AKD Quotidian about — Fertilizer Sector: The New Normal!

Karachi: AKD Securities upgrades its outlook on Pakistan Fertilizers to an Overweight stance. While the Fertilizer sector (ex-ENGRO) has been the top sector price performer over the last year, AKD Securities see room for further upside.

According to AKD Securities, although gas supply cuts are likely the new normal, the sector retains significant pricing power as illustrated by the 43% urea price hike over the last year. With domestic urea prices at a -50% discount to int’l prices, there is still ample room for Pakistan urea manufacturers to offset production cuts. AKD Securities flags ENGRO as its top pick with a target price of PkR1 83/share (upside of 38%) where AKD Securities believes gas curtailment and high debt stock have been overplayed (ENGRO has shed 18%CYTD). AKD Securities’ stress test analysis for pricing power for domestic fertilizers places ENGRO on the top spot. Outside of ENGRO, AKD Securities upgrades estimates and outlook on FFC with a Buy stance (Target Price: PkR198/share) and Accumulate on FFBL (Target Price: PkR55/share). AKD Securities’ outlook is underpinned by strong margins where, despite stellar outperformance over the last year, AKD Securities believes there are further gains to be harvested.

Valuations Snapshot

 

Symbol CY11 PER (x) TP (PkR) Upside CY11 DY  Stance
FFC 6.9 198 26% 14% Buy
FFBL  5.4 55  6% 18% Accumulate
ENGRO 6.4 183 38% 4%   Buy
EPCL n.m 8 -12% 0% Reduce
EFOODS 41.0  25 0% 0% Neutra

 

Industry Dynamics: The domestic fertilizer industry has entered unchartered territory of facing gas curtailment and AKD Securities believes this is going to be the new normal, particularly for Sui-based plants (46% of country’s rated urea capacity). In response, manufacturers have raised net urea prices by PkR355/bag or 43%CYTD, comfortably offsetting the loss in production and underscoring strong pricing power (domestic urea prices are still approx. 1/2 of int’l prices). While global urea capacity additions (particularly in China) may help bring down int’l prices going forward, the same should stay firm over the near-term due to the persistent decline in world grain stock-to-use ratio (2012F: 21.3% – a 6yr low). AKD Securities see Pakistan Fertilizer companies continuing to benefit from the tight supply position, particularly as urea import appears economically unviable as long as int’l urea prices remain firm at current levels.

ENGRO is the top pick: Higher urea prices/margins have reflected in sector profitability with NPAT of the AKD Fertilizer Universe up 57%YoY in 1HCY11. Although price performance of FFC and FFBL has reflected the surge in profits, ENGRO has been the key laggard. While AKD Securities is upbeat on FFC due to strong pricing power/margin expansion, ENGRO is AKD Securities’ top pick where AKD Securities believes gas supply concerns have been overplayed, diverting attention away from the company’s positives (e.g. 5yr NPAT CAGR of 22% over CY1 0-CY1 5F, forward PER of 6.4x and basket exposure to the fastest growing segments of Pakistan). Being key components of ENGRO, AKD Securities initiates coverage on EF000S with a target price of PkR25/share and reinitiate coverage on EPCL with a target price of PkR8/share.