Profit of Pakistani fertilizer manufacturers declines by 31%YoY for 3Q2019

Profit of fertilizer manufacturers of Pakistan has declined by 31%YoY to Rs8.6 billion for 3Q2019, primarily due to 1) decrease in gross profit margins, 2) increase in administrative expense up by 33%YoY, and 3) spike in finance cost by 110%YoY. The analysis is based on sample of 4 largest listed companies, namely Fauji Fertilizer (FFC), Engro Fertilizer (EFERT), Fatima Fertilizer (FATIMA) and Fauji Fertilizer Bin Qasim (FFBL). The analysis is based on unconsolidated statements of FFBL and FFC and consolidated statements of EFERT and FATIMA for true depiction of their fertilizer business. During the period, Urea sales of these companies witnessed a growth of 6%YoY to 1.5 million tons due to pre buying by farmers/dealers amid hike in urea prices along with resumption in operation by Agritech and FatimaFert, contributing 179,000 additional tons. DAP offtake of three companies (EFERT, FFBL and FFC) posted a decline of 10%YoY, in-line with sector’s volumetric decline of 11%YoY to 517,000 tons. Net sales of the sector witnessed a growth of 8%YoY to Rs93 billion during 3Q2019, despite decline in volumetric sales due to increase in Urea and DAP prices. Gross margin of the manufacturers declined to 25% during 3Q2019, from 33% last year due to higher input cost. Government of Pakistan (GoP) has increased feed and fuel prices by 62% and 31% respectively which translate into increase in cost by Rs210 per bag. Fertilizer manufactures tried to pass on the full cost to end consumer, but the GoP only allowed companies to increase urea price by Rs10 per bag, while the rest of amount would be offset by 50% waiver in GIDC. Due to media criticism and political reasons Prime Minister, Imran Khan withdrew the ordinance and directed the Attorney General to move the Supreme Court for an early decision on the matter in accordance with relevant laws. As the ordinance was withdrawn, manufactures increased urea prices by Rs200 per bag effective 8th September 2019. Finance cost increased by 110%YoY due to the hike in policy rate and increase in borrowings of the sector Effective tax rate during 3Q2019 rose to 44% as compared to 33% last year, effective tax rate for FFBL increased by 141% amid implementation of minimum tax.

Fauji Fertilizer Company (FFC) posted profit after tax of Rs4.6 billion (EPS: Rs3.63) for 3QCY19, up 21%YoY but down 11%QoQ. Cumulative profit for 9MCY19 rose to Rs13.5 billion (EPS: Rs10.63), up 58%YoY. FFC also announced its third interim cash dividend of Rs2.2/share, taking 9MCY19 payout to Rs7.55/share, termed below expectation by the market. The sequential decline in earnings is due to the hike in feedstock as well as fuel gas price effective 1st July 2019. While FFC immediately increased urea price by sR210/bag, it led to a disruption in urea offtake. Overall, FFC’s urea offtake declined in 3QCY19. Disruption in volumes and pricing post the most recent gas price hike resulted in 587 bps QoQ decline in gross margins to 28%, outweighing a 7% increase in topline. In addition to sequential decline on gross profits level, absence of dividend income from FFBL and AKBL dragged ‘other income’ lower by 24%QoQ. On YoY basis, the earnings remained flattish where 1) lower gross margins of 28% amid flattish topline, and 2) higher finance cost negating the benefit of the impact of higher ‘Other Income’ based on GIDC accrual.

Engro Fertilizers (EFERT) posted profit after tax of Rs3.3 billion (EPS: Rs2.49) for 3QCY19, down 35%YoY, but up 5%QoQ. The YoY decline in earnings is attributable to 1) lower Urea/DAP offtakes, 2) higher finance cost amid policy rate hikes over the last year and, 3) higher effective tax rate of 44% as against 25% for the same period last year due to reversal of deferred tax booked in 3QCY18. However, higher other income based on cash and higher short term investment (accumulated GIDC) cushioned the decline in 3QCY19 profitability. The earnings were below market expectation due to lower than expected gross margins. On a QoQ basis, a 5% increase in earnings resulted from lower effective tax rate of 44% as against 48% in the earlier quarter. The sequential decline in earnings came as a result of 15%QoQ lower other income. EFERT also announced above expectation second interim cash dividend of Rs6.0/share, taking 9MCY19 payout to Rs11.0/share. For 9MCY19, EFERT’s net profit of Rs10.5 billion (EPS: Rs7.87) was down 14%YoY due to: 1) lower gross margins, 2) higher admin, distribution and operating expenses and, 3) higher effective tax rate of 40% as compared to 29% during the same period last year. The higher other income cushioned the decline in earnings. While quarterly payout was above expectation, analysts await management’s comments on its sustainability.

Fauji Fertilizer Bin Qasim (FFBL), standalone losses during 9MCY19 increased to Rs2.4 billion (LPS: Rs2.59), much higher than Rs203 million (LPS: Rs0.22) during the same period last year, led by: 1) decrease in gross margins, 2) increase in finance cost and 3) spike in effective tax rate.  On the flip side, news flow indicates the GoP has framed the GIDC Levy, Collection and Implementation rules, which if implemented in tandem with gas infrastructure projects, may potentially strengthen the GoP’s case for GIDC—a bear case for fertilizer industry. Assuming continuity of current GIDC rates in this scenario, FFBL stands to be the most adversely impacted given lower DAP PMs. Assuming 1) a 20%YoY decline in urea offtake, coupled with 10%YoY higher DAP offtake for CY19, with slight improvement thereon, 2) current urea price and gas/GIDC rates and, 3) reduction in policy rate by 100 bps in CY20, FFBL shall continue to post losses on standalone basis. If FFBL offloads its existing stakes in cash-draining FFL (51%) and FML (83.33%), the cash inflow could assist FFBL in deleveraging, and transpire into positive EPS impact (assuming a transaction price as per book value). However, lower GIDC rates would remain crucial for standalone profitability.

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