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Review on Pakistan’s Fertilizers Industry

FERTILIZER INDUSTRY

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Group Members

1. Farina Ansari

2. Hira Jawaid

3. Sana Naveed

4. Umber Zareen

5. Zara Zehra

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Presentation Flow

1. Global Outlook

2. Economic Outlook

3. Sector Outlook

4. Company Outlook

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GLOBAL OUTLOOK

Global Context

Economic growth Globally is back but recovery fragile.

Unfavorable weather causes short cereal harvests in the CIS and the USA

Low grain production in the CIS and a US maize harvest well below initial expectations are driving the short-term agricultural outlook.

To meet world food, feed and bio energy demand, global cereal utilization is forecast to rise by some 2% in 2010/11

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Oilseed consumption is projected to rise firmly, by almost 5%.

Another food crisis could be looming

− On the policy side, the current focus in developed countries is on economic recovery and financial discipline.

− In developing countries, food security remains high on the policy agenda.

Global PlayersAmerica

s

Agrium Inc

CF Industrie

s

Intrepid Potash

Mosaic

Potash corp

Soquimich

Europe

Urklali

Silvinit

ACRON

Yara

Australia

Incitec

Nufarm

Asia

Taiwan Fertlizer

ENGRO

Fauji fertilizer

Middle east

Israeli Chemical

s

Saudi Fertilizer

Industries Qatar

Global Demand

The main demand driver for fertilizer is food demand which translates into demand for grains and other farm products.

Demand is rebounding firmly under the impulsion of Asia and the Americas. To meet world food, feed and bio energy demand, global cereal utilization is forecast to rise by some 2% in 2010/11

Total world fertilizer demand is forecast to rise firmly in 2010/11 by 4.7%

Rising International Prices of agriculture commodities− Consecutive year of deficit for

cotton and sugar− Drought and Floods in CIS− Export Restriction by Russia

and Ukraine− Lower expected maize yield in

USA

High Price –an Incentive for farmers to invest more.

Speculative Investments in the Industry (if withdrawn post threat)

Forecasts to 2011/12 are still very speculative due to fluctuation in price levels. The Risk is downside

Global Supply

• Globally, the fertilizer industry has operated at 82% of installed capacity, compared with 74% in 2009.

• Mosaic inc Issue to be resolved in 2011 and Ma’aden Project

− DAP prices are internationally linked

Local Demand Drivers

• Growing Population– The population growth rate stand at 1.6% 2010 est. (CIA

fact book)

• Water Availability– Adequate Rainfall in 2010

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Excess Demand Situation-Seller is the king

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Low Crop Yields

− According to Nation Master Pakistan ranks 46th in the world in terms of fertilizers consumption, where its fertilizer usage per hectare is 115 kgs

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Commodity Support Prices

Attractive wheat support price of Rs.950 per 40 kg.

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• Surging Grain prices

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Fertilizer Prices are low

― Reduction in Urea & DAP prices

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Economic Outlook

Economic Outlook

Fertilizer is strongly linked to agriculture in Pakistan

The Agriculture sector is the second largest sector, accounting for 22% GDP.

It remains by far the largest employer, absorbing 45 percent of the country’s total labour force.

Agricultural growth variation of 6.4 % to 1.1 % over past 5 years.

The volatility in agricultural growth is mainly caused by crop sector which is associated with the vagaries of mother nature, pest attacks, adulterated pesticides, improper use of fertilizers etc.

The total contribution by the fertilizer manufacturers to the farming community has been Rs. 266 billion over the past 5 years.

The domestic production of fertilizer during the first nine months (July‐March, 2009‐10) of the current fiscal year was up by 4.5 percent.

The import of fertilizer increased by 133 percent; hence, the total availability of fertilizer also increased by 25.3 percent.

Leveraging on the Domestic Economy

“Fertiliser sector gains from favourable government policies such as high crop support prices and gas subsidies”

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Wheat support price have almost doubled to PRs950/bag from Rs525/bag in the past three year

Farmers have also enjoyed huge subsidy on local urea, with the manufacturers and the government providing a total subsidy of about PRs400 bn since 2006, in the form of lower urea prices

Net benefit of Rs 62 billlion

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Leveraging on the Domestic Economy

Due to 20 percent gas curtailment to the fertilizer companies, the production of fertilizer is much affected, which resulted into its higher prices in the country. 

The prices could further go up in the coming weeks if the Government did not review the gas curtailment plan, otherwise it would import huge quantity of urea,” said a representative of a fertilizer company while talking to The Nation on Friday. 

….but gas curtailment remains a key risk..

Gas curtailment plan affecting fertilizer productionBy: Imran Ali Kundi | Published: November 20, 2010, The Nation

Fertilizer Policy 2001

Concessional feed gas allowed under the 1989 Fertilizer Policy to companies that undertook expansion will be continued until their 10 year period is exhausted.

 To facilitate new investment, a discount of 10% will be allowed on the determined price of gas i.e. the Middle Eastern Price prevailing on the date of signing of the GSA or $0.77/MMBTU which ever is higher.

Investors will be allowed to relocate second hand plant, equipment and machinery, with the same concession/exemption as applicable to new plants.

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Fertilizer Policy 2001

 If an investor undertakes an expansion, major BMR or de-bottlenecking of an existing plant, which results in increase in the production capacity of the plant, such additional feed gas shall be treated at par with a new plant for 5 years for purposes of concessions/exemptions.

NPK Fertilizers and Phosphatic Fertilizers are allowed to be imported free of duty.

Selling price of fertilizer shall remain deregulated on the understanding that while manufacturers will allow free market forces to prevail they will pass the benefits in the form of lower price of fertilizer to the farmers. 

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Flood damage has hit agri output but swift recovery next fiscal….

Flood damage has hit agri output but swift recovery next fiscal….

Output for major kharif crops cotton, rice and sugar cane (combined weight of 19% in agriculture) have all been hit with an estimated crop damage of 15-20%.

The fertiliser sector has already felt the pinch of this crop damage, as demand fell by 44%YoY during (July-August 2010).

On a positive note, though, wheat the key major crop (15% weight in agriculture) is sown in the Rabi season (October-March) and was spared from the floods.

With wheat prices rising 38% , better soil fertility and support from government in the form of free seeds and loan concessions, farmers have a strong incentive to attempt for a bumper wheat crop leading to increase in fertilizers.

10-11 Budget Impacts

• 5% tax credit facility for listing at the bourse: Engro Corporation’s long term vision of going public with its subsidiaries.

Fertilizer subsidy: Government has allocated Rs185mn as subsidy for FFBL while did not announce any subsidy on urea imports for FY11.

FED on natural gas raised to Rs10 per mmbtu: FED on natural gas has been increased by Rs4.9 per mmbtu to Rs10 per mmbtu.

2004-05 2005-06 2006-07 2007-08 2008-09 2009-100

10

20

30

40

50

Government Subsidy (Billion Rs)

UreaP&K FertilizersTotal

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Sector Outlook

SWOT Analysis

Strengths:

• Assured demand – Direct linkage of fertilizer sector with agriculture (22% GDP contribution)

• Preferential treatment – Gas subsidies and support prices (Rs.950 per 40 kg bag of wheat) lower the production cost

• Established distribution network – Ensures easy transport and availability of fertilizers even to remote areas

• Strong financial position of market players – Able to absorb gas price increases

• Political Influence of Agricultural sector – Directly beneficial for the fertilizer sector

Weaknesses

• Low capacity compared to demand

Pakistan has to import

• Black marketing activities

exploitation of price differential between local and international fertilizer prices

Uneducated end-users

majority of the farmers lack awareness about fertilizer application, crop and soil requirements, knowledge about fertilizer suitability

2010 floods

led to a decrease of 44% (July-August 2010) in fertilizer demand

OPPURTUNITIES

Expand capacity

Fertilizer demand expected to increase (surging international grain prices, post flood recovery)

Exports

New projects will result in excess supply e.g. Engro’s 1.3 mn tonne urea plant

Agricultural incentives will ease out liquidity constraints of farmers

e.g. concessional loans

• Introduction of bio-technology crops

THREATS

Gas curtailment - Key Risk!

To tackle energy crisis

Extended from May-October 2010 as supply concerns remained intact

Main concern is the extent to which price can be passed on to the consumer if there is an increase in both the quantum and duration of the curtailment

Removal of gas subsidies

Production cost will increase (local feed gas prices are at a discount of about 68-86% in comparison with US and European producers)

Rising global prices of fertilizer products

Particularly DAP prices, due to recent surge in phosphate prices

Rising environmental concerns

Harmful emissions during fertilizer production may entail adverse penalties and charges for companies

Threats (Contd)

Natural disasters

Foreign exchange risk

– Dependence on imports

PORTER’S 5 FORCES MODEL

Barriers to Entry – High

Capital intensive

Gas supply shortages

Bargaining power of Suppliers – High

Preferential treatment

Oligopoly structure

• Bargaining power of Buyers – Medium

Essential input in farming

Farmers switch in case of price hikes

• Threat of Substitutes – Very Low

- Basic input

• Rivalry – Low

- Market players work together to bridge the demand-supply gap

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KEY PLAYERS

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KEY PLAYERS

Engro Fertilizer

Fauji Fertilizer Company

Fatima Fertilizer

Fauji Fertilizer Bin Qasim Limited

Agritech

Pak Arab

Dawood Hercules

NFML

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ENGRO FERTILIZER

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INTRODUCTION TO ENGRO CORP.

Incorporated in 1965 and was formerly Exxon Chemical Pakistan Limited until 1991

Exxon decided to divest their fertilizer business on a global basis and sold off its equity of 75% shares in our company

Exxon employees, in partnership with leading international and local financial institutions bought out Exxon’s equity and the company was renamed as Engro Chemical Pakistan Limited

On 1 January 2010, Engro management demerged the fertiliser business and converted Engro Chemicals into a holding company - Engro Corporation

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ENGRO CORPORATION

• Engro Corp is one of Pakistan’s largest conglomerate with diversified lines of businesses

Accomplished significant progress not only in its base urea fertilizer business but also in diversification projects

ENGRO EXIMP

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STRUCTURE 0F CORP

Chairman Mr. Hussain Dawood

Management Directors

Shareholder Directors

Independent Directors

Board of Directors

President of Engro Corp Mr. Asad Omer

VopakMr.

Sheikh Imranulh

aq

PowerGenMr. Khalid Mansoor

FertilizerMr. Khalid

Siraj

FoodsMr.

Sarfaraz Khan

EXIMPMr. Abdul Samad

AvanceonMr. Bakhtiar

Wain

Polymer & Chemicals

Mr. Asif Qadir

DIVISIONAL CEOs

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SENIOR LEADERSHIP

ChairmanEngro Corporation Limited

• Mr. Hussain Dawood

− Chairman, Dawood Hercules Chemicals Limited, Engro Corporation Limited, Pakistan Poverty Alleviation Fund

− First Pakistani to become a member of the World Economic Forum in 1992

− Board member, Commonwealth Business Council, Pakistan Business Council

• Mr. Asad Umer

− President since January 2004

− MBA from the Institute of Business Administration

− Chairman, Pakistan Chemical & Energy Sector Skill Development Company

− Board member, Pakistan Business Council, Karachi Education Initiative, SBP, and Trustee of LUMS

− Ex- Director of OGDC, KSE, PSO

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ENGRO FERTILIZERS LIMITED – THE CASHCOW

The flagship fertilizer business is a wholly owned Engro subsidiary & a premier fertilizer manufacturing and marketing company

It remains very much at the heart of Engro Corp’s success story

Second largest producer of Urea fertilizer in Pakistan

The urea business has historically provided high margins and stable cash flows, which have been instrumental in providing the management with the platform to undertake massive expansions in both fertilizer and non-fertilizer ventures

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EFL PRODUCTS

UREA

ZINGRO

DAP ZORAWAR

PHOSPHATE

ZARKHEZ

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FAUJI FERTILIZER

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FAUJI FERTILIZER COMPANY

Incorporated in 1978 as a joint venture between Fauji foundation and Haldor Topsoe of Denmark

Largest chemical fertilizer producer in Pakistan (largest market share)

Has controlling shares in FFBL

Market leader in Pakistan for both Urea (48% market share) and DAP (45-50% market share) businesses together with its subsidiary FFBL

Has 3 plants with a combined capacity of 5770 MTPD of prilled urea

Remained in the list of top 25 best performing companies of Pakistan for 14 years

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FFC BUSINESS PORTFOLIO

The investment portfolio of the Company is fairly diversified with investments in:

− Fauji Fertilizer Bin Qasim Limited (FFBL)

− Pakistan Maroc Phosphore S.A, (PMP) – Morocco

− Fauji Cement Company Limited (FCCL)

− FFC Energy Limited (FFCEL)

These investments are aimed at tapping the positive developments in the financial and industrial sectors

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FFC PRODUCT MIX

Sona Urea

Sona DAP

Sona SOP

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MANAGEMENT

Lt. Gen Hamid Rab Nawaz (retired)

− Chairman, FFC

− Distinguished career in Pakistan army spanning over a period of 37 years

Lt. Gen Malik Arif Hayat (retired)

− CEO & Managing Director, FFC

− Distinguished career in Pakistan army

Mr. Jorgen Madsen

− Director, FFC

− Engineer by profession and works for Haldor Topsoe, Denmark

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FAUJI FERTILIZER BIN QASIM

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MANAGEMENT

Lt. Gen Hamid Rab Nawaz (retired)

− Chairman, FFBL

− Distinguished career in Pakistan army spanning over a period of 37 years

Lt. Gen Malik Arif Hayat (retired)

− Director, FFBL

− Distinguished career in Pakistan army

Lt. Gen Anis Ahmed Abbasi

− Chief Executive & Managing Director, FFC

− Distinguished career in Pakistan army

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FAUJI FERTILIZER BIN QASIM

Formerly known as FFC Jordan Fertilizer Company Limited

Principal activities are to manufacture, purchase and market fertilizers

Majority of the stake is held by FFC

Pioneer and sole producer of DAP and granular Urea (Sona Urea)

Manufacturing complex located in Eastern Zone of Bin Qasim, Karachi, with Head Office at Harley Street, Rawalpindi

FFBL Urea market share in 2009 was 9.7%

FFBL DAP market share during 2009 was 40%

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OUR PICK

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Recommendation

- BUY

- BUY

- HOLD

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ENGRO FERTILIZER

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ENGRO is our preferred pick in the sector!

EFL growth: expected CAGR of 33% during 2010-13

EFL’s market share is expected to match FFC’s by 2012

− With a post expansion urea capacity of 1.3 mn t, EFL would be at par with FFC as the largest urea manufacturer with an estimated market share of 32% by 2012

− 1.3 mn t urea expansion is expected to boost the operating cash flows

− Healthy urea cash flow to tackle leverage risk

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ENGRO diversification turning to Profit

Engro Corp’s strong profitability, mainly from its fertilizer and food businesses

Investments in diverse business ventures over the last three years are gradually making their mark

Capacity expansions in subsidiaries provide long term value to Engro Corp

Engro Foods recorded profits with its UHT milk and ice cream businesses taking up 41% and 18% market share respectively

Foods registered revenues worth 15bn, even higher than EFL

Energy, Eximp & Vopak also supported the bottom line

Engro Corp’s chemical storage and trading businesses also contributed 18% and 22% respectively, to its bottom line

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New capacities adding significant long term value

Engro Corp. has invested heavily in new projects

Future Projects include:

− 1000 MW Thar Coal Block II Power project

− a DAP plant, once new expansions start delivering maximum return

All these initiatives point towards an aggressive management approach and given the excellent track record and management quality, we believe the company is likely to provide consistent earnings momentum in years to come

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IS ENGRO ALL POSITIVE?

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Potential threats to ENGRO

HIGH DEBT- a key concern for the investors

Falling DPO

Flood Effects: Fertilizer industry was hit hard in August with depressing urea offtake (down by 8%YoY in 8M2010)

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Countering the Debt Situation

Engro’s rising debt - a source of concern for investors

Engro’s debt to equity, as of June 2010, stands at 3.2x. Repayments beginning from 2012M – most of it are to be made by Engro Fertilizer Limited (EFL)

Possible Solutions:

EFL can use some of the funds raised from the recently issued TFC by Engro.

Strong cash flows from the foods business can supplement the debt retirement.

As a conglomerate, Engro enjoys the advantage to list its subsidiaries at the stock exchange in order to raise more capital.

Engro is backed by a strong Dawood group, owning a 38.1% stake in Engro, which can step in to manage short term cash flow problems of the company.

In all, our conclusion is the the entire debt situation does not appear to pose a great threat to the company’s financials; however, any deviations from the plans laid out could hinder the expected cash flows.

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Engro’s Urea Margin to exceed in 2011

Engro new plant will be enjoying 10-year special feed gas subsidy after becoming fully operational.

Engro’s urea margins are expected to average 72% during 2011-13, as the major concentration of production shifts to a cost-effective new plant.

FFC’s low-cost structure would ensure that its margins also remain high but they will be lower than Engro’s.

Table : Urea Margins for Engro & FFC

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Engro’s Low Payout Countered by High ROE

Earnings have remained strong for Engro , but there has been a drastic fall in dividend payouts, as bulk of the earnings have been retained for new expansions.

Engro focuses on organic growth

High ROE potential has fully justified such retention.

We expect the payout ratio to remain muted until 2015 as ENGRO has extensive debt servicing commitments in the medium term.

Table : Dividends Payout for Engro, FFC& Industry

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Risk Factors

Enhancement of Gas Curtailment

Commissioning of the new plant

Increase in the Interest Rates

Increase in Feed Gas Prices

Foreign Exchange Risk

Issues with other Subsidiaries

Natural Calamity

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FAUJI FERTILIZERS COMPANY

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FFC – Low Cost & High Urea Margin

Currently the Market Leader in urea (48% share of FFBL & FFC)

One of the most stable companies with consistent cash flow & strong cash-flushed books

Has consolidated its position through acquisitions and continues to churn out strong earnings

Due to a low cost base, the company enjoys one of the highest EBITDA and gross margins

Low-cost structure would ensure that its margins also remain high averaging 70% over the next three years

FFC investment in FFBL gives it exposure in the high growth segment of DAP fertilizer

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FFC Growth strategy

Focuses on Inorganic Growth

Potential acquisition of Agritech Limited (79.85% shares of the company) could add synergies and would boost the earnings outlook for the company

50 MW Wind power project in Jhampir is expected to add some value

Successfully completed a 120 kt debottlenecking, along with significant investment in Pak Moroc Phosphore and Fauji Cement projects

FFC earnings are likely to see a modest average annual growth of 6% over the next five years, primarily driven by an increase in urea prices

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FFC – The Dividend King

FFC DPO has exceeded 100% over last four years

High payout ratio caters to the income need of the majority of the shareholders

Shareholding structure of FFC: 44% stake held by Fauji Foundation

Fauji Foundation, a charitable trust, relies heavily on dividends from its investments

Therefore, we expect a DPO of 90% going forward

However, potential acquisition of Agritech, a smaller peer could result in some cut back in dividends over the medium term

Nonetheless, given the stable nature of the urea business, this could eventually result in significantly higher payouts subsequently

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Risk Factors

Gas shortages in the country

Lending support to associates and subsidiaries

Increase in feed gas prices

Foreign exchange risk

Operational risks emanating from old plants

Natural Calamity

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FAUJI FERTILIZERS BIN QASIM LIMTED

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FFBL - HOLD

FFBL deals in Granular Urea and DAP

FFBL is the sole producer of DAP and for DAP it imports phosphorus from Morocco

FFBL is a price taker since its commodity prices are linked with the international market

Shareholding:

Reliance on high DPO because of investor demand.

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Scenario for FFBL

Lower than expected offtakes especially due to floods throughout the country have resulted in the high inventory situation for FFBL DAP & Urea.

However there has been continuous increase in DAP prices internationally

Locally, revenues have declined recently but DAP and urea prices which have been up by 21% and 11%, boosted margins of the company.

Start of Rabi season 2010-11 - favorable weather and adequate financial support by GoP to farmers shall bring favorable impact on FFBL sales

Massive growth in Other Income largely attributed to its JV, PMP (JV PMP was a Joint venture of a group of Morocco, OCP with FF, FFC and FFBL)

The profit has been a result of high phosacid prices and declining input costs (low sulphur and phosrock prices).

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Risk Factors

Gas shortages in the country

Unexpected pressure from competitors

Increase in feed gas prices

Increase in phosphoric acid cost without concurrent

increase in DAP prices could erode DAP margins

Natural Calamity