AKD Securities Limited – ENGRO: Analyst Briefing Notes

Karachi, February 20, 2015 (PPI-OT): Engro Corporation Limited (ENGRO) held its analyst briefing yesterday to discuss the company’s CY14 results. Recall that ENGRO announced NPAT of PkR7.80bn (EPS: PkR13.59) in CY14, lower by 6%YoY.

In 4QCY14 alone, the company recorded NPAT of PkR2.64bn (fully diluted EPS: PkR5.07), up 32%QoQ. In addition to this, CY14 result was accompanied by a final cash dividend of PkR4/sh, taking the full year dividend to PkR6/sh. In addition, ENGRO announced a spate of strategic actions including (i) transferring Engro Eximp to EFERT and buying back Engro Eximp Agriproducts from the latter and (ii) approval for further investment into EPCL.

ENGRO has gained 5% since result announcement to trade at a trailing P/E of 21x. In this regard, AKD Securities Limited believes the market is looking towards ENGRO’s upcoming developments including ongoing de-leveraging and work on its LNG terminal which is scheduled to achieve commissioning by Mar’15. While AKD Securities Limited intends to formally revisit AKD Securities Limited’s investment case for ENGRO shortly, AKD Securities Limited believes a more focused approach will stand the company in good stead going forward.

Analyst briefing notes: Much of the discussion in yesterday’s briefing centered on several strategic steps announced by the company alongside CY14 results. Details/impacts are as follows:

ENGRO will sell its entire shareholding in its wholly owned subsidiary Engro Eximp including the latter’s 100% held UAE based subsidiary Engro Eximp FZE to associated entity Engro Fertilizers (EFERT) for a consideration of PkR4.4bn. As per management, this will increase EFERT’s topline by about PkR20-PkR22bn and have a bottom-line impact of PkR500-PkR700mn (EPS impact: PkR0.37-PkR0.53).

In connection with the above, ENGRO will then purchase the entire issued share capital of Engro Eximp Agriproducts (EEAP), a wholly owned subsidiary of Engro Eximp, from the latter for a consideration of PkR4.4bn to make it a direct subsidiary. EEAP is engaged in the procurement, processing and sale of basmati rice and owns the largest integrated rice processing plant in the country.

Engro Polymer and Chemicals (EPCL), subject to regulatory and shareholder approval, has approved issuance of preference shares (by way of rights issue) of PkR4bn at a rate of 14%pa to its existing shareholders including ENGRO. In this regard, ENGRO will subscribe PkR2.24bn worth of these preference shares or, alternatively, lend PkR4bn as a long term subordinated loan to EPCL.
Management comments on individual subsidiaries are as follows:

EFERT: EFERT announced NPAT of PkR8.20bn (EPS: PkR6.29) in CY14, higher by 35%YoY. In addition to this, CY14 result was accompanied by a surprise first-ever DPS of PkR3. Key takeaways from the analyst briefing included reduction in volumetric urea sales by 4.5%YoY in CY14.

This was primarily due to lower sales in 2QCY14 (price enforcement issues leading to dealer uncertainty on margins) and 4QCY14 (poor local cotton/rice economics and late sowing of wheat). However, expected tight supply situation for the industry in 4QCY14 was ameliorated by continued diversion of Guddu gas to EFERT and timely arrival of imports.

EFOODS: Posted unconsolidated NPAT of PkR635mn (EPS: PkR0.83) in 4QCY14 vs. a loss of PkR77mn (LPS: PkR0.10) in 3QCY14. As a result, CY14 earnings stood at PkR888mn (EPS: PkR1.16), up 314%YoY (pre-tax basis: -2.5%YoY). With volumes showing an encouraging uptick and input costs on the downtrend, EFOODS appears on track to post a robust earnings rebound in CY15F, particularly as distribution efficiencies arise.

Eximp: Key takeaways included: (i) Margins are significantly depressed due to (a) sharp decline in int’l rice prices following a general fall in the global commodity prices and (b) sharp PkR appreciation vs. the US$ during 1QCY14, (ii) As at end-CY14, Eximp had ~15KT of finished equivalent rice and (iii) During the year, inventory was written down by PkR1.4bn to bring it down to NRV. Going forward, management intends to restructure the business model, with focusing on creating brand equity and reducing exposure to commodity price volatility.

EPCL: Posted Loss of PkR1.1bn (LPS: PkR 1.67) in CY14 vs. NPAT of PkR707mn (EPS: PkR1.07) in CY13. This setback was due: (i) Contraction of the PVC market due to imposition of duty on PVC pipes by Afghanistan and inventory depletion by end-users coupled with unfavorable swing in the US$/PKR exchange rate, (ii) Unfavorable vinyl chain prices especially in 4QCY14 forced EPCL to write down year-end inventory by PkR724mn to bring it down to its NRV, (iii) Higher gas price due to imposition of GIDC on gas price along with imposition of 5% duty on primary raw materials further depressed margins and (iv) Write-off of deferred tax assets of PkR387m (Minimum Turnover Tax expiring till FY18) on account of their improbable recoup ability.

Regarding EPCL’s proposed preference shares issuance, AKD Securities Limited believes this will allow the company to meet near-term debt obligations. Going forward, AKD Securities Limited expects the PVC market to remain stable while ethylene is set to track falling oil prices which should benefit the company in the medium-term.

Outlook: ENGRO has gained 5% since result announcement to trade at a trailing P/E of 21x. In this regard, AKD Securities Limited believes the market is looking towards ENGRO’s upcoming developments including ongoing de-leveraging (D/E at 52% in CY14 vs. 63% in CY13) and work on its LNG terminal which is scheduled to achieve commissioning by Mar’15.

Regarding the latter, news reports suggest the GoP has finalized an LNG import deal with Qatar at US$7/mmbtu with ENGRO set to collect tolling charges at US$0.66/mmbtu. While execution concerns remain on the company’s decision to retain the rice business (notwithstanding planned restructuring) and on plans to continue with small pilot projects (ala EFOODS’ Mabrook), ENGRO appears to be emerging as a more focused entity which, in AKD Securities Limited’s view, stands it in good stead going forward.

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