Initiation Report Role reversal in the sector; EFERT our ... reversal in...America project, so it would remain less of a yield play than EFERT and FFC. The stock offers a 13% upside

Pakistan Fertilizers

Initiation Report Sep 4th, 2015

Recommendation Engro Fertilizer (EFERT PA) BUY

Fauji Fertilizer (FFC PA) NEUTRAL

Fatima Fertilizer (FATIMA PA) NEUTRAL

Fauji Fertilizer Bin Qasim (FFBL PA) U/P

Companies Featured EFERT BUY

2014A 2015E 2016E

Net sales 61 96 81 GP 27 38 34 GP margin 44% 40% 41% EBITDA 23 33 30 EBITDA margin 38% 34% 37% PBT 12 25 23 PAT 8 17 16 Net margin 13% 18% 19% EPS 6.23 13.18 11.89 DPS 3.00 9.00 8.00 P/E 15.93 7.53 8.34 Div yield 3.0% 9.1% 8.1%

FFC NEUTRAL

2014A 2015E 2016E


FATIMA NEUTRAL

2014A 2015E 2016E


FFBL UNDERPERFORM

2014A 2015E 2016E


Ameet Doulat +92-21-111-639-825 Ext: 109 [email protected]

Role reversal in the sector; EFERT our top pick

Initiation- In light of the long anticipated gas tariff hike and the subsequent urea price increase, we initiate our

coverage on the Pakistani Fertilizer sector. We are selectively positive on the sector, with a Buy rating on EFERT (TP

of PKR127) as our top pick. We have a Neutral rating on both FFC (TP of PKR 136) and FATIMA (TP of PKR57).

Although FFC offers limited potential for capital gains, it still remains attractive as a yield play. FATIMA does offer

strong earnings growth, but positives are largely priced in, given the 51% CYTD rally. On FFBL (TP of PKR55), we

have an Underperform stance, with concerns over DAP margins and optimism over the consumer division being

overplayed, in our opinion.

Investment Case- The recent urea price hike on the back of a 23%/62% increase in the feedstock/fuel stock gas

prices highlights the changing dynamics of the Pakistan Fertilizer sector. We see a role reversal as compared to

2010; FFC defending its margins is now benefiting EFERT and FATIMA due to the concessionary gas pricing both

companies enjoy.

We like EFERT due to (1) margin accretion post urea price hike; (2) sharp deleveraging; and (3) concessionary gas

rate shielding the company from sector headwinds; we highlight EFERT as our top pick in the sector, with a 3-yr

earnings CAGR of 26%. Moreover, given plans of its holding company (Engro Corp) to increase its footprint in

Pakistan’s energy sector and lack of significant re-investment opportunities in the fertilizer space, we expect EFERT

to post strong payouts, going forward, thus providing an attractive dividend yield. CY17 dividend yield is 11%, at

par with FFC, whereas the company’s margins remains relatively shielded from further gas prices increases.

Importantly, our valuation on EFERT is fairly conservative; we have assumed single plant operations from CY16

onwards. Availability of Guddu or any other source of gas can provide considerable upside to our valuations.

FFC surprised the market by completely passing on the gas price hike, as most expected a complete pass through

would be difficult. Although earnings growth still remains a challenge for the company, FFC’s 11% dividend yield

looks attractive in the current interest rate scenario. We believe investors will keep FFC in their portfolios for the

dividend yield alone, despite limited potential for capital gains. We believe that market’s assessment of FFC’s

prospects will improve with this urea price hike, as most had not expected a complete pass though of gas price

hike. Thus, expectations will shift from a declining earnings trajectory to a stable one.

FATIMA is expected to post strong earnings growth (3- year CAGR of 17%) due to (1) concessionary gas pricing in a

rising urea price scenario; and (2) first debottlenecking project. With the stock price up by 51% in CY15TD, much of

the positives have already been priced in. Payout ratio is expected to remain lower than peers, due to the North

America project, so it would remain less of a yield play than EFERT and FFC. The stock offers a 13% upside to our

target price, and a CY16 dividend yield of 6.5%.

We have an underperform stance on FFBL, with DAP margins under pressure due to the recent gas price hike and

overplayed optimism on the consumer businesses, in our opinion. The stock has rallied considerably (+51% in

CYTD), and should correct.

Catalysts- The concessionary plants of EFERT and FATIMA put them in a sweet spot post the higher than expected

urea price increase of PKR155-160/bag. Margin accretion along with sharp deleveraging by the company is

expected to boost profitability.

Risks- Reversal of urea price increases due to increased government pressure, imposition of GIDC on new fertilizer

plants and delay in the ammonia debottlenecking for FATIMA are key risks to our valuation.

Upside risks to Valuation- While we are selectively bullish on Pakistan Fertilizers, upside risks to our valuations

include:

(1) Continuation of Guddu gas or approval of any other source for EFERT to ensure second plant operation;

(2) Int’l operations, reduction in gas curtailment and CAN/NP capacity expansions to complement debottlenecking

for FATIMA; and

(3) Consumer business contribution to bottom-line coming in earlier than expected for FFBL.

2

Industry Outlook –

Margin accretion for EFERT…

Post the gas price hike of 23-62%, FFC has surprised the market by increasing urea prices by PKR155-160/bag to

PKR1994/bag, effective immediately. Based on this hike, it seems both the current gas price increase and partial

increase in GIDC imposed in 2014, which was not completely passed on, has been passed on this time around.

EFERT has also followed suit, and raised prices. Interestingly, the current scenario is similar to 2010-11 price

increase scenario playing in reverse; EFERT, given their huge debt levels and lack of gas supplies had initiated a

massive price increase; and FFC and FATIMA enjoyed significant margin accretion; FFC gross margin increased by

18% YoY in 2011. This time around, with FFC increasing urea prices by PKR155-160/bag, EFERT along with

FATIMA’s margins and profitability are expected to improve.

Figure 1–During 2011, EFERT initiated a massive price increase due to gas shortages…

Figure 2 – …resulting in significant margin accretion for FFC

Figure 3 – EFERT will now enjoy the same benefit in 2016 from FFC’s price hike

Source: Next Research Source: Next Research

Urea price hike results in earnings upgrade for EFERT, FATIMA, and FFC

FFC: Post this increase, FFC’s earnings are expected to clock in at PKR15.7/sh for 2016, 2.6% higher than old

estimates. FFC required a PKR137/bag increase in the urea prices to completely pass on the impact of the recent

gas price hike.

FFBL’s reliance on DAP makes it highly vulnerable to the gas price hike and despite a PKR155-160/bag increase

in urea prices, our revised earnings estimates for FFBL suggest a 9% dip in its 2016 earnings. FFBL will face

difficulty in passing on the DAP cost hike amid shrinking discount between international and domestic DAP.

EFERT is expected to witness a 9.7% increase in 2016 earnings estimates as a result of PKR155-160/bag

increase in urea prices. However, if the Guddu gas continues to flow in during 2016, EFERT’s earnings are expected

to witness a 13% increase due to this urea price hike, with EPS to clock in at PKR15.18/sh.

Likewise, FATIMA’s concessionary gas rate agreements provide it protection from the feedstock price increase.

This, this PKR155-160/bag increase in urea prices will result in a 6.2% increase from our old estimates for FATIMA

for 2016. Recall, with CAN prices also linked to urea prices, CAN prices are also expected to increase by

PKR135/bag and with FATIMA only facing a cost increase of PKR35/bag, margins of the company are expected to

rise. With the first phase of debottlenecking expected to come online by 4Q15 provides further impetus to

earnings.

Source: Next Research

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FFBL

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Figure 4- Revised earnings estimates incorporating gas and urea price hike


Old EPS

Revised

EPS %

FFC 15.3 15.7 2.6%

FFBL 5.50 5.00 -9.1%

EFERT-ex Guddu 10.84 11.89 9.7%

EFERT-Guddu 13.44 15.18 12.9%

FATIMA 6.33 6.72 6.2%

CY16E EPS

3

Figure 5- EFERT’s gas mix


Figure 7- EFERT to match FFC’s D/Y by CY17


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SNGPL-Novated

Mari-SML

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2015 2016 2017 2018

EFERT FFC FATIMA FFBL

EFERT: In pole position to capitalize

Top pick in the sector; Initiate with TP of PKR 127

We initiate coverage on Engro Fertilizer Ltd (EFERT) with a Dec-16 TP of PKR127/sh, offering an upside of

28% from current levels. We expect EFERT to witness a 3yr earnings CAGR of 26% through 2014-17E owing to

(1) concessionary gas rate making up for the decline in production post 2015; (2) price increases of

PKR155/bag magnifying margin accretion during 2016; and (3) strong EBITDA generation resulting in sharp

deleveraging;. EFERT currently trades at a 2016E P/E of 8.34x v its immediate competitor FFC’s 8.62x.

Urea price hike in concessionary gas rate to boost margins

In the latest development, FFC’s initiative to increase urea prices to PKR1994/bag will result in EFERT’s urea

gross margins (cash basis) to clock in at 66.3% during CY16, from 57% previously. Thus, EFERT is best placed

to benefit from this price increase. EFERT’s concessionary gas rate agreement for the Enven plant shields it

from feedstock gas price increases to a large extent. This margin accretion is despite our conservative

assumption that EFERT will operate only a single plant at concessionary rates post Dec-15. Availability of

Gudu gas post Dec-15 will be an upside risk to margins and earnings.

Figure 6 –Urea price hike is expected to result in strong gross margin growth for EFERT


Strong EBITDA to enable deleveraging; payout ratio to increase to 90% by CY17

We expect EFEERT to post an average annual EBITDA of PKR31bn through CY15-18E which is expected to

trigger the company’s sharp deleveraging plans. As of 30th June 2015, the company’s debt level was PKR

40bn, which we expect will fall to PKR 11.5bn by end of CY17. As of 1HCY15, the company stands at a D/A

level of 37%, we project it to reduce further to 27% by 2015E. As a result of this sharp deleveraging, the

company’s financial charges are expected to drop by 23% annually through 2015-18E, boosting the bottom-

line.

Furthermore, reduction in debt levels is being achieved with substantial dividend payments, and once debt

levels reduce by CY17, we expect EFERT to comfortably be able to increase its payout ratio to 90%. Moreover,

we expect payouts to continue increasing as the company pays off its debt, as 1) dividends would help its

holding company’s (Engro Corp) plans to expand in the power business, and 2) there is very limited

opportunity for meaningful expansion in the fertilizer business in Pakistan. By CY17, we expect the payout

ratio to rise to 90%, resulting in a dividend yield of 11%, at par with what FFC offers.

Figure 8–EFERT’s financial position has dramatically improved.

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35%

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45%

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2014 2015E 2016E 2017E 2018E

2014 2015 2016 2017

EBITDA (PKR bn) 23.2 33.0 30.0 30.2

Principal repayment (PKR bn) 16.3 13.1 14.5 4.8

Financial charges (PKR bn) 6.6 4.4 3.3 2.5

Depreciation (after tax) /share 2.34 1.66 1.70 1.74

Capex per share 0.28 0.05 0.56 0.52

Dividends (PKR bn) 4.0 11.9 10.5 14.5

Payout ratio 48% 68% 67% 87% Source: Next Research

Given that Dep/sh is in excess of capex/sh, the firm can even increase its payout ratio above 100%, if required.

4

Figure 11- EPS sensitivity to Guddu gas

2016 EPS

EFERT-ex Guddu 11.89

EFERT- Guddu 15.18

28% Source: Next Research

Figure 9 –Strong EBITDA levels to support deleveraging theme…

Extension of Guddu gas; an upside risk

Our sensitivity analysis suggests that CY16 earnings of EFERT are expected to witness a hefty 28% jump (EPS

of PKR 15.18/sh) from current estimates if Guddu gas continues for CY16. Consequently, EFERT trades at a

P/E of 6.52x, a massive 25% discount to its immediate peer, FFC. Moreover, it would also offer a highly

attractive D/Y of 11% in such a case.

Valuations

Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR127/sh for EFERT. Key assumptions in

our valuation method include (1) cost of equity of 15%; (2) debt free status attained by 2019 which increases

our WACC of 14.8% to 15%; and (3) risk free rate of 9%.

Figure 12 –DCF Valuation summary

1HCY15 review: Impact of one-offs nullified

EFERT posted PAT of PKR3.8bn (EPS: 2.85) in 2Q15, up 96% YoY, taking 1H15 earnings to PKR6.9bn (EPS:

PKR5.15). Despite the concessionary gas rate clocking in for the entire 2Q, lower-than-expected gross

margins (cash basis) clocked in at 41%. This was largely due to (1) one-off expense of PKR925mn (pre-tax)

against asset classification of compressors installed with Guddu; and (2) low-margin DAP sales. Had the one-

off asset reclassification not happened, cash margins would have been 44%. Sharp deleveraging and lower

interest rates resulted in 31% YoY dip in the financial charges, thus boosting the bottom-line. On the taxation

front, one-offs came in the form of (1) reduction in tax rates in Finance Bill 2015 which resulted in Deferred

tax liability revaluation or PKR1.17bn; (2) super tax worth PKR357mn; (3) tax charge related to IFC stock

options worth PKR548mn; and (4) minimum tax due to better profitability worth PKR341mn. Consequently,

effective tax rate clocked in at 20%. EFERT is still to book PKR1bn of tax losses from the EXIMP division, this

can be a upside risk to earnings in the coming periods. The company also declared its first ever interim

dividend of PKR1.5/sh. Incorporating the one-offs during 2QCY15, we expect the company to post net

earnings of PKR17.4bn (EPS: PKR13.18) during 2015. Increased urea prices of PKR1994/bag effective Sep-

15 along with strong production levels are expected to boost profitability levels.

Figure 10 – …ensuring debt free status by 2019


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PKR Mn Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Dec-23 Dec-24

FCFF

20,744 21,641 20,919 21,197 21,022 21,436 19,967 20,154 15,859

WACC

14.9% 14.8% 15.0% 15.1% 15.0% 15.0% 15.0% 15.0% 15.0%

Discounted Cash flows

20,744 18,859 15,822 13,917 12,017 10,653 8,629 7,574 5,180

NPV of cash flows till 2024 113,395 NPV of Terminal Value 44,466

Enterprise Value 157,861 Less: Net Debt (10,807) Equity Value 168,669 No. Shares (millions) 1,331 Per Share Equity Value 127.00

5

Figure 13- EFERT Financial statements (PKR mn)

Profit and Loss statement 2014 2015E 2016E 2017E

Net Revenue 61,425 95,630 81,413 84,745

Cost of sales 34,140 57,387 47,793 50,909

Gross prof it 27,285 38,243 33,619 33,836

Admin & Selling Exp. 5,171 5,705 4,416 4,743

EBITDA 23,246 32,960 30,009 30,153

Dep & Amortization 4,725 3,299 3,331 3,354

EBIT 18,520 29,661 26,678 26,799

Financial Charges 6,625 4,363 3,344 2,469

Other income 2,449 2,045 2,375 2,636

Other charges 1,318 1,622 1,570 1,576

Profit before Tax 11,895 25,298 23,334 24,331

Taxation 3,687 7,927 7,663 7,744

Net Prof it after Tax. 8,208 17,371 15,671 16,587

EPS 6.17 13.05 11.77 12.46

DPS 3.00 9.00 8.00 11.00

Balance Sheet 2014 2015E 2016E 2017E

Long term Assets

Non-Current Assets 74,099 71,231 68,640 65,976

Total Non-Current Assets 75,175 71,944 69,352 66,688

Current Assets

Total inventory 1,101 1,851 1,541 1,642

Trade Debt 757 1,179 1,003 1,044

Other current asset 30,250 20,537 18,226 23,423

Cash and bank bal & Short term Investments 4,189 20,039 14,676 14,629

Total Current Assets 36,297 43,605 35,447 40,738

Total Assets 111,472 115,548 104,799 107,426

SHARE CAPITAL AND RESERVES

Share capital 13,183 13,183 13,183 13,183

Reserves 21,295 34,711 38,517 44,557

Total Equity 34,478 47,894 51,700 57,740

NON-CURRENT LIABILITIES

Long Term Debt 0 0 0 0

Other non current liabilities 5,347 5,839 5,840 5,841

Total Non current Liabilities 41,437 21,708 16,935 12,819

CURRENT LIABILITIES

Short term Debt 7,913 14,539 4,774 4,116

Trade Payables 24,472 28,693 28,676 30,036

Other Current Liabilities 3,171 2,713 2,713 2,714

Total Current Liabilities 35,556 45,945 36,164 36,866

Total Liabilities 76,994 67,654 53,098 49,686

Cash Flow Statement 2014 2015E 2016E 2017E

PAT 8,208 17,371 15,671 16,587

Working Capital 2,688 278 1,022 663

Cashflow from Operating Actitivities 19,063 22,906 19,280 20,962

Cashflow from investing Actitivities (22,604) 10,001 1,762 (5,688)

Fixed Capital Expenditures (373) (68) (739) (689)

Cashflow from Financing Activities (13,692) (17,057) (26,404) (15,321)

Dividend Paid 0 (3,955) (11,865) (10,547)

Debt repayments (16,342) (13,102) (14,539) (4,774)

Net decrease/increase in cash &equivalents (17,233) 15,850 (5,362) (47)

cash and cash equivalents at beginning 22,516 4,189 20,039 14,676

Cash & Cash equivalents at end of year 5,283 20,039 14,676 14,629

6

Figure 14- FFC SoTP valuation

EV

Holding (%)

FFC share

FFC-core 157,286 100.0% 123.7

FFBL 60,184 49.9% 23.6

AKBL 29,824 43% 10.1

FCCL 47,863 7% 2.6

FFC energy 4,937 50% 1.9

Total

162

Less: standalone debt

(0.87)

SoTP value (pre-discount) 161.0

SoTP value (post 30% discount) 149.5 Source: Next Research

FFC: Earnings outlook stable after urea price hike

Earnings outlook improves from negative to stable

We initiate coverage on Fauji Fertilizer Ltd (FFC) with a Neutral rating and a Dec-16 TP of PKR136/sh.

Previously FFC’s earnings were expected to dip as complete pass of higher gas prices was deemed unlikely.

However, having recently completely passed on the gas price to maintain margins, the earnings outlook is

now expected to be more stable, even though growth remains a challenge. The stock is expected to witness a

relief rally with the company managing to initiate a price hike of PKR155-160/bag, substantially above

consensus estimates. Our TP of PKR136/sh is derived through DCF valuation. Moreover, our SOTP valuation

analysis suggests a target price of PKR149.5/sh, post 30% conglomerate discount on the portfolio holdings.

FFC currently trades at CY16E P/E of 8.62x and offers a dividend yield of 11%.

Growth remains challenging…

In our view, FFC’s profitability shall remain largely subdued, with a 3 year EPS CAGR of 3.4%. Dividend

income from FFBL is likely to fall, resulting in other income decline of 5% annually through 2015-21E. We

expect FFC to post an EPS of PKR 15.2 in CY15, and PKR 15.7 in CY16.

…but dividend yield attractive in the current interest rate scenario

FFC currently offers a dividend yield of 11%, the highest in the fertilizer universe, and amongst the highest at

the KSE. Given that T-bill rates are hovering around 7%, we believe that some investors would find the yield

attractive, despite the limited potential for capital gains. The spread between FFC’s dividend yield and bond

yields currently stands at a healthy 3.7% vs 3-yr average of 3.5% and is expected to remain in this level in the

near future.

Figure 15 –Spread between FFC’s D/Y and bond yield is at a comfortable level of 3.7% vs 3 year average of 3.5%

Source: Bloomberg, Next Research

Valuations

Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR136/sh for FFC. Key assumptions in

our valuation method include (1) cost of equity of 15%; and (2) risk free rate of 9%.

Figure 16 –DCF Valuation Summary

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FFC D/Y Bond Yield Spread

PKR mn Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21

FCFF

19,332 19,251 17,452 17,537 18,082 17,194

WACC 14.5% 14.6% 14.6% 14.6% 14.6% 14.6%


19,332 16,801 13,291 11,655 10,483 8,699

NPV of cash flows upto 2021 80,261 NPV of Terminal Value 81,175 Enterprise Value 161,435 Less: Net Debt (11,608) Equity Value 173,043 No. Shares (millions) 1,272 Per Share Equity Value 136.00

7

Figure 17- FFC- Financial Statements (PKR mn)

Profit and loss 2014 2015E 2016E 2017E

Net Revenue 81,240 89,842 94,467 95,782

Cost of sales 48,420 55,196 59,733 61,439

Gross prof it 32,821 34,646 34,734 34,343


EBITDA 28,892 31,433 30,392 30,071


EBIT 27,090 29,622 28,486 28,068

Financial Charges 849 734 169 51

Other income 4,721 6,154 5,363 5,494

Other charges 2,303 2,348 2,325 2,283


Taxation 8,070 9,608 8,349 7,960


EPS 14.28 15.15 15.70 15.77

DPS 13.65 15.00 15.00 15.00




Current Assets

Total inventory 4,297 4,311 4,289 4,380

Trade Debt 822 738 776 787




Total Assets 86,562 74,520 73,839 73,441


Share capital 12,722 12,722 12,722 12,722

Reserves 12,947 14,415 15,300 16,274

Surplus 0 0 0 0

Total Equity 25,670 27,138 28,023 28,997


Long Term Debt 2,500 1,150 375 0



CURRENT LIABILITIES

Short term Debt 13,382 1,351 726 1

Trade Payables 37,935 37,806 37,640 37,369

Other Current Liabilities 2,501 2,501 2,501 2,501




PAT 20,135 18,171 19,280 19,968

Working Capital 14,318 (755) (508) (515)


Cashflow from investing Actitivities (19,452) 11,824 (996) (52)

Fixed Capital Expenditures (3,452) (3,933) (2,406) (2,453)


Dividend Paid (18,002) (17,811) (19,084) (19,084)

Debt repayments 3,142 (13,381) (1,400) (1,100)

Net decrease/increase in cash & equivalents (538) 1,435 89 1,417



8

Figure 18- CAN trades at a discount to Urea

Source: NFDC Figure 19- NP trades at a discount to DAP

Source:NFDC

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FATIMA: Positives largely priced-in Strong earnings growth from de-bottlenecking and urea price hike

We initiate coverage on FATIMA Fertilizer Ltd (FATIMA) with a Dec-16 TP of PKR57/sh and a Neutral rating.

Positives in the form of (1) debottlenecking (DBN) of its ammonia plant; (2) concessionary gas rate resulting

in margin accretion; and (3) aggressive deleveraging; have already been priced in our view. The stock has

witnessed a rally of 51% in CY15TD and currently trades at CY16E P/E of 7.5x. Upside risk to our estimates

include (1) contribution of Int’l operations in the profitability of the company; and (2) increase in capacity

expansions of CAN and NP to complement the second phase of ammonia debottlenecking.

DBN to drive 5 year earnings CAGR of 15%...

The two phases of ammonia debottlenecking (please refer to figure 20) are expected to result in the company

improving its utilization levels. The company has focused on CAN and NP as its prime products; thus their

utilization levels are already very high, however, it has room for production increase in urea. Thus, we expect

urea utilization levels to jump to 80% post Phase I of DBN from 73% currently, and can further increase as

high as 106% post Phase II. Thus, DBN is expected to result in a 5-yr earnings CAGR of 15% through 2014-

18E for the company.

Figure 20- Ammonia Debottlenecking project S

ource: Company accounts

Figure 21 –Expansion in ammonia to be diverted towards Urea production


…however, second phase reliant on gas supplies and capacity expansions

FATIMA currently has a gas supply arrangement with MARI to supply 110mmcfd of gas. While the current

curtailment ranges between 9-10%, we expect the company to successfully lower this curtailment to

successfully execute the second phase of debottlenecking. Moreover, while CAN and NP utilization levels are

expected to slightly improve post Phase I, capacity expansions in the two products which are believed to be in

the pipeline will enable FATIMA to divert excess ammonia (post Phase II) to these product lines, ensuring

optimal sales mix and profitability.

Mid-West project to constrain payout

As of Jun-15, FATIMA’s Debt-to-Asset ratio clocked in at 24% vs 29% by CY14. With the company generating

average annual EBITDA of PKR25bn through 2015-21E, we expect de-levering to continue. We have not

incorporated the debt pertaining to the company’s int’l operations which is expected to put some pressure on

the company’s balance sheet. Moreover, payout ratio is likely to remain below peers like FFC and EFERT, as

the project requires equity injection worth US$300-400mn. We have assumed a 50% payout ratio for FATIMA

in CY17.

Debottlenecking Cost Timeline expected

Ammonia capacity gain

New Ammonia capacity (tpd)

First phase US$58mn 2016 7% 1600

Second phase US$80mn 2018 13% 1800

Figure 22- DBN, deleveraging and concessionary rate to result in 15% EPS CAGR

60%

70%

80%

90%

100%

110%

Urea CAN NP

2014E 2015E 2016E


8

10

12

14

16

18

20

2015E 2016E 2017 2018 2019

9

Figure 23 –Deleveraging theme to continue; however, intl operations may raise debt levels again


Key upside risks

Upside risks to our valuations include:

(1) International operations: FATIMA’s plans of setting up a greenfield fertilizer complex in collaboration

with Midwest Fertilizer in Indiana, United States are in full swing with the plant expected to achieve

financial close this year. With a total cost of US$2.4bn, funding the projects equity participation would

constrain dividend payouts, although the project looks promising from a long-term perspective. The

project completion is expected around 4QCY18.

(2) Capacity expansions in CAN and NP: We expect CAN and NP capacity utilizations to go as high as 106%

through 2015-21E. In order to make the most out of its high-margin product CAN, the management’s

plans of increasing capacities of CAN and NP shall result in significant margin accretion.

Valuations

Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR57/sh for FATIMA. Key assumptions in


Figure 24 –DCF Valuation Summary

1HCY15 review; earnings increase due to lower tax rate

FATIMA posted PAT of PKR4.4bn (EPS: PKR2.10), up by a hefty 150% YoY in 1HCY15. The result came in

largely above ours and consensus expectations owing to a tax reversal worth PKR1.2bn booked by the

company (EPS impact: PKR0.57). Gross margins came in-line with our expectation at 63%, with one-off GIDC

impact stabilizing in 2Q. Sharp deleveraging by FATIMA reduced financial costs by 42% YoY during the period.

Tax reversal worth PKR1.2bn dragged down the effective tax rate of the company to 4% during the period,

overshadowing the one-off super tax expense. Incorporating the one-offs, we expect FATIMA to post net

earnings of PKR11.9bn (EPS: PKR5.68) during 2015. However, an upside risk to our estimate includes the

successful execution of the first phase of DBN in 4QCY15.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

2013

2014E

2015E

2016E

2017E

2018E

2019E

Gross debt Interest expense

PKR Mn Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21

FCFF 14,783 14,306 16,688 19,480 19,886 12,970

WACC

13.2% 13.8% 14.3% 14.6% 14.6% 14.6%


14,783 12,567 12,770 12,960 11,545 6,573

NPV of cash flows upto 2021 71,199 NPV of Terminal Value 68,831

Enterprise Value 140,030 Less: Net Debt 20,797 Equity Value 119,233 No. Shares (millions) 2,100

Per Share Equity Value 57.0

10

Figure 25- FATTIMA- Financial statements (PKR mn)

Profit and loss 2014 2015E 2016E 2017E

Net Revenue 36,169 40,368 46,073 45,910

Cost of sales 13,220 15,654 17,432 18,092

Gross prof it 22,949 24,714 28,641 27,818


EBITDA 19,505 20,882 24,734 24,261


EBIT 17,914 19,190 22,998 22,471

Financial Charges 3,767 2,564 2,231 1,035

Other income 624 458 552 624

Other charges 1,374 1,420 1,681 1,643


Taxation 4,891 4,698 6,645 6,645


EPS 4.41 5.68 6.72 7.04

DPS 3.00 3.25 3.50 4.00




Current Assets

Total inventory 6,771 7,447 8,247 8,092

Trade Debt 448 387 473 472


Cash and bank bal & Short term Investments 949 3,138 4,806 1,646


Total Assets 83,121 89,496 92,705 90,087


Share capital 21,000 21,000 21,000 21,000

Reserves 15,757 21,910 29,732 37,698

Total Equity 36,757 42,910 50,732 58,698


Long Term Debt 17,335 11,585 6,910 3,250



CURRENT LIABILITIES

Short term Debt 6,975 11,850 10,675 3,785

Trade Payables 7,374 8,230 9,467 9,434

Other Current Liabilities 259 500 500 500




PAT 9,256 11,928 14,122 14,791

Working Capital (389) 477 (40) 134


Cashflow from investing Actitivities 2,213 (5,499) (2,000) (2,500)

Fixed Capital Expenditures (2,827) (5,499) (2,000) (2,500)


Dividend Paid (5,250) (5,775) (6,300) (6,825)

Debt repayments (6,703) (634) (5,850) (10,550)

Net decrease/increase in cash & equivalents 718 2,189 1,668 (3,159)

cash and cash equivalents at beginning 238 949 3,138 4,806

Cash & Cash equivalents at end of year 957 3,138 4,806 1,646

11

Figure 26- FFBL’s consumer business implied value

FFBL holding (PKR bn)

Implied value (PKR/sh)

FFBL Market Cap 60.18 64.43 FFBL core* 40.17 43.00 AKBL** 6.43 6.89 FCCL** 0.65 0.70 FEWL & FPL* 2.80 3.00 NOPK** 1.05 1.12 Sub total 51.11 54.71 FML and FFL-implied 9.08 9.72 Source: Next Research *DCF based valuation **Market price

FFBL: Recent rally unjustified as DAP headwinds loom

Earnings growth priced-in

We initiate coverage on Fauji Fertilizer Bin Qasim Ltd (FFBL) with a Dec-16 TP of PKR55/sh and an

Underperform rating. Margin outlook on FFBL’s fertilizer business is expected to remain under pressure due to

(1) reliance on DAP business and the inability to pass on the gas tariff hike; and (2) rising phosacid prices

amid currency devaluation. In our view, the market has overplayed the consumer business by assigning an

implicit value of PKR9.08bn, whilst we believe it is unlikely to move the needle on profitability for the

foreseeable future. (please refer to figure 26).

Gas price hike to hurt margins

FFBL’s inability to pass on the gas price hike in its DAP business is expected to result in margin attrition for

the company. In order to nullify the impact of the gas price hike, FFBL will have to increase the DAP prices by

PKR81/bag, which seems unlikely in this scenario with international prices trading at US$443/ton.

Consumer business’ impact overplayed

The market has clearly overplayed the impact of the Halal meat business, in our view, by assigning a value of

~PKR9.1bn (against equity project cost of PKR 1.6bn). In our view, given the sensitivity of a stable supply

chain in such a venture, the payback period is expected to be much longer than the market is currently

expecting. Our channel checks suggest that Fauji Meat, which was previously expected to come online in Jul-

15, has now been shifted to 4Q15. Moreover, FFBL’s acquisition of 38.3% stake in Nur Pakistan (NOPK) is

expected to be incorporated in the earnings of the company by CY17. This acquisition was made after Fauji

Foods Ltd’s (FFL) plans to enter the dairy business by setting up a plant were put on hold.

Valuations

Our Discounted Cash Flow (DCF) based methodology yields a TP of PKR55/sh for FFBL. Key assumptions in


Figure 27–DCF Valuation Summary

PKR Mn Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21

FCFF

7,099 6,856 6,579 6,218 5,920 5,565

WACC

15.4% 15.2% 14.9% 14.7% 14.6% 14.6%

Discounted Cash flows 7,099 5,949 4,980 4,122 3,432 2,815

NPV of cash flows till 2021 28,398 NPV of Terminal Value 23,923 Enterprise Value 52,321 Less: Net Debt 796 Equity Value 51,525 No. Shares (millions) 934 Per Share Equity Value 55.00

12

Figure 28- FFBL- Financial statements (PKR mn)

Profit and Loss 2014 2015E 2016E 2017E

Net Revenue 49,445 54,333 57,183 59,792

Cost of sales 36,972 41,008 43,585 46,721

Gross prof it 12,474 13,325 13,598 13,072


EBITDA 8,475 8,664 9,019 8,302


EBIT 7,093 7,246 7,587 6,855

Financial Charges 1,313 1,026 1,022 858

Other income 1,063 736 1,223 1,406

Other charges 430 470 462 409


Taxation 1,764 1,972 1,893 1,654


EPS 4.30 4.55 5.00 4.65

DPS 4.25 4.25 4.75 4.50




Current Assets

Total inventory 3,895 3,608 3,457 3,322

Trade Debt 1,466 1,489 1,567 1,638




Total Assets 46,249 33,556 34,835 35,729


Share capital 9,341 9,341 9,341 9,341

Reserves 3,731 4,009 4,477 4,383

Total Equity 13,072 13,350 13,818 13,724


Long Term Debt 10,000 0 0 0



CURRENT LIABILITIES

Short term Debt 5,265 3,233 3,233 3,233

Trade Payables 13,860 12,920 13,732 14,720

Other Current Liabilities 775 775 775 775




PAT 4,016 4,248 4,671 4,343

Working Capital 5,120 (1,067) 1,036 1,213


Cashflow from investing Actitivities (8,129) 7,405 (335) (334)

Fixed Capital Expenditures (525) (738) (284) (287)

Cashflow from Financing Activities 715 (16,002) (4,203) (4,437)

Dividend Paid (3,736) (3,970) (4,203) (4,437)

Debt repayments 4,451 (12,032) 0 0

Net decrease/increase in cash & equivalents 2,619 (3,840) 2,408 2,032



13

APPENDIX 1

Analyst Certification: All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report.

Disclaimer

This information and opinion contained in this report have been complied by our research department from sources believed by it to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. All opinions and estimates contained in the document constitute the department’s judgment as of the date of this document and are subject to change without notice and are provided in good faith but without legal responsibility.

This report is not, and should not be construed as, an offer to sell or a solicitation of an offer to buy any securities. Next Capital Limited (the company) or persons connected with it may from time to time have an investment banking or other relationship, including but not limited to, the participation or investment in commercial banking transactions (including loans) with some or all of the issuers mentioned therein, either for their own account or the account of their customers. Persons connected with the company may provide or have provided corporate finance and other services to the issuer of the securities mentioned herein, including the issuance of options on securities mentioned herein or any related investment and may make a purchase and/or sale, or offer to make a purchase and/or sale of the securities or any related investment from time to time in the open market or otherwise, in each case either as principal or agent.

This report may contain forward looking statements which are often but not always identified by the use of words such as “anticipate”, “believe”, “estimate”, “intend”, “plan”, “expect”, “forecast”, “predict” and “project” and statements that an event or result “may”, “will”, “can”, “should”, “could” or “might” occur or be achieved and other similar expressions. Such forward looking statements are based on assumptions made and information currently available to us and are subject to certain risks and uncertainties that could cause the actual results to differ materially from those expressed in any forward looking statements. Readers are cautioned not to place undue relevance on these forward looking statements. NCEL expressly disclaims any obligation to update or revise any such forward looking statements to reflect new information, events or circumstances after the date of this publication or to reflect the occurrence of unanticipated events.

Exchange rate fluctuations may affect the return to investors. Neither the company or any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained therein.

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