641 27,818
Admin & Selling Exp. 2,693 2,871 2,778 2,538
EBITDA 19,505 20,882 24,734 24,261
Dep & Amortization 1,591 1,692 1,736 1,791
EBIT 17,914 19,190 22,998 22,471
Financial Charges 3,767 2,564 2,231 1,035
Other income 624 458 552 624
Other charges 1,374 1,420 1,681 1,643
Profit before Tax 14,147 16,626 20,767 21,436
Taxation 4,891 4,698 6,645 6,645
Net Prof it after Tax. 9,256 11,928 14,122 14,791
EPS 4.41 5.68 6.72 7.04
DPS 3.00 3.25 3.50 4.00
Balance Sheet 2014 2015E 2016E 2017E
Non-Current Assets 68,823 72,630 72,894 73,603
Total Non-Current Assets 68,952 72,760 73,024 73,733
Current Assets
Total inventory 6,771 7,447 8,247 8,092
Trade Debt 448 387 473 472
Other current asset 3,000 2,765 3,156 3,145
Cash and bank bal & Short term Investments 949 3,138 4,806 1,646
Total Current Assets 14,169 16,737 19,682 16,355
Total Assets 83,121 89,496 92,705 90,087
SHARE CAPITAL AND RESERVES
Share capital 21,000 21,000 21,000 21,000
Reserves 15,757 21,910 29,732 37,698
Total Equity 36,757 42,910 50,732 58,698
NON-CURRENT LIABILITIES
Long Term Debt 17,335 11,585 6,910 3,250
Other non current liabilities 14,421 14,421 14,421 14,421
Total Non current Liabilities 31,756 26,006 21,331 17,671
CURRENT LIABILITIES
Short term Debt 6,975 11,850 10,675 3,785
Trade Payables 7,374 8,230 9,467 9,434
Other Current Liabilities 259 500 500 500
Total Current Liabilities 14,608 20,580 20,642 13,719
Total Liabilities 46,364 46,586 41,973 31,390
Cash Flow Statement 2014 2015E 2016E 2017E
PAT 9,256 11,928 14,122 14,791
Working Capital (389) 477 (40) 134
Cashflow from Operating Actitivities 10,458 14,097 15,818 16,716
Cashflow from investing Actitivities 2,213 (5,499) (2,000) (2,500)
Fixed Capital Expenditures (2,827) (5,499) (2,000) (2,500)
Cashflow from Financing Activities (11,953) (6,409) (12,150) (17,375)
Dividend Paid (5,250) (5,775) (6,300) (6,825)
Debt repayments (6,703) (634) (5,850) (10,550)
Net decrease/increase in cash & equivalents 718 2,189 1,668 (3,159)
cash and cash equivalents at beginning 238 949 3,138 4,806
Cash & Cash equivalents at end of year 957 3,138 4,806 1,646
11
Figure 26- FFBL’s consumer business implied value
FFBL holding (PKR bn)
Implied value (PKR/sh)
FFBL Market Cap 60.18 64.43 FFBL core* 40.17 43.00 AKBL** 6.43 6.89 FCCL** 0.65 0.70 FEWL & FPL* 2.80 3.00 NOPK** 1.05 1.12 Sub total 51.11 54.71 FML and FFL-implied 9.08 9.72 Source: Next Research *DCF based valuation **Market price
FFBL: Recent rally unjustified as DAP headwinds loom
Earnings growth priced-in
We initiate coverage on Fauji Fertilizer Bin Qasim Ltd (FFBL) with a Dec-16 TP of PKR55/sh and an
Underperform rating. Margin outlook on FFBL’s fertilizer business is expected to remain under pressure due to
(1) reliance on DAP business and the inability to pass on the gas tariff hike; and (2) rising phosacid prices
amid currency devaluation. In our view, the market has overplayed the consumer business by assigning an
implicit value of PKR9.08bn, whilst we believe it is unlikely to move the needle on profitability for the
foreseeable future. (please refer to figure 26).
Gas price hike to hurt margins
FFBL’s inability to pass on the gas price hike in its DAP business is expected to result in margin attrition for
the company. In order to nullify the impact of the gas price hike, FFBL will have to increase the DAP prices by
PKR81/bag, which seems unlikely in this scenario with international prices trading at US$443/ton.
Consumer business’ impact overplayed
The market has clearly overplayed the impact of the Halal meat business, in our view, by assigning a value of
~PKR9.1bn (against equity project cost of PKR 1.6bn). In our view, given the sensitivity of a stable supply
chain in such a venture, the payback period is expected to be much longer than the market is currently
expecting. Our channel checks suggest that Fauji Meat, which was previously expected to come online in Jul-
15, has now been shifted to 4Q15. Moreover, FFBL’s acquisition of 38.3% stake in Nur Pakistan (NOPK) is
expected to be incorporated in the earnings of the company by CY17. This acquisition was made after Fauji
Foods Ltd’s (FFL) plans to enter the dairy business by setting up a plant were put on hold.
Valuations
Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR55/sh for FFBL. Key assumptions in
our valuation method include (1) cost of equity of 15%; and (2) risk free rate of 9%.
Figure 27–DCF Valuation Summary
PKR Mn Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21
FCFF
7,099 6,856 6,579 6,218 5,920 5,565
WACC
15.4% 15.2% 14.9% 14.7% 14.6% 14.6%
Discounted Cash flows 7,099 5,949 4,980 4,122 3,432 2,815
NPV of cash flows till 2021 28,398 NPV of Terminal Value 23,923 Enterprise Value 52,321 Less: Net Debt 796 Equity Value 51,525 No. Shares (millions) 934 Per Share Equity Value 55.00
12
Figure 28- FFBL- Financial statements (PKR mn)
Profit and Loss 2014 2015E 2016E 2017E
Net Revenue 49,445 54,333 57,183 59,792
Cost of sales 36,972 41,008 43,585 46,721
Gross prof it 12,474 13,325 13,598 13,072
Admin & Selling Exp. 4,632 4,926 5,340 5,767
EBITDA 8,475 8,664 9,019 8,302
Dep & Amortization 1,382 1,418 1,432 1,447
EBIT 7,093 7,246 7,587 6,855
Financial Charges 1,313 1,026 1,022 858
Other income 1,063 736 1,223 1,406
Other charges 430 470 462 409
Profit before Tax 5,780 6,220 6,565 5,997
Taxation 1,764 1,972 1,893 1,654
Net Prof it after Tax. 4,016 4,248 4,671 4,343
EPS 4.30 4.55 5.00 4.65
DPS 4.25 4.25 4.75 4.50
Balance Sheet 2014 2015E 2016E 2017E
Non-Current Assets 12,203 11,523 10,374 9,215
Total Non-Current Assets 24,412 23,732 22,584 21,424
Current Assets
Total inventory 3,895 3,608 3,457 3,322
Trade Debt 1,466 1,489 1,567 1,638
Other current asset 11,431 3,523 3,615 3,700
Cash and bank bal & Short term Investments 14,275 2,204 4,612 6,644
Total Current Assets 21,837 9,824 12,251 14,305
Total Assets 46,249 33,556 34,835 35,729
SHARE CAPITAL AND RESERVES
Share capital 9,341 9,341 9,341 9,341
Reserves 3,731 4,009 4,477 4,383
Total Equity 13,072 13,350 13,818 13,724
NON-CURRENT LIABILITIES
Long Term Debt 10,000 0 0 0
Other non current liabilities 3,277 3,277 3,277 3,277
Total Non current Liabilities 13,277 3,277 3,277 3,277
CURRENT LIABILITIES
Short term Debt 5,265 3,233 3,233 3,233
Trade Payables 13,860 12,920 13,732 14,720
Other Current Liabilities 775 775 775 775
Total Current Liabilities 19,900 16,929 17,741 18,729
Total Liabilities 33,177 20,206 21,017 22,005
Cash Flow Statement 2014 2015E 2016E 2017E
PAT 4,016 4,248 4,671 4,343
Working Capital 5,120 (1,067) 1,036 1,213
Cashflow from Operating Actitivities 10,034 4,757 6,946 6,803
Cashflow from investing Actitivities (8,129) 7,405 (335) (334)
Fixed Capital Expenditures (525) (738) (284) (287)
Cashflow from Financing Activities 715 (16,002) (4,203) (4,437)
Dividend Paid (3,736) (3,970) (4,203) (4,437)
Debt repayments 4,451 (12,032) 0 0
Net decrease/increase in cash & equivalents 2,619 (3,840) 2,408 2,032
cash and cash equivalents at beginning 2,478 5,045 1,204 3,612
Cash & Cash equivalents at end of year 5,096 1,204 3,612 5,644
13
APPENDIX 1
Analyst Certification: All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report.
Disclaimer
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