Inside Financial Markets

Engro Fertilizer (EFERT) Strong Outlook Despite Earnings Dip In 3rd Quarter

KASB Securities & Economics Research.

Reiterate Buy with new PO of PRs102; estimates trimmed

We have adjusted our earnings estimates for Engro Fertilizer Ltd (EFERT) down by 8/4/3% for CY15/16/17 to PRs11.40/11.26/11.89 post 3Q earnings announcement and analyst briefing. We have also reduced our DCF-based PO by a marginal 2% to PRs102. The revisions in estimates are mainly predicated on yet-to-be implemented urea price cut and lower other income ahead.

We are not worried over soft 3Q earnings and expect earnings momentum to pick up in 4Q. An unexpected DPS of PRs1.5/sh signals possible upside to our annual dividend estimate of PRs5.0/sh. We believe EFERT’s investment case is largely unharmed and reiterate our Buy rating on the stock.

Sharp seasonality depressed sales & earnings in 3Q

3Q earnings clocked in at PRs2.10/sh, down 31% QoQ (up 31% YoY). This translates into 9MCY15 earnings of PRs7.45/sh constituting 65% of our full-year earnings estimates. A key bright spot in 3Q is 1440pp QoQ improvement in gross margins to 56%. We hypothesize two reasons for the jump: (1) absence of one-off provisioning of GIDC booked in 2Q, and (2) seasonal shift in sales mix. We see two key red flags in 3Q earnings,however: (1) sharp 59% drop in other income due to the dual impact of lower cash levels post GIDC payment in 3Q and potential build-up of inventory; and (2) stickiness in financial charges, which were up 3% QoQ.

We reckon 3Q also incorporated the impact of rupee devaluation. We believe financial charges are likely to trend down 4Q onward as repricing of most of the loans fell in late 3Q. Lower sales partly due to PM Agricultural Package: EFERT 3Q earnings have been hit hard by sharp volatility in urea volumes. 2Q/3Q trend of industry sales of urea shows extraordinary volatility due to pre-buying by dealers in 2Q on expectation of urea price hike in early 3Q. Engro sales mirrors industry trend, which have dropped 2% for urea and 29% for DAP in 9MCY15. While the urea price hike finally materialized with a delay of 2-months in Sep-15, announcement of Prime Minister Agriculture Package gave rise to expectation of reversal in urea price hike which delayed normalization in sales trend.

Imminent urea price cut will have a modest impact

We believe the government and fertilizer producers are likely to reach a consensus on quantum of relief on gas cost hike (primarily on feedstock) and subsequent reversal in recently announced PRs160/bag hike in urea price. Accordingly, we have incorporated a PRs145/bag reduction in urea price (net increase in urea price since Jun-15 of PRs15/bag). A 6-18% hike in gas prices will partially impact the EFERT’s feedstock cost in 2015 only. However, EFERT may have to absorb the increase in fuel stock prices (standalone impact of 2.5-3%). Among the key players, Fatima Fertilizer has already announced the price cut while FFC has partially reduced prices. EFERT is providing partial credit, amounting to Rs120/bag.

Strong EBITDA growth underlie investment thesis

Three key reasons which underpin our liking are (1) strong cash flow generation (EBITDA of PRs27-30bn or PRs20/sh); (2) de-leveraging of B/S and (3) near-term catalyst in the form of clarity on gas supply to old plant post 2015, which can potentially result in earnings upside in 2016. We see high possibility of EFERT putting in place an arrangement for ensuring gas supply from the available options of existing fields of Mari and RLNG.

Baqar Hussain

A Wannabe CFO, just had stepped in the corporate sector, willing to explore every aspect here and learn as mush as i can, awareness for those who dont, get the info where ever possible and stay up to date always.

The Canadian Securities Institute


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Inside Financial Markets was a joint publication of Pakistan Stock Exchange (PSX)and Society of Technical Analysts Pakistan (STAP)