Changing global dynamics make us Underweight on the sector. Global urea cost curve has fallen by US$50/ton in 2015

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1 Industry Update Recommendation Engro Fertilizer (EFERT) Fauji Fertilizer (FFC) Fatima Fertilizer (FATIMA) Companies Featured EFERT BUY U/P U/P BUY 2014A 2015E 2016E EPS P/E (x) DPS Div yield (%) 4% 11% 8% FFC U/P 2014A 2015E 2016E EPS P/E (x) DPS Div yield (%) 11% 12% 11% FATIMA U/P 2014A 2015E 2016E EPS P/E (x) DPS Div yield (%) 6% 7% 7% Pakistan Fertilizers November 11 th, 2015 Nitrogen bubble makes us bearish; downgrade to Underweight Changing global dynamics make us Underweight on the sector We downgrade our stance on the Pakistan Fertilizer sector to Underweight from Market-weight, as increasingly bearish global urea price outlook will limit pricing power of local manufacturers, in our view. We expect weakness in global urea prices to persist (Int l urea prices witnessed a 12% YTD) as cost of production of the marginal producer (China) has fallen. Going forward, significant low-cost capacity expansions in China and North America are expected to result in a global supply glut, specifically in Asia. For local manufacturers, we believe it will be increasingly difficult to pass-on imminent gas price hikes, resulting in margin attrition. For our fertilizer universe, we have revised earnings and TP estimates downwards by 7%-12% and 12%-14%, respectively. EFERT remains in a relatively favored position, with steep correction in recent months and second plant operations a key upside risk to estimates. Convergence of local and int l prices limits pricing power for local manufacturers The combination of (1) hefty cumulative increase of 140% in local prices in the last five years, driven by gas curtailments and gas price hikes, and (2) 33% decline in international prices in the last three years due to a change in Chinese export policies and capacity expansions in the region during 2014 have resulted in convergence between domestic and international prices, for the first time in the last decade. Coupled with deteriorating farm economics (the prime reason for the breakdown in negotiations between the govt. and local manufacturers post Sep-15 price hike), pricing power of local urea manufacturers is expected to diminish considerably. Global urea cost curve has fallen by US$50/ton in 2015 China s role as a marginal producer in the current supply-driven global urea market makes its cost of production the relevant benchmark for determining global urea floor prices; int l prices are extremely sensitive to the country s policy changes. During 2015, urea prices have fallen to as low as US$250/ton; this dip is largely attributable to falling Chinese cost of production, which has declined from US$ /ton in 2014 to US$ /ton currently. Cost reductions have emanated from lower export taxes (flattened to RMB80/ton), and decline in coal prices (Chinese producers use coal as feedstock). Thus, any significant short-term rebound in urea prices is unlikely, in our view. with capacity led nitrogen bubble clouding long-term urea price outlook Significant urea capacity addition (net addition: 44mn tons from ) is creating a global supply glut, particularly in Asia. We estimate global urea utilization levels to fall from 80% in 2014 to 72% by In Asia, utilization is likely to be even lower, fall from 79% in 2014 to 64% by More importantly, these capacity additions are low cost (on bituminous coal in China, and cheap gas in the US), which should create further pressure on the urea cost curve. The heavy oversupply in Asian markets will likely force out high-cost anthracite coal based urea producers in China, and further reduce the urea floor price to around US$200/ton, from US$230/ton currently. North America, at this point the second largest importer of urea, aims to attain self-sufficiency by shoring up its capacity to 17.8mn tons by 2020 from 10.1mn tons in Imminent gas price hikes will be increasingly difficult to pass-on Currently, Pakistan s fertilizer gross margins rank on the higher end compared to global peers, primarily due to historically cheap gas pricing mechanism, and excessive urea price hikes in recent years. In contrast to the global scenario, local gas prices are rising, with another hike in Jan-16 already on the cards. The upward pressure on gas prices emanates from the govt. pursuing gas tariff rationalization. Key factors driving local gas costs include 1) introduction of high cost LNG, 2) increase in well-head prices for new domestic exploration, and 3) increased allowance of Unaccounted for Gas (UFG) losses for gas distribution companies. As our base case, we have assumed a one-time hike in fuel-stock gas of PKR300/mmbtu in Jan-16, which in our opinion, local manufacturers will find hard to pass-on, creating margin and earnings attrition. We believe an increase in feedstock gas prices is less likely, as it would create significant distortions within industry players. Ameet Doulat ameet.doulat@nextcapital.com.pk Naseer-ud-din Khalid naseeruddin.khalid@nextcapital.com.pk Valuations; downgrade FFC and Fatima to Underperform, EFERT remains a Buy We downgrade FFC and Fatima to Underperform with a revised TP of PKR121/sh and PKR 46.5/sh, respectively. Earnings estimates have been reduced by 11%/12% in CY16/CY17 for FFC, and 9% for CY16 and CY17 in Fatima s case. EFERT remains a Buy, owing to the sharp decline in stock price (-14.3% in last 3 months), and potential upside from second plant operations. However, EFERT s TP has also been reduced to PKR 105/sh, and earnings by 8%/7% in CY16/Cy17. Key risks Key risks to our investment thesis include: (1) prospective removal of GIDC followed by a urea price decrease; and (2) drastic increase in bituminous coal prices which will lift up the global cost curve from current levels.

2 Key Charts Figure 1 Convergence of local and int l urea prices will limit local manufacturers pricing power Figure 2- as will deteriorating farmer economics (fertilizer cost as % of revenue for major crops much higher than 10-yr average) Source: Bloomberg/NFDC/Next Research Source: Next Research Figure 3 Relaxed export tax policy and lower coal prices have lowered China s urea cost by approx.us$50/ton in CY15 Change (US$/ton) Export taxes 34.0 Coal price 13.0 Yuan deval 8.0 VAT (5.0) Change in Cost ($/ton) 50.0 Source: Bloomberg, Next Research Figure 4 250/ton pushing the global urea cost curve to US$225- Source: Argus FMB/Next Research Figure 5 Global capacity additions to keep utilization levels depressed Figure 6 Expansions mainly on low cost bituminous coal, which can further lower the Chinese cost curve, going forward Mn tons FY14 FY15 FY16 FY17 FY18 FY19 5yr CAGR Capacity % Demand % Surplus Utilization 80% 72% 73% 72% 72% 72% Source: IFDC/IFA/Argus/Next Research Figure 7 FFC to witness the greatest earnings dip in our base case scenario of fuel-stock price increase of PKR 200/mmbtu in Jan-16, assuming no pass-through New Old TP EPS Old New % FFC % FATIMA % EFERT % Source: Next Research 2

3 Convergence of local and int l prices limits pricing power for local manufacturers Domestic and int l urea price convergence makes international pricing relevant Historically, local urea prices remained at a significant discount to international prices, thus Pakistan fertilizer manufacturers have hardly been impacted in terms of margins or pricing power due to global price movements. That is now changing, with domestic urea prices in Pakistan increased by 140% in the last five years owing to (1) gas curtailment in , which led to a price increase of PKR /bag, (2) imposition of GST in 2012, and (3) increase in gas prices (base cost + introduction of GIDC) since 2013, which have also largely been passed on. In contrast, global urea price have been on a downtrend, down 14% YTD and 33% in the last three years. Resultantly, the discount between local and international urea prices has been largely eliminated, for the first time in the last decade. In our opinion, the international pricing scenario will now have a significant bearing on local urea pricing. As outlined in the section below, we believe international urea prices will remain under pressure for the medium to long-term. This will make it difficult for local manufacturers to raise urea prices as well. Figure 8 Local prices, which traded at a discount of 15-67% discount between 2005 and 2014, are now close to int l levels Figure 9- Local urea price have increased by 140% in the last 5 yrs on the back of gas curtailments and gas price hikes * Inc. in gas cost (PKR/bag) Inc. in urea prices (PKR/bag) *2015 gas and urea prices increased for 3 months Source: NFDC/OGRA/Next Research Source: NFDC/Bloomberg/Next Research Deteriorating farmer economics also limit pricing power Deteriorating farmer economics (due to the slump in commodity prices) is another key factor that diminishes urea manufacturers pricing power; this is the main reason for the breakdown in talks between urea manufacturers and the govt. post PKR165/bag urea price hike in Sep-15. Urea manufacturers project the price hike as a passing on of the gas price increase, whilst the govt. is reluctant to accept higher urea prices in the backdrop of poor farm economics. The impasse has resulted in extremely weak urea sales in Sep-Oct, and if not resolved in time, can impact urea sales in the peak Rabi season. As the graph below highlights, fertilizer cost as a % of wheat revenue is at 23%, compared to an eight year avg. of 19%. For cotton, fertilizer cost is 23%, compared to a 10yr average of 19%; for rice, fertilizer cost is 35% currently, versus a 10yr- avg. of 25%. As the recently announced PKR 400bn farmer package indicates, the govt. is looking to appease the extremely important political constituency of agriculture. Further increase in urea prices may be extremely difficult to institute, in this backdrop. Figure 10 Fertilizer input costs as % of revenue is much higher than the 10-yr avg. for key crops Figure 11- as primary margins for fertilizer manufacturers continue to remain on the higher side PKR/bag Primary margin (old plants) 630 1, , Primary margin (new plants) 621 1,132 1,343 1,371 1,424 Source: NFDC/OGRA/Next Research Source: Next Research 3

4 Global urea cost curve has fallen by US$50/ton in 2015 With significant capacity additions in the last couple of years, and more on the way, urea is in a supply-driven market, where the floor price is determined by the marginal cost producer. At this point, China is the world s marginal cost producer, and thus determines the floor price for urea. The international urea pricing outlook is bearish as 1) decline in urea prices, explained by lowering of Chinese cost of production and policy changes, 2) significant low cost capacity additions, coming online over the next couple of years, to decline the cost curve further, and 3) self-sufficiency in key import markets in North America will make China more aggressive on the export front. Changes in China s policies: The key reason behind recent dip in urea prices Global cost curves have declined in 2015 Urea prices have slipped by 12% YTD in 2015, falling as low as US$250/ton, and whilst it is tempting to see this as a part of the global commodity sell-off, we find that it is actually the result of a decline in Chinese cost of production. China s status as the marginal producer in a supply-driven market makes urea prices highly vulnerable to Chinese cost of production. 111 Figure 12 Floor price of urea ranged between US$ /ton in 2014 Source: Argus fmb/next Research 111 Figure 13 however, changes in export tax & coal prices have reduced the floor to US$230ton in 2015 Source: Agrus fmb/next Research 4

5 due to decreasing Chinese cost of production This year, 1) reduction in export tax, 2) decline in coal prices, and 3) weakening Yuan have reduced the production cost of Chinese urea manufacturers. The combination of these three factors has reduced the cost for Chinese urea exports by approx. US$55/ton, whilst VAT imposition has led US$5/ton increase. On a net basis, the cost of production for Chinese producers is down to US$230/ton during 2015, from US$280/ton in Subsequently, global urea prices reflect the said decline. 111 Figure 14 Policy changes and declining coal prices have reduced Chinese costs by US$50/ton Trend Effect on costs Change (US$/ton) Export taxes Decline Decrease Coal price Decline Decrease Yuan deval Decline Decrease 8.00 VAT Increase Increase (5.00) Change in costs (US$/ton) Source: Next Research Export tax: changing policy a sign of the times China s share in the global trade flow has strengthened, on the back of changes in export tax policy over the last two years. In 2015, the export tax is now a flat RMB 80/ton throughout the year, compared to 15% + RMB40/ton for peak season in This last decline resulted in US$34/ton cost saving for manufacturers in As a result, China s exports have further surged by 30% YoY in 8MCY15 with the peak season yet to start. Currently, China holds 7-8mn tons of inventory according to our channel checks, which is expected to keep exports on the higher end in the peak season of Nov-Dec. During 2014, exports had surged by a massive 64% YoY (to 13.6mn tons) as a result of relaxation in export tax in the peak season (Nov-Jun) to 15% + RMB40/ton, versus 77% in With a supply glut in their home market, and the govt. restricting demand growth to a mere 1% due to environmental reasons, we can reasonably expect further relaxations in export tax in 2016 and beyond. Figure 15 Favorable export policies have resulted in China becoming a significant export player Figure 16- with 2015 net exports expected to clock in massive growth of 132% YoY Source: Bloomberg/Next Research Source: Bloomberg/Next Research Declining coal prices creating further downward pressure Unlike most parts of the world, local manufacturers in China use coal as a feed-stock fuel. Anthracite coal and bituminous (thermal) coal have witnessed 23%/32% decline in prices in 2015, which is another key driver of reduction in production cost. Figure 17 Anthracite and thermal coal have dipped 23%/32% in the last 12 months Figure 18- resulting in urea price decline of 10%/17% in Guangdong and Black sea prices Source: Bloomberg/Next Research Source: Bloomberg/Next Research 5

6 Capacity led nitrogen bubble clouds long-term urea price outlook Demand unable to keep pace with rapidly rising supply As per International Fertilizer Development Centre (IFDC), total urea capacity is expected to grow at a CAGR of 3.8% through F to 258mn tons from 214mn tons, in The bulk of the expansion is coming from China (mainly to cater export demand) followed by North America (to achieve self-sufficiency). However, demand is expected to grow at a sluggish CAGR of 1.7% through the same period, with China s govt. policy to cap local fertilizer growth to 1.0% through F. Resultantly, global capacity utilization will fall to 72% in CY15, and is not expected to recover anytime soon. Figure 19 Capacity utilization to remain low, with supply growth (5yr CAGR:3.8%) to outpace demand growth (5yr CAGR: 1.7%) Mn tons FY14 FY15 FY16 FY17 FY18 FY19 5yr CAGR Capacity % Demand % Surplus Utilization 80% 72% 73% 72% 72% 72% Source: IFDC/IFA/Argus FMB/Next Research Figure 20 with China leading the race in terms of expansion FY13 FY14 FY15 FY16 FY17 FY18 FY19 North America 9,034 9,050 9,050 9,759 10,982 11,642 11,642 Latin America 7,883 8,023 8,749 10,599 11,482 11,482 11,482 Western Europe 5,703 5,703 5,703 5,703 5,703 5,703 5,703 Central Europe 4,571 4,571 4,968 4,968 4,968 4,968 4,968 Eurasia 16,171 16,251 16,251 18,436 19,954 19,954 21,326 Africa 7,679 13,047 14,393 20,183 20,183 20,183 20,183 Asia 153, , , , , , ,411 Oceania Total 204, , , , , , ,225 Source: IFDC/IFA/Argus FMB/Next Research Oversupply situation magnified in Asian markets Capacity utilization levels for the Asian region are expected to fall dramatically to 61% by 2016, from 79%, last year, vis-à-vis rest of the world s (ROW) utilization. The major reasons for this are 1) bulk of global capacity additions in China, 2) capped Chinese demand, and 3) reducing exports from Asia as some key importing nations achieve self-sufficiency. Figure 21 Capacity expansions to result in oversupply Figure 22- with Asia in particular facing a large surplus Mn tons FY14 FY15 FY16 FY17 FY18 FY19 Asia Others Total Source IFDC/IFA/Next Research Source: Bloomberg/Next Research 6

7 Chinese expansions on lower cost bituminous coal to further create a drag on the global cost curve The shift in the mix of the Chinese urea industry towards bituminous coal plants( to rise to 37% by 2020 from 17% in 2013) is likely to put further pressure on the urea cost curve, going forward, as bituminous coal is significantly cheaper than anthracite. The share of bituminous is rising as most of the expansions are based on it, as well as continued conversion of plants from anthracite to bituminous. Moreover, a total of nine to ten urea projects have been scheduled to come online in 2015 (five of which have already started commercial operations), which is expected to increase Chinese urea capacity by 10mn tons to a total of 90mn tons. However, the dip in cost curve has made it unfeasible for many high cost anthracite based producers to operate, with reports suggesting 20-22mn tons of anthracite based capacity will be idled by the end of this year. Figure 23 High-cost anthracite based plants dominated China s urea landscape in 2002 Figure 24 however, the shift towards lower cost bituminous coal is evident in 2013 Figure 25 which rises further to 37% from both expansions and conversions Source: Integer research/next Research Source: Integer research/ Next Research Source: Integer research/next Research Key importing nations moving towards self-sufficiency Besides China, capacity additions in North America are also expected to have an indirect but significant impact on the global cost curve. The USA, currently the second largest importing country, is expected to set up ten units by 2020 and shore up its nitrogen based capacity to 17.8mn tons from 10.1mn tons in As a result, imports are expected to fall sharply post these expansions. During 2014, USA imported its highest ever quantity of 8mn tons; Saudi Arabia and China exported 4mn/1mn tons, respectively. USA s attempts to move towards self-sufficiency are thus expected to result in an over-supplied market with both Saudi Arabia and China looking for alternative markets to channel their North American exports. Whilst Brazil could have been a potential market for both, Algeria s capacity expansion of 2.4mn tons (1/3 rd of current capacity) will target to cater to that demand as well. Algerian feedstock gas cost goes as low as US$0.5/mmbtu making it one of the cheapest producers in the world. 7

8 Imminent gas price hike likely to lead to margin attrition Gross margins of Pakistan fertilizer manufacturers have been on the higher end compared to global peers, primarily due to historically cheap gas pricing and significant urea price hikes in the last five years. However, given (1) rising gas prices; and (2) inability of local manufacturers to pass on cost increases; gross margins of Pakistan Fertilizers are expected to remain under pressure, going forward. Figure 26 Low gas prices have kept Pak fert margins in the top 5 globally Source: Integer, Next Research Further gas price hike in the offing The govt. of Pakistan has committed to the IMF that it will continue to pursue gas tariff rationalization (market based pricing), and in this regard, another gas price hike is expected in Jan-16. Given that (1) LNG s total cost would be in excess of US$10/mmbtu and (2) revision in well-head gas prices as per petroleum policy 2012 will provide prices ranging between US$5-7/mmbtu for new exploration; weighted average gas prices will continue to rise. Historically, avg. well-head gas prices in Pakistan have been US$2.5-3/mmbtu. makes cost pass-through difficult given the int l price outlook and deteriorating farm economics As int l prices are expected to remain depressed going forward, and farm economics are weak, gas price passthrough will be difficult, and margins of fertilizer manufacturers are expected to witness some pressure, going forward. With new plants (Fatima and Engro Enven) having 10 year exemption from any base price and/or GIDC increase on feedstock as per fertilizer policy 2001, we believe that in order to meet its revenue targets and create a level playing field in the sector, the govt. would focus on increasing fuel-stock gas price, going forward. However, given the difference in usage, the quantum of fuel-stock gas increase would have to be significant, so as to compensate for the lack of revenue from feedstock. While uncertainty continues as to the eventual outcome, we believe two key scenarios are probable: Scenario 1 (base case): Only fuel-stock gas cost increases; no pass-on Our base case assumes a cumulative fuel-stock gas price hike of PKR300/mmbtu in Jan-16 comprising of (1) PKR140/mmbtu increase to make up for the revenue decline from PKR75/mmbtu feedstock reversal in Sep-15, and (2) a PKR160/mmbtu further price increase in Jan-16 in line with IMF requirements. Our back of the envelope calculations suggest that PKR75/mmbtu increase in feedstock was estimated to bring in annual revenue of PKR5.0bn from FFC, FFBL, EFERT and FATIMA. We feel that a substantial increase in fuel-stock gas prices is more likely, as it impacts all producers. Feed-stock price increases will create a significant distortion amongst industry players, which is why we view it as a less likely scenario. Scenario 2: Feed-stock gas and fuel-stock gas cost increases; no pass-on While we believe a feedstock gas price increase seems unlikely, as it would create significant distortion in the sector, but gradual increases in both feedstock and fuelstock will hurt earnings of FFC the most. Every PKR100/mmbtu price increase in feed and fuelstock price (assuming no pass-through) will result in earnings attrition of 11-12% for FFC. 8

9 Valuations; downgrade FFC & Fatima, maintain Buy on EFERT We downgrade our stance on Pakistan Fertilizers to Under-weight from Market-weight. We lower our TP s for FFC, EFERT, and Fatima by 14%, 12%, and 13% respectively and downgrade our rating to Underperform on FFC and Fatima. EFERT remains a Buy, mainly due to its sharp stock price decline; potential upside to estimates from its second plant post 2016 should also be highlighted. Figure 27 FFC to witness the greatest earnings dip in base case scenario of only fuel-stock price increase New Old TP Old New % FFC % FATIMA % EFERT % Source: Next Research FFC: Downgrade to Underperform on unattractive risk-reward profile We revise down our earnings estimates for FFC by 11%/12% for CY16/CY17 owing to fuel-stock gas price assumption as stated above. Thus, we downgrade our rating for FFC to Underperform. However, in the case of feedstock and fuel-stock price increase, FFC faces the greatest risk of earnings attrition; every PKR100/mmbtu increase in both feedstock and fuel-stock cost assuming no cost pass-on would result in an annualized impact of PKR3.1/sh (20%). In our base case scenario assuming only increase in fuel-stock cost, FFC currently offers a CY16-CY18 avg. div. yield of 11%, compared to a 9.2% yield on the 10 year govt. bond and trades at a forward PER of 8.9x. The risk-reward profile is unattractive, in our view, where potential downside from feedstock gas price increase is significant, and very little upside risk to our estimates exists. EFERT: Maintain Buy on sharp price decline; second plant operations an upside risk to estimates Mainly owing to the sharp price decline in recent months (down 14.3% YTD in the last 3 months), EFERT still remains a Buy, although we reduce our TP to PKR 105/sh, from PKR 119/sh, previously. We revise down our earnings estimates for EFERT by 8%/7% in CY16/CY17. EFERT currently trades at CY16 PER of 8.3x and offers a CY16-CY18 dividend yield of 11%, similar to FFC s. However, in contrast to FFC, two significant upside risks to our estimates are 1) operations of second plant (we are assuming single plant operation post CY15), which can add upto PKR 2.25/sh to our annual EPS estimates and 2) relative immunity from feedstock gas price increase. FATIMA: Positives priced in; downgrade to Underperform We revise down our TP for FATIMA to PKR46.5/sh, from PKR54/sh, previously, and downgrade our stance from Neutral to Underperform. FATIMA is expected to witness 9% earnings dip during CY16/CY17 as a result of the feedstock gas price revision. Avg. dividend yield of 7.0% for CY16-CY18 is significantly below peers. The key upside risk to our estimate is an increase in feedstock gas, from which FATIMA is shielded because of its concessionary gas rate agreement. However, our base case assumes there will be no feedstock gas price increases, as it would create huge distortions within the industry players. 9

10 Appendix Annex-I Nitrogen- The most important nutrient Potassium (K) 16% Improve Crop quality Phosphorus (P) 23% Increase crop size Nutrient characteristics Primary Benefit Application Industry Structure Annual application not always done Increase crop size Industry more fragmented, under consolidation Nitrogen (N) 61% Annual application critical Most important and commonly lacking nutrient More dynamic prices, but stable volume Source: YARA industry handbook Annex-II The Nitrogen cycle Source: CF Industries Annex III Nitrogen value chain Source: YARA industry handbook 10

11 Annex-IV Fertilizer consumption by region- five key markets Source: YARA industry handbook Annex-V Nitrogen fertilizer demand Source: YARA industry handbook 11

12 Annex-VI Nitrogen fertilizer value drivers Annex-VII Global urea trade flow Source: YARA industry handbook 12

13 Annex-VIII Top five exporting countries Source: Bloomberg, Green markets Annex-IX Monthly Chinese exports Source: Bloomberg 13

14 Annex-X Top 10 importing countries Source: Bloomberg, Green markets Annex-XI Monthly US imports Source: Bloomberg, Green markets Annex-XII Monthly Brazil imports Source: Bloomberg, Green markets 14

15 Annex-XIII Worldwide urea capacity expansions 15

16 Annex-XIII contd. Worldwide urea capacity expansions Source:IFDC 16

17 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. Next Capital Ltd Research and Sales team Research Team Sectors Contact Farrukh Karim Khan, CFA Strategy, Macros Ameet Doulat Fertilizer & Banks Muhammad Ali Cement & Power Sonia Agarwal E&Ps Ext 109 Naseer uddin Khalid Insurance, Fertilizer Ext 109 Nayhan Mohajir Automobile & OMC Ext 109 Sohaib Subzwari Consumer & Textile Ext 109 Sales Team Contact Karachi Shoib Memon Muhammad Zubair Ellahi Muhammad Shakeel Syed Faheem Raza Saad Rafi Abdul Basit Lahore Zulqarnain Khan Muhammad Yaqoob Asim Aslam Jawad Idrees 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 ac- count 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. 17

18 Exchange rate fluctuations may affect the return to investors. Neither the company nor 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. Next Capital Limited, its respective affiliate companies, associates, directors and/or employees may 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 Over Weight Market Weight Under Weight Sector s proposed weight in the portfolio > Weight in KSE 100 index = Weight in KSE 100 Index < 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: Rating Expected Total Return Buy R 15% Neutral 0% R < 15% Sell R < 0% 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 (1) prospective removal of GIDC followed by a urea price decrease; and (2) drastic increase in bituminous coal prices which will lift up the global cost curve from current levels. 18