Written as on June 19, 2012
Highlights
• Fertilizer business facing gas curtailment rampage
• Foods a front runner in Engro portfolio, revenues to grow 19.5%CAGR
• Polymer lacks gloss, but recovering steadily
• Recommendation -Buy with Dec-12 Price Target of Rs135
In today's Value Seeker, we present update on Engro Corp.’s valuations along with earnings estimates as well as our Dec-12 target price for the company with a ‘Buy’ recommendation.
Fertilizer business facing gas curtailment rampage
Engro's Fertilizer segment has not been doing well this year while being heavily hurt by frequent gas curtailments on new plant and high financial cost. In our value update, we have assumed that capacity utilization in the next 5 years on new urea plant (1.3mn tons capacity), which is on SNGPL network, will average ~30% due to pertaining gas curtailments. On the other hand, old urea plant (975k tons capacity), which is on Mari gas network, is expected to maintain average capacity utilization of ~91% in next 5 years. However, as per recent developments, SNGPL has devised and implemented a gas management policy of providing gas on 1-month rotational basis to four fertilizer plants on its network, which essentially means that, every plant on SNGPL network will get gas for 6 months in a year. However, this is yet to be reiterated whether this policy is implemented temporarily or permanently, we expect it will be a difficult task for SNGPL to ensure gas supply for 6 months to fertilizer plants that will remain short of allocated amount under new gas mgmt policy.
Engro to continue to maintain 20% of urea and 25% of DAP market
On offtake side, we expect urea market to grow by CAGR of 4.5% to 6.4mn tons in next 5 years while imports will continue to pressure local manufacturers. Engro’s market share in the urea segment is expected to average ~20% for next 5 years while Fauji’s are expected to maintain market leadership in this segment. Since urea is an essential input for agriculture sector, retail prices of urea are expected to remain firm and grow at a CAGR of 5% to Rs2,100/bag for the next 5 years. Being largest DAP importer, Engro’s DAP market share is expected to stand at ~25% while DAP industry is expected to expand by a CAGR of 2.7% to 1.28mn tons in the next 5 years. As local prices of DAP move in line with int’l prices, margins in the DAP segment for Engro remain stiff, and we expect local DAP prices to grow at a CAGR of 6.3% to Rs4,700/bag, going forward.
GIDS to limit key margins at 70% in urea segment in CY12
Increase in GIDS (Gas Infrastructure Development Surcharge) to Rs303 per mmbtu will continue to impact key margins for Engro, but compared to other fertilizer manufacturers, impact of cess increase on ENGRO will be limited to the production on old (975k tons capacity) urea plant as new plant (1.3mn tons capacity) enjoys gas subsidy for 10 years under gov't fertilizer policy and therefore cess will not be charged on the gas supply to new plant. Incorporating the impact of GIDS, we expect key margins in urea segment for Engro to average at ~70% from CY12 onwards.
Fertilizer segment earnings to remain depressed in CY12
Excessive imports of urea this year along with their low cost availability have deeply affected local manufacturers’ offtake during CY12. Due to this adverse situation, Engro Fertilizer's topline is expected to shrink by 4% to stand at Rs30bn in CY12. On the other hand, due to implementation of GIDS, gross margins of the company is expected to decline to 42% in CY12 compared to 53% last year. Also, high financial cost and low offtake are expected to revert company’s operating margins to only 9% during CY12 compared to 22% last year. Engro Fertilizer is expected to post the CY12 PAT of Rs1.8bn (EPS of Rs1.69) compared to PAT of Rs4.5bn (EPS of Rs4.28) during last year.
Foods a front runner in Engro portfolio, revenues to grow 19.5%CAGR
Foods segment (EFOODS) being the most growing business in Engro's portfolio is expected to contribute significantly to the overall company's valuation. Milk processing volumes by EFOODS are expected to grow by a CAGR of 8.5% in next 5 years to 500mn liters till 2016, while we also expect EFOODS’s market share in UHT milk to improve to 50% during same period. With heavy capital expenditures to improve backward integration for milk collection and storage alongside aggressive marketing strategy, compared to that of competitors’, EFOODS’s revenues are expected to grow by a CAGR of 19% during next 5 years. However, incorporating the inflationary impact, cost of milk is also expected to grow by CAGR of 18% during same period. We expect company to post CY12E PAT of Rs2.0bn (EPS of Rs2.78) and CY13E PAT of Rs3.17bn (EPS of Rs4.22).
Polymer lacks gloss, but recovering steadily
After the completion of expansion activities on VCM plant, Engro Polymer has achieved improved backward integration with PVC plant. Being market leader in the PVC market, company’s revenues are expected to grow by a CAGR of 6% during next 5 years. Capacity utilization is expected to remain full in both PVC and caustic soda segments. We expect Engro Polymer to post CY12E PAT of Rs461mn (EPS of Rs0.69) and CY13E PAT of Rs248mn (EPS of Rs0.37).
Engro Corp’s financial cost to put heavy burden on overall earnings
Financial cost currently stands as major dampening factor for the earnings of Engro Corp. as last year company paid the financial cost of Rs12.3bn on a consolidated basis, up 84% on YoY basis. We expect financial cost to continue its momentum with expected outflow of Rs10.4bn during CY12E and Rs8.5bn during CY13E. Major proportion of this financial cost is from Fertilizer (CY12E cost of Rs7.0bn) and Polymer business (CY12E cost of Rs1.4bn). On an overall basis, we expect Engro Corp to post CY12E PAT of Rs6.73bn (EPS of Rs13.17), down 14% YoY.
Outlook and recommendation
After incorporating most of the negatives and conservatively estimating company’s earnings outlook, as detailed before, we recommend 'Buy' on Engro Corp with our revised Dec-12 target price of Rs135, on SOTP valuation basis. We expect a payout of Rs4.5 per share from the company in CY12. The scrip is currently trading at PE of 7.8x and holds the upside potential of 31% from current levels.
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