AKD Quotidian about — FFBL – Mapping out the near term outlook

Karachi, July 20, 2012 (PPI-OT): FFBL has underperformed since its result last week, where despite returning to profitability in 2QCY12, absence of interim dividend disappointed the broader market. While AKD Securities remains cognizant of near terms concerns relating to i) sales risk of DAP given huge inventory pile up and relatively higher prices and ii) gas supply concerns especially given the recent downgrade of the fertilizer industry in the gas supply pecking order. However, there has been a strong run in commodity prices off late, triggered by

A severe drought in the US and below line regional monsoon. Furthermore, Russia has also downward revised its wheat production target. Within this backdrop, fertilizer prices are also expected to rally after a subdued 2QCY12, with fertilizer application set to rise as farmers try to maximize yields.

Soft commodity rebound could be a game changer for FFBL: Rebound in softy commodities could be a game changer of FFBL in particular where domestic DAP prices are more closely aligned to international prices as compared with urea. Furthermore, assuming bullish wheat prices in the int’l market, domestic prices could also follow suit, which may induce farmers to apply higher DAP quantities in order to enhance yields, where wheat yields are projected to have declined by 4%YoY in FY12. Furthermore, DAP offtake in the country has dropped for two consecutive year (CY10 and CY11) where AKD Securities could see a sharp rise in sales towards the end of CY12 and into CY13.

What’s happening in the int’l market? As per Mosaic, the world’s biggest phosphate producer, DAP demand will be strong in 3QCY12 as despite lower imports from India, higher demand from Latin America and lower producer inventories should more than offset lower Indian demand. Furthermore, as per IFA’s latest estimates, surplus supply of Phosacid will excess that of urea which bodes well for non-integrated DAP manufactures like FFBL. Furthermore, soft commodity prices have rebounded strongly owing to concerns over crop sizes due to the draught in US, where higher crop prices going forward bodes well for farmer income at home as well.

IFA – Fertilizer Suuply/Demand balance

(million Ntons)201220132014
World Nitrogen Supply/Demand Balance   
Total Supply

140.8

146.4

149.7

Total Demand

137.3

139.6

141.9

Potential Balance

3.5

6.8

7.8

World Phosphoric Acid Supply/Demand Balance

2.5%

4.6%

5.2%

Total Supply

44.3

45.9

47.4

Total Demand

42.5

43.8

44.7

Potential Balance

1.8

2.1

2.7

% of Supply

4.1%

4.6%

5.7%

Source: IFA   

AKD Securities expects earnings to grow 7.6xHoH in 2HCY12: With DAP off take expected to enter into fifth gear by the 4QCY12, AKD Securities expects strong rebound in earnings during 2HCY12. While gas supply issues remain a concern, FFBL does have the advantages of production flexibility, where DAP consumes approximately 60% less gas than urea. AKD Securities has assumed DAP Phosacid PMs to average at US$240ton in 2HCY12, where are above the trend average. Full year urea and DAP sales are assumed at 395k tons and 525k tons, which would denote a fall of 21%YoY and 9%YoY respectively. However, earnings for CY13 are estimated to grow by 24%YoY on higher DAP sales (75k tons of carryover DAP inventory expected to be sold in CY13).

Food security could take precedence over energy supply. While gas supply towards power generation and other industries seems to be the priority at the moment, AKD Securities could see this change as AKD Securities heads into the post election era, where food security could take precedence over others, which in turn could result in improved gas flows to the fertilizer sector. Furthermore, any re-entry into the IMF program would also have fringe benefits for the fertilizer sector in the form of reduced subsidies on urea imports.

Recommendation: At current levels AKD Securities has an accumulate stance on FFBL which offers 9% upside to AKD Securities’ Dec-end price target of PKR 41.5. The scrip is trading at undemanding CY12 and CY13 PE ratios of 6.5x and 5.2x respectively. The real eye catcher is FFBL’s dividend yield, offering a yield of 14.4% for CY12 and 18.4% for CY13. More importantly, given the skewed distribution of earnings towards 2HCY12, AKD Securities expects a total dividend payout of PKR 7.5 over the next year 2HCY12 and 1HCY13), translating into a one year dividend yield of 20%. Higher than expected gas curtailment is the major downside risk to AKD Securities’ estimates. Upside risks to AKD Securities’ call include i) higher than forecast DAP-Phosacid PMs and ii) reduced urea subsidies going forward as Pakistan re-enters the IMF program.