Karachi, March 14, 2022 (PPI-OT): Fertilizer: Price hike materializes; pricing power intact

Pakistan’s largest urea manufacturers i.e. Fauji Group has announced an increase of Rs80/bag in urea prices – first hike since August 2021 – and we expect other manufacturers to follow suit.

Inflationary pressures, demand supply situation and global fertilizer prices have long created expectations of urea price hike and recent developments i.e. commodity price boom along with local urea inventories dipping to ~7,000 tons as of end Feb have further reinforced the same.

Going ahead, urea pricing landscape could stand significantly altered if WACOG is implemented but pricing power of local players remains strong. We maintain our Overweight stance on the sector due to its stable revenues and margins, which also offers a D/Y of 12%.

Price hike was long overdue

Urea manufacturers have been patient over the years when it comes to price increments. As a result, a price increase was naturally long overdue as prices were last increased by the sector in Aug-2021. The spike in inflation in recent months has increased costs across the board. In response to which, Fauji Fertilizer Company Ltd (FFC) has increased Urea prices by Rs80/bag over the weekend taking the retail price to ~Rs1,863/bag. A similar announcement by other companies is expected in the coming days. We do not rule out further increase in prices in case of a hike in gas prices.

The said increase will have an after tax per share impact of Rs2.04 for FFC, Rs1.63 for EFERT and Rs0.40 for FFBL. This will likely be offset by more than 50% due to cost increases owing to inflation. DAP in local market on the other hand, have seen rising prices since the past one year and have gained around 50% in the last 12 months.

Soaring global fertilizer prices make imports expensive

Global fertilizer prices have recently been triggered due to Russian fertilizer exports facing disruption owing to sanctions imposed by western nations on Russia. China’s Urea prices, however, have been disconnected with the supply crunch situation and are in fact trading at a discount to global prices but that is because of the country imposing a ban on exports which is in place since October last year. Global fertilizer market was already facing shortages before the Russia- Ukraine tensions emerged but this tussle exacerbated the food security issue as it caused gas prices to rise globally which in turn forced regional players to reduce production of fertilizers prompting higher food inflation.

The rising differential between local and international prices has also encouraged smuggling of the commodity from Pakistan to neighbouring countries because of which the country has not been able to maintain any buffer stock in recent times. The domestic urea prices have been c.80% discount to international urea prices of late. The government now plans to import 200k tons of Urea to ensure ample reserve of the commodity for Kharif season but it will likely be at higher rates due to increased prices in the international market, the procurement of the same also seems difficult owing to global supply chain disruptions.

Implications of the proposed new fertilizer policy

A new fertiliser policy has been proposed under which there would be no gas subsidy and industry would have a uniform rate. The fertilizer industry acknowledges that decisions like WACOG need to be taken but also proposes that the industry is then de-regulated in essence which would give liberty to the manufacturers when it comes to pricing. It is unclear at the moment whether a national uniform rate would be applied or a separate rate would be formulated for the sector. However, we believe it is more likely that a separate weighted average rate would be devised for the sector. In either case, it is expected that any increase in gas prices is likely to be passed on by the industry to end consumer.

In case the industry moves toward a WACOG mechanism, EFERT would gain a higher benefit as compared to peers. Since ~70% of the Feed gas used by EFERT’s Base plant is charged at Petroleum Policy 2012 rates, the company would require a lower per bag price increment.

Bottomline: Pricing landscape for Urea remains attractive

In light of the aforementioned reasons, the pricing power for local Urea manufacturers seems to appear substantial. The current inventory situation for Urea, expected to touch an all-time low since CY08, adds weight to our view. The government has directed companies to maintain buffer stocks to ensure availability for Kharif season but it would likely be difficult to implement given high demand from dealers.

The fertilizer manufacturers’ stable revenue stream and margins keep our stance Overweight on the sector. The sector’s cash rich position also directs at sustainable pay-outs for the future offering attractive D/Y of 12-13%. In light of improved farmer economics, better support prices and focus of government on the agriculture sector it is evident that the fertilizer sector will continue to be of key importance.