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Morning Call about Fauji Fertilizer Company Limited – Arif Habib Limited

Karachi: Negatives are overplayed; Buy

Amid all the noise of possible reduction in Urea prices and imposition of Gas Infrastructure Development Cess (the Cess), the stock of Fauji Fertilizer Company Limited (FFC) has lost its vigor by 17.9%, underperforming the benchmark index by 14.5% since start of November 2011.

According to Arif Habib Limited is of the view that the market has overplayed the above mentioned negatives as positives like strong dividend yield, relatively lower risk of gas curtailment and upwards revision in Urea price due to persistence gas curtailment are still intact.

Cess imposition; a pass through?

Imposition of the Cess and uncertainty regarding its pass through impact has downplayed on the stock price of FFC. After the imposition of the Cess, price of feed gas would take a leap of 194% to PKR 300/mmbtu. This would require a PKR 200/bag price increase for FFC to keep the margins intact. Arif Habib Limited is providing an earnings sensitivity regarding the Cess pass through impact on the stock of FFC.

Zero Pass through; if the company is unable to pass through the impact of rising cost due to the Cess, it is likely to erode its CY12 earnings by 26.1% to PKR 20.4/share.

Gradual Pass through; Arif Habib Limited does not rule out the possibility of gradual increase in the Urea prices to pass through of the impact of the Cess. ENGRO had to face a stern action by the government, when they increased Urea prices by PKR 400/bag in one go. Keeping that in mind, fertilizer manufacturers are likely to pass through this rising cost impact gradually. Assuming complete pass through by 2HCY12, Arif Habib Limited’s CY12 earnings could slash by 3% to PKR 26.8/share.

 

Earnings Sensitivity (PKR/share) CY11 CY12 CY13
Base Case  24.90  27.69 28.99
Zero Pass through  NA 20.47 20.71
Gradual Pass through NA 26.85 28.99
Source: AHL Research

 

Persistence of gas curtailment may keep Urea prices downwards sticky

Rising gas demand from domestic sector and strong lobbying by the Textile sector caused disruption of gas supply to the fertilizer plants on the SNGP’s network. Fertilizer manufacturers had reduced the urea price by PKR 100/bag on the condition of uninterrupted gas supply till December 31, 2011. Thus, Arif Habib Limited does not rule out the possibility of another price hike by ENGRO, which in turn will benefit the FFC.

Negatives are overplayed; Buy

Arif Habib Limited eyes the recent price decline as an opportunity to take long position in the stock, which at current price levels offers an attractive upside potential of 50%. Besides this sizeable upside potential the stock is trading at attractive PER and dividend yield of 5.7 and 16.4%, respectively based on CY12F earnings estimates.

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