TPL_111813_53639

Engro Fertilizers Limited Initiating Coverage

Floor Price Rs20

Fair value in Worst case scenario Rs15

Fair value in Base case scenario Rs27

Fair value in Best case scenario Rs37

Share outstanding (mn) 1,298

Book Building (mn) 56.25

Initial Public Offering (mn) 18.75

Engro Corp Divestment (mn) 30.00

Engro Fertilizers: Key numbers2011A 2012A 2013E 2014F 2015F 2016F

EPS * 3.5 (2.3) 3.9 2.4 4.0 6.4

Growth 23% N/M N/M -37% 63% 60%

PE at Rs20 5.7 N/A 5.2 8.2 5.0 3.1

ROE 25% N/M 24% 13% 18% 22%

Div. Yield at Rs 20 0% 0% 0% 0% 10% 20%

* Base Case ScenarioSource: Topline Research

PAKISTAN INSIGHT

Engro Fertilizers - IPO

November 18, 2013

INITIATING COVERAGE

The Research Department of Topline Securities has prepared this report for information purpose. The information on which this report is based from sources, which Topline Research believes to be reliable, but we do not guarantee that it is accurate or complete. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors who should seek further professional advice or rely upon their own judgment and acumen before making any investment. This report should also not be considered as a reflection on the concerned company’s management and its performances or ability, or appreciation or criticism, as to the affairs or operations of such company or institution. Warning: This report may not be reproduced, distributed or published by any person for any purpose whatsoever. Action will be taken for unauthorized reproduction, distribution or publication.

Topline Securities (Private) Limited

306, Continental Trade Centre, 3 Floor Block 8 Clifton, Karachi

Pakistan Tel: +9221-35303330-32

Fax: +922135303349

Betting on more gas

Investing in Engro Fertilizers public offering is betting on additional gas supply to run its second plant. Though they have efficiently managed to run their new plant (EnVen) on Mari gas and seek some interim gas allocations. But the actual value of the company will unlock if government provides them more gas to run both plants. With long-term gas plan on Economic Coordination Committee (ECC) agenda since last few meetings, there are bright chances that the new government may soon ratify the allocation made to four plants in Dec 2012, though the pricing of that gas is still uncertain.

Amid this uncertainty, assigning a target price for Engro Fertilizers IPO is not easy and investors should take this IPO as a risky proposition that can generate above average gains or losses due to ambiguity on gas allocation. Looking at Sharif government’s seriousness to provide business friendly environment, we bet that more gas will be supplied to them but not at a discounted price. Thus, in base case, we value the stock at Rs27 compared to minimum offer price of Rs20. Based on one plant (worst case) we value it at Rs15 and based on two plants at subsidized rate (best case) at Rs37.

New govt. ratification of long-term gas plan awaited

Since the commencement of new US$1.1bn EnVen plant in 2011, the company faced severe gas outages being on SNGPL network. However, active attempts to secure gas supplies brought 60mmcfd gas from Guddu Power since July 2013 and 22mmcfd gas from Mari SML since April 2013.

In Dec 2012, ECC under the previous govt. approved dedicated 202mmcfd gas to the consortium of four fertilizer manufacturers from five fields. Engro Fertilizers’ share is 79mmcfd. If the decision is ratified by the current ECC, additional gas may flow from 4Q2014 for which Engro Fertilizers will invest around Rs5.3bn for the pipeline.

Debt restructuring and delay in dividends Engro Fertilizers total debt of Rs64bn in Sep 2013 is better than Rs72bn in Dec 2011. In recent debt restructuring, senior loans tenor has been extended by another 2.5 years with a new covenant restricting to pay dividend until 33% (or Rs17bn) of outstanding loans as at Jun 30, 2012 have been paid off. Thus, in base case, we expect Engro Fertilizers to pay first dividend for 2015 of Rs2 per share.

Asad I. Siddiqui [email protected]

Tel: +9221-35303331 Ext: 112 Report completed on November 18, 2013. Prices as of November 12, 2013.

Topline Research is also available on Bloomberg, Thomson Reuters & Capital IQ

BUY / SUBSCRIBE

Salman Badami [email protected]

Tel: +9221-35303331 Ext: 136


IPO: Issue Breakup

Stage 1:

IPO (75mn shares)

Book building (56.25 mn shares)

Retail portion (18.75 mn shares)

Stage 2:

Engro Corp's divestment

30mn shares at strike price

Source: Topline Research

Engro Fertilizers EPS: Different Scenarios2014F 2015F 2016F

Base 2.4 4.0 6.4

Best 2.8 6.4 8.0

Worst 2.0 2.0 2.8


Fertilizer Sector: Peer P/E Comparison2014F 2015F

FFC 7.3 6.9

FFBL 6.2 5.8

FATIMA 6.1 5.3

EFERT (PE at Rs20) 8.2 5.0

Average 7.0 5.8


Valuation: Fair value range Rs15-37

For valuation of Engro Fertilizers we have devised three different scenarios. In our base case scenario, we have assumed that both plants will be operational at average 80% capacity utilization. Though US$4.5/mmbtu is the price for long term gas that is being quoted by different sources, but we believe, realized gas price will be around US$6.5/mmbtu (due to US$2/mmbtu GIDC). In this scenario, we arrive at a target price of Rs27 per share.

Our best-case scenario is based on assumption that the company will be getting long-term gas supply at US$4.5 per mmbtu and that there will be no GIDC on this supply. Through this, the company’s fair value will be at Rs37 per share. In worst case, we have assumed the company’ will continue to receive gas that it is currently receiving (ex Guddu) and will run its US$1.1bn more efficient EnVen plant. In this case, the fair value of the company is Rs15 per share. Engro Fertilizers long-standing demand has been that it should be allocated gas at US$0.7 per mmbtu, which is as per their agreement with SNGPL for 10 years. In this case, the company will substantially reduce its urea price and the target price can go beyond our best case scenario.

Public Offering

Engro Fertilizers, a major subsidiary of listed Engro Corporation (ENGRO), is doing book building on Nov 19-21, 2013. This will be the second IPO at Karachi bourse of this calendar year. The timing of this offer cannot get any better as both plants have been operating at 86% capacity smoothly since Aug 2013 and long term gas price is on the agenda of ECC.

Engro Fertilizers Limited will issue 75mn ordinary shares, out of which, in the first stage, 56.25mn shares (75% of the total issue and 5.8% of the total paid-up capital) will be offered through book-building mechanism at a floor price of Rs20/share. The remaining 18.75mn (25% of the total issue), in the second stage, will be offered to the general public at the strike price to be determined via book-building mechanism. Moreover, up to 30mn shares will divested by Engro Corporation (ENGRO) at the strike price determined by the same book-building mechanism which will be offered to HNWI (High net-worth individuals) and foreign investors on first come first serve basis. The OFS (offer for sale) of 30mn shares is at the discretion of the company and is not mandatory.

2

Engro Fertilizers: Key numbers (Base case scenario)2011A 2012A 2013E 2014F 2015F 2016F

Sales (k tons) 1,260 938 1,599 1,497 1,810 1,813

EBITDA (Rs mn) 16,772 11,697 22,584 19,488 21,544 23,920

PAT (Rs mn) 4,589 (2,935) 5,024 3,156 5,148 8,272

EPS (Rs) 3.5 (2.3) 3.9 2.4 4.0 6.4

Div Yield 0% 0% 0% 0% 10% 20%

EV/EBITDA 2.6 3.5 1.7 2.0 1.7 1.3

EV/ton (Rs) 42,923 40,695 38,362 38,288 36,199 31,086



Urea Production (000' tons) & Growth


-30%

10%

50%

90%

-

500

1,000

1,500

2,000

2011

A

2012

A

2013

E

2014

F

2015

F

2016

F

Production (LHS) Production Growth (RHS)

Long-term gas & its pricing: Main earnings driver

Ever since, Engro Fertilizers started commercial urea production of its 1.3mn tons US$1.1bn EnVen plant in June 2011, the company has been facing gas outages on this new plant being on SNGPL network. This is because Pakistan has been facing acute gas shortage as gas production has grown at only 0.5% CAGR in last 5 years in spite of rising energy needs.

From the start of 2013, however, the company actively pursued alternative solutions to resolve gas issues. In this regard, the company first diverted Mari gas from its base plant to its more efficient EnVen plant. This shift brought incremental production capacity of around 10-15%. Moreover, from July 2013, 60mmcfd gas was diverted from Guddu power plant which is close for maintenance till 1Q2014 enabling Engro Fertilizers to operate its both plants at production capacity of 87% in 3Q2013. This helped the company to post highest ever profits of Rs3.2bn (EPS of Rs2.8) in 9M2013 with EPS of Rs1.48 in 3Q2013 alone.

Going forward, as part of the FFM (Four Fertilizer Manufacturers) consortium, the company is actively pursuing a long-term gas allocation. In Dec 2012, ECC (Economic Coordination Committee) approved allocation of 202mmcfd of gas to the FFM consortium from five dedicated fields (Mari SML, Reti Maru, Kunar Pasaki Deep in Sindh, Makori East in KPK and Bahu in Punjab). Engro Fertilizer share in this is 79mmcfd while fertilizer plants are to sign Gas Supply Agreement (GSA) directly with the field operators instead of the Gas Distribution Companies (GDCs) being SNGPL and SSGC. The field operators will charge weighted average gas price at US$4 per mmbtu, in addition to US$0.5 per mmbtu tolling charges to SNGPL.

If the decision is ratified by the ECC which is expected soon, additional gas inflow will start from 4Q2014 enabling the company to run both plants at 80% capacity on consistent basis. Although Engro Fertilizers demand is to get at discounted price of US$0.7 per mmbtu that was committed, we think ECC may allocate gas at current prices along with GIDC and other charges that comes to US$6.5 per mmbtu.

De-leveraging and debt restructuring Engro Fertilizers is deleveraging its balance sheet since 2011. Currently, as of Sep 2013, the company’s interest bearing liabilities stand at Rs64bn with debt to equity ratio of 3:1. At 2012 year-end this was Rs69bn with debt to equity ratio 4.4:1 and at end of 2011 it was Rs72bn with debt to equity of 3.9:1. As of Jun 2013, local component stands at Rs43.bn, while foreign component stands at Rs23bn. Capex of US$115mn is required for the gas pipeline which will connect the urea manufacturers to different fields in which Engro Fertilizers’ has to pay US$48mn. The company intends to finance this through internally generated funds and money from the upcoming IPO.

The company has successfully restructured its debt obligation as senior loans tenor have been extended by 2.5 years. However, the new debt covenant suggests that company will not pay dividends until 33% or Rs17bn of the outstanding loans (Rs52bn as at June 30, 2012) have been paid off. The company is expected to pay this loan by the end of 2015. Though the company is optimistic that long term gas supply will start from mid-2014, we feel that this gas will be available from 4Q2014. Nonetheless, Engro Fertilizers will still be able to post EBITDA of Rs22bn in 2015 vs. Rs16bn posted in 9M2013. This suggests that the company will be in a comfortable position to fulfill its debt obligations. We expect Engro Fertilizers to pay first dividend for 2015 of Rs2 per share followed by Rs4 per share for 2016.

3

-40%

0%

40%

80%

120%

-

5,000

10,000

15,000

20,000

25,000

2011

A

2012

A

2013

E

2014

F

2015

F

2015

F

EBITDA (LHS) EBITDA Growth (RHS)

EFERT: EBITDA & EBITDA Growth



EBITDA to grow at 5-year CAGR of 15% (Base case) With restoration of gas supply to Engro Fertilizers by 4Q2014, we believe, company’s production will increase at 5-year (2012-16) CAGR of 13% against last 3-year (2010-12) CAGR growth of just 1%. And since Pakistan is a net importer of urea, the company will be able to sell all of its produce. Engro Fertilizer’s revenues will grow at 5-year (2012-16) CAGR of 17% and will reach Rs66bn by 2016, as per our estimates. Engro Fertilizer’s EBITDA will grow at 5-year (2012-16) CAGR of 15% and will reach Rs24bn by 2016. Similarly, Engro Fertilizer’s earnings are estimated to grow at 5-year (2012-16) CAGR of 18% and will reach Rs8.3bn mark by 2016, we believe.

4


Local & International Urea Price Gap

Source: Topline Research, Bloomberg

2014 EPS sensitivity to interest rateChange in IR EPS impact

50 bps -4.5%

100 bps -9.0%

150 bps -13.5%

200 bps -17.9%


Risk to Investment

Gas curtailment Gas shortage in Pakistan is the topmost concern for investors with regard to fertilizer sector profitability. Demand for gas is likely to remain above supply level until gas import projects or new discoveries come online. Any delay in ratification of long term gas supply to Engro Fertilizers by ECC may increase risk. However, in case long term gas supply plan gets delayed, existing cash flows from one plant (EnVen) will be enough to retire debts and can eventually pay dividends when debt goes down in 2015. Moreover, company is actively pursuing litigation against Ministry of Petroleum and Natural Resources and SNGPL against curtailment of gas despite Sindh High Court (SHC) decision to supply gas to the company. Any favorable decision on this front will have a positive impact on Engro Fertilizers.

Gas price increase risk Besides gas curtailment, another fear is the expected hike in gas price. This risk has emerged in last few months when gov’t was in process of rationalizing gas price across the board and gained further traction post IMF agreement. In the LoI (Letter of Intent) the govt. earmarked Rs100bn which will be collected by increasing the cess/levy on gas. Our discussion with the industry players suggests that the govt. is likely to impose additional cess/levy of Rs100-150 per mmbtu on feed stock gas of fertilizer companies, currently getting gas at Rs323 per mmbtu. Moreover, further increase in fuel gas price cannot be ruled out.

This is not a major risk as locally manufactured urea is currently trading at a discount of 30% to international urea. The space is there for fertilizer companies to pass on the additional cost impact to the end consumer and maintain its margins. As per our calculation, with every Rs100 per mmbtu increase in gas price due to cess/levy, the company will be required to increase price (inclusive of GST) of urea by Rs125 per bag to maintain margins.

Decline in international urea prices Another risk to company’s profitability comes from decline in international urea prices. International urea prices declining significantly pose substitution risk. Since local urea manufacturers cannot sell at a higher price than international urea, decline in international prices will negatively affect the pricing power of not just the company but of whole sector. This will make it difficult for the company to maintain its margins.

We flag low probability to this scenario. Though, international urea price declined significantly to US$290/ton in July 2013 due to oversupply from China. However, this oversupply window has closed and as a result we have seen urea prices (FoB) rebound to US$320 per ton. Moreover, rupee devaluation is also supporting local players.

Increase in Interest Rate At the time when economy is going through a phase of monetary tightening, investors flag additional risk to leveraged companies. Engro Fertilizers having debt to equity of 3.1 (as of Sep 2013), is the most leveraged company amongst its peers. With local debt of Rs43bn we estimate that 1% rise in interest rate will push financial cost upwards by Rs430mn. After tax impact of this will be 9% on 2014F earnings of Rs2.4 per share. Going forward, as the debt start to decline, impact of rising interest rate will also be diluted.

5

0

800

1600

2400

3200

Jan-

09M

ay-0

9Se

p-09

Jan-

10M

ay-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2Se

p-12

Jan-

13M

ay-1

3Se

p-13

International Urea Price Local Urea Price


Production FacilitiesPlant Product Annual Capacity(MT)

Base Plant Urea 975,000

EnVen Plant Urea 1,300,000

Zarkhez NPK 150,000


About Engro Fertilizer:

Engro Fertilizers Limited was incorporated in June 2009, following a decision to demerge fertilizer concern from its parent company (Engro Corporation Limited). Engro Fertilizers Limited is a wholly owned subsidiary of Engro Corporation and a renowned name in Pakistan’s fertilizer industry. It is primarily in the business of manufacturing and marketing of urea and NPK (compound) fertilizers. With the establishment of 1.3mn metric ton state of the art fertilizer complex in 2011 the company’s annual urea production capacity stands at 2.3 MT representing 33% of entire Pakistan’s capacity. The expansion project was undertaken at a total project cost of US$1.1bn with financing from consortiums comprising of both foreign and local lenders. Engro Fertilizers’s product line comprises of urea sold under the brand name of Engro Urea and NPK, a compound fertilizer, as Zarkhez. The company, as an agent to Engro Eximp, an affiliate, is also engaged in distribution & marketing of phosphate-based fertilizers mainly DAP.

Engro Fertilizers has been engaged in the fertilizer business since 1965, when Esso Pakistan Fertilizer was established following the discovery of the Mari gas field near Daharki, Sindh. In 1978, as part of an international name change program, Esso became Exxon and the company was renamed Exxon Chemical Pakistan Ltd. Later in 1991, Exxon decided to divest its fertilizer business on a global basis. The existing Exxon employees at that time in partnership with local financial institutions led a management buyout of Exxon’s equity stake and subsequently renamed the company Engro Chemical Pakistan Ltd (ECPL). Over the years, the company has diversified by establishing several other business lines in the form of subsidiaries. Effective Jan 01, 2010, ECPL was renamed Engro Corporation and adopted a holding company structure by transferring the fertilizer business to Engro fertilizers as a wholly owned subsidiary. With its head office in Karachi, Engro Fertilizers Limited employs over 1,200 individuals.

About Engro Corporation Engro Corporation is a public listed company incorporated in Pakistan with current market capitalization of Rs73bn (US$680mn). Engro Corporation is one of Pakistan’s largest conglomerates with businesses extension from fertilizers to power generation. Currently, Engro Corporation’s portfolio consists of seven businesses that include chemical fertilizers, foods, a bulk liquid chemical terminal, industrial automation, PVC resin, power generation & commodity trade. The continual expansions & diversifications in its enterprises necessitated a broad reorganization in Engro Chemical operations and management. The main activity of the company is to manage investments in subsidiary companies and joint ventures. Engro Fertilizers, Engro Polymer, Engro Foods, Engro Eximp and Engro Power are the subsidiaries of Engro Corporation, while Engro Vopak is a joint venture.

6

Business Wise BreakupBusiness (Rs mn) Revenue PAT

Engro Fertilizers 34,422 3,234

Engro Foods 28,023 1,240

Engro Eximp 18,345 (442)

Engro Polymers 18,137 552

Engro PowerGen 8,074 1,527

Engro Vopak 1,485 890

Source: Engro Corp Presentation

Jan - Sep 2013


Mr. Mohammed Sohail CEO Dir: +92 (21) 35303333-4 [email protected]

Research Team: Mr. Asad I. Siddiqui Senior Research Analyst +92 (21) 35303330-2 Ext: 140 [email protected] Mr. Vahaj Ahmed Senior Research Analyst +92 (21) 35303330-2 Ext: 125 [email protected] Mr. Zeeshan Afzal Senior Research Analyst +92 (21) 35303330-2 Ext: 125 [email protected] Mr. Tahir Saeed Research Analyst +92 (21) 35303330-2 Ext: 133 [email protected] Mr. Salman Badami Research Analyst +92 (21) 35303330-2 Ext: 136 [email protected] Mr. Uzair Ahmed Research Officer +92 (21) 35303330-2 [email protected] Mr. Fahad Qasim Database Manager +92 (21) 35303330-2 Ext: 112 [email protected] Equity Sales Team: Mr. M. Rizwan Manager Equity Sales Dir: +92 (21) 35303337 [email protected] Ms. Samar Iqbal Manager Equity Sales Dir: +92 (21) 35370799 [email protected]

Corporate Office: 306, Continental Trade Center, Block 8, Main Clifton, Karachi, Pakistan. Phone +9221-35303330-2 Fax +9221-35303349

CONTACT US

Analyst Certification

We, Salman A. Badami & Asad I. Siddiqui, for the views expressed in this report certify that all the views about the subject matter are accurate depiction of my personal view and no part of my compensation or any other benefits, was in/will be, directly or in indirectly, related to the specific recommendation expressed in this report. Furthermore, we do not hold any beneficial.

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