Morning Call about – ECC decision on gas pricing: Blurred silver lining for Engro!-Arif Habib Limited

Karachi, March 11, 2013 (PPI-OT): As per the media reports, the Economic Co-ordination Committee (ECC) has approved the summary moved by the Ministry of Industries regarding gas supply to Engro’s new plant from Mari Network on subsidized rates.

According to Arif Habib Limited further mores, the gas supply would be on a dedicated basis and its terms and conditions would be same as the existing SNGPL contract with Engro, gas price being the major component.

This scenario eventually brings Engro Fertilizer in the limelight as, in accordance with its contract with SNGPL, the company will receive gas at subsidized rate of USD 0.7/mmbtu. Currently, Engro is operating its new plant (Enven) on Mari gas network (gas diversion from base plant). Total gas availability to the new plant is 103 mmcfd (93 Mari and 10 SNGPL). Arif Habib Limited has run sensitivity on the company’s earnings assuming Enven would receive gas at subsidized rate from 2QCY13.

Financial Highlights CY12A CY13E CY14F CY15F
NetSales 30,627 36,017 55,040 59,895
Gross Profit 9,861 16,706 30,481 31,187
Margins 32% 46% 55% 52%
Selling and Distribution 3,083 2,340 3,406 3,807
Finance Cost 10,703 9,538 8,051 7,648
Profit after tax (2,935) 2,877 11,923 11,869
EPS Fertilizer (2.74) 2.68 11.11 11.06
EPS Impact on Corporation (5.74) 5.63 23.32 23.22

Source: Company Accounts, Arif Habib Research

Earnings expected to grow from 2QCY13 onwards

In Arif Habib Limited bases case, Arif Habib Limited has assumed that subsidized gas would be available from 2QCY13 onwards. Arif Habib Limited expects total 1QCY13 off take to be around 311k tons, and with subsidy materialization from 2QCY13 onwards, company’s gross margins would significantly improve to an average of 46% in CY13 compared to 36% in 1QCY13. With the current gas availability of 103mmcfd for new plant (93 Mari and 10 SNGPL), the company is expected to produce 3,536 tons of urea/day.

Taking full 9M of production in the remaining year, Arif Habib Limited calculations suggest Engro would produce 955k tons in 9MCY13. Arif Habib Limited expects total urea off take to clock in at 1,170k tons in CY13. This could pull EFert’s bottom-line out of red-zone and Arif Habib Limited initials estimates suggest that the company is expected to record EPS PKR 2.68 in CY13, having a bottom-line impact of PKR 5.6/share on ENGRO Corp.

Future Outlook

Along with the short-term gains, the company would benefit the most from implementation of the long term gas plan as well. Arif Habib Limited expects the company to receive gas from mid CY14, enabling it to operate both of its plants (90% base and 80% EnVen). With these utilization assumptions, Arif Habib Limited expects Exert to post a massive 4x earnings growth in CY14 to PKR 11.11/share (CY13: PKR 2.68/share), having a per share impact of PKR 23.32 on ENGRO Corp.

Should the prices come down?

No! In CY13, Arif Habib Limited does not foresee any price cut by the local manufacturers due to the widening demand-supply gap. However in CY14, when all the capacities are expected to be operational on expected completion of the long-term pipeline plan, Arif Habib Limited can expect a price cut in the range of PKR 100/bag. In this regard, Arif Habib Limited ran’s a sensitivity analysis on urea price cut with its impact on Efert. For every PKR 100/bag cut in local urea prices, EFERT’s EPS would be impacted by PKR 1.97.

CY14 Price/bag Margins EPS Change % change
PKR 1703 (base-case)

55%

11.11

PKR 1603

53%

9.14

(1.97)

-18%

PKR 1503

50%

7.16

(1.98)

-36%

PKR 1403

46%

5.19

(1.97)

-53%

Source: Arif Habib Research

Recommendation

Arif Habib Limited  SOTPs based Jun-13 target price for the scrip works out to PKR 161/share, translating into an upside potential of 27% from current level. However, any further change/revision in the subsidized gas availability and the long term gas plan would lead us to amend Arif Habib Limited  earnings estimates and the price target accordingly.

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