Pakistan Fertilizers

Event 27th October, 2016

BRP – 116

www.jamapunji.pk

Figure 1 - GIDC Act, 2015

Sector PKR/mmbtu

Fertilizer- Feed (Old) 300

Fertilizer- Feed (New) 300

Fertilizer- Fuel 150

CPP 200

Industrial 100

KESC/GENCO 100

IPPs 100

CNG Region-1 263

CNG Region-2 200

Source: GIDC Act 2015

Aijaz Siddique +92-21-111-639-825 Ext: 109

aijaz.siddique@nextcapital.com.pk

GIDC, adding up to the uncertainties

As per the latest news flow, Sindh High Court (SHC) has ruled against the application of Gas

Infrastructure Development Cess (GIDC) on natural gas consumed by industries.

Given the fiscal gap that the absence of GIDC payments would create (PKR 150bn is the

GIDC paid by the fertilizer sector alone, PKR 202bn is the total GIDC paid to the govt.), the

most likely scenario in our view is that the government would obtain a stay order, or work out

a mechanism to continue imposing GIDC.

We highlight three possible scenarios (1) GIDC remains (base case), (2) GIDC removal

without retrospective application coupled with urea price decrease (bearish case), and (3)

GIDC removal with retrospective application (bullish case).

While retrospective application is positive for all fertilizer manufacturers, the most likely

prospective application in our view would be accompanied by a urea price reversal, which is

largely negative for EFERT and FATIMA.

GIDC case challenged by Supreme Court

As per the latest news flow, Sindh High Court (SHC) has ruled against the application of GIDC on the

natural gas consumed by industry players. The government can appeal the decision on the higher

benches of the SHC, before this decision comes under the Supreme Court’s jurisdiction. In case the

decision of the SHC prevails, we foresee a neutral to negative impact on local fertilizer manufacturers,

as GIDC removal would most likely be accompanied by a subsequent cut in urea prices either through

(1) discontinuation of current subsidies or (2) further decrease in urea prices. However, in the extremely

unlikely scenario that there is retrospective application, there would be a massive positive cash flow

impact for all manufacturers, especially FFC, FFBL and EFERT as they have paid GIDC on feed gas

and fuel gas, while FATIMA would benefit the least due to payment of GIDC on just fuel gas.

However, given the large amounts involved (we estimate GIDC of PKR 150bn has already been paid

by the fertilizer sector alone), the fiscal constraints makes retrospective application unlikely.

Base Case- GIDC remains in place

Being out of the IMF program does provide some flexibility to the government to remove GIDC.

However, there are significant fiscal constraints of both the retrospective and prospective application,

which limits the chances of GIDC removal, in our view. The government earned PKR 80bn in the

GIDC head in FY16, and have budgeted a similar amount for FY17. GIDC removal would mean this

creates a significant gap (approx. 0.3% of GDP) in the govt’s revenue each year. Even more

problematic would be GIDC removal retrospectively, as it would entail the govt. paying back approx.

PKR 202 bn to industries (0.7% of GDP). In light of this, we expect the govt. to challenge the decision

in the higher benches of the Sindh High Court first, and after that, also have the option to go to the

Supreme Court.

Figure 2 - GoP would have to pay PKR102bn

(after tax) to fertilizer manufacturers in case of

a retrospective application GIDC payments (2012-16E) PKR bn

FFC 51.09

EFERT 25.17

Fatima 0.61

FFBL 14.58

Others 10.57

Total 102.03

Source: Next Research

2

Bearish scenario-GIDC removal with no retrospective application, coupled with urea price

decline

In case the Sindh High Court decision prevails and the government has to remove GIDC, we believe the

government would negotiate a urea price revision with manufacturers and either roll-back the subsidies

being provided to the manufacturers or demand a price decrease. This move will be the most negative

for concessionary based players with limited downward revision in costs, accompanied with downward

revision in revenue. A complete pass on of GIDC cost reduction would require a PKR 370/bag dip.

However, GIDC cost increase was not completely passed-on when it was imposed, which makes the

scope of a complete roll-back limited. Thus, we also highlight the scenario where a GIDC removal

leads to a PKR 250/bag decline in urea prices, in-line with the increase at the time of GIDC imposition.

GIDC removal will negatively impact the earnings and Fatima and Efert significantly, with FFC and

FFBL standing to gain if the urea price decline is below PKR 370/bag.

Bullish Case scenario- Retrospective removal of GIDC would be a massive cash flow boast

Whilst this scenario seems the most unlikely, a retrospective application will improve the cash flow

situation of the local manufacturers immensely. FFC/EFERT/Fatima/FFBL are expected to have an

after tax cash flow/sh impact of PKR 40.2/18.9/0.3/15.6, respectively. Given the working capital

requirements of the manufacturers in the depressed commodity cycle, this would come out as a huge

relief.

Efert and Fatima may see stock price overhand till issue clears up

Although we believe it is highly unlikely that GIDC will be removed, this issue is likely to create

negative sentiment and a stock price overhand in Efert and Fatima, till there is more clarity.

Figure 3 - EPS change from GIDC removal and a urea price decline

PKR 250/bag

PKR 370/bag

EPS/sh As % of CY17 EPS

EPS/sh As % of CY17 EPS

FFC

3.21 32%

0.13 1%

EFERT

(1.07) -13%

(3.87) -46%

FATIMA*

(1.31) -38%

(1.70) -50%

FFBL**

1.03 43%

0.07 1%

Source: Next Research

*Assuming CAN prices would fall by ~PKR 200/bag to maintain discount vis-à-vis urea prices

**Assuming DAP prices would be revised down by PKR 200/bag following reversal in GIDC

Figure 4 - Retrospective application would be a huge cash flow positive

GIDC Payments PKR bn Cash flow/sh ST borrowing/sh

FFC 75.13 40.2 13.0

EFERT 37.02 18.9 8.9

Fatima 0.90 0.3 7.6

FFBL 21.45 15.6 32.5

Source: Next Research

3

APPENDIX 1

Analyst Certification: All of the views expressed in this report accurately reflect the personal views of

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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

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have investments in securities or derivatives of securities of companies mentioned in this report, and

may make investment decisions that are inconsistent with the views expressed in this report.

Rating System

Next Capital Limited employs a three tier rating system depending upon sector’s proposed weight in

the portfolio as compared to sectors weight in KSE-100 index, as follows:

Rating Sector’s proposed weight in the portfolio

Over Weight > Weight in KSE 100 index

Market Weight = Weight in KSE 100 Index

Under Weight < Weight in KSE 100 Index

Ratings are updated regularly based on the latest developments in the economy/sector/company,

changes in stock prices, and changes in analyst’s assumptions.

Next Capital Limited employs a three tier rating system, depending upon expected total return (R) of

the stock, as follows:

4

Where;

R

= Expected Dividend Yield + Expected

Capital Gain

‘R’ is before tax

Investment horizon is between six

months to twelve months

Ratings are updated regularly based on the latest developments in the economy/sector/company,

changes in stock prices, and changes in analyst’s assumptions.

Valuation Methodology

The Research Analyst has used DCF (Discounted Cash Flow) methodology to arrive at Dec-16 Target

Price.

Key Risks

Lack of implementation of the decision by Sindh High Court and subsequent status quo on the case

with the government

Rating Expected Total Return

Buy R ≥ 15%

Neutral 0% ≥ R < 15%

Sell R < 0%