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Foundation Research Equities

10 March 2014Engro Fertilizer Ltd OutperformCurrent Price Rs 57.1 Dec 14 target Rs 70.0 Upside/dow nside % 22.5 Valuation Rs 70.0 - DCF based

Fertilizer sectorMarket cap Rs bn 74.1 30-day avg turnover US$m 3.5 Market cap US$m 716 Number shares on issue m 1,298

Investment fundamentalsYear end 31 Dec 2013A 2014E 2015E 2016E

Total revenue m 50,129 50,117 65,892 67,877 EBIT m 17,054 21,506 25,289 25,509 EBIT Growth % 153 26 17.6 0.9 Recurring pro fit m 5,498 10,627 14,237 15,187 Reported profit m 5,498 10,627 14,237 15,187

EPS rep Rs 4.2 8.2 11.0 11.7 EPS rep growth % n/a 93.30 33.98 6.67

PE rep x 13.5 7.0 5.2 4.9

Total DPS Rs 0.0 0.0 2.0 4.0Total div yield % - - 3.50 7.00

ROA % 5.3 10.0 13.2 13.3 ROE % - 26.9 35.0 33.2 Current Ratio x 1.3 1.3 1.6 2.1 Net debt/equity x 1.45 0.89 0.30 -0.01Price/book x 2.1 1.5 1.2 1.0

Scenarios on gas situation14-EPS 15-EPS 16-EPS TP

PKR PKR PKR PKR/sh

Base Case 8.2 11.0 11.7 70.0

Ex. Concession 5.5 7.6 8.1 46.5

Ex Con. & KPD 5.5 4.5 4.9 28.3

Source: Foundation Research, M arch 2014

AnalystMahad Farrukh mahad.farrukh@fs.com.pk92 21 5612290- 94 Ext 339

Engro Fertilizer Ltd

Heavy cash balance to deliver early de-leveraging Re-iterate O/P Event We lift our earnings estimate for Engro Fertilizer Ltd (Efert) by 73-76% for CY14-16 and upgrade our TP to PKR70.0 (up 54%). On our revised estimates, we believe Efert’s valuation still has room to grow despite 103% run-up since listing in Jan14. We reiterate Outperform rating (22.5% upside). Efert’s CY13 detailed accounts show stronger than expected cash balance of PKR22/15bn on gross/adjusted basis. With stronger than expected year end surplus cash balance coupled with stable production outlook, Efert should turn into dividend paying capacity by CY15, and a virtually debt free balance sheet by CY16. We estimate EBITDA of PKR 26.5/19.8/21.1bn under our base-case scenario/KPD w/o US$0.7/mmbtu concessionary prices with KPD/worst-case scenario of no US$0.7/mmbtu concessionary gas prices w/o KPD, respectively. Impact Deleveraging and excess cash to improve earnings: Engro’s high gearing has remained a constant point of concern for investors as it implies a high degree of financial risk. With the production jump in CY13 (60%), financial position has also exhibited an impressive improvement. Details on recently released CY13 report exhibits explain this turnaround where our key +ve surprise is presence of stronger than expected cash balance of PKR15bn (adjusted). We have adjusted gross cash balance of PKR22bn with the year-end stock of payable GIDC and excessive advance payment.

Two obvious implications of improved liquidity position are; (1) Efert’s ability to pre-pay a portion of its debt. Efert’s net debt/asset ratio has dropped to 33% by end of CY13 from 61% in CY12, and (2) significant drop in financial charges in medium-term incase of prepayment of debt.

Debt free balance sheet by CY16: We believe Efert will benefit from concessionary gas prices and start of gas supply from KPD over the next two years. This will significantly enhance Efert’s capacity to churn out sizeable EBITDA of PKR30bn p.a. Under our base-case scenario, we see rapid deleveraging of Efert balance sheet and expect complete debt-free B/S by CY16. We expect debt repayment in CY14 to be PKR15bn approximately which could further decrease finance cost by PKR1.6bn in CY14.

Case for additional gas supply remains strong: The case for additional gas supply to fertilizer plant is well founded, in our opinion, and hence we expect the current govt to accord approval to long-term gas supply plan envisaged and approved by the previous govt. Merits of local urea production versus import of urea are driven by its positive implications on (1) external and fiscal account and (2) maintaining stability in urea supply. However, we opine fertilizer companies including Efert will have to pay higher gas prices than earlier agreed. We have incorporated US$5.5/mmbtu gas prices for KPD in our base-case. Efert’s share of gas supply was 79mmcfd meant for its new plant Enven.

Just to recall, Economic Coordination Committee (ECC) had approved 202mmcfd of gas supply to four fertilizer plants in Dec-12. Efert has already started receiving 32mmcfd of gas supply from 5 fields with an average gas price

PAKISTAN

Engro Fertilizer Ltd March 10, 2014

2 Foundation Securities (Pvt) Limited

of US$6.53/mmbtu. Gas supply from KPD field is subject to fresh approval from the government.

Concessionary gas prices-modalities delaying implementation: Progress on recent relief on gas prices for new plant is slow due to delay in finalization of legal and procedurals modalities. We expect the arrangements to be finalized by end Mar’14 and have accordingly incorporated the impact of concessionary gas prices from 2QCY14. Under the arrangement, prices for current feedstock gas supply from Mari field have been reduced to US$0.7/mmbtu in order to honor earlier government’s commitment of providing concessionary gas prices to new urea plant, Enven, as per the Fertilizer Policy 2001.

Production outlook-not a big drop in CY14: We are not expecting a big drop in production in CY14 in case of withdrawal of 60mmcfd gas supply from Mar’14 and 20-25 days expected maintenance shut-down of new plant (likely in March). Gas supply of 60mmcfd from Mari Additional was provided to Efert on temporary basis in July’13 for about 6-months.Post withdrawal of Mari Additional gas, Efert will likely be left with 138 mmcfd of gas which would be more than enough to operate its new plant at higher load-factor. We expect a scenario where Efert will likely make effort to establish new plant’s capacity to run at above 100% load factor. We estimate CY14 production of 1.47mn tons, down 5.67% YoY and expect volumes to recover to 1.91mn tons from CY15 onwards.

Earnings revision In light of aforementioned developments and expectations, we have revised our estimates. We expect CY14 and

CY15 earnings to clock in at PKR8.19/sh and PKR10.79/sh, respectively. Our base case incorporates gas inflow from KPD in CY15 and concessionary gas rates from 2QCY14,

We have considered a few other potential scenarios as well. Keeping inflow from KPD intact and excluding concessionary gas rates, earnings estimates for CY14 and CY15 will decrease to PKR5.5/sh and PKR7.6/sh and TP will fall to PKR46.5/sh. In our worst-case scenario where gas flow from KPD is also excluded along with the exclusion of concessionary gas prices, earnings estimate for CY14 will remain intact at PKR5.5/sh as KPD is not expected until 1QCY15. In this case, earnings for CY15 are expected to decrease to PKR4.45/sh and our TP will fall to PKR28.3/sh.

Action and recommendation On our revised estimates, we believe Efert’s valuation still has room to grow despite 103% run-up since listing in Jan-14.

We reiterate Outperform rating (22.5% upside). Declining leverage, stable future production outlook and expected maiden payout from CY15 (a year earlier than envisaged before) will go a long way in delivering further stock price outperformance, in our view. The stock trades at CY14 P/E of 7x and P/B of 1.5x translating into 9.3% and 72% discount to its close peers, respectively.

Engro Fertilizer Ltd March 10, 2014

3 Foundation Securities (Pvt) Limited

PKRmn CY12A CY13A CY14E CY15E CY16E

Balance Sheet

Non Current Assets

83,123

79,563

77,006

75,228

71,704

Current Assets

14,385

30,366

25,997

36,816

43,787

Total Assets

97,508

109,929

103,004

112,044

115,492

Non Current Liabilities

55,459

62,186

47,476

39,544

31,613

Debt

48,482

55,896

41,186

33,254

25,324

Current Liabilities

26,250

22,673

19,811

22,546

21,333

Equity

15,798

25,069

35,717

49,954

62,546

Total Liabilities and Equity

97,508

109,929

103,004

112,044

115,492

Cash Flow Statement

Net profit

(2,934)

5,498

10,627

14,237

15,187

Change in NWC

3,199

10,846

(8,669)

518

(113)

Other

4,893

4,871

5,009

4,975

4,950

Operating cashflows

5,158

21,214

6,967

19,730

20,025

Capital expenditure

(1,308)

(2,452)

(3,196)

(1,427)

(1,358)

Other

(169)

1,142

744

(1,769)

(69)

Investment cashflows

(1,477)

(1,311)

(2,452)

(3,196)

(1,427)

Borrowings

(7,917)

7,415

(14,710)

(7,932)

(7,930)

Other

4,826

(9,886)

5,570

(118)

(3,990)

Financing cashflows

(3,091)

(2,471)

(9,140)

(8,050)

(11,921)

Change in Cashflows

590

17,432

(4,625)

8,483

6,677

Opening Balance

4,495

5,085

22,516

17,891

26,374

Ending Balance

5,085

22,516

17,891

26,374

33,052

Source: Company Accounts, Foundation Research, March 2014

Engro Fertilizer Ltd March 10, 2014

4 Foundation Securities (Pvt) Limited

About the company Engro fertilizer Ltd (Efert) is a public limited company incorporated on June 29th 2009 as a wholly owned subsidiary of Engro Corporation Ltd. The principal activity of the company is manufacturing, purchasing, and marketing of fertilizers. It is located in Daharki, District Ghotki. The site hosts two plants, Base and Enven namely. Base plant has an installed capacity of 975k tons per annum, while Enven has a production capacity of 1267k tons per annum.