JS Securities Limited - JS Research (October 27, 2022)

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JS Securities Limited – JS Research (October 27, 2022)

October 27, 2022

Karachi, October 27, 2022 (PPI-OT): Fertilizers: 3Q profits jump over normalized taxes, margins take a dip

Profitability for fertilizer companies under our coverage increased by 3.5x in 3QCY22 on a sequential basis, primarily due to absence of the one-time high tax charge of 10% on CY21 earnings in the previous quarter which had wiped out 50% of the quarter earnings.

We saw a sequential decline in gross level performance of almost all fertilizer companies due to cost side pressures despite higher retention prices for the period.

We believe that opportunity cost due to lost demand in 4QCY22 will keep stock prices in check during the short term. The extended plant turnarounds would further reduce production, impacting CY22 D/Y. We however maintain our Overweight stance on the Fertilizer sector as the sector’s cash rich position directs at sustainable pay-outs for the future. The sector offers a CY23 D/Y of ~16%.

Companies witness a QoQ jump in earnings

JS Fertilizer Universe posted an increase in 3QCY22 earnings on a sequential basis over one-time 10% Super tax charge in the previous quarter. Recall that in the Federal Budget FY23, the sector was subject to a 10% Super Tax on its CY21 income and a 4% tax on income from CY22 onward, resulting in a one-time higher tax charge in 2QCY22.

On the gross level, however, the sector witnesses a decline due to cost side pressures despite higher retention prices during the period. The sector also witnessed exemption of output tax on Fertilizers, making input tax a part of cost as per the Finance Act 2022. This increased manufacturing costs during 3QCY22, which was passed on by increasing Urea prices during the previous quarter taking retail price of Urea to ~Rs2,200/bag (+Rs350/bag).

Fauji Fertilizer Company (FFC) reported unconsolidated earnings of Rs4.12/share for 3QCY22, an increase of 56% on a QoQ basis. The result was broadly consistent with industry projections. The company’s top-line for 3QCY22 came in at Rs 24.5bn, while gross margins came in at 39% which were slightly lower than last quarter due to lower volumetric sales and higher repair charge. Other income was higher over increase in interest rates while dividend from wind power plants provided further support. FFC also announced an interim cash dividend of Rs 3.18/share along with the 3QCY22 results taking 9MCY22 dividend pay-out to Rs 8.98/share.

Engro Fertilizers Limited (EFERT) reported a profit of Rs3.13/share during 3QCY22 vis-à-vis LPS of Rs0.07 in 2QCY22. The company showed a decrease of ~3ppt QoQ at the gross margin level in 3QCY22, mainly due to lower volumetric sales, higher repair and maintenance charge and higher costs due to elevated PP12 gas rates (c. US$5.9/mmbtu).

Tax charge was lower by 72% on a QoQ basis mainly due to the absence of 10% super tax charged in previous quarter based on last full year’s income along with a charge related to deferred tax due to 4% increase in future tax rates (Rs1.6bn). EFERT announced a dividend of Rs3/share alongside 3QCY22 results taking 9MCY22 dividend pay-out to Rs8.5/share.

Engro Corporation Limited (ENGRO) reported 3QCY22 consolidated profit after tax of Rs8bn (EPS: Rs13.9) compared to a loss of Rs557mn (LPS: Rs0.97) in 2QCY22. Company depicted a slight sequential decline of 1ppt in gross margins due to lower gross level performance of EPCL and EFERT. Other expenses of the company decreased by 68% QoQ owing to reduction in WWF and WPPF. Whereas finance cost increased over surge in KIBOR rates during the period. Effective tax rate for the third quarter clocked in at 23%, lower by 65ppt on a QoQ basis mainly due to the absence of 10% super tax charged in the previous quarter. Alongside the result, the company announced a cash dividend of Rs10/share in 3QCY22 (cumulative Rs33/share during 9MCY22).

Fauji Fertilizer Bin Qasim (FFBL) posted a loss of Rs1.7bn (LPS: Rs1.31) during 3QCY22, compared to a profit of Rs1.8bn in the previous quarter. On a YoY/QoQ basis, finance cost increased by 113%/32% in tandem with rising interest rates. Other income clocked in lower at Rs0.96bn due to lower than expected dividend income from subsidiaries. While other expenses were higher as FFBL likely booked exchange loss on DAP payables.

Long term value intact despite temporary challenges

Fertilizer sector offtake is expected to take a noticeable hit due to the flash floods as impacted agriculture land will have lower demand for fertilizers. The areas most impacted are agriculture lands in Sindh and the lower Punjab belt comprising of Dera Ghazi Khan and Rajanpur districts. In the medium term, we think that opportunity cost resulting from lost demand in the last quarter will restrain stock prices. A further blow to CY22 D/Y would come from lower production brought on by prolonged plant turn-arounds by FFC and specially EFERT in 4QCY22.

We however maintain our Overweight stance on the Fertilizer sector as it is likely to continue to report a stable revenue stream going forward whereas its cash rich position also directs at sustainable pay-outs for the future. The sector offers a CY23 D/Y of ~16%.