JS Securities Limited – Morning Briefing

Karachi, January 10, 2018 (PPI-OT): Fertilizers: No policy, but proposals for lower urea prices under consideration

Rumours have been circulating in the market pertaining to introduction of a new fertilizer policy, which can potentially alter the existing sector dynamics.

Our discussions with industry sources deny such assertions; however, there are some proposals under consideration to lower urea prices ahead of the general elections.

We believe proposals likely to be under consideration are (1) reduction in Sales Tax on Urea from 5% to 2% and (2) rationalizing existing GIDC tariff along with other sectors.

The proposal to reduce Sales Tax is likely to have an adverse impact on fertilizer manufacturers as it will lead to higher Sales Tax refunds, due to mismatch between input and output tax.

We believe reduction in GIDC would materially benefit FFC and FFBL, as both companies remain top GIDC contributors in the sector.

We expect inventory situation of the industry to hover in the range of 250-350k tons, providing an opportunity for local players to continue with sturdy prices.

No policy but proposals to lower prices under consideration

Rumours have been circulating in the market pertaining to introduction of a new fertilizer policy, which can potentially alter the existing sector dynamics. Our discussions with industry sources deny such assertions; however, there are some proposals under consideration to lower Urea prices ahead of the general elections. We believe proposals likely to be under consideration are (1) reduction in Sales Tax on Urea from 5% to 2% and (2) rationalizing existing GIDC tariff along with other sectors. Interestingly, these changes were proposed by the Ministry of Food Security and Research as opposed to the Ministry of Industries and Productions, which is responsible for drafting long-term policies with respect to various industries.

(1) Reduction in Sales Tax to affect WC requirements

The proposal to reduce Sales Tax on Urea is likely to have an adverse impact on fertilizer manufacturers as it will lead to higher Sales Tax refunds (aggravating manufacturers working capital requirement), due to mismatch between input and output tax. However, the same will translate into decrease in Urea prices by Rs42/bag.

(2) Possible changes in GIDC will benefit old players

Taking cue from recent measures by Punjab government to provide direct subsidy to local farmers during the election year, we highlight possibility of new round of relief measures through adjustments in GIDC tariff for the sector by federal GoP which would result in reduction in key input cost. The same is also being considered for other sectors (particularly for textiles). We believe the said decision would materially benefit FFC and FFBL, as both companies remain top GIDC contributors in the sector, whereas EFERT and FATIMA would be least affected due to availability of concessionary rates on feed gas. We believe possible reduction of GIDC payment by Rs50/mmbtu can provide substantial room to FFC and FFBL to cut retail prices by Rs60-93/bag. However if the companies decides to absorb said benefit, we estimate profitability of the company to jack up by Rs1.84/share and Rs0.69/share, respectively. As proposals remain under consideration, we present a sensitivity analysis below to discuss impact on the sector.

Inventory position remains potent trigger

Amidst robust domestic urea demand supported by bumper crop production and optimal utilization of exports quota, inventory is expected to clock in at 232k tons as at Dec-2017 (down 78%/54% YoY/MoM). Furthermore, industry’s near term outlook further stands to gain from government’s decision to export additional ~75k tons till Feb-2018. It is pertinent to mention that with the absence of LNG players, industry’s average production in last few months (excluding maintenance period of EFERT plant) has settled around 504k tons (~497k tons in Dec-2017), while average domestic monthly sales during 2017 settled at ~493k tons, indicating a relatively lower inventory build-up scenario in 2018. Thus, we expect inventory situation of the industry to hover in the range of 250-350k tons, providing an opportunity for local players to continue with sturdy prices. In the backdrop of improving fundamentals of the industry, we retain our liking for FFC (TP: Rs87) and Engro Fertilizers (EFERT, TP: Rs74). Key risks to our thesis are (1) decline in urea retention prices, (2) increase in gas prices and (3) increase in inventory levels.

   

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