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Growth in farm sector pushing up demand for fertilisers

Staff Report

KARACHI: The economic boom in the country has brought about an impressive agricultural growth, putting pressure on domestic suppliers of fertilizers with demand outstripping supply, whereas local producers scramble to maximise their production to meet the rising demand.

Equities’ analysts feel that the sector is poised for continued growth.

According to a research report prepared by the BMA Capital Management, short-and medium-term fundamentals of the sector are likely to remain strong and the factors contributing to the rising demand for fertilizers is to remain highly positive.

Growth in the agriculture sector over the past four years registered a growth of 4.1 percent per annum, with a five percent year on year increase in the area under cultivation, with much improved yields per hectare. Wheat and cotton support prices have been increased. Irrigation water availability is likely to improve after President Musharraf announced a Rs 64 billion four-year plan to brick-line 80,000 watercourses, which will reduce water loss by 30 percent and conserve about 20 million acre feet (MAF) of water annually.

The government of Pakistan approved agri-credit disbursement target for fiscal year 2006 that now stands at Rs 130 billion, and targets have been met by all the large providers to date. Thus the demand for urea, a fertilizer that constitute 78 percent of the local demand for fertilizers, is expected to grow at three percent and the demand for Di-Ammonium Phosphate (DAP) is expected to grow at the rate of 2.5 percent, despite local urea and DAP prices rising with five year CAGRs of 5.4 percent and 9.8 percent, respectively.

Now the country has a tight supply situation with a demand-supply gap of 500 kilotons per annum for urea. This is despite the fact that key local producers Engro Chemicals Pakistan, Fauji Fertilzer Company and Fauji Fertilzer Bin Qasim Limited, which have 79 percent of local urea production capacity, are at over 100 percent production of capacity. The demand shortfall has to be met by government subsidised imported urea which is available at a 40 percent premium to locally manufactured urea. Urea is produced from natural gas termed feedstock, which constitutes nearly 70 percent of its total cost of production. Thus for a Greenfield plant in the country the main factor is gas supply. Last year, 14 percent of national gas consumption was by this sector and companies have long-term gas-supply agreements with various gas fields and distribution companies. The government regulates the natural gas pricing mechanism, to benefit local urea productions.

The Economic Coordination Committee (ECC) has directed Sui Northern Gas Pipelines Limited (SNGPL) to market an additional 100 million cubic feet a day (mmcfd) of natural gas from the Qadirpur gas field, close to both Engro and the FFC.

The research report of BMA Capital anticipates robust earnings, for all three focus companies. Their recently posted 2005 third-quarter earnings reinforce this. In sales revenue, Engro posted a 37 percent growth compare with last year, FFC posted a 21 percent growth in year-to-year comparison, while maintaining their net margins and the FFBL had a 32 percent growth, while its net margin grew from a historical average of 9.6 percent to 14.4 percent.

For Engro it is considered the forerunner in a potential new urea plant in Pakistan, which could potentially double its existing urea production capacity. Though it is difficult to accurately estimate a post-expansion fair value, current market price momentum suggests trading significantly over the fair value estimate up to a 33 percent upside at current levels. Currently, the main profitability drivers are higher urea sales prices, good market share in imported fertilizers (DAP), increasing brand recognition of its crop-specific balanced NPK fertilization product Zarkhez and increasing dividend income from its joint investments in chemical terminal and storage, PVC resin manufacturing and marketing and automation and controls business.

The FFC is Pakistan’s largest fertilizer manufacturer and distributor with a 62 percent market share and the best selling brand Sona Urea. It also plans to increase its 2002 plant acquisition’s nameplate capacity from 557ktpa to 725ktpa. The FFC should maintain the best margins in the sector despite its gross profit margin slightly declining from 41 percent, at an average of 2000-2004 to 38 percent due to increasing cost of goods sold. Forecasts indicate the FFC should be effective at passing along the increasing gas costs, limiting its operating margin decline.

Regarding Fauji Fertilizer Bin Qasim Limited (FFBL) the report said the local manufacture of DAP and granulated urea is unique to the FFBL. Granular urea is very well regarded in the farming community over the standard prilled variety as it is the cheapest nitrogen-based product in terms of unit cost of nutrient. For DAP production, phosphoric acid is a key raw material and is not available locally. To ensure uninterrupted supply, the FFBL has entered into a long-term agreement for the supply of phosphoric acid with Maroc Phosphore S A.

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