Karachi, July 06, 2023 (PPI-OT): Fertilizers: Well positioned to navigate recent changes
We visit the recently announced changes in taxation and incentive landscape for fertilizer sector. While companies have adjusted retail prices to account for 5% FED on fertilizers and removal of tax exemption on DAP, the likely increase in gas prices will test pricing power where we expect companies to pass on the same and preserve retention / margin levels.
Our long-term view remains positive depicted by our Overweight stance on the sector given its stable revenue stream. The 10% Super Tax imposition, however, poses a risk to bottom line of both FFC and EFERT where we expect 2023E avg yield to scale down from 20% to 17% in absence of any mitigating steps.
News flow on the demand front remains positive with sequential uptick in offtake expected for Jun-2023. As per provisional data, Urea sales are expected to clock in at 611k tons, up 33% MoM, taking 1HCY23 offtake to 3.1mn tons, down by 4% YoY. Similarly, DAP offtake for June-2023 is expected to clock in at ~134k tons, a MoM rise of 103%.
Fertilizer sector passes on the impact of duties and taxes
Fertilizer sector attracted taxes and duties in the recently passed Finance bill for FY24. Whereby, FED of 5% was imposed on the sector estimated impact of which comes to around Rs125-150/bag for Urea and ~Rs470/bag for DAP. Another major move was removal of tax exemption for DAP subjecting it to a 5% tax without allowance for differential claims.
Companies attempted to pass on the impact of these incremental taxes to consumers during the ongoing week. Fauji Fertilizer Company (FFC) increased Urea prices by Rs350/bag, while Fauji Fertilizer Bin Qasim Limited (FFBL) raised Urea prices by Rs162/bag to account for the impact of FED. Additionally, both FFC and FFBL announced a DAP price increase of Rs480/bag, effective from 1st July- 2023. Engro Fertilizers Ltd (EFERT) also raised Urea prices by approximately Rs174/bag and DAP prices by around Rs332/bag to offset the impact of the recently imposed Federal Excise Duty (FED).
Post increase, FFC Urea price stands at Rs2,910/bag whereas FFBL Urea prices are at Rs3,212/bag. Similarly, FFC and FFBL DAP prices stand at Rs9,995/bag and Rs10,045/bag, respectively. EFERT's Urea and DAP prices now stand at Rs3,169/bag and Rs10,114/bag, respectively. Agritech and Fatima Fertilizers have also increased prices to Rs3,277/bag and Rs~2,910, respectively.
On the other hand, some pro-agri measures were also announced in the recent budget given the need to manage food inflation and maximise export potential. Notably, allocations were made for the Research and Development of Agriculture. Moreover, resources were allocated to ensure availability of quality seeds, solarisation of tube wells and financing of agri machinery. Government also vowed to take prompt measures this year to prevent the agriculture sector getting affected like last year from the impacts of heavy rainfall.
Further input cost escalation anticipated
The sector's demonstrated resilience in promptly transferring the impact of duties and taxes positions it well to pass on any future increases in input costs. With the previous gas price hike announced in Feb-2023 yet to receive clarity, it becomes crucial for the fertilizer sector to prepare for potential pass-on adjustments. We believe, the sector can effectively manage any future cost hikes and ensure its sustained stability.
Sales growth expectation for Urea strengthens case
We expect Urea sales during June-2023 to clock in at 611k tons, a 33% sequential improvement. Fauji Fertilizer Company (FFC) is likely to post a 32% MoM improvement in sales (-3% YoY) as it had held inventory to ensure buffer stock to meet Kharif demand. On the other hand, Engro Fertilizers Ltd (EFERT) is expected to also post sequential uptick of 79% for June as the company’s base plant was shut for almost the whole month of May owing to technical issues. With production estimates at 550k tons, we expect the industry’s closing inventory to clock in around 216k tons for Jun-2023.
DAP offtake to also show sequential improvement
DAP off-take for Jun-2023 is expected at ~134k tons, 103% MoM improvement. On a YoY basis, offtakes are expected to show an 8% decline. Fauji Fertilizer Bin Qasim Limited (FFBL), sole manufacturer of the product, is expected to post offtake of 80k tons for June. FFC and EFERT on the other hand, are expected to post DAP sales volume of 17k tons and 12k tons during the same period, respectively.
Long term positive stance intact; DY to take a hit this year
We reiterate our positive stance on the sector as it is anticipated to continue to broadly report a steady revenue stream in the future. We, however, believe that the 10% Super tax imposition will impact Dividend yield for FFC and EFERT by around 3ppt for CY23. Fertilizer manufacturers will likely provide for the respective tax amounts in the June quarter.