Karachi, December 22, 2022 (PPI-OT): FFC: A safer bet in turbulent times

We reiterate our BUY stance on Fauji Fertilizer Company (FFC) as we believe the stock offers a stable dividend yield, a cash rich balance sheet and focus on diversification to reduce reliance on the fertilizer business.

Given that a gas price increase has been long overdue and the recent IMF demand that gas prices, like electricity prices, be also rationalized we reckon that an increase in the near future is possible, which we believe would be likely passed on to the farmer by the company, thereby keeping the investment thesis intact.

Stable dividend yield and a diversified portfolio

FFC remains our top pick from fertilizer universe as we believe the stock offers stable dividend yield, cash rich balance sheet and focus on diversification. The company has investments in Energy, Food, Banking and Fertilizers. Due to stable urea fundamentals, adequate pricing power, higher payout and low downside risk, FFC can be used as a shield in ongoing uncertain times. FFC has maintained a stable dividend, maintaining average payout of 80% in last five years. With ample cash and short-term investments (Rs56/sh), we believe that FFC will maintain its payout momentum. Our SoTP based target price for the stock accumulates to Rs128.

Any increase in gas prices will likely passed on

Given that a gas price increase has been long overdue and the IMF demand that gas prices, like electricity prices, also be rationalized, we reckon that an increase in the near future is likely. The last gas price rise for the industry was announced in July 2019 when Feed gas prices had jumped by 62% (to Rs. 115/mmbtu) while fuel prices climbed by 31% (to Rs. 241/mmbtu). Fertilizer companies have been in discussion with the government regarding a new fertilizer policy for the past several months under which the industry would be charged a uniform gas rate.

It is also being proposed to effectively deregulate the fertilizer industry. Currently, fertilizer companies under the Fertilizer Policy 2001 must pay Rs 302/mmbtu for feedstock and Rs 1,023/mmbtu for fuel stock. With better demand-supply situation, urea pricing power would be strong for the largest urea manufacturer and any increase in gas prices would be likely passed on to the farmer by the company.

In a scenario where feed gas rates increase by ~Rs100/mmbtu, the largest Urea manufacturer FFC would require a ~Rs118/bag increase in Urea prices to neutralize the impact. EFERT, on the other hand would need a lesser price increment of Rs82/bag as ~30% of the Feed gas used is charged at Petroleum Policy 2012 rates.

Short term headwinds in CY22, long term fundamentals intact

Due to the impact of floods we have seen lower urea offtake, on the other hand DAP trading business has also been dull for the company. We believe that the opportunity cost due to lost production in the ongoing quarter will keep stock prices in check during the short term. Given expected increase in crop prices and government’s focus on improving farmer income, demand will however climb back in the coming year. Our D/Y estimate for the company for CY23 remains intact at 18%.