fertilizer_sector_financial_analysis.pdf
TRANSCRIPT
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Corporate Finance
Financial Analysis of Fertilizer
Industry
Fatima Fertilizer
Fauji Fertilizer
Fauji Fertilizer Bin Qasim
Group # 5 - Members
Anwar Ul Hassan Syed Muzzamil Imam
Muhammad Arsalan Ahmed
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TABLE OF CONTENTS
Executive Summary ........................................................................................................................... 3
Risk Profile .......................................................................................................................................... 5
Investment Analysis ............................................................................................................................ 5
Capital structure ................................................................................................................................. 5
D iv i de n d p ol ic y ................................................................................................................................. 7
V al u a t i o n ........................................................................................................................................... 7
Introduction .................................................................................................................................... 7
Brief description of the companies ..................................................................................................... 8
Fatima Fertilizer ............................................................................................................................. 8
About the company .................................................................................................................... 8
Final Products.............................................................................................................................. 9
Intermediary Products ................................................................................................................ 9
Cost estimates & Plant Performance .......................................................................................... 9
Fauji Fertilizer Company Limited ................................................................................................ 11
About the Company ................................................................................................................. 11
Largest Urea producer ............................................................................................................. 11
Production Efficiency .............................................................................................................. 12
MIRPUR MATHELO-Urea Production (met Tons/Year) .......................................................... 14
Vast distribution networks an important plus point ............................................................... 14
Low leverage levels .................................................................................................................. 14
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Cost of equity ................................................................................................................................ 22
Cost of debt ..................................................................................................................................... 24
Cost of capital .................................................................................................................................. 26
M a rk e t v al u e o f e q u i t y ............................................................................................................ 26
De b t a n d E q u i t y r a t i o s ............................................................................................................ 26
Measuring Returns ..................................................................................................................... 27
ROE and ROC ........................................................................................................................... 27
Future outlook ......................................................................................................................... 28
C o nc l us i o n s .................................................................................................................................... 30
Current financing mix ...................................................................................................................... 31
FFBL .............................................................................................................................................. 31
FATIMA ......................................................................................................................................... 31
FFBL .............................................................................................................................................. 31
Current Cost of Capital / Financing Mix .......................................................................................... 48
Cost of Capital at Different Financing Mixes .............................................................................. 49
Quantitative Analysis ...................................................................................................................... 50
Current Dividend Policy .............................................................................................................. 50
Fatima Fertilizer .......................................................................................................................... 58
FFC BIN QASIM ............................................................................................................................. 58
Valuation models ............................................................................................................................ 58
Valuation model and inputs. ....................................................................................................... 59
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EXECUTIVE SUMMARY
21% of Pakistan’s GDP is backed by the agriculture sector and a hefty 62% of country’s population is
directly or indirectly dependent on agriculture. The Agriculture sector’s strong linkages with the rest of
the economy are not fully captured in the statistics. While on the one hand, the sector is a primary
supplier of raw materials to downstream industry, contributing substantially to Pakistan’s exports, on
the other, it is a large market for industrial products such as fertilizer, pesticides, tractors and
agricultural implements. A thriving agriculture sector is also essential to the prosperity of
manufacturing sector of the economy which mainly consists of agro based industries such as textiles,
sugar, food etc.
Fertilizers are substances added to soil to improve the growth of plants, as well as their yield. Fertilizer
industry in Pakistan is dominated by two main products; urea (nitrogen based product, accounting for
66% market share) and DAP (phosphorus based product, having 19% market share). Country’s annual
urea demand is approximately 6.5mn tons with local manufacturing capacity being 5.0mn tons. Delta
demand is met through imports. While Fauji Fertilizer Bin Qasim is the sole producer of DAP in
Pakistan, accounting for 42% of local DAP market share, whereas the remaining 58% demand is met
through imports.
Due to this high dependence ratio on agriculture sector, Government has always maintained a
transparent and consistent policy for fertilizer industry regarding, a) fresh investments, b) input prices,
c) supply of inputs. After domestic consumers, fertilizer industry is placed at priority list when it comes
to rationing of gas. The largest domestic urea producing companies receive their gas supply from Mari
Gas field. Mari field gas is not pipeline quality due to which there is limited risk of gas diversion, even ifthere is shortage of gas in other segments.
The government sets minimum purchase prices of major crops (wheat, paddy, sugarcane). In the
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in FY92). Likewise, the year following 1992 floods, nitrogen application growth slowed down to +1%
while phosphate demand slipped to -5%. A potential positive for the longer term is that the present
increase in dams’ water level may actually bode well for agricultural growth and fertilizer demand oneyear out where lower than mean water availability has stunted growth in major crops in the last couple
of years.
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RISK PROFILE
FIGURE 1: RISK PROFILE
We used beta to estimate the exposure of each company to market risk. The results reflect the
fundamental characteristics of each company and in particular variance of earnings and leverage.
The riskiest company as measured by historical regression beta is Fauji Fertilizer Bin Qasim and the
least risky is Fauji Fertilizer Limited (FFC). Because of the historical character of the regressions beta
and high standard errors of the estimates we used bottom-up betas in our further analysis.
In addition, returns on capital of each company with relation to its risk have been calculated. The top
performing companies were Fauji Fertilizer Limited and Fatima Fertilizer Limited (FFL).
INVESTMENT ANALYSIS
W d ti f t t l th t t i l i t t j t
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we computed optimal capital structures for each firm and assessed the impact on the WACC from
moving from the current capital structure to the optimal. The result was an average of 3-5%change
in the WACC value of the firms, most of this decrease comes from FFC.
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D I V I D E N D P O L I C Y
All three companies are dividend paying companies, although for very different reason,
FFC and FFC Bin Qasim pays out all almost profit in its dividend .This exhibits a great potential to
invest in both of these companies for short term gains. On the other hand Fatima Fertilizer
Limited (FFL) pays half of its profits as dividends.
V A L U A T I O N
The results from our valuations are presented in the table below:
FIGURE 2: VALUATION
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FIGURE 3: COMPANY INFORMATION
Throughout the report analysis has been presented based on information gathered from
various public sources, including statutory filings with regulatory authorities in the respective
jurisdiction, company annual reports, management presentation and other publicly available
information. We have tried to acknowledge each source of information where possible. Figures
and data that are not referenced to any source has been result of our own analysis.
For computational ease the analysis for each company has been undertaken in the reporting
currency under which the company reports annual results.
BRIEF DESCRIPTION OF THE COMPANIES
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FIGURE 4
CAN and Urea have already started production. NP plant is projected to start commercial production fromDecember this year. The project is located on 947 Acres of land acquired at Plant site Mukhtar Garh
Sadiqabad, Rahim Yar Khan in the Punjab Province.
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at 69.4k tons and 23.9k tons. As per the mgmt., current utilization of both urea and CAN plants stands at
107% and 94% respectively.
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FAUJI FERTILIZER COMPANY LIMITED
ABOUT THE COMPANY
Fauji Fertilizer Company (FFC) was incorporated in 1978 as a private limited company, in a joint
venture between Fauji Foundation (a leading charitable trust in Pakistan) and Haldor Topsoe A/S of
Denmark. Present share capital of the company stands at PKR6.8bn. FFC has 51%, 12.5% and 13.5%
stake in Fauji Fertilizer Bin Qasim Limited (formerly FFC-Jordan Fertilizer Company Limited), Pak
Maroc Phosphor (PMP) and Fauji Cement Company Limited (FCCL) respectively. FFC commenced
commercial production of urea in 1982 with designed annual capacity of 570k tons, which has beensubsequently augmented to 1.9mn tons at present. FFC currently has 678.5mn shares outstanding
out of which 44% shares are held by Fauji Foundation, being the largest shareholder of the
company.
FFC is involved in manufacturing & sale of urea, and also imports and sells phosphate fertilizers.
Fauji holds 50.88% share in Fauji Fertilizer Bin Qasim (FFBL), a listed company involved in
manufacturing and sale of urea and DAP. FFBL is the only DAP manufacturer in the country. FC alsohas joint-venture investment with OCP of Morocco in phosphoric acid manufacturing operations
(Pak Maroc Phosphore). PMP is a USD 240mn project with FFC holding 12.5% of the equity.
SONE UREA
Most widely used fertilizer in the country. Fertilizer is white in color, free flowing, readily soluble in
water and both contain 46% Nitrogen. Because of its high solubility, it is suitable for solution
fertilizers.
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The company has a production capacity of approximately 1.9mn tons. Being the largest urea
manufacturer, FFC benefits from economies of scale, and as a result has the best gross, operating
and net margins in the industry.
FIGURE 5: FIVE YEAR AVERAGE MARGIN
PRODUCTION EFFICIENCY
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1986 594,901 104.36 - - 594,901 104.36
1987 632,079 110.89 - - 632,079 110.89
1988 637,737 111.88 - - 637,737 111.88
1989 632,972 111.04 - - 632,972 111.04
1990 652,665 114.50 - - 652,665 114.50
1991 629,266 110.39 - - 629,266 110.39
1992 648,178 102.55 - - 648,178 102.55
1993 657,376 94.58 477,339** 95.85 1,134,715 100.41
1994 678,114 97.57 659,526 103.86 1,337,640 100.57
1995 680,062 97.85 700,031 110.24 1,380,093 103.76
1996 710,862 102.28 695,749 109.56 1,406,611 105.76
1997 773,048 111.22 734,275 115.63 1,507,323 113.33
1998 742,599 106.84 682,969 107.55 1,425,568 107.18
1999 726,723 104.56 734,689 115.69 1,461,412 109.88
2000 729 864 105 01 695 938 109 59 1 42 5802 107 20
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MIRPUR MATHELO-UREA PRODUCTION (MET TONS/YEAR)
Base Unit Expansion Unit Total
Years Production
Capacity
Factor (%
Design)
Production
Capacity
Factor (%
Design)
Production Capacity Factor
(% Design)
2002 59,886* 102.91 - - 590,886 102.91
* FFC acquired 100% management control of PSFL-Mirpur Mathelo
effective from July 1,2002
Source: http://www.ffc.com.pk/contents/manfacturing.htm
VAST DISTRIBUTION NETWORKS AN IMPORTANT PLUS POINT
FFC being the current market leader in urea, has the most stretched out distribution network. The
company has its outreach in all four provinces with market leadership in Punjab, Baluchistan and
NWFP provinces, whereas the company’s prime competitor Engro only has a strong hold in Sindh
region. FFC also markets FFBL’s products through its distribution setup. The company charges
commission for marketing these products. This ensures that FFBL is able to cost efficiently and
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GAS CURTAILMENT MORE THAN OFFSET BY PRICE HIKE
FFC and Engro have more than offset the negative impact of lost production by raising urea pricesby PKR 75/50kg bag. The price increase was calculated on the assumption of 12% gas curtailment
on Mari field based plants whereas the actual curtailment during 1h2010 has been only 4-5%. Mari
field based fertilizers plants have witnessed margin increased during 2q2010 due to lesser than
expected gas curtailment.
MULLING PURCHASE OF AGRITECH LTD
FFC is reportedly contemplating bidding for Agritech Ltd (AGL) and its 100% owned subsidiary
Hazara Phosphate Fertilizers (HPFL), as Azgard Nine Ltd, the majority shareholder of Agritech, has
decided to completely divest its 80% equity stake in the company. Agritech currently has the
capacity to produce 0.38mn tons of urea and 0.1mn tons of single super phosphate (SSP) per
annum. The company plans to increase urea capacity to approx 0.46mn tons / annum through BMR
in Cy10.
While the details on the proposed transaction are not yet available, simplistic calculation indicates
that FFC can easily fund its acquisition through leverage due to company’s low current leverage.
Assuming acquisition price is equal to prevailing market price of approximately PKR 23/share, FFC
would require approx PKR 9bn to purchase 100% equity of the target company. Given that cash and
liquid investments amounted to PKR 3.8bn as at Mar 31, 2010, out of which payment of ~PKR 2.7bn
would have been made for the 1qCy10 dividend, FFC would be left with PKR 1.1bn in
cash/investments. Assuming this as minimum cash balance required for working capital needs, it is
likely that the company takes on PKR 9bn (100%) worth of debt to fund the acquisition.
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FIGURE 6: FREE CASH FLOW TO EQUITY
BENEFITS FROM ENGRO’S COST INCREASE AND MARGIN PUSH
To mitigate its rising expansion costs, stemming from depreciating Rupee and higher financialcharges, Engro has been pushing for increase in urea selling prices. This as a result has directly
benefited FFC, as the company has followed Engro’s price hikes. The above has resulted in margin
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FIGURE 7: FAUJI FERTILIZER MANAGEMENT COMPENSATION
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FIGURE 9: FAUJI FERTILIZER BIN QASIM MANAGEMENT COMPENSATION
SOCIAL RESPONSIBILITY
FFC CSR
For Fauji Fertilizer Company Limited, social responsibility means facilitating communities andempowering its people. Sustainability shall always remain quintessential for the performance of
CSR. Historically, FFC has always been socially a responsible corporate entity. The Company
t t d it CSR l i 1982 b i t d i A i S i th h l i i t
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In districts Rahim Yar Khan and Ghotki, flood had crippled the lives of people of the area.
FFC thus took the task of shouldering its share of responsibility initially in flood relief effort
for the affected natives of District Rahim Yar Khan and Ghotki. Some of these relief effortswere:
Distribution of cooked food
Dry ration for families
Transport for Evacuation
Mineral & FFC filtered Drinking Water
Tents/ shelters
Cloths, Blankets & Shoes for the affected families
Soap & Washing Powder
Crockery
FFC employees voluntarily made remarkable contribution in their respective plant sites
which amounts to millions. Food, drinking water, beddings, shelters and clothing was
provided to the flood affectees in the relief phase of the operation. Medical teams from
FFC medical units performed day night service for the flood affectees in Rahim Yar Khan
and Ghotki, saving many precious lives.
REHABILITATION
FFC h t k th h ll f t ti 3 ill f di t i t R hi Y Kh d
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FATIMA FERTILIZER WELFARE HOSPITAL (FFWH)
Fatima Fertilizer Welfare Hospital (FFWH) is a key project of Company's vision towards community welfare.
The Company, under the guidance of Government of Punjab has undertaken to establish a modern welfare
hospital in the vicinity of Plant site, to cater for the needs of underprivileged of the area.
This is the first ever initiative of its kind and magnitude in private sector.
CLEAN DEVELOPMENT MECHANISM
Global warming has become the most important challenge the world is facing in the 21st century. A lot of
research and development is being done for curtailing greenhouse gas emissions. Following its accession to
the Kyoto Protocol of the United Nations Framework Convention on Climate Change (UNFCCC) in January
2005 Pakistan made the Ministry of Environment the Designated National Authority (DNA) for CDM under
the protocol. A CDM cell was created in the Ministry in August 2005.
In order to care for the environment and greenhouse effect, the Management has installed a Clean
Development Mechanism (CDM) Project on its Nitric Acid plant.
It is expected that about 1.3 million CER's per annum will accrue from the start of the project up to 2020.
Mitsubishi Corporation has assisted in implementation of the project and is now in the process of
registration of Fatima Fertilizer's CDM Project with the United Nations.
UHDE has provided the technology and equipment and also helping with the implementation of CDM for
Fatima Fertilizer.
MARKET RISK AND RETURN
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FIGURE 10
In general, none of the three firms did better than the market. These results w e r e expected for all
three as due to severe economic crises fertilizer sector facing as a whole.
To analyze the market risk of the three firms we regressed their returns against broad based
market index and used the coefficient of the regression as a measure of market risk. We us ed t w o
year daily returns for t h e r e g r e s s i o n . The choice of index reflected the marginal investor in each
company, assuming that each investor is exposed to the same market risks in their respective
-60.00%
-40.00%
-20.00%
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
3 - J a n - 1 2
3 - F e b - 1 2
3 - M a r - 1 2
3 - A p r - 1 2
3 - M a y - 1 2
3 - J u n - 1 2
3 - J u l - 1 2
3 - A u g - 1 2
3 - S e p - 1 2
3 - O c t - 1 2
3 - N o v - 1 2
3 - D e c - 1 2
3 - J a n - 1 3
3 - F e b - 1 3
3 - M a r - 1 3
3 - A p r - 1 3
3 - M a y - 1 3
3 - J u n - 1 3
3 - J u l - 1 3
3 - A u g - 1 3
3 - S e p - 1 3
3 - O c t - 1 3
3 - N o v - 1 3
3 - D e c - 1 3
Fatima
FFC
FFBL
KSE
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SLOPE OF THE REGRESSION – BETA
The coefficients of the individual regressions are the companies’ betas and are used as a
measure of the company exposure to market risk. The analysis indicates that FFBL is the company
with highest exposure to market risk (regression beta of 0.83). This is a reflection of high
indebtedness and negative and volatile earnings. FFC on the other hand have regression beta
much lower than the other two companies in the industry. The reasons behind the different risk
profiles of each firm will be examined in greater details further in the report.
R - SQUARED
R-squared of the regression provides information as to what proportion of the variability inreturns could be explained by the regression. The market non-diversifiable risk represents 17.54%,
4.044 % and 19.37% for Fatima, FFC, and FFBL respectively. The remainder is company specific,
non-diversifiable risk. While the relatively high R-squared for Fatima and FFBL could be explained
by the fact that they were small, fast growing companies during the observed period and were
facing numerous company specific challenges in establishing their business models.
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• Market risk premium (Rp)- this measure reflects the excess return to which an investor is
entitled as a compensation for the higher risk he / she undertakes by investing in risky security rather
than a riskless one
Beta – as computed above.
The cost of equity, for all companies, is defined as:
Ke = Rf + β x Rp
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The cost of equity computation is summarized in Figure below
FIGURE 12: CALCULATION OF COST OF EQUITY
Cost of Equity Fatima Fertilizer Fauji Fertilizer FFBL
Risk Free Rate 12.8% 12.8% 12.8%
Beta 0.72 0.55 0.83
Risk Premium 7% 7% 7%
Country Risk - - -
Cost of Equity 17.86 % 16.63% 18.63%
COST OF DEBT
The other important component of the cost of capital is the cost of debt. It reflects the
perceived risk of the companies by lenders and debt investors, or its credit risk. The two
components of credit risk are default risk (or the probability that a company will cease making
payments as agreed in the credit agreement) and non-recovery risk (or the probability of
recovery of the capital provided, once the company goes in default).
The cost of debt for each company has two components – a risk free rate of return and
compensation for the credit risk associated with the company. In estimating the credit risk for
h t k h
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After computing the cost of debt for each firm we computed the after tax cost of debt. The after tax cost of
debt reflects the fact that interest payable on debt is deductible from the operating income for tax purposes
and results in tax savings for the firms.
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COST OF CAPITAL
M A RK E T V A L U E O F E Q U I T Y
The market value of equity for each firm has been estimated by multiplying the
number of shares outstanding for each company by the current share price. The market values of
equity are presented in Figure below
Figure 20 Market values of equity place from excel file
Value of Equity (million) American Airlines BAA
Fatima FFC FFBL
Market Value of Equity (million) 67,200 143,762 37,364
D E B T A N D E Q U I T Y R A T I O S
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FIGURE 15: CALCULATION OF COST OF CAPITAL
The company with highest cost of capital is Fauji Fertilizer. The lowest cost of capital,
is that of F a u j i F e r t i l i z e r B i n Q a s i m .
The ability of each firm to grow and create value for its stockholders ultimately
depends on its management capability to identify and undertake projects that generate
returns exceeding the cost of capital employed. In this section we will analyze the quality of
the projects that the three companies undertake ad review the past performance of the
companies as measured by indicators such as Return on Capital (ROC) and Return on Equity(ROE).
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FIGURE 16: ROC & ROE
FUTURE OUTLOOK
The ability of any of the companies to generate positive excess returns depends on itscompetitive advantages and their sustainability in the medium and long term. In this section welook at some key indicators for the Fertilizer sector, which could help us to understand how thecompanies are positioned for the future.
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FAUJI FERTILIZER FATIMA FERTILIZER FFC BIN QASIM
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C O N C L U S I O N S
In conclusion, we believe that in the medium term FFC and FFBL can sustain competitive
advantages which will allow the company to earn return on capital in excess of its cost of capital.
Fatima Fertilizer in the other hand has been keen to invest in expansion programs aimed to
increase its capacity.
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CURRENT FINANCING MIX
Summary of the current debt structure of all three companies has been given below. As can be
observed, the three companies employ very different kinds of debt:
FFBL
FFC has outstanding a variety of debt notes, from bank debt. On one hand this is driven by the
necessity to tailor the debt to match the company’s cash flow profile and risk, which is very
specific. On the other hand this is a symptom of the financial difficulties the company has been
going through and the need to raise capital in any form it was available.
FATIMA
fatima also has debt outstanding and this is a reflection of both the early stage of the life cycle is in and
its ability to generate cash flows, thus funding growth largely with internal funds. we expect the financing
mix to change as the company continues to expand.
FFBL
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Fatima Fauji Fertilizer Fauji Fertilizer Bin Qasim
FIGURE 17
Based on the above analysis, we draw the following conclusions:
FFC and FFBL have the ability to carry higher debt ratios given the relative stability of their cash
flow profile compared to Fatima. Whereas Fatima’s debt ratio is at the correct level. FFBL’s debt
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FIGURE 18
COST OF CAPITAL AT D IFFERENT FINANCING MIXES
As the next step in our analysis to estimate the optimal capital structure we used the
cost of capital approach to compute a different WACC at each debt ratio for our companies. The
table below summarizes the result.
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QUANTITATIVE ANALYSIS
CURRENT DIVIDEND POLICY
All three companies that we are analyzing, all of them pay dividends:
FFC has kept a stable dividend policy over the past several years, with an average
dividend payout ratio of 90%.
FIGURE 20
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FATIMA FERTILIZER
The company generates and still have a dividend payout ratio of 65%. the company‘s
ROC is higher than its cost of capital and it is rapidly accumulating excess cash.
FIGURE 21
FFC BIN QASIM
The company pays out almost all of its profit in dividends.
VALUATION MODELS
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The choice of growth period reflects the sustainability of competitive advantages of each
firm as outlined in above – Investment Returns and Future prospects.
VALUATION MODEL AND INPUTS.
The valuation assumptions are.
Sales growth is only due to increase in prices due to inflation. Terminal Growth is minimal for all three
firms. Firm will refinance its existing loan at the same cost of financing.
FATIMA FERTILIZER:
FIGURE 23
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FIGURE 25
FAUJI FERTILIZER LIMITED
FIGURE 26
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FAUJI FERTILIZER BIN QASIM
FIGURE 28
FIGURE 29
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APPENDIX
FATIMA FERTILIZER BALANCE SHEET
FIGURE 30
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FIGURE 31
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FATIMA FERTILIZER INCOME STATEMENT
FIGURE 32
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FAUJI FERTILIZER BIN QASIM LIMITED BALANCE SHEET
FIGURE 33
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FIGURE 34
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FAUJI FERTILIZER BIN QASIM PROFIT & LOSS ACCOUNT
FIGURE 35
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FAUJI FERTILIZER COMPANY BALANCE SHEET
FIGURE 36
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FIGURE 37
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FAUJI FERTILIZER PROFIT & LOSS ACCOUNT
FIGURE 38