AKD Quotidian about — Fertilizers: What to expect?

Karachi, December 27, 2013 (PPI-OT): Fertilizer Price Performance The fertilizer sector has gained 7% in Dec’13TD in anticipation of strong earnings and payouts in 4QCY13 amid looming uncertainty over hike in gas tariffs in Jan’14 and reversion to US$0.7/mmbtu for Engro Fertilizers.

According to AKD Securities, while various proposals have come forth with regards to the revision in gas tariffs, AKD securities expects a 30% to 40% increase Fertlizer Sector vs. KSE100 Index for feedstock gas and 15% to 20% for fuel stock gas in Jan14, resulting 48% in a cost hike of PkR225/bag.

AKD securities believes most of the additional cost should be passed on by local players as international prices have spiked to US$328/ton, a premium of 33% to local prices. For Engro Fertilizers, while investors remain bullish with respect to reversion of feedstock rate to US$0.7/mmbtu for Enven, AKD securities believes materialization of the proposal is far from certain given strong opposition by industry players. Amidst the ambiguity, FATIMA remains AKD Securities’ top pick in the sector, presenting upside of 26% to AKD Securities’ TP of PkR36/share while AKD securities awaits further developments on gas prices to further cement AKD Securities’ view.

Gas tariff hike-still a guessing game: Amid myriad statements by the GoP with regards to a planned hike in gas tariffs in Jan’14, uncertainty still prevails over the quantum of the hike. As per reports, the IMF seeks a complete removal of subsidy on feedstock gas for fertilizer manufacturers implying an ex-GIDC increase of PkR365/mmbtu (+296%), which may be implemented in a phased manner, in AKD Securities’ view. Additionally, the IMF has also suggested imposition of a new gas levy in order to generate revenue to the tune of 0.5% of GDP (~PkR133bn) while the fate of GIDC still hangs in the balance. Meanwhile, SNGP has requested an increase of PkR132/mmbtu (ex-GIDC) in feedstock tariffs while SSGC has called for FFBL’s feedstock rates to remain unchanged. In this backdrop (political considerations aside), AKD securities expects the GoP to announce an increase of 30% Landed Cost (PkR/bag) to 40% in feedstock gas tariffs and 15%-20% in fuel stock gas tariffs, resulting in a cost hike of PkR225/bag for urea.

Pricing power is back: With low export tax season in China coming to an end amid a rebound in coal prices, international urea prices have spiked to US$328/ton after bottoming out in Nov’13. At current levels, local urea price is at a discount of 24% to international prices, implying room to on most of the cost hike resulting from an increase in gas prices. International DAP prices have also spiked to US$410/ton after bottoming out in Nov’13, where AKD securities expects higher local DAP prices and favourable DAP primary margins, as a result, in CY14.

Question mark on US$0.7/mmbtu: While a proposed reversion to US$0.7/mmbtu for Engro Fertilizers has driven sentiment in ENGRO (+8% in Dec’13TD) and Engro Fertilizer’s IPO (over-subscribed by 3.4x), AKD securities Local Ex-GST (PkR/bag) iterates that the proposal is still in the pipeline amid strong opposition by industry players such as SNGP and MARI. Materialization of the proposal would, however, result in CY14F earnings downside of 18% for FFC, 15% for FFBL and 9% for FATIMA.

Investment Perspective: With uncertainty still prevailing over gas pricing going ahead, recent gains in the sector (+7% in Dec’13TD) largely reflect anticipation of strong earnings and payouts for 4QCY13. Amidst the ambiguity, FATIMA remains AKD Securities’ AKD Securities’ top pick in the sector, presenting upside of 26% to AKD Securities’ TP of PkR36/share while AKD securities awaits developments on gas tariff hikes to further cement AKD Securities’ view.