AKD Securities Limited Equity Research – Daily Report

Karachi, December 11, 2017 (PPI-OT): ENGRO: More opportunity than meets the eye

In the backdrop of recent weakness in stock price (-18%CYTD), we reiterate our liking for ENGRO with our rolled forward Dec’18 TP of PkR348.8/sh (upside: 34%). Our recommendation for the conglomerate is underpinned on all-round improvements in the form of: 1) recovery in fertilizer business (EFERT earnings up 18%YoY for 9MCY17), 2) impressive turnaround in polymer business (EPCL earnings up 61.1xYoY in 9MCY17), 3) higher utilization for its Elengy and Vopak business lines and 4) smooth progress at its flagship Thar coal mining and power project (currently 4 months ahead of schedule and expected to reach COD by Jun’19).

In addition to value enhancements prospects through ongoing operations, there has been some clarity on utilization of its cash rich balance sheet (cash and cash equivalent of PkR62bn) in the shape of: 1) investment in 450MW RLNG based Power Plant at Port Qasim and (pending tariff approval from NEPRA) and 2) intentions to setup a second LNG terminal. Recent price correction due to relegation from MSCI Global EM index to the small cap EM index offers attractive entry points, considering fundamental growth remains intact (4yr forward earnings CAGR of 44%).

EFERT remains the flagship business: EFERT announced NPAT of PkR6.69bn (EPS: PkR5.03) on standalone basis in 9MCY17 (higher by 18%YoY) along with a strong payout of 109%. With the continued support of the GoP fertilizer subsidy and improving farmer economics, we have witnessed robust growth of 21%YoY and 18%YoY in total fertilizer and urea offtake during 10MCY17. This trend is likely to continue with demand propped up by the ongoing Rabi season (3yr avg. offtake during Oct-Dec: 1.7mn tons), taking CY17F total offtake to its 3yr high (AKD estimates CY17F offtake at 5.7mn tons).

Additionally, recent recovery in international urea price to US$225/ton (up 18% since its low of US$190/ton in Jun’17) aids local manufacturers in exporting allocated quotas of urea at decent margins (70k tons urea remaining to be exported out of the allocated quota of 600k tons). Declining consistently every month, urea inventory now stands at 690k tons (down 59%YoY/6%MoM) in Oct’17. Going forward, we anticipate further improvement in sales dynamics on the back of: 1) strong demand in Rabi season, 2) normalization of inventory levels and 3) rising international prices. In this backdrop, we also expect urea manufacturers to rationalize increasing amount of sales discounts (currently hovering around PkR80-100/bag), hence improving margins.

EPCL depicts an impressive turnaround: EPCL posted NPAT of PkR1.95bn (EPS: PkR2.93) in 9MCY17 (higher by 61.1xYoY) vs. NPAT of just PkR32mn (EPS: PkR0.05) in 9MCY16. This significant uptick in 9MCY17 earnings resulted from, 1) 23%YoY growth in topline to PkR13.05bn from strong performance in PVC segment and 2) impressive 12.1pptYoY jump in GMs to 24.3% owing to higher PVC prices and 62%YoY improvement in PVC – Ethylene core delta that averaged at US$380/mt in 9MCY17.

On the production side, the Company maintained operational excellence and achieved highest ever PVC and VCM production. Plant debottlenecking remains a key highlight for the year, which is on track to achieve 195 KT of production capacity for PVC and VCM by the end of CY17 and 1QCY18. Going forward, we expect the company to maintain its improved performance taking support from recently imposed regulatory duty of 2% on import of PVC and preliminary imposition of antidumping duties on imported PVC resin. Both these steps will be beneficial for growth of local PVC industry, where EPCL has a market share of ~32%.

EPQL – recovery in earnings from a major overhaul and forced outage: Higher earnings (9MCY17 EPS: PkR5.72; up 21%YoY) in EPQL were due to normalization of grid issues pertaining to WAPDA and major overhaul carried last year, resulting in a higher load factor of 94% in 9MCY17 vs. 60% in 9MCY16. Consequently, the company increased its net electrical output to 1,314GWh in 9HCY17. In the backdrop of current troubles in the power chain, we believe gas based power plants should continue to be ranked higher in the merit order list, keeping EPQL’s dividend income stream steady.

Vopak and LNG business remains stable: VOPAK continues to benefit from high handling volume of LPG (up 6%YoY). On the LNG terminal front, SSGC has started utilizing additional 200mmscfd of spare LNG capacity after a revised arrangement in Mar’17, allowing EETL to handle 600mmcfd of LNG at an average tolling fee rate of US$0.479/mmbtu. The LNG terminal handled 52 cargoes during 9MCY17 vs. 32 cargoes in 9MCY16 maintaining an availability rate of 97.5%.

SECMC and Thar Coal Power Project – ahead of schedule: ENGRO’s continues with smooth progress at its flagship Thar coal mining and power project, which is currently 4 months ahead of schedule and is expected to reach COD by Jun’19. Progress on the project continues at a steady pace and 60% completion level has been completed to date. 660MW flagship project is likely to demonstrate an average availability of 85%, transmitting 607MW net capacity at a levelized tariff of PkR9.29/KwH for a period of 30yrs with a US$ IRR of 20% and ROE of 34.49%. Based on the following data, we estimate EPTL to add ~PkR6.3bn (PkR11.9/sh) to ENGRO’s bottom-line from CY20, contributing PkR43.7/sh (assuming 30% portfolio discount) to our Dec’18 TP.

Cash Rich Balance Sheet: After the stake sale of 47% and 22% in EFOODS and EFERT, ENGRO has sizeable cash reserves of ~PkR62bn (US$580mn). While evaluating potential avenues for redeployment of its capital, ENGRO has given some indications for its capital reallocation plans in the shape of investment in, 1) 450MW (441.77MW net capacity) RLNG based Power Plant at Port Qasim through its subsidiary Kolachi Portgen (KPL) and 2) second LNG terminal based on private consortium (very early stage).

Regarding the former (RLNG based Power Plant) based on tariff filed with NEPRA (pending approval) the project is expected to deliver IRR of 23.5% by transmitting 100% net capacity to KEL under a power purchase agreement (Letter of inter-LOI issued by KEL) at an expected levelized tariff (at base case – RLNG without compressor) of PkR7.09/KwH for a period of 30yrs at 92% load factor (tariff application). While we have not incorporated the project in our estimates on awaited tariff approval, our preliminary workings based on the tariff petition filed is expected to add an estimated PkR2.69bn (PkR5.15/sh) to ENGRO’s bottom-line from CY21, contributing an additional PkR25.5/sh to our SOTP based TP of 348.8/sh.

Investment Perspective: Going forward, developments with regards to, 1) capital reallocation plans in the shape of Kolachi Portgen (KPL) and the second LNG terminal, 2) upcoming flagship investment projects (Thar power project, SECMC) and 3) improved performance by its subsidiaries (EFERT and EPCL) is expected to keep ENGRO in the limelight. Recent price correction due to relegation from MSCI Global EM index to the small cap EM index offers attractive entry points, considering fundamental growth remains intact (4yr forward earnings CAGR of 44%). In the backdrop, we currently have a Buy stance on the scrip with our SOTP based Dec’18 TP standing at 348.8/sh. (upside 34%).

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