Morning Call about Fertilizer – Arif Habib Limited

Karachi, June 21, 2012 (PPI-OT): Uptick in urea offtake adds credence to Cess pass through

Jun-12 urea sales poised to rise
Arif Habib Limited’s industry checks suggest that offtake of locally produced urea is likely to register a substantial increment of more than 100% MoM in May-12, with even conservative estimates putting this figure in excess of 300 kTons.

According to Arif Habib Limited, with dealers ever-wary of the manufacturers’ historic ability to pass through increase(s) in production cost(s), Arif Habib Limited believes that Jun-12 urea sales are likely to be a bright spot in an otherwise subpar year for fertilizer companies. Arif Habib Limited’s sources indicate that offtake has been on the rise since the last week of May-12, and fertilizer companies are hopeful of this trend continuing into Jun-12. Preliminary reports suggest that urea offtake in the first half of Jun-12 have already crossed the 500kTons mark. Official numbers for May-12 offtake are expected to be released in the last week of Jun-12.

So, will the Cess be passed through?
Arif Habib Limited’s analysis suggests that fertilizer companies operating old fertilizer plants will take a sizeable hit on their bottom lines in case the increase in Cess is not passed through. In such an eventuality, Arif Habib Limited calculates the annualized per share impact on earnings of FFC, ENGRO and FFBL to be around PKR 2.8, PKR 3.1, and PKR 0.8 respectively. However, Arif Habib Limited is optimistic about the pass through of the Cess. Arif Habib Limited’s view is supported by Arif Habib Limited’s discussions with the managements of different fertilizer companies. Although none of the companies under Arif Habib Limited’s coverage have made any (public) decision with respect to increasing fertilizer prices, Arif Habib Limited estimates that fertilizer companies will be increasing their prices by PKR 140-170 in 2HCY12 in order to maintain margins. The biggest question mark in this regard however, remains the continuation of import of urea by GoP. As of Apr-12, GoP has already imported 748 kTons of urea since the start of CY12. A tender for the import of another 100 kTons has already been executed, with an additional 200 kTons of urea imports also in the pipeline. Therefore, total estimated urea imports for CY12 is likely to be more than 1mn tons. Based on this estimate, local urea manufacturers are still left with a sizeable 4.2-4.6mn tons of urea demand during the remainder of the year, suggesting that the fertilizer companies have plenty of room to increase prices and maintain their margins.

FFC remains Arif Habib Limited’s top pick amidst renewed gas outages
With the fertilizer industry (especially plants operating on SNGP network) hit hard by gas outages, Arif Habib Limited reiterates Arif Habib Limited’s preference for Fauji Fertilizer Company Limited (FFC). At last closing price of PKR 111.6/share, the stock offers an upside potential of 30% to Arif Habib Limited’s Dec-12 DCF based target price of PKR 144.9/share and a CY12 dividend yield of 14.3%. With gas being diverted to the power sector amidst a debilitating energy crisis in an election year, there are doubts that the government will be able to fulfill (completely) its commitment to manufacturers on the SNGP network of provision of gas even on rotational basis. Furthermore, there are reports doing the rounds that around 650MW electricity being supplied to the Karachi Electric Supply Company (KESC) by WAPDA may be diverted to Punjab. In such an eventuality, KESC will be provided additional gas from the SSGC network. Arif Habib Limited thus flags the risk of gas supply cuts to Fauji Fertilizer Bin Qasim (FFBL) in the coming months arising out of any such development(s).

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