Fertilizer Sector Is the worst over?

Event
We discuss the latest development in the sector pertaining to imports and GIDC, and discuss our outlook for the upcoming period. We have also incorporated the increase in GIDC in our model resulting in downward revision in earnings and target prices.

Impact and analysis

• Higher quantum of imported urea reduced pricing power: In FY12 the government is expected to have imported around 1.6mn tons of urea resulting in subsidy of around PKR45bn as per the Economic Survey FY12. Majority of this import came in 2HFY12, resulting in reduced pricing power for the local manufacturers who despite producing around 1.4mn tons (in 4MCYCY12), were able to sell only half the produce. Though urea imports will continue in Kharif season with 100k tons finalized and tender for remaining 200k set to be given soon, we believe that the quantum of imports seems to be subsiding (See side table).

• Price discount offered by local players seems to have partly worked with channel checks suggesting MoM rise in sales. Due to this, urea price is set to increase by PKR50/bag from 16th June. We expect local producers’ sales to further improve in June as NFML’s imported urea stock is on the lower side, and Kharif season demand is on the upswing. Another price hike is possible from July in our view to partially compensate for GIDC.

• Increase in GIDC will reduce margins: As expected GIDC on Feed and Fuel stock has been increased resulting in cost impact of around PKR160/bag. With government’s focus on upcoming election (keeping farming community happy), we feel that local players will find it difficult to fully pass on the cost hike and restore their margins. We believe that producers will only be able to hike the prices only to the previous level of PKR1,790/bag for 2HCY12. We are of the view that post-election/entering in a new IMF program, imports volume and subsidy will be rationalized/reduced and local players will again get their pricing power. Thus we expect CY13 to be a relatively better year for the industry compared to the current year.

• Though GIDC collection will be substantially more than the projected figure of PKR30bn, we believe that the government will likely be putting the remaining balance in a separate escrow account. It may be recalled that the purpose of GIDC is to use the collection to fund IP/TAPI gas pipeline.

Conclusion
In CY12, all players seem to be at the receiving end be it due to gas curtailment, rising working capital needs, lower selling price (resulting in lower margins) or possible impact of increase in GIDC. Amongst our FSL Fertilizer universe, Fatima is the key beneficiary due to fixed feed price agreement. While Engro and Fatima both provide the most in terms of target price upside potential (See side table for FSL fertilizer universe snapshot).
(FS)

Fertilizer Sector Is the worst over?