Brief Company Overview/Description

ENGRO: Evolution of the Giant

The company was incorporated in 1965 as ‘Esso Pakistan Fertilizer Company’ with the

name changed to Exxon Chemical Pakistan Ltd. later. After the exit of Exxon (75%

stake) in 1991, the company underwent an employee led buyout and continued as

ENGRO Chemicals Pakistan Ltd. The core activities of ENGRO pertain to the

manufacturing and marketing of Urea and NPK fertilizers, which are sold under the brand

names of ‘ENGRO Urea’ and ‘Zarkhez’ besides sales of imported fertilizers.

Urea production commenced from 1968, with plant located at Dharki with a rated annual

Urea capacity of 173k tons. Successive de-bottlenecking and capacity expansions have

resulted in increasing present Urea capacity to 975k tons. The NPK plant is located at

Port Qasim and was commissioned in 2002 with an annual rated capacity of 160k tons.

Moreover, the company has been quite active in investing in new business ventures,

which are expected to bear fruit going forward

Core Operations:

Engro Chemical Pakistan Limited is the second largest producer of Urea fertilizer in

Pakistan. The core business of the company is manufacturing, purchasing and marketing

of fertilizers. ENGRO; having acquired the market share of 25.3%, is the second largest

producer of Urea and the largest NPK fertilizer manufacturer in the country. Urea

expansion of 1.3mntons is expected to come online, by mid-2011; it will make ENGRO

the largest producer of fertilizer with 35% market share and with the production capacity

of 2.27 mtpa. Furthermore, the company sells imported fertilizer such as DAP/MAP. The

core business is valued at RS 93.1per share, which is 60% of the value in the firm's SOTP

valuation.

Urea accounts for around 65% of the total revenue mix within ENGRO’s core business.

Zorawar (DAP) and Zarkhez have 26% and 8% of ENGRO’s total revenue mix, while

Zingro and other micro nutrients have a 1% share. Going forward we expect DAP’s

revenue share to increase to 30% in the shorter term (till 2010) untill the new urea plant

will come online, after which we expect its share to go down.

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Financing Expansion:

Engro's expansion of 1.3 mtpa urea plant is expected to be operational by mid-2011.

Total cost of the project is estimated at USD970mn with a debt to equity ratio of 2.95

(79:21). The debt to equity mix is presented in the table below:

Thus far, the company ha arranged all the

debt financing of $750 mn (Rs. 45 bn),

from a mix of Local Currency (LCY) of

USD515mn and Foreign Currency (FCY)

of USD235mn loans. And for the internal

financing the company issued right shares

worth of Rs. 3.1bn at Rs. 125 per share in

CY07 while another issue of 10% right

shares was announced at the end of CY07.

Entire interest amount due from the new

loan will be capitalized by the company

since the plant becomes operative in CY11.

Company To Post Higher Margins After Expansion:

The feed gas expense would not be high until 2011, due to fixed tariff of $ 0.7 per

MMBTU for 10 years, and after 2011 the tariff would increase to $ 1.10 MMBTU. But

with the post expansion increase in consumption of gas will result in economies of scale

and eventually lower cost of production and higher margins. Post expansion bottom line

is expected to be increased by almost 57% engendered by an increase in the market share

of the company to 35%.

Subsidiaries--- Adding Value

ENGRO has diversified its investment portfolio in various sectors in the form of different

subsidiaries and joint ventures. The cumulative value of these subsidiaries is Rs

63.4/share, which represent 40% of total value. Diversified investment into attractive

business segments is expected to boost ENGRO dividend income.

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ENGRO’s diversification is expected to enhance shareholder value in the following

ways:

i. Dividend income to prop up the bottom-line.

ii. Provide synergetic sales opportunities especially in the case of EPCL and EVTL,

ENGRO and EEPL, and ENGRO and EFL.

iii. Smooth out earnings during CY11-12 when financial charges accruing from

Urea expansion loans, hit the bottom-line.

Here is the list of subsidiaries and joint ventures of ENGRO Chemicals.

LIST OF SUBSIDIARIES

ECPL is set to increase investment in these subsidiaries as taking through a number of

projects; promising tremendous future returns.

ENGRO Expected Project Completion Time Table:

Each subsidiary has been discussed in detail in latter part of this report.

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Description and Valuation of Subsidiaries

EEPL: Engro Eximp Pvt Ltd.

EEPL holds 100% equity of Engro Eximp. Engro Eximp deals in the business of

imported fertilizer The Company offers value to ECPL as the company gets imported

fertiliser at less cost than it would have to bear otherwise. The imported fertiliser demand

is expected to continue at a growth rate of 30% till 2010 and after that import of fertiliser

will be almost zero as the capacity expansion of 1.8 mtpa by Fatima Fertiliser and Engro

Chemical Pakistan will become operational by 2011.

The value of the EEPL is Rs.5.7 in total subsidiaries’ value of 63.4.

Engro Foods Limited (EFL): set to jump higher

EFL is the 100% owned subsidiary of ENGRO. The company's milk production capacity

is 700k litters per day. Moreover an investment plan of $ 3.4 bn in Engro Foods has been

approved by the board for: expanding UHT capacity to 900 k lpd, expanding milk

powder capacity to 70 kpd, import of 1000 cows and an ice cream plant. The company is

all set for growth as the milk business profitability is increasing due to increasing

consumption of milk and increasing prices of dairy products. Besides selling milk, the

company also sells the company also sells related products such as creams and unbranded

products such as ghee, and recently introduced a milk whitener; namely "Tarang".

Currently, the company is incurring losses due to expansionary activities.

The value of the EFL is Rs.36 in total subsidiaries value of 63.4.

]

ENGRO Energy (EEL):

ECPL holds 100% equity of EEL. The plant is expected to commence production by

2009. The plant has production capacity of 217 MW is located at Qadirpur (Ghotki

District). The plant will cost US $ 205 m; of which 75% is to be raised through offshore

debt financing while rest to be raised through an equity issue.

The value of the EEL is Rs.10.7 in total subsidiaries value of 63.4.

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Engro Innovative Automation Pvt Ltd (EIAL):

ECPL holds 63% of EIAL. The core business of EIAL is to provide process control

solutions to leading industrial units. During CY07, the company has acquired 70% stake

in a US based Automation and Engineering company named Advanced Automation LP

(AALP).

Engro Polymer and Chemical Limited (EPCL):

EPCL is a joint venture between Engro Chemicals and Mitsubishi Corporation of Japan.

EPCL's facility is designed to produce 100k tones of PVC resins; the plant is located at

Port Qasim. The company is going through expansion of PVC manufacturing capacity

after which the production capacity will increase to 150k tpa. The plant is being setup at a

cost of $220 mn and would be completed by 1H-CY09. For financing purposes ECPL

injected equity worth Rs. 1.5 bn. The designed facility will also be able to produce

additional intermediary products and caustic soda.

The company is showing increasingly high numbers in its bottom line and it's a great

source of dividend revenue for ECPL. The company paid a dividend of Rs. 229 million in

CY07.

Engro Vopak Terminal Limited (EVPL):

It is a joint venture with Royal Vopak of Netherlands. Engro holds 50% of equity. The

core business of the company is storage and handling of chemicals. The Engro Vopak has

entered into an agreement with EPCL for ethylene storage services, and plans to construct

first cryogenic storage facility, which would cost $ 30 mn. All the financing will be

raised from debt issue.

The company paid a dividend per share of Rs. 5 in CY07. The profit of the company is

expected to grow by 18-20% and the company is expected to maintain a payout of 92%

going forward. The value of the EVPL is Rs.11 in total subsidiaries’ value of 156.5.

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Significant Progress

Engro accomplished significant progress not only in its base urea fertilizer business but

also in diversification projects. Urea production was increased from an annual capacity of

270,000 tons in 1991 to 850,000 tons in 2001. Further expansion plans are being

developed to debottleneck plant capacity to 1.2 million tons in stages. In addition, Engro

has over thirty years of experience of fertilizer marketing in Pakistan with an elaborate

dealer network. Construction of Engro’s 100,000 tons p.a. capacity NPK fertilizers plant

at Port Qasim at a cost of US $10 million was completed in 2001. The plant is in

production and considerably benefiting the country’s agriculture by providing balance

nutrition to improve farm yields.

Economic/Macro

Fiscal policy affect

DAP fertilizer is an essential input that enhances crop yields. The step increase in

its international prices is discouraging the use of this important fertilizer and

thereby adversely affecting productivity. Our government will more than double

the subsidy on DP from Rs470 per bag to Rs1000 per bag. Subsidy on other

fertilizers will also continue. A total allocation for subsidy on fertilizers has been

increased from Rs25 billion to Rs32 billion.

Complete exemption from sales tax and other duties on imported and local supply

of fertilizers and pesticides, so that the farmers can get these at much cheaper

prices. The effect of exemption form duties in respect of both fertilizers and

pesticides is Rs6 billion.

Shortage of Urea in the domestic market led to price flare up creating significant

stress on the Industry, which worked in close coordination with Government at

federal, provincial and district levels to manage the situation.

Monetary policy affect

Agriculture credit increasing over years.

Involvement of commercial banks.

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SBP’s Initiatives towards Promotion of agriculture Credit

Handbook on Agri-Finance Products of Banks

Specialized Training Programs

Relative Performance of Engro

ENGRO relative performance to KSE-100

Source: Bloomberg

Industry Analysis

Industry Moving in the Right Direction

The agricultural sector plays a key role in Pakistan’s macroeconomic growth by

contributing approximately 21% to the GDP. Increases in crop support prices and

enhanced water availability has resulted in improved agricultural output. Hence, fertilizer

demand remains strong with an anticipated demand-supply gap of 1.3mn tons by 2010,

however, the current capacity of 5.8mn tons is expected to increase to 7.7mn tons by then

which will partially bridge this shortfall. Moreover, the fertilizer prices are anticipated to

rise gradually (6%) due to increasing gas prices and overall inflationary pressures.

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Contributor to the Economy

A successful agricultural setup is essential for the country’s overall growth due to its 21%

contribution to the GDP. GoP, in the recent past has taken some positive steps to boost

the industry. The overall credit disbursements to the agriculture sector has grown

consistently; water distribution has improved and the product pricing has been looked

upon well. We believe it is essential for the GoP to continue it’s support towards the

sector for the betterment of the overall economy.

Snapshot of the Fertilizer Industry

Demand for fertilisers is strong in Pakistan. Farmers increasingly look towards increased

fertiliser applications to firstly maintain and secondly improve crop yields. Generous

subsidies in the form of lower gas feed stock prices and direct subsidy on Potash and

Phosphatic based fertilizers have made this commodity within the reach of most farmers.

Urea and DAP sales are forecasted to rise by an average of 3% per annum for the

foreseeable future.

Limited availability of gas has capped the investment in the fertiliser manufacturing.

Present rated Urea capacity stands at 4.5mn tons while that of DAP stands at 0.445mn

tons per annum. 2011 forecast Urea capacity forecast to climb to 6.11mn tons per annum

following the expansions of ENGRO and Fatima fertilizer.

Changing Trends

Fertilizer industry in Pakistan is mostly dominated by fertilizer, having a market share of

66%. Considering the nature of Pakistani soil, the advisable Nitrogen: Phosphate

application ratio is 1:0.66, whereas the current ratio stands at around 1:0.27. Major

reasons for this disparity include phosphoric nutrients being relatively expensive to their

nitrogenous counterparts and lack of education amongst farmers about the importance of

balanced fertilization.

However considering the GoP’s commitment towards promoting balanced fertilization,

(by announcing a subsidy of PKR 470 per bag) and an expected increase in farmer

education regarding the benefits of balanced fertilization, a change in trend can be

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anticipated. But at the same time soaring prices of DAP in international markets, forcing

farmers to rely more on Urea rather than DAP. Another subsidy for DAP is expected this

year; to get it accessible for the formers at reasonable price.

Players in the Fertilizer Sector

The fertilizer sector in Pakistan currently comprises of 10 companies 6 of which are in

the public sector while 4 are in the private sector. Fertilizer sector recorded 24 percent net

profit of Rs 13.7 million in FY08 as against Rs 11 billion in the same period last year. In

terms of earnings growth in percentage terms, Engro stood first with 34 percent growth in

profit after taxation. FFC recorded 22 percent, FFBL earnings grew by 14 percent

whereas DAWHs earnings declined by 70 percent.

Growth Drivers/Catalysts/Positives/Issues

Market Position

Currently, Engro market share is 25.3% and

it expected to grow in future by 35% until

2011 because of two main reasons, which

includes Urea expansion plan and the other

reasons is that the agricultural sector in

Pakistan is growing. Therefore, being one of

the largest fertilizer companies of Pakistan,

Engro would be able to increase its market share in the coming years.

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Market Share Engro, 20%

Other

Growth of company’s businesses

Brands of the CompanyEngro is an agri based company. Its core business includes manufacturing and marketing

of chemical fertilizers. Engro is Pakistan’s one of the largest producers of urea fertilizer

which is manufactured at Daharki and marketed under brand name Engro. They also

produce crop specific NPK fertilizers at the plant at Port Qasim Karachi and these are

marketed under the brand name of “Zarkhez". Engro also markets imported MAP

fertilizer under the brand name of "Zorawar" and imported DAP fertilizer. The company

also markets micronutrients Zinc Sulphate branded as "Zingro" and Boron branded as

"Zoron".

Production and Offtake

Pricing

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Government Subsidy to Fertilizer Sector Subsidy remained at Rs.470/bag of DAP during the first half of the year. The government

in the second half of the year increased the subsidy amount to Rs. 2,200/bag. Despite a

significant increase in the subsidy amount, local DAP prices went up from Rs. 1,685 at

the start of the year to Rs.3,050/bag at the end of the year due to the increase in global

fertilizer prices. The subsidy for urea is:

Company Operating Performance

Industry urea sales were 5.5 million tons during 2008, growing 12% from 2007 whereas

national urea production during 2008 was 4.98 million tons which is 5% higher than

2007. In 2008, Engro produced 995KT, a bit less than target of one million tons. Engro

has urea market share of 19.2%. During 2008, industry saw unprecedented urea shortages

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due to late arrival of imports. To minimize the impact of shortage, Engro extensively

coordinated with government at federal, provincial and district levels.

Expansion project is progressing well with an overall progress of 47%. Total project cost

has increased to $1.05 billion because of increase in interest rates, devaluation of rupee

and a minor design change to increase capacity.

In 2008, industry sales dropped to 0.8 million tons from1.461million in 2007. This huge

decrease is attributed to highest ever phosphate prices, liquidity crunch, uncertainty on

subsidy and support prices for produce. Engro sold 128KT of phosphate in 2008 against

514KT in 2007 and achieving 16% market share. This decline is because of industry

dropped by 45%, local production share of FFBL increased and two new urea producing

private importers participated in the market.

On the other hand Zarkhez prices are also shooting up in 2008, owing to increase in

prices of phosphate and potash. Thus Zarkhez sales dropped to 69KT, a 28% decline

from 2007. Poor crops of sugarcane and potatoes, which absorb 36% of Zarkhez sales

had a negative impact.

In 2008, company achieved highest ever

Zingro sales that is 1,781 metric tons against

the plan of 1500 metric tons.

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Risks/Concerns of Valuation

The agriculture growth factors such as water availability, farm credit, and farm

income can lead to agriculture growth slowdown and thereby affect fertilizer

offtake.

Timely completion of expansion projects: Deteriorating security situation in the

country may delay project expansions going forward.

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Availability of gas: Persistent gas shortages in the face of demand/supply gap may

inhibit production. Consequently, if the IPI pipeline reaches completion by 2011,

it may encourage further investments in the Urea manufacturing and result in a

supply glut situation post 2011.

GoP’s support for balanced fertilizer usage regime: the level of subsidy given on

Phosphatic fertilizers is going to influence farmer usage of DAP/ MAP fertilizers.

Fertilizer Value Cost Ratio (VCR) for major crops: Defined as the incremental

benefits received by the farmer in the form of increased yields over the additional

cost of fertilizer. It is used, a ratio greater than 1 would suggest that farmers will

continue applying increased fertilizer successively thus sustaining demand growth

and vice' versa.

Prices of grains: Grain prices, especially wheat is going to influence farmer

fertilizer usage in future.

  2005A 2006A 2007A 2008A 2009E 2010E 2011E 2012E 2013E   

Net Sales 18,276 17,602

23,183

23,317

22,730

29,262

45,333

49,810

54,753

Cost of Sales 14,333 13,365

18,263

17,121

14,426

19,943

27,276

28,106

29,091

   

Gross Profit 3,943 4,237 4,920 6,197 8,305

9,319

18,057

21,704

25,661

   gross margins 22% 24% 21% 27% 37% 32% 40% 44% 47%   Selling and Distribution Expenses 1,302 1,482 1,642 1,658

3,198

4,647

7,450

7,834

8,239

Other Income 1,145 1,339 1,831 2,754 1,313

2,448

2,729

3,096

3,406

Other operating Charges 287 287 339 580 581

652

1,264

1,519

1,796

Finance Costs 280 363 535 1,509

14

673 634 3,271 7,258 8,857    

Profit before taxation 3,220 3,445 4,236 5,205 5,165

5,834

8,800

8,189

10,175

  18% 20% 18% 22% 23% 20% 19% 16% 19%   Taxation 900 897 1081 964 1287 1261 2094 1837 2371   Profit after taxation 2319 2547 3155 4240 3878 4574 6706 6351 7804

Financials

Profit and Loss Account

Cashflow Statement

  2008A 2009E 2010E 2011E 2012E 2013E

Net cash inflow from operating activities 5,488 7,798 8,789 9,261 7,899 11,631 Net cash used in investing activities

(22,257)

(29,470)

(23,111)

(1,712)

(1,432)

(1,333)

Net cash inflow from financing activities 15,534 19,997 17,102

(4,105)

(8,675)

(12,974)

     

CCE beginning 7,771 1,687 13 2,793 6,238 4,029 Net increase in cash and cash equivalents (1,235) (1,674) 2,780 3,445 (2,208) (2,677)

CCE end 1,687 13 2,793 6,238 4,029 1,353

Short term finance 1,711 3,077 3,077 3,077 3,077 3,077

CASH BALANCE 3,398 3,090 5,870 9,315 7,106 4,430

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Balance Sheet

 2006

A 2007A 2008A 2009E 2010E 2011E 2012E 2013E

   Share Capital and Reserves  Issued, subscribed and paid up

1,682

1,935

2,128

6,384

6,384

6,384

6,384

6,384

Reserves 5,498

9,431

14,045

14,045

14,045

14,045

14,045

14,045

Unappropriated Profit 2,190

4,117

6,911

10,014

13,673

18,367

22,813

28,276

Total Equity 9,370

15,482

23,084

30,443

34,102

38,796

43,242

48,705

   

Non current liabilities  

Long term loans

16

1,800 15,423 27,757 45,272 60,792 54,491 43,913 31,365

Others 1,168

1,988

3,448

1,036

1,036

1,036

1,036

1,036

Total Non current liabilities

2,968

17,410

31,205

46,307

61,828

55,527

44,949

32,400

   

Current liabilities  Current portion of long term loans

1,106

1,319

95

518

3,014

7,223

11,031

12,946

Short term borrowing 1,300 -

1,711

3,077

3,077

3,077

3,077

3,077

Trade and other payable 1,082

3,753

3,875

2,219

2,856

4,425

4,862

5,344

Others 154

193

318

318

318

318

318

318

Total current liabilities 3,642

5,265

5,999

6,132

9,266

15,043

19,288

21,686

Equity & Liabilities 15,981

38,157

60,289

82,882

105,196

109,365

107,479

102,791

  

Non current assets  

Net fixed assets 6,558

13,812

33,396

63,869

84,708

80,347

76,530

73,213

Intangible assets 18

134

123

136

137

138

139

140

Long term investments 3,658

7,764

11,092

11,092

11,092

11,092

11,092

11,092

Long term loans, advances 63

49

355

214

275

427

469

515

Total Non current assets

10,296

21,759

44,965

75,311

96,212

92,003

88,229

84,960

   

Current assets  

Stores, spares and loose

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tools 689 741 957 722 523 3,855 4,010 4,170

Stock in trade 923

2,690

4,681

1,745

1,443

1,857

2,877

3,161

Trade debts 623

1,409

262

1,108

916

1,179

1,827

2,008

Loans, advances, other recievables

1,644

9,940

7,643

3,890

3,215

4,139

6,412

7,046

Cash and equivalent 1,805

1,618

1,687

13

2,793

6,238

4,029

1,353

Total current assets 5,684

16,397

15,323

7,571

8,983

17,362

19,249

17,831

TOTAL ASSETS 15,981

38,157

60,288

82,882

105,195

109,365

107,479

102,791

Ratios

 2005

A2006

A2007

A2008

A2009

E2010

E2011

E2012

E2013

E   PROFITABILITY RATIOS                  

Profit Margin 12.7%14.5

%13.6

%18.2

%17.1

%15.6

%14.8

%12.8

%14.3

%

Gross profit margin 21.6%24.1

%21.2

%26.6

%36.5

%31.8

%39.8

%43.6

%46.9

%

Return on Assets 16.4%15.9

% 8.3% 7.0% 4.7% 4.3% 6.1% 5.9% 7.6%

Return on Equity 31.4%27.2

%20.4

%18.4

%12.7

%13.4

%17.3

%14.7

%16.0

%   

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LIQUIDITY RATIOS                  

Current Ratio 1.79 1.56 3.11 2.55 1.23 0.97 1.15 1.00 0.82   DEBT MANAGEMENT RATIOS                  

Debt to Asset 0.48

0.41

0.59

0.62

0.63

0.68

0.65

0.60

0.53

Debt to Equity Ratio 0.91

0.71

1.46

1.61

1.72

2.08

1.82

1.49

1.11

Long Term Debt to Equity

0.53

0.32

1.12

1.35

1.52

1.81

1.43

1.04

0.67

   

MARKET RATIOS                  

Earning per share 7.78

8.55

10.59

14.23

13.02

15.35

22.51

21.32

26.19

Price/Earnings Ratio 13.84

12.60

10.17

7.57

8.27

7.02

4.78

5.05

4.11

Dividend per share 11 9 7 6 1 1 3 3 4

Book value per share 48 56 80 77 102 114 130 145 163

Price/BV ratio 2.23 1.93 1.35 1.39 1.05 0.94 0.83 0.74 0.66

FAIR VALUE CALCULATION

Dividend yield method is used to calculate fair value of shares of Engro.

FAIR VALUE (Dividened Yield Method)   No. of shares 212816

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   Rate of Dividend 0.2   Industry Rate of dividend* 0.1357   Value per share PKR 199.48

* FFC rate of dividend is considered

Though every investor has a different point of view towards fair value of any share, we

estimate the company’s stock fair value to be at least Rs. 199.48. We expect handsome

earning growth as we saw the future expansion. We recommend a BUY for ENGRO at

current price. Currently, the stock price of ENGRO limited moving around to Rs 135.35.

Recommendation

It is expected that the company will be able to perform well because of its future

expansion plan which will increase the market share from current 25% to 35%. EPS is

also showing the increasing trend. One more thing which is favorable for company is its

diversification projects and investment horizon. If the company would be able to continue

its current stability and investments in profitable projects then the company would be

able to increase its market share as well as Profitability. We recommend “BUY” for the

scrip, and according to our fair valuation we dig out to the fair value of Rs. 199.48.

Conclusion

We foresee growth in earrings of fertilizer companies in the years to come. Similarly the

said position will be with ENGRO. We expect positive earnings of ENGRO in the

coming years; currently we maintain our stance by recommend “BUY” on ENGRO.

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