Gas Cut: Engro fertilizers profit to decline by Rs4.9b

End of concessionary gas flows along with the payment of GIDC on concessionary flows as per Supreme Court directives would reduce the Engro fertilizers profitability by Rs 4.9 billion and dividend payouts.

Engro fertilizers have been receiving gas at a discount rate and the expiry of a gas supply agreement with SNGPL is going to hit the profits of the company.

However, Urea dynamics are likely to remain favorable for the Engro Fertilizers given restricted urea supply and better farmer agronomics.

We have an “Underperform” stance on the scrip with Jun-22 TP of Rs59.4, Foundation Securities said in a report.

GIDC payment to restrict dividend payout capacity

Execution of gas infrastructure projects by the government and mounting pressure on fiscal management given the increasing cost of debt servicing and lower revenue collection would bring GIDC collection under the limelight in FY22.

The total liability of the company amounts to Rs57.8 billion including those on concessionary flows too. To highlight, the company hasn’t booked GIDC charges on concessionary flows in its financials.

The company would have a cash outflow of Rs6.0/14.5/14.5/14.5/8.4bn in CY21/22/23/24/25 in our base case scenario assuming full payment of GIDC in 48 monthly installments starting from Aug’21.

Adjustment of receivables from Gov’t of Rs9.2 billion would reduce the cash outflow of the company and enhance our valuation by 5.9%.

Our valuation would enhance by 21.1% in case of exemption on payment of GIDC on concessionary gas, the report adds.

End of concessionary gas to Engro Fertilizers

Meanwhile, EFERT profitability would decline by Rs4.9 billion or EPS impact of Rs2.4/sh after the ending of concessionary gas flows. We expect these flows to continue till Mar’22 based on our calculation of concessionary flows to the company since COD, the report said.

Concessionary gas flows are available to EFERT for 10 years after the COD of its plant which expired in Jun’21 as per SNGPL.

However, the company is in discussion with the government and SNGPL to extend the concessionary flows for the number of days for which the minimum Contract Quantity of gas under the GSA, gas utility did not supply gas.

DAP Trading

DAP trading to remain on the lower side as prices reached multiple-year high: DAP demand is expected to decline by 12% YoY in CY21 to 1.9mn tons as its usage in cash crops (rice & cotton) would remain restricted due to a 69% YoY increase in DAP prices in Jul’21.

Thus, we have assumed the Engro Fertilizers DAP sales to shrink by 23% YoY in CY21, the research report said.

Higher Urea Production

Furthermore, higher Urea production amid pricing power will support profitability. Foundation Research hoped that pricing power in the Urea market to remain with base players given better farmer agronomics, restricted Urea supply, and higher breakeven of RLNG players without subsidy. Based on the same it expects EFERT to clear the inventory backlog of the previous year.

Earnings Revision

Moreover, we have revised our earnings upward by 32/54/18% for CY21/22/23 as we tweak our assumption of Urea production, DAP margins, and extension of concessi onary flows, the report adds.

The government’s commitment to collect the Gas Infrastructure and Development Cess (GIDC) in many payments in accordance with Supreme Court instructions is anticipated to significantly reduce EFERT dividend payout capacity.
This comprises GIDC on concessionary flows that the firm has not recorded in its financials, totaling Rs38 billion.

According to the GIDC Act 2015, both new fertilizer companies created under the fertilizer policy 2001 and existing fertilizer plants must pay GIDC on feedstock and fuel gas supply.

EFERT, like other fertilizer firms, has already passed on the GIDC impact to farmers by raising their prices.

In its novation agreement signed with Sui Northern Gas Pipelines Limited and Mari Petroleum Company Limited, MARI agreed in principle to charge invoices at OGRA published gas pricing plus relevant duty/taxes.

In addition, the government has provided information on GIDC receivables from fertilizer firms employing concessionary gas flows in the Supreme Court’s full verdict on the GIDC problem.

According to our calculations, EFERT’s current GIDC payable on non-concessionary gas is Rs19.6 billion, while the company’s outstanding GIDC on concessionary flows is Rs38 billion. We have assumed payment of GIDC in 48 monthly installments beginning in August of this year for our fertilizer universe.

It also anticipates that Pakistan and Russian companies will sign a commercial deal for the building of the North-South project, to execute in the second half of 2HCY21.

Furthermore, as per Supreme Court directions and the GIDC Act 2015, the government would finance its equity component of the project with GIDC collecting proceeds.

The government has set an Rs130 billion collection target for GIDC in the FY22 budget.

Furthermore, in our base case scenario, assuming 48 monthly installments and no government refund adjustments, the EFERT GIDC payment would be Rs6.0/14.5/14.5/14.5/8.4bn for CY21/22/23/24/25. However, if the company receives a GIDC exemption on discounted gas, our valuation will increase by Rs12.5/sh.