Underperformance to continue for Fertilizer Sector – JS and KASB Research
By: Naveed Tehsin,
+ 9221 111-574-111 Ext::3100
JS Global Capital Limited
Recent news flow suggests domestic gas prices are likely to be hiked for all consumers including the fertilizer sector. Moreover, it is proposed that feedstock gas prices (Rs320/mmbtu including GIDC) be increased to the level of fuel gas prices (Rs538/mmbtu including GIDC).
If the current feedstock gas price increases to the level of fuel gas price, we estimate the same would require local urea producers to hike prices by ~Rs250/bag to negate the impact.
In the case that urea producers pass through 100% of incremental cost, FATIMA should emerge as the major beneficiary given its subsidized gas price of US$0.7/mmbtu. Other urea producers would remain unscathed provided they are able to offload their full inventory at the higher price.
In the case where urea producers do not fully pass on the incremental cost impact, our sensitivity analysis suggests that every Rs100/mmbtu higher gas price not passed through would result in an annualized EPS cut of Rs2.5, Rs0.4 and Rs3.3 for FFC, FFBL and ENGRO respectively.
Gas price hike to test pricing power of urea producers
According to recent news flow, domestic gas prices are likely to be increased for all consumers including the fertilizer sector. Moreover, there has also been a proposal to increase feedstock gas prices (Rs320/mmbtu including GIDC) to the level of fuel gas prices (Rs538/mmbtu including GIDC). If the current feedstock gas price increases to the level of fuel gas price, we estimate the same would require local urea producers to hike urea price by ~Rs250/bag to negate the earnings impact.
That said, in the current international urea price and supply scenario, complete pass through of incremental cost by domestic producers appears a challenge. Note that in tandem with overall soft commodity prices in recent weeks, international urea prices have fallen to ~US$320/ton(FOB) with the price differential between imported and locally produced urea shrinking to ~Rs600/bag. At the same time, the government has made a higher subsidy allocation for urea import at Rs30bn in the FY14 federal budget. We estimate the subsidy would allow the government to import ~2mn tons of urea (at the current international urea price) which raises the risk that ample imported urea may once again be available as a substitute for locally produced urea.
Although it is premature to tinker with earnings estimates in the absence of any formal notification of gas price hike, we discuss a couple of likely scenarios for our fertilizer coverage universe in the case of a substantial feedstock gas price hike:
Scenario 1 – 100% incremental cost pass through
In the scenario that local urea producers pass through 100% of incremental gas cost, FATIMA should emerge as the major beneficiary given its subsidized gas price of US$0.7/mmbtu. Meanwhile other urea producers would remain relatively unscathed provided they are able to offload their entire production + inventory. However, as flagged above, keeping in view the current international urea prices and enhanced subsidy allocation in Federal Budget FY14 it may not be easy for local producers to hike urea prices substantially and sell everything they produce.
Scenario 2 – incomplete gas cost pass through
In the case where local urea producers decide not to or are unable to fully pass on the incremental cost impact, we flag downside risk to 2014E earnings. Our sensitivity analysis suggests that every Rs100/mmbtu increase in gas price not passed through would result in an approximate annualized EPS impact of Rs2.5 for FFC (15% of 2014E EPS); Rs0.4 for FFBL (8% of 2014E EPS) and Rs3.3 for ENGRO (15% of 2014E EPS). On the other hand, FATIMA’s earnings should remain intact because of its fixed feedstock gas price agreement.
Conclusion and recommendation
There is still a lot of ambiguity regarding the issue and the actual implementation of the drastic gas price hike, therefore we have not incorporated any of these scenarios into our models and await formal notification of gas price hike that may be able to shed some light on the current uncertainty in the sector. In the current scenario, FATIMA seems to be the safest bet in fertilizer space owing to its subsidized fixed feedstock gas price of US$0.7/mmbtu.
By: Shagufta Irshad Khurram,
+92 21 111 222 000
KASB Securities Limited
Fertilizer sector has YTD under-performed the market by over 30% and we believe the underperformance will continue, given threat to urea margins. We reiterate our under-perform rating for both FFC and FFBL.
Urea sales were up 24% YoY while DAP sales were up 67% YoY during Jan-May. We highlight, urea supply remained at comfortable levels while DAP stock is continuously building up, forcing FFBL to start offering trade discounts.
While Engro has reverted urea ex-factory prices back to pre-budget levels of PRs1,700/bag, FFC continues to sell the product at PRs1670/bag. We believe full pass-on of any major feedstock gas price hike (from 1st July) would be difficult when accompanied with the GST impact of ~PRs30/bag.
Fertilizer Sector under‐performance to continue
Fertilizer sector (ex‐Engro) has under‐performed the broader market by over 30% YTD 2013 where FFC/FFBL are down 7%/1% respectively while KSE‐100 index is up 25%. In the absence of positive triggers, we believe these stocks will continue to under‐perform the market in 2H13 given threat to margins from potential hike in gas prices amid weak pricing power and bleak outlook for gas supply to FFBL.