Morning Shout released by KASB Securities Limited and Economics Research

Karachi, July 31, 2012 (PPI-OT): Fertilizer: Record June sales; headwinds ahead

According to KASB Securities Limited,

• Fertilizer industry reported 109% jump in urea, 41% jump in DAP, 153% jump in CAN and 98% jump in NP sales during the month of June.

• Local industry urea sales were up 106% reducing inventory levels to 0.22 million tons(from 0.8 million tons) out of which 54% of the inventory was left with Engro alone.

• Fatima Fertilizer is KASB Securities Limited’s top pick in the sector offering 23% upside to KASB Securities Limited’s PO of PRs30. KASB Securities Limited expects Fatima to report EPS of PRs1.51 for 2Q12 (1Q12: PRs0.14).

• KASB Securities Limited sees headwinds ahead from 1) possible reaction of the govt. to MOI proposal to import 0.6mt of urea and cut prices, 2) possible increase in cess and 3) continuation of gas supply disruption to plants on SNGPL network.

Record urea sales in June, leading to jump in 2Q12 earnings
As per the report released by NFDC, urea sales jumped 109% YoY while DAP sales were up 41% during June, as the industry reported record levels of urea sales for a month, crossing 1 million ton mark. Sales of domestically produced urea were up 106% to 0.9 million tons. Increase in urea sales purely reflect time-bound price cuts/hikes announced by FFC, which was later followed by peers. Since FFC had taken the initiative to announce price cuts to kick-off sales, FFC witnessed the strongest volumetric growth (526kt, +157% YoY) and saw minimal level of left over inventories by month-end.

Pick-up in DAP sales mainly reflected jump in imported DAP sales since FFBL’s DAP sales were down 6% YoY. Among non-traditional fertilizers, CAN sales were up 153% YoY while NP sales were up 98% YoY. FFC has reported 58% YoY jump in 2Q12 EPS and KASB Securities Limited expects Fatima Fertilizer to report EPS of PRs1.51 in 2Q12 (post preference dividend) from PRs0.14 reported in 1Q12. Fatima is KASB Securities Limited’s top pick in the sector with 23% upside to KASB Securities Limited’s PO of PRs30.

Significant cut down in local industry inventory levels; Engro lags behind peers
With price cuts announced by the local industry, the attractiveness for imported urea was reduced (ex-factory price differential went to as low as PRs50/bag compared to the retail price differential of only PRs30/bag between imported and local urea). Resultantly imported urea inventory increased from 0.12 million tons in May-2012 to 0.185 million tons in Jun-2012. Strong sales of domestically produced urea enabled the local industry to reduce urea inventory from 0.81 million tons in May-12 to merely 0.22 million tons in Jun-12. Notably FFC cleared 95% of the stock available in June, FFBL cleared 99%, Fatima cleared 83% while Engro managed to clear only 65% of the available inventory during the month. As of 30-June-2012, Engro was carrying the highest level of urea inventory among peers which is equivalent to 54% of total local producers’ inventory.

Potential headwinds ahead

1) Import of 0.6 million tons of urea as proposed by the Ministry of Industries will create pressure on local industry sales with 0.2 million tons already in transit.

2) PRs150/bag decrease in imported urea prices to PRs1,450/bag in order to benefit farmers– this will raise local-imported urea price differential from the current level of PRs120/bag to PRs270/bag, diverting dealers’ attraction back to imported urea. This will eventually force local industry to announce price cuts to clear inventory.

3) Continuation of gas supply disruption to fertilizer plants on SNGPL network for the rest of the year, raising near term cash flow concerns for these companies.

4) Possible increase in cess within FY13 – This is negative for old plants mainly FFC with 16% downside to FFC’s earnings in case of no pass-on of higher cess in end product prices.