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Karachi: Engro has stirred the hornets’ nest again by its unprecedented PkR400/bag urea price hike.
According to AKD Securities, ENGRO’s ex-factory urea price now stands at an uncomfortably high level of PkRI,980/bag, where successive price hikes during CY11 have increased ex-factory price from PkR83O/bag at the start of the year to -PkR2,000/bag currently. So far, it seems that the government has been helpless in controlling the price spiral; however as per ENGRO’s latest notice, excise department officials have disallowed Engro from dispatching any urea shipments at the new price.
Urea industry snapshot: Industry urea production in Sep’11 was 471k tons, of which 284k tons was produced from Man based networks and FFBL (SSGC supplied). Currently, majority of urea capacity on the SNGP supplied plants has been rendered ineffective due to the gas curtailment, which would imply monthly urea imports of -215k tons based on demand of 500k tons. If gas to SNGP supplied plants is not restored, the government would have to import urea worth US$ll8irin (PkR10.4bn) every month to meet the shortfall which, even after Engro’s urea price hike, would result in net subsidy of PkR3bn/month.
Assessing some of the possible GoP actions: The government has a few options which it could conceivably exercise to lower urea price. Below AKD Securities discusses some of the possible government actions and potential reactions:
• Crackdown on urea hoarding: Fertilizer dealers have made hay from the urea shortage psyche, with dealers selling urea at -PkR15O- PkR25O/bag premium to the company price. Dealer hoarding has provided Man based manufacturers a logical excuse to raise their prices alongside Sui supplied plants as in any case the dealer would charge the higher price. Improving price administration and making it mandatory for manufacturers to print urea price on bags would help in bringing down urea price and end Man manufacturers’ free ride.
• Restore gas to Engro: Supplying the full 100,rimcfd of gas to Engro, which in turn would result in a sharp reversal of the recent price hikes. However, in this case gas would have to be diverted from industries, IPPs or even households.
• Remove GST: Removal of GST would provide an immediate price relief of PkR317/bag at the new urea price. However, this would result in a revenue loss of PkR3.2bn/month for the government, where currently the additional inflow from GST on urea is sufficient to fund urea imports of up to 66k tons.
Remove both feed gas subsidy and GST: Equating feed gas price with fuel could result in a per bag cost increase of PkR365 for urea manufacturers, which they would duly pass-through. For the farmer, impact could be softened by removing GST, resulting in a net price increase of -PkR5Obag to PkR2,030/bag. Loss in revenue from GST would be compensated by PkR2.8bn additional revenue from higher feedstock gas after adjusting for Fatima and Engro’s new plant production. In the short term, such a move may be counterproductive as it would raise urea prices, but going forward it would enhance governments bargaining power with the fertilizer manufacturers as it would further reduce the price gap with imported urea and leave manufacturers susceptible to reversal in international urea prices.
Earnings sensitivity to urea price reversal: In case the government restores gas supply to ENGRO and the company as well as other heavy weights reverse urea price hikes by up to PkR600/bag (including Sunday’s PkR400/bag hike and last month PkR2O2/bag increase), AKD Securities estimates CY12F earnings to fall sharply for FFBL, FFC and FATIMA. As for ENGRO, if the new plant operates at 100%, the company would be able to fully absorb the urea price reversal, however earnings would fall the most in case plant operates at lower than 100% as provided in AKD’s EPS sensitivity table on right side. In AKD’s view, it is likely that the GoP would restore gas to ENGRO in the short term as keeping urea prices at PkR2,000/bag would be highly unpopular with the rural vote bank. However, with no tangible solution of the gas crisis at hand, stable gas supply to the fertilizer sector would be wishful, leading to another round of urea price hikes.