Aug-16 Sep-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 May-17 Jun-17 Jul-17 Fertilizer Sector Report Pressure on margin set to continue; Maintain Marketweight Chemical sector Performance 3M 6M 12M Absolute % -4% -11% 4% Relative to KSE % 0% -6% -15% Chemical Sector vs. KSE100 Source: PSX 40% Chemicals KSE100 Index 30% 20% 10% 0% -10% Source: PSX Provisional Fertilizer Offtake for Jul 17 (000' tons) Jul 17 MoM YoY Urea FFC 137-65% -56% EFERT 74-77% -73% FATIMA 31-62% 6% FFBL 43-51% -50% NFML 46-6% NA Industry Total 340-68% -0.56 DAP FFBL 72 482% 6% FFC 56 348% 489% EFERT 70 154% 2% Industry total 220 97% 0.11 Urea Exports FFC 18 300% NA EFERT 50 19% NA Industry Total 70 36% NA REP-005 www.jamapunji.pk Latest updates on urea prices and sales are not encouraging. Provisional offtake numbers for Jul 17 indicate expected decline in urea sales by 68% MoM on the back of high base effect in anticipation of reduction in cash subsidy while DAP offtake jumped by 97% MoM. Despite peak demand season, prices remained under pressure ranging between PKR1,200-1,280/bag, with NFML being an exception (MRP of PKR1,000/bag). We believe price pressure on both export and domestic front is likely to weigh on margins for our fertilizer universe in 2H17. We maintain our Marketweight stance on the sector with Engro Fertilizer (EFERT) as our top pick given company's low cost of production enabling it to weather the pricing pressures better than its peers. Lower urea and higher DAP offtake witnessed in Jul 17: As per our channel checks, Urea offtake for Jul-17 dropped 68%/56% MoM/YoY to 340k tons owing to (i) high-base effect, and (ii) sowing season for Kharif approaching its end. DAP offtake, on the other hand, is expected to jump by 97%/11% MoM/YoY to 220k tons fully reflecting the seasonal growth. On a cumulative basis, Urea/DAP offtake increased by 17%/18% YoY to 3.04/0.81mn tons in 7MCY17.Urea inventory for the month is expected to surge slightly to 1.15mn tons (20% of annual sales) with FFC holding the highest inventory of 475kton. Subsidy on DAP has continued unabated with certain changes in mechanism (cash subsidy substituted with GST adjustment). This allowed seasonal pick-up in DAP demand to be fully reflected on monthly sales. Exports surged 36% MoM; retention prices declined: Urea exports also shot up in Jul 17 by 36% MoM to ~70k tons, restricting the inventory pile-up from lower local off-take to some extent (inventory is expected to close the month at 1.15mn tons level). EFERT contributed to bulk of exports and managed to sell ~50k tons followed by FFC (18ktons). However, retention prices for exports remained at the lower end ranging from USD190-225/ton (1HCY17 average: USD230-240/ton). Pricing pressure on local sales remains: Despite peak demand season, urea prices remained under pressure where a PKR50-100/bag jump in prices witnessed in first week of Jul'17 did not last for long owing to limited demand and huge stock piling by dealers during Jun'17 in anticipation of changes in subsidy. Urea prices during Jul'17 ranged between PKR1,200-1,280/bag, with NFML being an exception (MRP of PKR1,000/bag). Weak margin environment may persist for now: We believe pricing pressure on both export and domestic front is likely to weigh on margins for our fertilizer universe in 2H17 where prevailing local realized prices are at a 15% premium to international prices compared to an average of 10% discount witnessed in CY16. We believe current downward trend in international prices (came off by 12-32% from its high seen in Jan 17) is likely to persist in the near-term and may put pressure on local industry in two possible ways: (i) elimination of exports on being unviable (industry s average breakeven cost stands at USD225/ton), and (ii) threat of low cost urea imports to facilitate farmers in case international prices decline by another USD5-10/ton (translating into landed cost of PKR1,200/bag vs industry s prevailing average realized price of PKR1,300-1,380/bag). That said, we believe, fertilizer industry currently faces two options: (i) export at a price below breakeven cost which we believe is more preferred option, or (ii) let go the option of exports while taking a hit in terms of inventory carrying cost where increasing stock pile will continue to haunt. Research Analyst Syeda Humaira Akhtar, FRM +92 111 262 111 www.bmacapital.com humaira.akhtar@bmacapital.com
Pricing pressure likely to impact margins in 2HCY17; top pick is EFERT Provisional offtake numbers for Jul 17 indicate expected decline in urea sales by 68% MoM on the back of high base effect in anticipation of reduction in cash subsidy while DAP offtake jumped by 97% MoM. Subsidy on DAP has continued unabated with certain changes in mechanism (cash subsidy substituted with GST adjustment). This allowed seasonal pick-up in DAP demand to be fully reflected on monthly sales. Urea exports also shot up in Jul 17 by 36% MoM to ~70k tons, restricting the inventory pile-up from lower local off-take to some extent (inventory is expected to close the month at 1.15mn tons level). We believe price pressure on both export and domestic front is likely to weigh on margins for our fertilizer universe in 2HCY17. We maintain our Marketweight stance on the sector with Engro Fertilizer (EFERT) as our top pick given company's low cost of production enabling it to weather the pricing pressures better than its peers. Lower urea and higher DAP offtake witnessed in Jul 17 As per the provisional numbers, Urea offtake for Jul-17 dropped 68%/56% MoM/YoY to 340k tons owing to (i) high-base effect where Jun 17 sales marked the highest ever offtake for fertilizer industry as dealers built-up inventories in anticipation of decline in subsidy from Jul 17, and (ii) sowing season for Kharif approaching its end. DAP offtake, on the other hand, is expected to jump by 97%/11% MoM/YoY to 220k tons fully reflecting the seasonal growth. Fatima Fertilizer (FATIMA) once again outperformed the industry with 6% YoY growth in urea offtake, courtesy aggressive price discounts. National Fertilizer Marketing Limited (NFML) also managed to sell 46ktons. Urea inventory for the month is expected to surge slightly to 1.15mn tons with Fauji Fertilizer Company (FFC) holding the highest inventory of 475ktons (41% of total industry inventory). On a cumulative basis, Urea/DAP offtake increased by 17%/18% YoY to 3.04/0.81mn tons in 7MCY17. Provisional Urea Exports (000' tons) Jul-17 MoM FFC 18 300% EFERT 50 19% Industry total 0 36% Provisional Fertilizer offtake for Jul'17 (000' tons) Jul-17 MoM YoY 7MCY17 YoY Urea FFC 137-65% -56% 1222-2% EFERT 74-77% -73% 893 12% FATIMA 31-62% 6% 260 152% FFBL 43-51% -50% 241 0% NFML 46-6% NA 147 924% Industry total 340-68% -56% 3041 17% DAP FFBL 72 482% 6% 336 43% FFC 56 348% 489% 144 268% EFERT 70 154% 2% 165-13% Industry total 220 97% 11% 810 18% Exports surged 36% MoM; retention prices declined Exports shot up during Jul'17, thus playing a major role in containing significant surge in stock pile following lower local offtake. Total exports during the month stood at ~70k tons which is 36% MoM jump, mainly contributed by EFERT which managed to sell ~50k tons followed by FFC (18ktons). Major exports destinations during the month include Afghanistan, Kenya, Mozambique and Africa. However, retention prices for exports 2
Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Dec-16 Feb-17 Jun-17 remained at the lower end ranging from USD190-225/ton (1H17 average: USD230-240/ton), where EFERT churned the best FOB price while others sold below the breakeven in some cases. Pricing pressure remains on home ground as well Despite peak demand season, urea prices remained under pressure during Jun-Jul'17 where a PKR50-100/bag jump in prices was witnessed in first week of Jul'17 after reduction in cash subsidy by the government (cash subsidy reduced from PKR156/bag to PKR100/bag for FY18), however the same did not last for long owing to limited demand and huge stock piling by dealers during Jun'17 in anticipation of changes in subsidy. Urea prices during Jul'17 ranged between PKR1,200-1,280/bag, with NFML being an exception (MRP of PKR1,000/bag). Urea primary margins shrinking with mounting price pressure amid sticky costs 1,800 1,600 1,400 1,200 1,000 800 600 400 200 - Gas cost Primary margin/bag Source: NFDC, BMA Research Weak margin environment may persist for now Earnings sensitivity if local urea prices decline by PKR50/bag Impact EPS (PKR) Base case (%) FFC* 9.96-9% EFERT 7.84-10% FATIMA 3.96-2% FFBL* 3.89-7% *Base case earnings are under review We believe pricing pressure on both export and domestic front is likely to weigh on margins for our fertilizer universe in 2HCY17 where prevailing local realized prices (PKR1,473/bag as of Jun 17) are at a 15% premium to international prices compared to an average 10% discount witnessed in CY16 (note that small players like Pak Arab, FATIMA etc are selling well below average industry levels and at par to current landed cost of imported urea i.e. PKR1,250/bag). International urea prices have come off by 12-32% from a high of USD280/260/ton for Middle East/China seen in Jan 17; Middle East Urea is currently trading at an average of USD190/ton while Chinese urea prices stands at USD229/ton (move to next para on intl prices). We believe current downward trend in international prices is likely to persist in the near-term and may put pressure on local industry in two possible ways: (i) elimination of exports as prevailing international prices are unfeasible for local manufacturers when compared to industry s average breakeven cost of USD225/ton, and (ii) in case international prices decline by another USD5-10/ton (translating into landed cost of PKR1,200/bag vs industry s prevailing average realized price of PKR1,300-1,380/bag and maximum retail price of PKR1,400/bag), import of low cost urea to facilitate farmers cannot be ruled out. This may also allow room for the government to cut current urea subsidy of PKR100/bag. That said, we expect pressure on 3
6-Jan-14 6-Mar-14 6-May-14 6-Jul-14 6-Sep-14 6-Nov-14 6-Jan-15 6-Mar-15 6-May-15 6-Jul-15 6-Sep-15 6-Nov-15 6-Jan-16 6-Mar-16 6-May-16 6-Jul-16 6-Sep-16 6-Nov-16 6-Jan-17 6-Mar-17 6-May-17 6-Jul-17 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Jan-17 margins for our fertilizer universe in 2H17, where industry currently faces two options: (i) export at a price below breakeven cost (a preferred option in our view), or (ii) let go the option of exports while taking a hit in terms of inventory carrying cost where increasing stock pile will continue to haunt. Local realized prices hovering at significant 15% premium to int l prices 3,800 3,400 3,000 2,600 2,200 1,800 1,400 Discount (RHS) Local Price of Prilled Urea International Price per bag 45% 35% 25% 15% 5% -5% -15% 1,000-25% International prices to remain soft Source: NFDC, BMA Research Our view of soft international prices is based on (i) significant global supply additions of 17Mt/+8% over 2017-21E (90% of planned additions will be operational by 2018), (ii) weak agronomics and ample agricultural inventories leading to marginal demand growth (1.5%p.a growth expected by IFA), and (iii) increasing supply from other countries which would nullify China s (one of the largest urea exporter) recent policy to curb exports to fulfill local demand. International urea price on a downward trajectory 450 400 350 300 250 200 150 100 50 0 Middle East Urea Chinese Urea Source: Bloomberg 4
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